FUND AMERICAN ENTERPRISES HOLDINGS INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

Commission file number 1-8993

FUND AMERICAN ENTERPRISES HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)

DELAWARE 94-2708455
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

80 SOUTH MAIN STREET, HANOVER, NEW HAMPSHIRE 03755-2053
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (603) 643-1567

Securities registered pursuant to Section 12(b) of the Act:

Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, par value $1.00 New York Stock Exchange
per share

Securities registered pursuant to section 12(g) of the Act:

None

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

The aggregate market value of voting shares (based on the closing price of
those shares listed on the New York Stock Exchange and the consideration
received for those shares not listed on a national or regional exchange) held by
non-affiliates of the Registrant as of March 22, 1999, was $720,239,846.

As of March 22, 1999, 5,843,731 shares of Common Stock, par value of $1.00
per share, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Notice of 1999 Annual Meeting of Shareholders and
Proxy Statement dated March 29, 1999 (Part III)

FUND AMERICAN

TABLE OF CONTENTS

PART I

ITEM 1. Business....................................................... 1

a. General................................................... 1

b. Insurance Operations...................................... 1

c. Mortgage Banking Operations............................... 15

d. Investment Portfolio Management........................... 19

e. Certain Business Conditions............................... 20

f. Regulation................................................ 20

g. Employees................................................. 21

h. Forward-Looking Statements................................ 21

ITEM 2. Properties .................................................... 22

ITEM 3. Legal Proceedings.............................................. 22

ITEM 4. Submission of Matters to a Vote of Security Holders............ 22

PART II

ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters ......................................... 22

ITEM 6. Selected Financial Data........................................ 24

ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................... 26

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk..... 52

ITEM 8. Financial Statements and Supplementary Data.................... 52

ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ......................... 52

PART III

ITEM 10. Directors and Executive Officers............................... 53

ITEM 11. Executive Compensation......................................... 54

FUND AMERICAN

ITEM 12. Security Ownership of Certain Beneficial Owners and
Management .................................................. 54

ITEM 13. Certain Relationships and Related Transactions................. 54

PART IV

ITEM 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K ................................................ 65

PART I

ITEM 1. BUSINESS

GENERAL

Fund American Enterprises Holdings, Inc., (the "Company"), is a Delaware
corporation which was organized in 1980. Within this report, the consolidated
organization is referred to as "Fund American". Fund American's principal
businesses are conducted through White Mountains Holdings, Inc. and its
operating subsidiaries ("White Mountains"). White Mountains' consolidated and
unconsolidated insurance operations are conducted through its subsidiaries and
affiliates in the businesses of property and casualty insurance, property and
casualty reinsurance and financial guaranty insurance. White Mountains' mortgage
banking operations are conducted through Source One Mortgage Services
Corporation and its subsidiaries ("Source One"). The Company's principal office
is located at 80 South Main Street, Hanover, New Hampshire, 03755-2053, and its
telephone number is (603) 643-1567.

INSURANCE OPERATIONS

CONSOLIDATED REINSURANCE OPERATIONS

FOLKSAMERICA HOLDING COMPANY, INC. ("FOLKSAMERICA"). Folksamerica, through
its wholly-owned subsidiary, Folksamerica Reinsurance Company (a New York
corporation), is a multi-line broker-market reinsurance company which provides
reinsurance to insurers of property and casualty risks in the United States,
Canada, Latin America and the Carribean. Folksamerica is rated "A" (Excellent)
by A.M. Best Company. During 1998, 1997 and 1996, Folksamerica had net written
premiums of $212.6 million, $232.4 million and $171.9 million, respectively. At
December 31, 1998 and 1997, Folksamerica had total assets $1.2 billion and $1.2
billion, respectively, and shareholders' equity of $302.0 million and $255.0
million, respectively.

In June 1996 White Mountains purchased a 50.0% economic interest in
Folksamerica for $79.9 million from a group of European mutual insurance
companies (the "European Mutuals") who continued to own the remaining 50.0%
interest. White Mountains' initial investment in Folksamerica consisted of
6,920,000 shares of ten-year 6.5% voting preferred stock having a liquidation
preference of $79.4 million ("Folksamerica Preferred Stock") and ten-year
warrants ("Folksamerica Warrants") to purchase up to 6,920,000 shares of the
common stock of Folksamerica ("Folksamerica Common Stock") for $11.47 per share,
subject to certain adjustments. In November 1997 White Mountains and the
European Mutuals each purchased an additional 1,563,907 shares of Folksamerica
Common Stock for $20.8 million which maintained White Mountains 50% economic
ownership position.

1

On August 18, 1998, White Mountains acquired all of the remaining
outstanding shares of the Folksamerica Common Stock from the European Mutuals
for $169.1 million which resulted in Folksamerica becoming a wholly-owned
consolidated subsidiary of Fund American as of that date. Following the August
18, 1998 transaction, Folksamerica retired the Folksamerica Preferred Stock and
issued White Mountains an equivalent amount of Folksamerica Common Stock. As of
December 31, 1998, White Mountains owned all of the outstanding shares of
Folksamerica Common Stock.

REINSURANCE OVERVIEW

Reinsurance is an arrangement in which a reinsurance company (the
"reinsurer") agrees to indemnify an insurance company (the "ceding company") for
all or a portion of the insurance risks underwritten by the ceding company under
one or more insurance policies. Reinsurance can benefit a ceding company in a
number of ways, including reducing net liability exposure on individual risks,
providing catastrophe protections from large or multiple losses, stabilizing
financial results and assisting in maintaining acceptable operating leverage
ratios. Reinsurance also provides a ceding company with additional underwriting
capacity by permitting it to accept larger risks and underwrite a greater number
of risks without a corresponding increase in its capital or surplus. Reinsurers
may also purchase reinsurance, known as retrocessional reinsurance, to cover
their own risks assumed from primary ceding companies. Reinsurance companies
enter into retrocessional agreements for many of the same reasons that ceding
companies enter into reinsurance agreements.

Folksamerica writes both treaty and facultative reinsurance. Treaty
reinsurance is an agreement whereby the ceding company is obligated to cede, and
the reinsurer is obligated to assume, a specified portion or category of risk
under all qualifying policies issued by the ceding company during the term of a
treaty. In the underwriting of treaty reinsurance, the reinsurer does not
evaluate each individual risk assumed and generally accepts the original
underwriting decisions made by the ceding insurer. Facultative reinsurance is
underwritten on a risk-by-risk basis whereby Folksamerica applies its own
pricing to an individual exposure. Facultative reinsurance is normally purchased
by insurance companies for individual risks not covered under reinsurance
treaties or for amounts in excess of limits on risks covered under reinsurance
treaties. The majority of Folksamerica's assumed premiums are derived from
treaty reinsurance contracts.

Folksamerica obtains virtually all of its business through brokers and
reinsurance intermediaries which seek its participation on reinsurance being
placed for their customers. Reinsurance is provided both on an excess of loss
and quota share basis, which in 1998 amounted to 30.2% and 69.8% of its
business, respectively. Folksamerica derives its business from a spectrum of
ceding insurers including national, regional, specialty and excess and surplus
lines writers. Folksamerica selects transactions based solely on

2

anticipated underwriting results of the transaction which are evaluated on a
variety of factors including the quality of the reinsured, the attractiveness of
the reinsured's insurance rates, policy conditions and the adequacy of the
proposed reinsurance terms.

A significant period of time normally elapses between the receipt of
reinsurance premiums and the disbursement of reinsurance claims ("float"). The
claims process generally begins upon the occurrence of an event causing an
insured loss followed by: (i) the reporting of the loss to the ceding company;
(ii) the reporting of the loss by the ceding company to Folksamerica; (iii) the
ceding company's adjustment and payment of the loss; and (iv) the payment to the
ceding company by Folksamerica. During this time, Folksamerica earns investment
income on the float. Therefore, Folksamerica's combined ratio can generally be
higher than that of Fund American's consolidated property and casualty insurance
operations and yet may still earn an equivalent or superior return on equity.

LINES OF BUSINESS AND GEOGRAPHIC LOCATION

The following tables set forth information regarding Folksamerica's net
written premiums by lines of business and geographic location:

Year Ended December 31,
-------------------------------------------------------
Millions 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------

Liability $122.0 $123.6 $ 79.6 $ 71.9 $ 63.0
Property 87.2 104.9 85.9 87.9 89.9
Marine 3.4 3.9 6.4 - -
-------------------------------------------------------
Total $212.6 $232.4 $171.9 $159.8 $152.9
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

Year Ended December 31,
-------------------------------------------------------
Millions 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------

United States $190.9 $208.6 $155.2 $159.8 $152.9
Canada 13.9 10.1 4.2 - -
Latin America 7.8 13.7 12.5 - -
-------------------------------------------------------
Total $212.6 $232.4 $171.9 $159.8 $152.9
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

3

UNDERWRITING

Folksamerica's primary underwriting objective is to carefully assess
reinsurance opportunities to determine the probability of a particular
transaction providing an underwriting profit. Those risks that do not provide a
reasonable likelihood of delivering an underwriting profit are rejected.
Underwriting opportunities presented to Folksamerica are evaluated based on a
number of factors including historical analysis of results, estimates of future
loss costs, a review of other programs displaying similar exposure
characteristics, the primary insurers underwriting and claims experience and the
primary insurer's financial condition. Folksamerica regularly conducts
underwriting and claims audits of ceding companies to assist it in evaluating
the information submitted by the ceding companies.

