OVERVIEW

The following discussion highlights significant factors influencing the consolidated financial position and results of operations of The National Security Group, Inc. (referred to in this document as we, our, us, the Company or NSG) and its subsidiaries. We are a "smaller reporting company" under Securities and Exchange Commission (SEC) regulations and therefore qualify for the scaled disclosure of smaller reporting companies. In general the same information is required to be disclosed in the management discussion and analysis by smaller reporting companies except that the discussion need only cover the latest two year period and disclosures relating to contractual obligations are not required. In accordance with the scaled disclosure requirements, this discussion covers the two year period ended December 31, 2008.

This discussion and analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements and related notes included in this Form 10-K. Please refer to our note regarding forward-looking statements on page 4 of this report.

Summary of Consolidated Results of Operations

Condensed revenue and income information follows:

                                               Three Months                        Year
                                            Ended December 31,              Ended December 31,
                                         2008            2007             2008            2007
Premium Earned                        $ 14,003,000    $ 15,888,000    $  56,264,000    $ 62,250,000
Investment Income                        1,017,000       1,120,000        4,911,000       4,749,000
Realized Investment Gains (Losses)         255,000         964,000      (1,049,000)       1,493,000
Other Income                               180,000         251,000        1,107,000       1,071,000
Total Revenues                          15,455,000      18,223,000       61,233,000      69,563,000
Income (Loss) from Continuing              995,000       1,552,000      (5,204,000)       4,721,000
Operations
Income from Discontinued Operations              -               -                -       1,319,000
Net Income (Loss)                     $    995,000    $  1,552,000    $ (5,204,000)    $  6,040,000

Income (Loss) Per Share from          $       0.40    $       0.63    $      (2.11)    $       1.91
Continuing Operations
Income Per Share from Discontinued               -               -                -            0.54
Operations
Net Income (Loss) Per Share           $       0.40    $       0.63    $      (2.11)    $       2.45

Total revenues for the year decreased 11.97% to $61,233,000 compared to $69,563,000 for 2007. Leading the decrease in total revenue was a 9.62% decline in premium revenue to $56,264,000 in 2008 compared to $62,250,000 for the year 2007. The decline in revenue in the property and casualty subsidiaries combined with an increase in ceded premiums due to catastrophe reinsurance reinstatements were the primary contributors to the decline in premium revenue.

Net loss for the year ended December 31, 2008 was $(5,204,000), or $(2.11) per share compared to net income of $6,040,000, or $2.45 per share for 2007.

Net loss from continuing operations of the insurance subsidiaries was $(5,204,000) for the year ended December 31, 2008 compared to net income from continuing operations of $4,721,000 for the same period in 2007. Significant factors contributing to the 2008 net loss included catastrophe related losses and loss adjustment expenses combined with charges for other-than-temporary impairments in the Company's investment portfolio.

The Company incurred significant tornado and hurricane related catastrophe losses during 2008. Nineteen named windstorm and tornado related catastrophe events occurred in the first half 2008. Gross losses and loss adjustment expenses from these catastrophes were over $4,903,000. During the third quarter of 2008, the Company incurred substantial losses due to Hurricane Gustav and Hurricane Ike. The Company incurred total gross losses and loss adjustment expenses from Hurricane Gustav of $14,140,000 ($4,032,000 after reinsurance recoveries). With respect to Hurricane Ike, the Company incurred total gross losses and loss adjustment expenses of $4,271,000 ($3,539,000 after reinsurance recoveries). Net of reinsurance, total 2008 pre-tax income was reduced by $12,474,000 from catastrophe related losses and loss adjustment expenses. Net of tax, catastrophe related losses totaled $8,233,000 and reduced net income by $3.33 per share.

Also impacting the net loss from continuing operations was the recognition of $2,973,000 ($2,239,000 or $0. 90 per share, after tax) in other-than-temporary impairments. These write-downs were related to the Company's fixed income investments in American General Financial, Freddie Mac, Fannie Mae, Lehman Brothers, Harborview Financial and Washington Mutual.

The Company had no net income from discontinued operations in 2008. In 2007, net income from discontinued operations of $1,319,000 consisted of a gain on disposal of a 50% owned subsidiary, Mobile Attic, Inc. in the second quarter of 2007.