Folksamerica's most senior underwriters and executives are responsible for
its underwriting policy and quality standards and informing Folksamerica's board
of directors of current and anticipated market conditions and underwriting
results.

MARKETING

Folksamerica generally obtains all its reinsurance business through brokers
and reinsurance intermediaries which represent the ceding company in
negotiations for the purchase of reinsurance. The process of effecting a
brokered reinsurance placement typically begins when a ceding company enlists
the aid of a reinsurance broker in structuring a reinsurance program. Often the
ceding company and the broker will consult with one or more lead reinsurers as
to the pricing and contract terms for the reinsurance protection being sought.
Once the ceding company has approved the terms quoted by the lead reinsurer, the
broker will offer participations to qualified reinsurers until the program is
fully subscribed by reinsurers at terms agreed to by all parties.

Folksamerica pays its reinsurance brokers commissions representing
negotiated percentages of the premium it writes. These commissions, which
generally average 5% of premium, constitute part of Folksamerica's total
acquisition costs and are included in its underwriting expenses. During the year
ended December 31, 1998, Folksamerica received approximately 67% of its gross
reinsurance premiums written from three major reinsurance brokers as follows:
(i) E. W. Blanch - 25%; (ii) Guy Carpenter and affiliates - 23%; and (iii) AON
Re, Inc. - 19%. During the year ended December 31, 1998, Folksamerica received
no more than 10% of its gross reinsurance premiums from any individual ceding
company.

LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES

Insurers and reinsurers establish loss and loss adjustment expense reserves
representing estimates of future amounts needed to pay claims and related
expenses with respect to insured events that have occurred.

4

Loss and loss adjustment expense reserves have two components: case reserves,
which are reserves for reported losses, and incurred but not reported ("IBNR")
reserves, which are reserves for losses not yet reported. Reserve estimates
reflect the judgement of both the ceding company and the reinsurer, based on the
experience and knowledge of its claims personnel, regarding the nature and value
of the claim. The ceding company may periodically adjust the amount of the case
reserves as additional information becomes known or partial payments are made.

Upon notification of a loss from a ceding company, Folksamerica establishes
case reserves, including loss adjustment expense reserves, based upon
Folksamerica's share of the amount of reserves established by the ceding company
and Folksamerica's independent evaluation of the loss. Where appropriate,
Folksamerica establishes case reserves in excess of its share of the reserves
established by the ceding company.

Folksamerica uses a combination of actuarial methods to determine its IBNR
reserves. These methods fall into two general categories: (1) methods by which
ultimate claims are estimated based upon historical patterns of reported claim
development experienced by Folksamerica, as supplemented by reported industry
data, and (2) methods in which the level of Folksamerica's IBNR claim reserves
are established based upon the IBNR claim reserves relative to earned premium
applied by accident year, line of business and type of reinsurance written by
Folksamerica. Due to the inherent uncertainties of estimating claim reserves,
actual losses and loss adjustment expenses may deviate, perhaps substantially,
from estimates of Folksamerica's reserves reflected in its consolidated
financial statements.

5

During the claims settlement period, which may extend over a long period of
time, additional facts regarding claims and trends may become known which may
cause Folksamerica to adjust its estimates of the ultimate liability. The
revised estimates of ultimate liability may prove to be less than or greater
than the actual settlement or award amount for which the claim is finally
discharged.

REINSURANCE INDUSTRY AND COMPETITION

Folksamerica commenced writing business in 1980 as one of a host of newly
formed, foreign-owned reinsurers capitalized with minimum surplus. In 1991,
recognizing that surplus size and critical mass would become an increasingly
important business issue, Folksamerica launched an aggressive strategy to
increase its resources and capacity through the acquisition of select
broker-market companies. Since 1991, Folksamerica has acquired three such
reinsurers which has raised Folksamerica's surplus and contributed a number of
important business relationships.

In general, competition among primary companies has caused primary insurers
to reduce their own premium writings or restructure their reinsurance programs,
reducing the amount of reinsurance they purchase. As a result of consolidation
within the industry, many ceding companies are now larger and financially
stronger, enabling them to retain more risk. In addition, increasingly intense
competition in the reinsurance markets has driven reinsurance prices on a number
of accounts below pricing levels which Folksamerica will accept. Folksamerica's
management believes that the reinsurance industry, including the intermediary
market, will continue to undergo further consolidation. Management further
believes that, although size and financial strength will continue to be factors
in selecting reinsurance partners, product pricing has become the most telling
competitive factor.

CONSOLIDATED INSURANCE OPERATIONS

Since 1995 White Mountains has been acquiring and developing various
insurance operating interests. In December 1995 White Mountains acquired Valley
Group, Inc. ("VGI") of Albany, Oregon and Charter Group, Inc. ("CGI") of
Richardson, Texas for $41.7 million in cash less $3.0 million of purchase price
adjustments. In September 1995, White Mountains formed White Mountains Insurance
Company ("WMIC") which is a New Hampshire-based midsize commercial property and
casualty company. In December 1995 CGI and WMIC were contributed to VGI thereby
making them wholly-owned subsidiaries of VGI.

VALLEY INSURANCE COMPANIES. Valley Insurance Company ("VIC"), Valley
Property & Casualty Insurance Company ("Valley P&C"), Valley National Insurance
Company ("Valley National") and certain related non-insurance affiliates,
collectively ("Valley"), write personal and commercial lines as further
described below:

6

VIC: A Northwest-based property and casualty company which writes personal
and commercial lines. In 1998, 1997 and 1996, VIC had $86.7 million, $77.7
million and $75.1 million of net written premiums, respectively, primarily in
Oregon, California and Washington. At December 31, 1998 and 1997, VIC had $158.2
million and $146.6 million of total admitted assets, respectively, and $56.5
million and $61.2 million of policyholders' surplus, respectively. VIC was
established in 1982 and began writing insurance policies in 1985. VIC is rated
"A" or "excellent" by A.M. Best.

VALLEY P&C: On December 5, 1996, VGI formed Valley P&C to specifically
write property and casualty insurance within Oregon. Valley P&C wrote its first
policies in February 1997 and had $6.2 million and $5.2 million in net written
premiums during 1998 and 1997, respectively. At December 31, 1998 and 1997,
Valley P&C had $13.0 million and $7.7 million of total admitted assets,
respectively, and $7.3 million and $3.7 million of policyholders' surplus,
respectively. Valley P&C is rated "A" or "excellent" by A.M. Best.

VALLEY NATIONAL: On January 19, 1996, Valley purchased an inactive
insurance company for $13.2 million, net of cash balances acquired. The newly
acquired insurance company, which was renamed Valley National, is licensed to
write property and casualty insurance in 48 states. Assets acquired pursuant to
the purchase of Valley National included an investment portfolio, consisting
principally of fixed maturity investments, totalling $6.7 million. Valley
National wrote its first policies in December 1996 and had $10.9 million and
$2.7 million in gross written premiums ($1.4 million and $.3 million of net
written premiums) during 1998 and 1997, respectively. In the future, Valley
National may further expand its operations to certain other states in which it
is currently licensed. At December 31, 1998 and 1997, Valley National had $13.2
million and $11.5 million of total admitted assets, respectively, and $11.9
million and $11.1 million of policyholders' surplus, respectively. Valley
National is a wholly-owned subsidiary of VIC and shares its A.M. Best's "A"
rating through a combination of a reinsurance arrangement with VIC and its
ownership structure.

Valley markets insurance products principally through independent agents.
Valley's primary business focus is to establish strong long-term relationships
with its agents and insured customers by focusing on providing quality insurance
products to families and family-owned businesses. This approach has resulted in
an established track record of growth:

Year Ended December 31,
--------------------------------------------
Statutory Basis(a), in Millions 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------

Gross written premiums $ 95.8 $ 89.2 $ 81.9 $ 73.1 $ 64.8
Ending total assets 171.2 154.3 138.2 126.8 80.4
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
Ending policyholders' surplus 63.8 64.9 57.8 58.5 23.5
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------

7

(a) The term "statutory" as contained herein refers to a basis of accounting
other than generally accepted accounting principles ("GAAP") that is
prescribed by the individual states that an insurance company transacts
business in.

In 1998, 1997 and 1996 Valley wrote $95.8, $89.2 million and $81.9 million,
respectively, of gross premiums within the following states, through
approximately 317 independent agents:

Year Ended December 31, 1998
----------------------------------------
Gross Written Policies
Dollars in millions Premiums In Force* Agents*
- ---------------------------------------------------------------------------

Oregon $ 44.5 30,876 99
California 27.7 12,084 90
Washington 16.6 6,983 62
Arizona, Idaho, Utah and other 7.0 5,372 66
----------------------------------------
Totals $ 95.8 55,315 317
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------

Year Ended December 31, 1997
----------------------------------------
Gross Written Policies
Dollars in millions Premiums In Force* Agents*
- ---------------------------------------------------------------------------

Oregon $ 43.1 30,789 98
California 26.2 12,333 80
Washington 17.2 6,960 69
Arizona, Idaho, Utah and other 2.7 2,180 38
----------------------------------------
Totals $ 89.2 52,262 285
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------

Year Ended December 31, 1996
----------------------------------------
Gross Written Policies
Dollars in millions Premiums In Force* Agents*
- ---------------------------------------------------------------------------

Oregon $ 40.9 31,118 99
California 27.5 12,910 74
Washington 13.2 4,554 63
Arizona, Idaho, Utah and other .3 222 9
----------------------------------------
Totals $ 81.9 48,804 245
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------

* Determined at year end.