Fourth quarter 2008 net income declined 35.88% to $995,000, or $0.40 per share, compared to $1,552,000 or $0.63 per share for the quarter ended December 31, 2007. The recognition of other than temporary impairments on Harborview Mortgage and American General Financial in the amount of $1,196,000 ($972,000 or $0.39 per share net of tax) were the primary contributors to the decline in fourth quarter 2008 net income.

Results of Operations for Years Ended December 31, 2008 and 2007

Net premiums earned totaled $56,264,000 in 2008 compared to $62,250,000 in 2007, a decline of 9.6%. The most significant factors leading to the reduction in premium revenue were a decline in property and casualty premium in the dwelling fire and homeowners lines of business and an increase of $1,335,000 in ceded reinsurance premiums primarily due to the payment of catastrophe reinsurance reinstatement premium triggered by Hurricane Gustav.

Net investment income increased $162,000 from $4,749,000 in 2007 to $4,911,000 in 2008. A slight increase in income associated with investment real estate was the primary factor contributing to the increase in investment income.

Net realized capital losses totaled $1,049,000 in 2008 compared to capital gains of $1,493,000 in 2007. The recognition of other than temporary impairments on fixed income investments in American General Financial, Freddie Mac, Fannie Mae, Lehman Brothers, Harborview Financial and Washington Mutual were the primary factors contributing to the net realized capital loss in 2008. Other than temporary impairments recognized in 2008 totaled $2,973,000. No other than temporary impairments were recognized in 2007. The remaining net realized investments gains in both years resulted from investment portfolio turnover and reallocations.

Other income increased $36,000 due primarily to increased fees from automobile insurance policies issued in 2008.

Policyholder benefit expenses increased 18.8% from $37,678,000 in 2007 to $44,746,000 in 2008. The property and casualty subsidiaries incurred tornado and windstorm related catastrophe losses in the first half of 2008 totaling $4.9 million. Net losses from Hurricane Gustav and Hurricane Ike, which both occurred in the third quarter of 2008, totaled $4,032,000 and $3,539,000 respectively. Net of reinsurance, total 2008 catastrophe related losses were $12,474,000. We incurred only $921,000 in catastrophe related losses in 2007.

Other expenses decreased $762,000 primarily due to declines in commission expense associated with agent bonus commissions and a reduction in deferred compensation expenses.

Interest expense increased $67,000 due to interest associated with a short term loan that was repaid in mid 2008. Our 2008 income tax benefit totaled $2,610,000 compared to income tax expense of $2,168,000 in 2007. Our 2008 operating loss was primarily due to catastrophe related losses in the property and casualty subsidiaries. It is expected that tax benefits generated by the 2008 net operating loss will be fully recovered through the utilization of net operating loss carry backs to tax years 2007 and 2006.

The Company had no net income from discontinued operations in 2008. In 2007, net income from discontinued operations of $1,319,000 consisted of a gain on disposal of a 50% owned subsidiary, Mobile Attic, Inc. in the second quarter of 2007.

Stockholder Equity and Book Value per Share

Stockholders equity for the year ended December 31, 2008 was $34,648,000 compared to $48,447,000 at December 31, 2007, a decrease of $13,799,000 or 28.48%. The change in stockholders equity is composed of dividends paid to shareholders of $2,220,000 and a net loss of $5,204,000 as well as a decline in accumulated other comprehensive income due to declines in investment portfolio market values. The accumulated loss in other comprehensive income totaled $6,375,000 which includes an unrealized loss of $228,000 on an interest rate swap and an unrealized loss on securities of $6,147,000. Year end book value per share, defined as stockholders equity divided by common shares outstanding of 2,466,600, was $14.04 at December 31, 2008 compared to $19.64 at December 31, 2007. Underwriting losses in the property and casualty insurance operations and declines in investment portfolio fair value were the two primary factors contributing to the decline in stockholder's equity.

Industry Segment Data



Certain financial information for The National Security Group's two operating
segments (Life segment, property and casualty segment) and holding company level
expenses is summarized as follows (amounts in thousands) :



        Premium revenues:
                                               2008      %       2007      %

        Life, accident and health insurance $  6,956   12.36% $  7,031   11.29%
        Property and casualty insurance       49,308   87.64%   55,219   88.71%
                                            $ 56,264  100.00% $ 62,250  100.00%

The property and casualty segment composed 87.64% of total premium revenue in 2008 compared to 88.71% in 2007. The property and casualty segment is primarily composed of dwelling fire and homeowners lines of business. The property and casualty segment consists of the operations of National Security Fire and Casualty Company (NSFC) and Omega One Insurance Company (Omega).