8

Valley's focus on delivering insurance products to families and
family-owned businesses has resulted in a book of business which is balanced
between personal lines and commercial lines. Gross written premiums for Valley's
primary lines of business are shown below:

Year Ended December 31,
------------------------------------------------
Millions 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------

Personal lines:
Automobile $ 33.1 $ 29.3 $ 25.9 $ 23.9 $ 22.5
Homeowners 14.0 13.4 12.0 10.4 8.3
Other 1.0 1.5 1.3 1.1 .8
------------------------------------------------
Total personal lines 48.1 44.2 39.2 35.4 31.6
------------------------------------------------
Commercial lines:
Multiple peril 45.2 42.2 39.1 34.3 30.2
Other 2.5 2.8 3.6 3.4 3.0
------------------------------------------------
Total commercial lines 47.7 45.0 42.7 37.7 33.2
------------------------------------------------
Total gross written premiums $ 95.8 $ 89.2 $ 81.9 $ 73.1 $ 64.8
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------

The long-term relationships cultivated by Valley with its agents and
insured customers, along with superior customer service and convenient premium
billing and payment systems, have produced a relatively high level of
persistency in Valley's "package" book of business. In 1998, 1997 and 1996,
package business represented approximately 73.6%, 79.1% and 80.0% of Valley's
premium writings, respectively, for both personal and commercial lines:

Year Ended December 31,
------------------------------------------------
Renewal retention ratios 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------

Personal automobile/homeowners packages 91.0% 91.4% 89.4% 88.2% 87.8%
Commercial multiple peril packages 74.6% 78.9% 75.5% 76.5% 84.5%
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------

Renewal persistency can be a significant indicator of an insurance
company's long-term prospects for successful underwriting. An insurance company
typically incurs more marketing and underwriting costs to write new business
(e.g., policies written for new customers)

9

than it does to write "seasoned" business (e.g., policy renewals). Additionally,
losses and loss adjustment expenses are typically higher and less predictable
for new business than for seasoned business.

CHARTER INSURANCE COMPANIES. CGI, through its wholly-owned subsidiary
Charter Indemnity Company, its controlled affiliate Charter County Mutual
Insurance Company and certain related non-insurance subsidiaries (collectively
"Charter"), markets and underwrites nonstandard automobile insurance to
individuals primarily in the states of Texas and Oklahoma. For the years ended
December 31, 1998, 1997 and 1996, Charter's net written premiums totalled $64.3
million, $62.9 million and $69.9 million, respectively, and its earned premiums
totalled $64.2 million, $62.4 million and $37.7 million, respectively. Written
premiums (and related expenses and losses) for Charter's policies written prior
to January 1, 1996, were entirely ceded to Charter's former parent and are now
fully retained, therefore, Charter's 1996 earned premiums are not directly
comparable to its 1998 and 1997 earned premiums.

Charter writes all its business through independent agents. At December
31, 1998 Charter had approximately 1,600 agents. During 1998 Charter began to
write policies in California and Missouri and is expected to expand its
operations to other states. Charter is rated "A-" or "excellent" by A.M. Best.

The nonstandard automobile insurance market consists of drivers who are
unable to obtain coverage from standard carriers due to their prior driving
records, other underwriting criteria or market conditions. Management believes
that opportunities in the nonstandard automobile insurance market are influenced
by many factors including the market conditions for standard automobile
insurance, residual market plans, and the extent to which state motor vehicle
laws are enforced. The nonstandard automobile insurance market has grown in
recent years as the result of tightening of underwriting standards by
underwriters of standard and preferred automobile insurance, and increased
enforcement of motor vehicle laws including driving while intoxicated and
uninsured motorist laws.

Charter offers both liability and physical damage coverage in its
nonstandard automobile insurance markets, generally with policies having terms
of 6 months or 12 months. Most of Charter's policyholders choose basic limits of
liability coverage, typically $20,000 per person and $40,000 per accident for
bodily injury, and $15,000 for property damage. For the year ended December 31,
1998, Charter's net written premiums totalled $43.1 million for liability
coverages and $21.2 million for physical damage coverages.

Management pursues a strategy of establishing Charter as a low cost
provider of nonstandard automobile insurance while maintaining a commitment to
provide "service beyond expectation" to both agents and the insured. Management
believes that Charter has become a low cost provider of nonstandard automobile
insurance. Increased automation of certain marketing, underwriting, claims and
administrative functions has provided Charter with the ability to process more
business without a corresponding increase in costs, while maintaining a high
level of service to its agents and insured customers.

10

Management believes that most classes of nonstandard automobile insurance
can be underwritten profitably if they are priced adequately. Charter seeks to
classify risks into narrowly defined segments through the utilization of
available underwriting criteria and internal performance statistical data.
Charter maintains a proprietary database which contains statistical records with
respect to its agents and the insured. Management believes this database
enhances Charter's ability to analyze loss experience, and to underwrite and
price its products based on a number of variables. Charter utilizes many factors
and analyses to determine its rates including: type, age and location of the
vehicle; number of vehicles per policyholder; number and type of traffic
violations or accidents; limits of liability; deductibles; and age, sex and
marital status of the insured.

Automobile damage claims are normally settled in a timely manner which
limits the amount of investment income that can be generated on the earned and
unearned insurance premiums that it has received from its policyholders.
Therefore, Charter's combined ratio must generally be lower than that of Fund
American's other consolidated property and casualty insurance operations in
order to earn an equivalent return on equity.

WHITE MOUNTAINS INSURANCE COMPANY. WMIC is currently licensed to write
insurance in Maine, New Hampshire, Vermont, Massachusetts, New York, Rhode
Island and Texas and is expected to expand its operations to other states as
additional regulatory approvals are obtained. WMIC markets its products
principally through independent agents and had gross written premiums during
1998, 1997 and 1996 of $7.5 million, $5.2 million and $2.4 million ($6.3
million, $4.7 million and $2.0 million of net written premiums), respectively.
At December 31, 1998 and 1997, WMIC had $33.3 million and $31.4 million of total
admitted assets, respectively, and $30.3 million and $29.1 million of
policyholders' surplus, respectively. WMIC is a wholly-owned subsidiary of VIC
and shares its A.M. Best's "A" rating through a combination of a reinsurance
arrangement with VIC and its ownership structure.

UNDERWRITING

Valley, Charter and WMIC's primary underwriting objective is to carefully
assess insurance risks to determine the likelihood of a particular risk
providing an underwriting profit. Those risks that do not provide a reasonable
likelihood of delivering an underwriting profit are rejected.

Valley, Charter and WMIC's Underwriting Committee, composed of its most
senior underwriters and executives, is responsible for its underwriting policy,
quality standards and for informing their boards of directors of current and
anticipated market conditions and its actual underwriting results.

MARKETING

In the United States, property and casualty insurance can be obtained
through national and regional companies that use an agency distribution system,
direct writers, brokers or through self-insurance including the use by
corporations of subsidiary captive insurers. Valley, Charter and WMIC market
their products principally through independent agents.

11

Valley, Charter and WMIC pay their independent agents commissions
representing negotiated percentages of the premium they write. These
commissions, which currently range from 10.0% to 17.5% of premium, depending on
the line of business, constitute part of total acquisition costs and are
included in underwriting expenses.

COMPETITION

The principal competitive factors that affect Valley, Charter and WMIC
are: (i) pricing; (ii) underwriting; (iii) quality of claims and policyholder
services; (iv) appointing and retaining high quality independent agents; (v)
operating efficiencies; and (vi) product differentiation and availability. No
single company or group of affiliated companies dominates the insurance
industry. The highly competitive environment in the property and casualty
insurance market during the past several years has intensified due to increased
capacity resulting from growing capital supporting the industry and robust
investment returns achieved in recent years. Valley, Charter and WMIC strive to
be low cost operators within their sectors of the insurance industry while
maintaining superior levels of customer service. Valley, Charter and WMIC each
maintain a disciplined approach to pricing and underwriting of insurance risks.
Application of this disciplined approach in a highly competitive environment
results in a lower volume of insurance premiums than would result from a less
disciplined approach, but should produce better overall financial returns from
the business over long periods of time.

Perception of financial strength, as reflected in the ratings assigned to
an insurance company, especially by A.M. Best, is also a factor in determining
an insurance company's competitive position. Valley, Charter and WMIC have
consistently maintained adequate capitalization and claims payment ratings to
effectively conduct its business and management believes that such strength will
continue to be maintained in the future.

INVESTMENTS IN UNCONSOLIDATED INSURANCE AFFILIATES

White Mountains' investments in unconsolidated insurance affiliates
represent strategic operating investments in other insurers in which White
Mountains has a significant voting and economic interest but does not own
greater than 50% of the entity. Since 1994, Fund American has been active in
accumulating its investments in unconsolidated affiliates which are further
described below:

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. ("FSA"). FSA, through its
wholly-owned subsidiary, Financial Security Assurance Inc., guarantees scheduled
payments of principal and interest on municipal bonds and asset-backed
securities, including residential mortgage-backed securities. FSA's guaranty on
investment-grade securities helps issuers lower their funding costs and provides
bondholders with the highest-quality investments. FSA's claims-paying ability is
rated Triple-A by Fitch IBCA, Inc., Moody's Investors Service, Inc., Standard &
Poor's Rating Services and Nippon Investors Service Inc. For 1998, 1997 and 1996
FSA's gross premiums written totalled $319.3 million, $236.4 million and $177.0
million, respectively, and its net income was $117.0 million, $100.5 million and
$80.8 million, respectively. As of December 31, 1998 and 1997, FSA's total
assets were $2.4 billion and

12

$1.9 billion, respectively, and its shareholders' equity was $1,073.4 million
and $882.4 million, respectively.

In May 1994 Fund American purchased 2,000,000 shares of the common stock of
FSA ("FSA Common Stock") from MediaOne Capital Corp. ("MediaOne", formerly U S
WEST Capital Corp.), a wholly-owned subsidiary of MediaOne Group, Inc. (formerly
U S WEST, Inc.). The purchase was part of an initial public offering of
8,082,385 shares of FSA Common Stock at the offering price of $20.00 per share.

In September 1994 Fund American acquired various fixed price options and
shares of convertible preferred stock ("FSA Options and Preferred Stock") which,
in total, give Fund American the right to acquire up to 4,560,607 additional
shares of FSA Common Stock for aggregate consideration of $125.7 million.

In 1995 and 1996, respectively, Fund American purchased an additional
460,200 shares of FSA Common Stock on the open market for $8.8 million and an
additional 1,000,000 shares of FSA Common Stock in a private transaction for
$26.5 million.

All shares of and rights to FSA Common Stock owned or acquired by Fund
American as described above (other than those acquired on the open market) are
subject to certain restrictions on transfer, voting provisions and other
limitations and requirements set forth in a Registration Rights Agreement and a
Voting Trust Agreement. As of December 31, 1998, 1997 and 1996 Fund American's
economic interest in FSA was approximately 25.1%, 26.2% and 25.1%, respectively,
and Fund American's voting interest in FSA was approximately 23.1%, 24.0% and
23.0%, respectively. During 1997 Fund American transferred all of its interests
in FSA to Source One.

Mr. John J. ("Jack") Byrne (Chairman of the Company) is Vice Chairman of
FSA and Mr. K. Thomas Kemp (President and CEO of the Company) and Mr. James H.
Ozanne (President of Fund American Enterprises, Inc. ("FAE"), a wholly-owned
subsidiary of White Mountains) are directors of FSA. In addition to being FSA
directors, Mr. Kemp is Chairman of FSA's Human Resources Committee and Mr.
Ozanne is Chairman of FSA's Underwriting Committee.

Fund American's investment in FSA Common Stock is accounted for using the
equity method. FSA Common Stock is publicly traded on the New York Stock
Exchange ("NYSE"). The market value of the FSA Common Stock as of December 31,
1998 and 1997, as quoted on the NYSE, exceeded Fund American's carrying value of
the FSA Common Stock under the equity method. Fund American's investments in FSA
Options and Preferred Stock are accounted for under the provisions of Statement
of Financial Accounting Standards ("SFAS") No. 115 whereby the investments are
reported at fair value as of the balance sheet date, with related unrealized
investment gains and losses, after tax, reported as a net amount in a separate
component of shareholders' equity and reported on the income statement as a
component of comprehensive net income.

MAIN STREET AMERICA HOLDINGS, INC. ("MSA"). MSA is a subsidiary of National
Grange Mutual Insurance Company of Keene, New Hampshire ("NGM"). NGM insures
property and casualty risks located primarily in New York, Massachusetts,
Connecticut, Pennsylvania, New Hampshire, Virginia and Florida. NGM's principal
lines of business and approximate percentage of total written premiums are
personal

13

automobile (45%), homeowners (15%), commercial multi-peril (15%), commercial
automobile (10%) and all other (15%). MSA participates in NGM's property and
casualty business through a reinsurance agreement. MSA's net written premiums
totalled $258.5 million, $156.6 million and $147.2 million in 1998, 1997 and
1996, respectively, and its net income was $13.4 million, $11.9 million and $9.7
million, respectively. MSA's total assets as of December 31, 1998 and 1997 were
$588.6 million and $337.2 million, respectively, and its shareholders' equity
was $232.5 million and $120.6 million, respectively.

In December 1994 the Company (who subsequently transferred the MSA
investment to White Mountains) acquired 90,606 shares of the common stock of MSA
("MSA Common Stock") for $25.0 million in cash plus $1.2 million in subsequent
purchase price adjustments. White Mountains initial investment in MSA
represented approximately 33.1% of the MSA Common Stock outstanding at that
time. From 1994 to 1997 MSA participated in 40% NGM's property and casualty
business through a reinsurance agreement.

In March 1998 White Mountains acquired an additional 131,487 shares of MSA
Common Stock for $70.3 million (subject to certain purchase price adjustments
which are not expected to exceed $3.5 million) which raised White Mountains
ownership of MSA to 50.0%. As a result of White Mountains' additional investment
in MSA during 1998, MSA's reinsurance pooling agreement was increased from 40%
to 60% and NGM contributed certain of its insurance, reinsurance and financial
services subsidiaries to MSA. Fund American's investment in MSA Common Stock is
accounted for using the equity method.

Messrs. Raymond Barrette (Executive Vice President and Chief Financial
Officer of the Company), Terry L. Baxter (President of White Mountains), Morgan
W. Davis (Executive Vice President of White Mountains) and Kemp are directors of
MSA.

AMLIN PLC ("AMLIN") FORMERLY ML (BERMUDA) LIMITED ("MURRAY LAWRENCE").
Amlin is a managing agency group in the Lloyd's insurance market. On December 8,
1997, White Mountains purchased approximately 15.8% of the common stock of
Murray Lawrence for $23.6 million. At December 31, 1997 White Mountains carried
this investment as an "investment in unconsolidated insurance affiliate" and
valued it at its original cost of $23.6 million which approximated its fair
value at that date.

During 1998 Murray Lawrence merged with Angerstein Underwriting and the
combined entity was named Amlin. Amlin is publicly traded on the London Stock
Exchange. White Mountains owns 13,980,861 shares of the common stock of Amlin,
which represents an approximate 6.5% ownership stake as of December 31, 1998. As
a result of White Mountains' decreased ownership percentage of this investment
resulting from the merger, White Mountains recharacterized its investment in
Amlin as an "other investment" and carried the investment at its fair value of
$25.1 million at December 31, 1998. Mr. Kemp is a director of Amlin.

14

MORTGAGE BANKING OPERATIONS

Source One was incorporated in 1972 and is the successor to Citizens
Mortgage Corporation which was organized in 1946. As a mortgage banker, Source
One engages primarily in the business of producing and selling residential
mortgage loans and servicing and subservicing residential mortgage loans for
third parties. Through subsidiaries, Source One also markets credit-related
insurance products (such as life, disability, health, accidental death and
property and casualty insurance).

Source One's principal office is located in Farmington Hills, Michigan.
Source One is a wholly-owned subsidiary of Fund American whereby the Company
currently owns 3% of the outstanding common stock of Source One and White
Mountains owns the remaining 97% of the outstanding common stock of Source One.

MORTGAGE BANKING OVERVIEW

Mortgage banking is the business of serving as a financial intermediary in
the origination and purchase of mortgage loans, the holding of such loans while
aggregating sufficient loans to form appropriate mortgage-backed security pools,
selling such loans through pools or directly to investors and servicing or
subservicing such loans during the repayment period.

The origination process involves providing competitive mortgage loan rates,
soliciting loan applications, reviewing title and credit matters, and funding
loans at closing. Mortgage loans can also be purchased from other originating
mortgage bankers.

Marketing or selling mortgage loans requires matching the needs of the
production market (homebuyers and homeowners seeking new mortgages) with the
needs of the secondary market for mortgage loans (securities broker-dealers,
depository institutions, insurance companies, pension funds and other
investors). Conventional mortgage loans (e.g., those not guaranteed or insured
by agencies of the Federal government) which are secured by residential
properties, and which comply with applicable requirements, are packaged for
direct sale or conversion to a mortgage-backed security. Such mortgage-backed
securities are guaranteed by the Federal Home Loan Mortgage Corporation
("FHLMC") or the Federal National Mortgage Association ("FNMA"). Mortgage loans
insured by the Federal Housing Administration ("FHA") and the Veterans
Administration ("VA") are packaged in the form of modified pass-through
mortgage-backed securities guaranteed by the Government National Mortgage
Association ("GNMA") for sale primarily to securities broker-dealers. In
addition, private entities may pool mortgage loans in various forms and offer
the resulting mortgage-backed securities to the public through securities
broker-dealers.