The life segment composed 12.36% of premium revenue compared to 11.29% in 2007. The life segment consists of the operations of National Security Insurance Company (NSIC).

Both the property and casualty segment and life segment experienced contractions in premium revenue in 2008. The continued deterioration of economic conditions led to increased lapse rates of existing policies and limited our ability to issue new business.

The following discussion outlines more specific information with regard to the individual operating segments of the Company along with non-insurance related information (primarily administration expenses) associated with the insurance holding Company.

Life and Accident and Health Insurance Operations:

The Company's life, accident and health insurance business is conducted through National Security Insurance Company (NSIC), a wholly owned subsidiary of the Company organized in 1947. Our life segment is the smaller of our insurance segments contributing 12% of total insurance premium revenue in 2008 and 11% in 2007. Premium revenues and operating income for the life segment for the years ended December 31, 2008 and 2007 are summarized below (amounts in thousands):

2008 2007

        REVENUE
         Net premiums earned                               $   6,956 $ 7,031
         Net investment income                                 1,940   1,796
         Net realized investment (losses) gains              (1,423)     143
         Other income                                             60       6
                                                               7,533   8,976

        BENEFITS AND EXPENSES
         Policyholder benefits paid or provided                5,027   5,489
         Amortization of deferred policy acquisition costs     1,032   (715)
         Commissions                                             490   1,565
         General and administrative expenses                   1,614   2,168
         Insurance taxes, licenses and fees                      288     293
         Interest expense                                         61      68
                                                               8,512   8,868

        (Loss) Income Before Income Taxes                      (979)     108

        INCOME TAX (BENEFIT) EXPENSE
         Current                                               (281)     734
         Deferred                                                161   (603)
                                                               (120)     131

        NET LOSS                                           $   (859) $  (23)

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007:

NSIC ended 2008 with premium revenue of $6,956,000 compared to $7,031,000 for the same period last year; a decrease of 1%. Although premium revenue was down slightly overall, revenue in the independent agent method of distribution was over $4,000,000 with premium revenue up 7.4% as compared to 2007. The home service method of distribution ended 2008 with a decline in premium revenue of 2.8% compared to the prior year.

Premium revenue in the life segment remained in a mode of moderate decline in 2008. The current economic downturn combined with the customer base we service with our products contributed to the overall negative impact on potential premium revenue growth. Our typical customer is in the middle income to lower income levels. This group tends to be most severely impacted by economic downturns and reduces our customer's ability to purchase certain insurance products. Our customers also encounter competing alternatives for their spending dollars and sometimes are forced to reduce or eliminate certain insurance coverage when they have a reduction in household income.

NSIC premium accounted for 92% of total revenue for 2008. As mentioned above, NSIC operates using two primary methods of distribution: home service employee agents and independent agents. While the company has used the traditional home service distribution process since its founding in 1947, the independent agent distribution method has become the largest book of business for the life company. For 2008, the home service and independent agent distribution methods accounted for 35.3% and 56.2%, respectively of NSIC premium revenue.

NSIC ended 2008 with year to date net loss of $(859,000) compared to a year to date net loss of $(23,000) for the same period last year. The primary factor contributing to the increase in net losses was an increase in unrealized capital losses due to other than temporary impairments on investments securities.

Life insurance income was also reduced by other than temporary impairment losses totaling $1,358,000 during 2008. For information regarding management's method of determining investment impairment, please see the other than temporary impairment and credit quality section under investments on page 30.