Servicing involves collecting principal, interest and funds to be escrowed
for tax and insurance payments from mortgage loan borrowers, remitting principal
and interest collections to mortgage loan investors, paying property taxes and
insurance premiums on mortgaged property and performing all related accounting
and reporting

15

activities. Servicing may also involve advancing uncollected payments to
mortgage loan investors, administering delinquent loans and supervising
foreclosures in the event of unremedied defaults. Servicing generates cash
income in the form of fees, which represent a percentage of the declining
outstanding principal amount of the loans serviced and are collected from each
mortgage loan payment received plus any late charges. Subservicing involves the
administrative servicing of loans owned by others for a fee.

MORTGAGE LOAN PRODUCTION

Source One produces residential mortgage loans through: (i) a correspondent
network of more than 200 banks, thrift institutions and other mortgage lenders;
(ii) 163 retail branch offices in 31 states and Puerto Rico; (iii) approximately
425 mortgage brokers; and (iv) a specialized marketing and affinity program.
Source One primarily produces fixed rate mortgage loans. Generally speaking,
fixed rate mortgages tend to capture a large share of origination volumes in a
declining interest rate environment. Additionally, fixed rate mortgage loans are
inherently less susceptible to prepayment risk than adjustable rate mortgages.
During periods of increasing interest rates, the likely adverse effects of lower
fixed rate mortgage loan originations are mitigated by a reduction in the
prepayment risk on the fixed rate mortgage loans Source One services. During
1998 and 1997, fixed rate mortgage loan production accounted for approximately
98% and 88%, respectively, of Source One's total mortgage loan production.

The following table sets forth selected information regarding Source
One's mortgage loan production:

Year Ended December 31,
-----------------------------------------------------------
Millions 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------

Loan production by type of loan:
FHA insured and VA guaranteed $ 3,009 $ 2,985 $ 2,035 $ 1,565 $ 2,065
Conventional 7,857 1,418 1,796 1,287 2,521
-----------------------------------------------------------
Total $10,866 $ 4,403 $ 3,831 $ 2,852 $ 4,586
-----------------------------------------------------------
-----------------------------------------------------------
Loan production by origination source:
Correspondent network acquisitions $ 6,880 $ 2,552 $ 1,640 $ 1,157 $ 1,081
Retail branch office originations 2,692 1,339 1,590 1,347 2,005
Mortgage broker originations 872 390 369 196 696
Specialized marketing program originations 290 122 232 152 804
Subprime and other 132 -- -- -- --
-----------------------------------------------------------
Total $10,866 $ 4,403 $ 3,831 $ 2,852 $ 4,586
-----------------------------------------------------------
-----------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------

16

During 1997 Source One broadened its product line by offering higher profit
margin products such as FHA home improvement ("203(k)") loans, manufactured
housing loans, subprime loans and 125% loan to value second mortgage ("125%
LTV") loans. The 203(k) loans and manufactured housing loans produced by Source
One are sold to third parties with servicing retained whereby the subprime loans
and 125% LTV loans produced by Source One are sold to third parties on a
servicing released basis. Source One is currently expanding its capability to
service and subservice subprime loans and to subservice 125% LTV loans. These
new products did not account for a significant portion of Source One's total
mortgage loan production during 1998 or 1997.

SALES OF LOANS

Source One sells mortgage loans either through mortgage-backed securities
issued pursuant to programs of GNMA, FNMA and FHLMC, or to institutional
investors. Most mortgage loans are aggregated in pools of $1.0 million or more,
which are purchased by institutional investors after having been guaranteed by
GNMA, FNMA or FHLMC. During 1998 approximately 71.1%, 20.6% and 5.3% of the
principal amount of Source One's loans were sold in pools through GNMA, FNMA and
FHLMC, respectively. During 1997 approximately 65.5%, 23.3% and 6.7% of the
principal amount of Source One's loans were sold in pools through GNMA, FNMA and
FHLMC, respectively. During 1996 approximately 42.8%, 35.3% and 11.6% of the
principal amount of Source One's loans were sold in pools through GNMA, FNMA and
FHLMC, respectively. Since 1993, substantially all GNMA securities have been
sold without recourse to Source One for loss of principal in the event of a
subsequent default by the mortgage borrower.

Servicing agreements relating to mortgage-backed securities issued pursuant
to the programs of GNMA, FNMA or FHLMC require Source One to advance funds to
make the required payments to investors in the event of a delinquency by the
borrower. Source One expects that it would recover most funds advanced upon cure
of default by the borrower or at foreclosure. However, in connection with VA
partially guaranteed loans and certain conventional loans (which may be
partially insured by private mortgage insurers), funds advanced may not cover
losses due to potential declines in collateral value.

To minimize interest rate risk associated with mortgage loans whose
interest rate is "locked" but has not yet been sold, Source One obtains
mandatory forward commitments of up to 120 days to sell mortgage-backed
securities with respect to all loans which have been funded and a substantial
portion of loans in process (the "Pipeline") which it believes will close.
Source One's risk management function closely monitors the Pipeline to determine
appropriate forward commitment coverage on a daily basis.

17

LOAN SERVICING

Source One generally retains the rights to service the mortgage loans it
produces. In addition, Source One may purchase servicing rights from banks,
thrift institutions and other mortgage lenders. There were no significant
purchases of mortgage servicing rights by Source One during 1998 and 1997.

Source One also sells servicing rights when management deems it
economically advantageous. During 1998 Source One sold the rights to service
$10.6 billion of nonrecourse mortgage loans and continues to subservice a large
portion of these loans pursuant to a subservicing agreement. During 1997 Source
One sold the rights to service a $17.0 billion portfolio of nonrecourse mortgage
loans and continues to subservice a portion of these loans pursuant to a
subservicing agreement.

The following table summarizes the changes in Source One's mortgage loan
servicing portfolio, excluding loans sold but not transferred:

Year Ended December 31,
---------------------------------------------------
Billions 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------

Servicing portfolio owned at beginning of year $ 11.6 $ 26.4 $ 27.8 $ 35.3 $ 38.4
---------------------------------------------------
Mortgage loan production 10.9 4.4 3.8 2.9 4.6
Servicing acquisitions and other -- -- 2.8 4.7 3.7
Total servicing in 10.9 4.4 6.6 7.6 8.3
Regular payoffs 1.6 1.2 3.0 2.3 4.7
Sales of servicing 10.6 17.0 3.3 11.0 3.9
Principal amortization, foreclosures and other 1.1 1.0 1.7 1.8 2.8
Total servicing out 13.3 19.2 8.0 15.1 11.4
Servicing portfolio owned 9.2 11.6 26.4 27.8 35.3
Subservicing portfolio 15.9 14.9 2.8 4.0 4.3
Balance at end of year $ 25.1 $ 26.5 $ 29.2 $ 31.8 $ 39.6
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------

COMPETITION

18

Source One competes nationally and locally for loan production with other
mortgage banks, state and national banks, thrift institutions and insurance
companies. National banks and thrift institutions have substantially more
flexibility in their loan origination programs than Source One, which generally
originates loans meeting the standards of the secondary market. Mortgage lenders
compete primarily with respect to price and service. Competition may also occur
on mortgage terms and closing costs. Source One competes, in part, by using its
commissioned sales force to maintain close relationships with real estate
brokers, builders and developers and members of its correspondent and broker
network. It is the opinion of the management of Source One that no single
mortgage lender dominates the industry.

INVESTMENT PORTFOLIO MANAGEMENT

Fund American's philosophy is to invest all assets to maximize their after
tax total return over extended periods of time. Under this approach, each dollar
of after tax investment income, realized capital gains and unrealized
appreciation is valued equally. Management further believes that insurance
company float generated should be invested in a "balanced portfolio" consisting
of a mixture of fixed income investments, equity securities and occasionally
other investments in order to maximize returns over extended periods of time.
This investment philosophy of Fund American is established and administered by
the Fund American and White Mountains Finance Committees. The Finance Committees
also regularly monitor the overall investment results of Fund American, review
the results of each of Fund American's various investment managers, review
compliance with established investment guidelines, approve all purchases and
sales of investment securities and ultimately report the overall investment
results to the Company's Board of Directors (the "Board").

The fixed income portfolios of Valley, Charter and WMIC are actively
managed by an affiliate of MSA pursuant to discretionary management agreements.
The fixed income and equity investment portfolio and other investments of
Folksamerica are managed internally by employees of Folksamerica.

The equity investment portfolios and other investments of the Company,
White Mountains, Valley, Charter and WMIC are managed by a small group of
employees located in Hanover, New Hampshire and various internal and external
portfolio managers pursuant to discretionary management agreements. FAE's
investment portfolio is primarily managed by a small group of employees located
in White River Junction, Vermont.

As previously stated, the investment portfolios of Fund American's
insurance operations consist, in part, of common equity securities and related
investments as follows: (i) $143.0 million at Folksamerica or approximately 15%
of Folksamerica's total investment portfolio at December 31, 1998; (ii) $48.5
million at Valley and Charter or approximately 28% of Valley and Charter's total
investment portfolio at

19

December 31, 1998; and (iii) $26.7 million at WMIC or approximately 83% of
WMIC's total investment portfolio at December 31, 1998. Management believes that
modest investments of equity securities within the investment portfolios of its
insurance operations will enhance their after tax returns without significantly
increasing the risk profile of the portfolio when considered over long periods
of time.

CERTAIN BUSINESS CONDITIONS

Inflation and changes in market interest rates can have significant effects
on White Mountains' insurance operations. Inflation increases the costs of
settling insurance claims over time. Increases in market interest rates, which
often occur during periods of high inflation, reduce the market value of the
insurance operations' fixed-income investments. Conversely, reductions in market
interest rates increase the market value of White Mountains' fixed-income
investments.

Changes in the economy or prevailing interest rates can also have
significant effects, including material adverse effects, on the mortgage banking
industry including Source One. Inflation and changes in interest rates can have
differing effects on various aspects of Source One's business, particularly with
respect to marketing gains and losses from the sale of mortgage loans, mortgage
loan production, the value of Source One's servicing portfolio and net interest
revenue. Historically, Source One's loan originations and loan production income
have increased in response to falling interest rates and have decreased during
periods of rising interest rates. Periods of low inflation and falling interest
rates tend to reduce loan servicing income and the value of Source One's
mortgage loan servicing portfolio because prepayments of mortgages increase and
the average life of mortgage servicing rights is shortened. Conversely, periods
of increasing inflation and rising interest rates tend to increase loan
servicing income and the value of Source One's mortgage servicing rights because
prepayments of mortgages decline and the average life of loan servicing rights
is lengthened. In an attempt to mitigate Source One's exposure to changes in
market interest rates, Source One utilizes various derivative financial
instruments. See "Management's Discussion and Analysis".

REGULATION

Folksamerica, Valley, Charter and WMIC are subject to regulation and
supervision of their operations in each of the jurisdictions where they conduct
business. Regulations vary between jurisdictions but, generally, they provide
regulatory authorities with broad supervisory, regulatory and administrative
powers over such matters as licenses, standards of solvency, premium rates,
policy forms, investments, security deposits, methods of accounting, form and
content of financial

20

statements, reserves for unpaid losses and loss adjustment expenses,
reinsurance, minimum capital and surplus requirements, dividends and other
distributions to shareholders, periodic examinations and annual and other report
filings. Over the last several years most states have, and continue to
implement, laws which establish standards for current, as well as continued,
state accreditation. In addition, the National Association of Insurance
Commissioners has adopted risk-based capital ("RBC") standards for property and
casualty companies. The RBC ratios for Folksamerica, Valley, Charter and WMIC,
as of December 31, 1998 and 1997, were above the levels which would require
regulatory action.

Source One is subject to the rules and regulations of, and examinations by,
investors and insurers including FNMA, FHLMC, GNMA, FHA and VA with respect to
the origination and selling and servicing of mortgage loans. Lenders are
required to submit audited financial statements annually and to maintain
specified net worth levels which vary depending on the amount of loans serviced
and annual production. Mortgage loan origination activities are also subject to
fair housing laws, the Equal Credit Opportunity Act, the Federal
Truth-in-Lending Act, the Real Estate Settlement Procedures Act, the Fair Credit
Reporting Act, licensing laws, usury laws, the Home Mortgage Disclosure Act, and
other regulations which, among other things, prohibit discrimination in
residential lending and require disclosure of certain information to borrowers.
There are various other state laws and regulations affecting Source One's
mortgage banking operations. Source One's internal audit function (which is
managed by Source One but is outsourced to a third party) and quality control
departments monitor compliance with all these laws and regulations.

Fund American is not aware of any current recommendations by regulatory
authorities that would be expected to have a material effect on its results of
operations or liquidity or any other matters that would require disclosure
herein.

EMPLOYEES

As of December 31, 1998, the Company employed 11 persons and White
Mountains employed 2,825 persons (including 261 persons at Valley, 186 persons
at Charter, 34 persons at WMIC, 2,212 persons at Source One, 125 persons at
Folksamerica and 3 persons at FAE). None of Fund American's employees are
covered by a collective bargaining agreement. Management believes that Fund
American's employee relations are good.

FORWARD-LOOKING STATEMENTS

From time to time, the Company may publish forward-looking statements
relating to such matters as anticipated financial

21

performance, business prospects, new products and similar matters. This
information is often subject to various risks and uncertainties. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, the Company notes that numerous factors could cause actual results and
experience to differ materially from anticipated results or other expectations
expressed in its forward-looking statements. The risks and uncertainties that
may affect the operations, performance, development and results of the Company's
business include those discussed elsewhere herein (such as those involving
competition, regulation and certain business conditions).

ITEM 2. PROPERTIES

The Company leases 8,600 square feet of space at 80 South Main Street,
Hanover, New Hampshire, under a lease expiring in 2006, which serves as its
corporate office. Folksamerica leases 40,000 square feet of office space in New
York, New York, under a lease expiring 2004, which serves as its principal
office. Charter leases 56,000 square feet of office space in Richardson, Texas
under a lease expiring in 2007, which serves as its principal office. Valley and
Source One own their principal offices in Albany, Oregon and Farmington Hills,
Michigan, respectively. Fund American leases several other office facilities and
operating equipment under cancelable and noncancelable agreements. Most leases
contain renewal clauses.

ITEM 3. LEGAL PROCEEDINGS

Various claims have been made against Fund American in the normal course of
its business. In management's opinion, the outcome of such claims will not, in
the aggregate, have a material effect on Fund American's financial position or
results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of Fund American's shareholders
during the fourth quarter of 1998.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

As of March 22, 1999, there were 470 registered holders of shares of the
Company's Common Stock, par value $1.00 per share ("Shares").

During 1998 and 1997 the Company declared and paid quarterly cash dividends
of $.40 per Share and $.20 per Share, respectively. The Board currently intends
to reconsider from time to time the declaration of regular periodic dividends on
Shares with due consideration given to the financial characteristics of Fund
American's remaining invested

22

assets and operations and the amount and regularity of its cash flows at the
time. The Company's Common Stock (symbol FFC) is listed on the NYSE. The
quarterly trading range for Shares during 1998 and 1997 is presented below:

1998 1997
----------------------- -----------------------
High Low High Low
- ---------------------------------------------------------------------

Quarter ended:
December 31 $144 3/8 $117 $124 $105 1/4
September 30 153 1/4 119 108 99 1/2
June 30 150 1/4 135 9/16 110 1/2 98
March 31 137 5/16 120 1/8 109 3/4 94
- ---------------------------------------------------------------------
- ---------------------------------------------------------------------

23

ITEM 6. SELECTED FINANCIAL DATA

Selected consolidated income statement data and ending balance sheet data
for each of the five years ended December 31, 1998, follows:

Year Ended December 31,
--------------------------------------------------------------------------
Millions, except per share amounts 1998(a) 1997 1996 1995 1994
--------------------------------------------------------------------------

INCOME STATEMENT DATA:
Revenues $ 578 $ 310 $ 325 $ 222 $ 228
Expenses 519 329 336 234 219
Pretax operating earnings (loss) 59 (19) (11) 4 9
Net realized investment gains 71 97 39 39 39
Pretax earnings 130 78 28 43 48
Income tax provision 48 29 19 17 21
After tax earnings 82 49 9 26 27
Loss on early extinguishment of
debt, after tax -- (6) -- -- --
Gain from sale of discontinued
operations, after tax -- -- -- 66(b) --
Cumulative effect of accounting
change - purchased mortgage
servicing, after tax -- -- -- -- (44)(c)
Net income (loss) 82 43 9 92 (17)
Other comprehensive income (loss),
after tax (9) 42(d) 54 18 (55)
Comprehensive net income (loss) $ 73 $ 85 $ 63 $ 110 $ (72)
Basic earnings per share:
After tax earnings $ 13.38 $ 6.89 $ .66 $ 1.88 $ 1.27
Net income (loss) 13.38 5.98 .66 10.30 (3.72)
Comprehensive net income (loss) 11.87 12.33(d) 8.01 12.64 (9.89)
Diluted earnings per share:
After tax earnings 11.94 6.22 .60 1.71 1.20
Net income (loss) 11.94 5.40 .60 9.36 (3.51)
Comprehensive net income (loss) 10.58 11.15(d) 7.33 11.48 (9.34)
Cash dividends paid per share of
common stock 1.60 .80 .80 .20 --
ENDING BALANCE SHEET DATA:
Total assets $ 3,281 $ 2,010(d) $ 1,981 $ 1,872 $ 1,807
Short-term debt 749 571 408 445 254
Long-term debt 360 304 424 407 547
Minority interest - preferred stock of
subsidiary 44 44 44 44 100
Shareholders' equity 703 659(d) 687(e) 700(e) 661(e)
Book value per common and equivalent
share (f) 109.68(g) 100.08(d) 90.81 83.28 68.95

24

(a) Includes the ending balance sheet and the interim period results of
operations of Folksamerica which was acquired by Fund American on August
18, 1998.
(b) Reflects the settlement of certain tax liabilities relating to the sale of
Fireman's Fund Insurance Company ("Fireman's Fund") for less than the
previously accrued amount.
(c) Reflects the prior years' cumulative effect of a change in Source One's
methodology used to measure impairment of its purchased mortgage servicing
rights asset.
(d) Restated as a result of Fund American's acquisition of Folksamerica during
1998. See Note 2.
(e) Reflects significant redemptions of the Company's Voting Preferred Stock
Series D, par value $1.00 per share and repurchases of Shares.
(f) Book value per common share as adjusted for the after tax dilutive effects
of outstanding options and warrants to acquire Shares.
(g) Excludes a $37.1 million unamortized deferred credit associated with Fund
American's purchase of Folksamerica which will serve to increase the
Company's future book value per common and equivalent share by $5.43 over
an approximate five year period. See Note 2.