Property & Casualty Operations:

The Company's property and casualty insurance business is conducted through National Security Fire & Casualty Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One Insurance Company (Omega), a wholly owned subsidiary of National Security Fire & Casualty Company organized in 1992. Property and casualty operations constitute our largest segment composing 88% and 89% of our total premium revenue in 2008 and 2007, respectively. Premium revenues and operating income for the P&C segment for the years ended December 31, 2008 and 2007 are summarized below:

2008 2007

        REVENUE
         Net premiums earned                               $  49,308 $ 55,219
         Net investment income                                 2,852    2,823
         Net realized investment gains                           372    1,350
         Other income                                          1,047    1,065
                                                              53,579   60,457

        BENEFITS AND EXPENSES
         Policyholder benefits paid or provided               39,719   32,189
         Amortization of deferred policy acquisition costs     3,312    3,274
         Commissions                                           7,772    7,788
         General and administrative expenses                   7,265    6,580
         Insurance taxes, licenses and fees                    1,159    2,032
         Interest expense                                          1   -
                                                              59,228   51,863

        (Loss) Income Before Income Taxes                    (5,649)    8,594

        INCOME TAX (BENEFIT) EXPENSE
         Current                                             (2,919)    1,718
         Deferred                                                867      869
                                                             (2,052)    2,587

        NET (LOSS) INCOME                                  $ (3,597) $  6,007

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007:

Premium revenues for the property and casualty segment were down 12% compared to the same period last year. The primary reasons for the decline were the increase in ceded premium related to the reinstatement premium for the catastrophe reinsurance agreement as well as the overall decline the company has experienced in new business over the past year.

The property and casualty segment incurred an increase in ceded premium triggered by Hurricane Gustav. Reinstatement premium related to this catastrophe increased ceded premium by over $1,335,000 during 2008. In addition, premium revenue declined due to a reduction in new business production. The primary factor leading to the decline in new business production is the downturn in the overall economy. Our customer base consists primarily of middle to lower income individuals that are particularly adversely impacted by the current economic downturn. We also continue to enhance underwriting standards which further limits new business production as we become more selective of the risks we undertake. Our rate structures are also routinely reviewed and continue to be closely monitored to ensure the P&C companies are charging the appropriate rates for each product offered. Due to increased cost of reinsurance these reviews lead to significant rate increases in many of our coverage areas, further limiting our ability to grow new business but is intended to lead to improved underwriting profitability.

The slowing premium revenue growth affected both the dwelling fire and homeowner's lines of business. The dwelling fire program was up moderately at 1.8% while the homeowners program was down 4.7% compared to the same period last year. The reasons listed above were the primary factors contributing to the moderate rate of growth in the dwelling program and decline in the homeowners program.

The P&C segment ended 2008 with a year to date pre-tax net loss from underwriting of $8,872,000 compared to a pre-tax underwriting income of $4,421,000 for the same period last year. The unprecedented tornado and windstorm activity during the first half of 2008 combined with the losses incurred from Hurricanes Gustav and Ike during September led to the underwriting losses for the year. The P&C companies were slammed with nineteen storms in the first half of 2008 which increased losses by almost $5,000,000. None of the storms were individually significant enough to reach our layers of reinsurance protection but cumulatively, significantly adversely impacted our underwriting profitability. The reinsurance agreement for 2008 was structured with retention of $3,500,000 and the company retaining 5% of losses between $3,500,000 and $17,500,000. Two additional layers provide 100% coverage up to $57,500,000 with one reinstatement. Gross losses and loss adjustment expenses incurred from Hurricane Gustav totaled $14,140,000 ($4,032,000 after reinsurance recoveries) while gross losses and loss adjustment expenses incurred from Hurricane Ike totaled $4,271,000 ($3,539,000 after reinsurance recoveries). Net of reinsurance, total 2008 pre-tax income was reduced by $12,474,000 from catastrophe related losses and loss adjustment expenses. Net of tax, catastrophe related losses totaled $8,233,000 and reduced net income by $3.33 per share.

The catastrophe losses were the primary reason for the year to date underwriting losses in the dwelling and mobile homeowner lines of business. These programs ended 2008 with underwriting losses of $(2,551,000) and $(9,802,000), respectively compared to underwriting income (loss) of $2,983,000 and $(272,000), respectively for 2007.

We routinely evaluate our claims frequency and severity statistics in order to better understand the nature of our risks and aid in the loss reserve liability evaluation process. Claims frequency is a measure of the number of claims incurred during a measurement period regardless of amount. Claims severity is a measure of the average dollar amount of claims during a measurement period. The severity of claims related to the nineteen catastrophic storms affecting the P&C companies during 2008 totaled approximately $2,400 per claim while the average severity of claims related to Hurricanes Gustav and Ike totaled $2,900 and $3,400, respectively.