25

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS: YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

CONSOLIDATED RESULTS

Fund American reported comprehensive net income of $73.3 million for the
year ended December 31, 1998, which compares to comprehensive net income of
$84.7 million and $63.2 million for 1997 and 1996, respectively. Comprehensive
net income for 1998 includes after tax unrealized investment holding gains of
$37.2 million versus $104.6 million and $79.6 million for 1997 and 1996,
respectively.

Net income, which does not include comprehensive income items (primarily
unrealized investment holding gains and losses), for 1998 was $82.2 million
versus $43.0 million and $8.6 million for 1997 and 1996, respectively. Net
income for 1998 includes after tax realized investment gains of $46.1 million
versus $62.9 million and $25.0 million for 1997 and 1996, respectively.

Net income applicable to common stock (which is net of preferred stock
dividends) for 1998, 1997 and 1996 was $78.5 million, $39.3 million and $4.9
million, respectively.

Book value per common and common equivalent share was $109.68 at December
31, 1998 ($115.11 including the after tax unamortized deferred credit associated
with Fund American's purchase of Folksamerica in August 1998), which compares to
$100.08 at December 31, 1997. Strong operating results at the Company's
reinsurance and mortgage banking subsidiaries and favorable investment portfolio
results produced most of the increase in book value per share from 1997 to 1998.

INSURANCE OPERATIONS

REINSURANCE OPERATIONS

Folksamerica contributed $10.0 million to net income during 1998, which
includes $4.5 million of net income from January 1, 1998 to August 18, 1998
during which Folksamerica was an unconsolidated affiliate and $5.5 million of
net income during which Folksamerica was consolidated. Folksamerica contributed
$5.2 million and $2.4 million to net income as an unconsolidated insurance
affiliate during 1997 and 1996, respectively.

Folksamerica's results for the three years ended December 31, 1998, 1997
and 1996 included $238.1 million, $238.0 million and $181.4 million of earned
reinsurance premiums, respectively, and $170.3 million, $165.6 million and
$138.6 million of losses and loss adjustment expenses, respectively. For 1998
Folksamerica's combined ratio was 108.0% versus a combined ratio of 102.9% and
108.9% for the comparable 1997 and 1996 periods.

26

A summary of Folksamerica's 1998, 1997 and 1996 underwriting results
follows:

Year Ended December 31,
--------------------------------------
Dollars in millions 1998 1997 1996
- ----------------------------------------------------------------------------

Net written premiums $ 212.6 $ 232.4 $ 171.9
--------------------------------------
Earned premiums 238.1 238.0 181.4
Losses and loss adjustment expenses 170.3 165.6 138.6
Underwriting expenses 92.6 81.6 54.8
Underwriting loss $ (24.8) $ (9.2) $ (12.0)
Combined ratios:
Loss and loss adjustment expense 71.5% 69.6% 76.4%
Underwriting expense 36.5 33.3 32.5
--------------------------------------
Combined 108.0% 102.9% 108.9%
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------

27

During 1998, Folksamerica's written premium volume decreased approximately
9% versus 1997 premium levels reflecting an increase in non-renewed business due
to deteriorating terms and conditions. Folksamerica's combined ratio for 1998
was higher than that of 1997 due primarily to two property events experienced
during the year (Canadian ice storms and Hurricane Georges) and higher asbestos
and environmental losses. During 1997, Folksamerica's premium volume increased
approximately 35% versus 1996 premium levels reflecting its acquisition of
Christiania General Insurance Corporation in June 1996.

As previously mentioned, Folksamerica underwrites each reinsurance contract
anticipating an element of underwriting profit. The anticipated degree of
underwriting profit varies by contract and is based on a variety of factors
which can include some degree of float. Despite this expectation on an
individual contract basis, Folksamerica's reported results for the years ended
December 31, 1998, 1997 and 1996 included overall underwriting losses due to the
following: (i) actual results on some accounts or classes have produced higher
than anticipated loss costs. Considering the highly competitive market
conditions, there has been insufficient margin in profitable accounts to absorb
higher loss costs produced by other accounts; (ii) higher than anticipated
property catastrophe losses, particularly during 1998; and (iii) continued
strengthening of reserve portfolios relating to acquired companies, particularly
for claims related to mass torts. In this regard, Folksamerica has built ample
protections into its prior acquisition structures which partially mitigate the
underwriting losses. The financial benefits of those protections are generally
not reflected in the underwriting results, rather, such benefit is included in
"other insurance operations revenue" in the income statement.

Since Folksamerica's claims settlement period generally extends over a long
period of time, Folksamerica earns significant amounts of investment income on
the float generated by its reinsurance operations. When considering investment
income and certain other items at the Folksamerica holding company level
(primarily interest expense and income taxes), Folksamerica reported net income
of $27.3 million, $35.9 million and $17.1 million for the three years ended
December 31, 1998, 1997 and 1996, respectively, and reported comprehensive net
income of $53.3 million, $50.9 million and $18.4 million during those periods,
respectively. This resulted in Folksamerica attaining an after tax return on its
beginning equity of 20.9%, 29.9% and 16.0% for 1998, 1997 and 1996,
respectively.

The following table presents the subsequent development of the year-end
reinsurance losses for the ten year period from 1988 to 1998. Section I of the
table shows the estimated liabilities that were recorded at the end of each of
the indicated years for all current and prior year unpaid losses and loss
adjustment expenses ("lae"). Section II shows the re-estimate of the liabilities
made in each succeeding year. Section III shows the cumulative liabilities paid
of such previously recorded liabilities. Section IV shows the cumulative
deficiency representing the aggregate change in the liability from the original
balance sheet dates:

28

Reinsurance Losses and Loss Adjustment Expenses (a)
Year Ended December 31,
----------------------------------------------------------------------------------------------------
Dollars in Millions 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
- ---------------------------------------------------------------------------------------------------------------------------------

I. Liability for unpaid
losses and lae $267.7 $312.7 $355.2 $425.2 $647.1 $670.6 $709.7 $760.8 $740.8 $739.1 $723.2

II. Liability re-estimated
as of:
1 year later 276.7 321.5 388.8 456.3 695.4 701.1 768.7 786.4 765.2 755.8 -
2 years later 279.0 353.1 413.3 462.2 717.0 757.3 797.8 810.4 785.4
3 years later 301.4 376.1 415.4 476.9 759.2 779.2 818.6 833.0
4 years later 326.5 378.0 424.9 496.6 770.4 800.1 837.5
5 years later 328.7 391.0 438.2 499.2 795.0 817.1
6 years later 344.2 400.5 441.7 509.6 808.9
7 years later 351.4 403.7 450.4 516.0
8 years later 354.5 410.4 456.8
9 years later 364.6 415.7
10 years later 370.3

III. Cumulative amount of
liability paid through:
1 year later 66.0 84.5 93.8 119.4 220.8 201.5 203.1 214.1 183.1 175.0 -
2 years later 103.5 135.4 154.7 179.1 338.1 324.9 341.4 339.5 305.6
3 years later 131.7 171.5 191.7 233.9 416.5 422.6 432.4 424.5
4 years later 156.1 195.5 226.8 278.3 487.2 487.7 494.5
5 years later 172.1 221.6 258.3 312.4 534.0 529.4
6 years later 193.5 243.7 285.0 339.1 563.1
7 years later 211.4 265.5 304.7 353.0
8 years later 229.2 278.6 314.4
9 years later 242.8 286.4
10 years later 250.2

IV. Cumulative deficiency $102.6 $103.0 $101.6 $ 90.8 $161.8 $146.4 $127.9 $72.2 $44.6 $16.8 -
Percent deficient 38% 33% 29% 21% 25% 22% 18% 9% 6% 2% -
- ---------------------------------------------------------------------------------------------------------------------------------

(1) For the years 1988 through 1991 liabilities are shown net of reinsurance
recoverable. For the years 1992 through 1998 liabilities are shown without
regard to reinsurance recoverable in accordance with SFAS No. 113. The
table excludes

29

the insurance operations of VGI whose liability for unpaid losses and lae
totalled $88.5 million, $71.9 million and $65.4 million as of December 31,
1998, 1997 and 1996, respectively. Historic data for VGI is not considered
to be meaningful due to Charter reinsuring all of its business to its
former owner for periods prior to 1996. During 1998 and 1996, VGI's losses
and loss adjustment expenses relating to prior years developed unfavorably
by $6.7 million and $3.5 million, respectively. During 1997, VGI's losses
and loss adjustment expenses relating to prior years developed favorably by
$2.5 million pretax.