The P&C segment continued to be involved in litigation pertaining to claims from Hurricane Katrina which slammed into Louisiana and Mississippi in August 2005. During 2008, the claims associated with Hurricane Katrina exceeded the $37,500,000 million limit of the reinsurance agreement in affect during 2005. As of December 31, 2008, claims related to Hurricane Katrina exceeded the reinsurance cap by just under $1,000,000. The primary reason the company exceeded the maximum reinsurance available under the contract was due to assessments by the Mississippi Windstorm Underwriting Association totaling over $9,600,000. Although the reinsurance for this catastrophe has been exhausted and the ultimate outcome of these claims is unknown, the company believes it maintains adequate reserves for the open claims based on information available at the present time. Additional adverse development related to the claims in litigation is possible and therefore these files are carefully monitored on a continuous basis. The company currently has 59 open claims related to Hurricane Katrina.

We have a small commercial auto program that showed improved results ending 2008 with a year to date underwriting income of $305,000 compared to an underwriting loss of $(262,000) for the same period last year. The primary reason for the improved results was a reduction in average severity as one litigation claim in 2007 led to significantly higher incurred losses in the program. The loss ratio in this program decreased from 102.9% in 2007 to 18.4% in 2008; an 84.5 percentage point decrease.

The P&C segment was also impacted by the write-down of other than temporary impairments. During 2008, other than temporary impairment losses totaled $1,254,000 in NSFC and $361,000 in Omega One. For information regarding management's method of determining investment impairment, please see the other than temporary impairment and credit quality section under investments on page 30.

The combined ratio for 2008 was negatively impacted by the unprecedented storm activity, the decrease in premium revenue and the other than temporary impairments recognized during the year. For 2008, the combined ratio was 120% compared to 93.9% for 2007. The components of this ratio are broken out in the table below under the section Property and Casualty Combined Ratio.

Property & Casualty Combined Ratio:

A measure used to analyze a property/casualty insurer's underwriting performance is the combined ratio. It is the sum of two ratios:

a. The loss and loss expense ratio, which measures losses and loss adjustment expenses incurred as a percentage of premium revenue.

b. The underwriting expense ratio, which measures underwriting expenses incurred (e.g., agents' commissions, premium taxes, and other administrative underwriting expenses) as a percentage of premium revenue.

The results of these ratios for the past two years were:

                                                 2008  2007
                     Loss and LAE Ratio          80.5% 53.3%
                     Underwriting Expense Ratio  39.5% 40.9%
                     Combined Ratio             120.0% 94.2%

Maintaining a combined ratio below 100%, which indicates that the company is making an underwriting profit, depends upon many factors including hurricane activity in the Gulf of Mexico and the southern Atlantic coast, strict underwriting of risks, and adequate and timely premium rates. A major hurricane hitting the coast of Alabama, Georgia, South Carolina, Mississippi, Louisiana, or Texas could cause the combined ratio to fluctuate materially from prior years. The property and casualty subsidiaries maintain catastrophe reinsurance to minimize the effect of a major catastrophe.

As discussed previously, catastrophe losses related to tornado and windstorm outbreaks in the first half of 2008 coupled with losses in September from Hurricane Gustav and Hurricane Ike were the primary factors contributing to the significant increase in the combined ratio. Tornado and windstorm losses totaling $4,903,000 incurred in the first half of 2008 added 9.9 percentage points to the combined ratio. Losses, net of reinsurance recoveries, from Hurricane Gustav totaled $4,032,000 and added 8.2 percentage points to the 2008 combined ratio. Losses, net of reinsurance recoveries, from Hurricane Ike totaled $3,539,000 and added 7.2 percentage points to the 2008 combined ratio.

Non-insurance Operations:

REVENUE
 Net premiums earned                               $       - $       -
 Net investment income                                   119       130
 Net realized investment gains                             2         -
 Other income                                              -         -
                                                         121       130

BENEFITS AND EXPENSES
 Policyholder benefits paid or provided                    -         -
 Amortization of deferred policy acquisition costs         -         -
 Commissions                                               -         -
 General and administrative expenses                     222       931
 Insurance taxes, licenses and fees                        -         -
 Interest expense                                      1,085     1,012
                                                       1,307     1,943
. . .