The table above has been prepared in accordance with prescribed
instructions, however, management believes that this information is not
indicative of Folksamerica's actual loss development history for the following
reasons: (i) with respect to 1992 through 1998, the information is presented
prior to considering the benefit of significant amounts of ceded reinsurance
recovered (and recoverable) from Folksamerica's reinsurers; (ii) the information
includes the complete loss development history for companies acquired by
Folksamerica for all periods presented, including periods prior to
Folksamerica's acquisition of such companies; and (iii) the structure of each of
Folksamerica's acquisitions has provided effective economic protections to
offset potential post-acquisition loss development. The form of these
protections has included deferred and adjustable purchase consideration and
favorable purchase prices. In consideration of such factors, the table presented
below is management's attempt to adjust the deficiencies presented above for the
most recent five years:

Year Ended December 31,
---------------------------------------
Percent of deficit to carried 1994 1995 1996 1997 1998
reserves:
- ----------------------------------------------------------------------

Deficiency as reported 18% 9% 6% 2% -%
Deficiency as adjusted for
the effects described above 3% 2% 1% -% -%
- ----------------------------------------------------------------------
- ----------------------------------------------------------------------

INSURANCE OPERATIONS

Valley, Charter and WMIC represent Fund American's consolidated insurance
subsidiaries. Valley, Charter and WMIC's results for the years ended December
31, 1998, 1997 and 1996, included $160.6 million, $145.3 million and $109.7
million of property and casualty insurance premiums earned, respectively, and
$115.1, $97.1 million and $85.9 million of losses and loss adjustment expenses,
respectively.

A summary of 1998, 1997 and 1996 underwriting results for Valley, Charter
and WMIC follows:

Year Ended December 31, 1998
-------------------------------------
Dollars in millions Valley Charter WMIC
- ---------------------------------------------------------------------------

Net written premiums $ 94.3 $ 64.3 $ 6.3
-------------------------------------
Earned premiums 91.1 64.2 5.3
Losses and loss adjustment expenses 67.8 43.7 3.6
Underwriting expenses 31.3 15.5 3.5
Underwriting profit (loss) $ (7.9) $ 5.0 $ (1.8)
Combined ratios:
Loss and loss adjustment expense 74.4% 68.0% 67.3%
Underwriting expense 33.5 23.8 61.1
-------------------------------------
Combined 107.9% 91.8% 128.4%
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------

30

Year Ended December 31, 1997
-------------------------------------
Dollars in millions Valley Charter WMIC
- ---------------------------------------------------------------------------

Net written premiums $ 83.2 $ 62.9 $ 4.7
-------------------------------------
Earned premiums 79.6 62.4 3.3
Losses and loss adjustment expenses 51.8 41.8 3.5
Underwriting expenses 28.3 17.1 2.0
Underwriting profit (loss) $ (.5) $ 3.5 $ (2.2)
Combined ratios:
Loss and loss adjustment expense 65.0% 66.9% 107.8%
Underwriting expense 34.8 27.3 53.1
-------------------------------------
Combined 99.8% 94.2% 160.9%
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------

Year Ended December 31, 1996
-------------------------------------
Dollars in millions Valley Charter WMIC
- ---------------------------------------------------------------------------

Net written premiums $ 75.1 $ 69.9 $ 2.0
-------------------------------------
Earned premiums 70.7 37.7 1.3
Losses and loss adjustment expenses 54.4 30.3 1.2
Underwriting expenses 24.8 8.0 .9
Underwriting loss $ (8.5) $ (.6) $ (.8)
Combined ratios:
Loss and loss adjustment expense 76.8% 80.4% 95.8%
Underwriting expense 34.9 18.9 50.4
-------------------------------------
Combined 111.7% 99.3% 146.2%
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------

31

Valley's 1998 underwriting results suffered from losses in certain of its
commercial lines business (primarily within Washington) which resulted in an
underwriting ratio of 107.9% for the year and an underwriting loss of $7.9
million. Charter's 1998 underwriting results produced a satisfactory 91.8%
combined ratio and a $5.0 million underwriting profit. For 1998, Charter's
policy counts increased strongly but total premiums were down due to price
reductions, a shift towards liability-only policies and a shift towards
six-month policies. WMIC's loss and loss adjustment expense ratio for 1998 of
67.3% shows significant improvement over prior year results but its expense
ratio for 1998 of 61.1% will not be meaningful for some time. WMIC's premium
volumes must grow significantly from current levels to provide sufficient
expense ratio economies of scale.

Valley and Charter's 1997 underwriting results produced satisfactory
combined ratios and an overall underwriting profit. However, premium growth at
both Valley and Charter suffered during 1997 as a result of increased
competition in the marketplace which illustrates Fund American's underwriting
discipline in a highly competitive market. WMIC's 1997 results were adversely
impacted by several large workers' compensation claims although underwriting
results on this small and growing book of business are not yet considered to be
meaningful.

Valley's 1996 underwriting results were adversely impacted by severe fourth
quarter storm-related losses and by $3.5 million in reserve strengthening for
losses and loss adjustment expenses incurred in prior years. Charter's earned
premiums trailed net written premiums during 1996 because Charter began to
retain virtually all its written premiums. Charter's policies written prior to
1996 were fully ceded to a former affiliate of Charter.

Valley, Charter and WMIC's claims are normally settled in a more timely
manner than those of Folksamerica which limits the amount of investment income
that can be generated on the earned and unearned insurance premiums that it has
received from its policyholders. When considering investment income and certain
other items of VGI (primarily interest expense, income taxes and goodwill
amortization), VGI reported net income (loss) of $5.0 million, $7.2 million and
$(2.6) million for the three years ended December 31, 1998, 1997 and 1996,
respectively, and reported comprehensive net income (loss) of $11.4 million,
$13.6 million and $(1.8) million during those periods, respectively. This
resulted in VGI attaining an after tax return (loss) on equity of 11.0%, 14.8%
and (1.9)% for 1998, 1997 and 1996, respectively.

INVESTMENTS IN UNCONSOLIDATED INSURANCE AFFILIATES

FSA and MSA represented Fund American's investments in unconsolidated
insurance affiliates at December 31, 1998. Fund American's investment in FSA
increased $42.0 million during 1998 which consisted of $13.8 million of pretax
earnings from FSA Common Stock, $26.6 million of pretax unrealized investment
gains from FSA Options and Preferred Stock, $3.1 million of pretax unrealized
investment gains

32

from FSA's investment portfolio, less $1.5 million of dividends received from
FSA Common Stock. White Mountains' investment in MSA increased $9.0 million
during 1998 (excluding White Mountains' additional purchase of MSA Common Stock
for $70.3 million in February 1998) which consisted of $4.9 million of pretax
earnings from MSA Common Stock and $4.1 million of pretax unrealized investment
gains from MSA's investment portfolio.

FSA, MSA, Folksamerica and Murray Lawrence represented Fund American's
investments in unconsolidated insurance affiliates as of December 31, 1997. Fund
American's investment in FSA increased $80.0 million during 1997 which consisted
of $11.4 million of pretax earnings from FSA Common Stock, $68.0 million of
pretax unrealized investment gains from FSA Options and Preferred Stock, $2.1
million of pretax unrealized investment gains from FSA's investment portfolio,
less $1.5 million of dividends received from FSA Common Stock. White Mountains'
investment in MSA increased $6.2 million during 1997 which consisted of $3.8
million of pretax earnings from MSA Common Stock and $2.4 million of pretax
unrealized investment gains from MSA's investment portfolio. White Mountains'
investment in Folksamerica increased $2.7 million during 1997 (excluding White
Mountains' purchase of Folksamerica Common Stock for $20.8 million during
December 1997) which consisted of $.9 million of pretax earnings from
Folksamerica Common Stock and $1.8 million of pretax unrealized investment gains
from Folksamerica's investment portfolio. White Mountains investment in Murray
Lawrence, which was acquired on December 8, 1997, remained at its cost of $23.6
million during 1997.

FSA, MSA and Folksamerica represented Fund American's investments in
unconsolidated insurance affiliates as of December 31, 1996. Fund American's
investment in FSA increased $23.1 million during 1996 (excluding Fund American's
purchase of 1,000,000 additional shares of FSA Common Stock for $26.5 million
during 1996) which consisted of $7.8 million of pretax earnings from FSA Common
Stock, $17.3 million of pretax unrealized investment gains from FSA Options and
Preferred Stock, less $1.0 million of pretax unrealized investment losses from
FSA's investment portfolio, less $1.0 million of dividends received from FSA
Common Stock. White Mountains' investment in MSA increased $1.0 million during
1996 which consisted of $1.5 million of pretax earnings from MSA Common Stock
offset by $.5 million of pretax unrealized investment losses from MSA's
investment portfolio. White Mountains' investment in Folksamerica increased $.2
million from June 1996 to December 31, 1996.

MORTGAGE BANKING OPERATIONS

For the year ended December 31, 1998, Source One's mortgage banking
operations contributed $33.2 million of net income to Fund American versus net
losses of $22.1 million and $8.0 million for during 1997 and 1996, respectively.
Source One's 1998 results include a $15.2 million

33

pretax, $9.9 million after tax, gain on sales of mortgage servicing rights.
Source One's 1997 results included the following charges: (i) a $6.0 million
after tax extraordinary loss on early extinguishment of debt, (ii) restructuring
and compensation charges of $3.1 million pretax, $2.0 after tax, associated with
Source One's plan to reduce its operating costs and improve its financial
performance, (iii) an $8.0 million pretax, $5.2 million after tax, loss on sales
of mortgage servicing rights and assumption of subservicing and (iv) a $17.7
million pretax, $11.5 million after tax, charge to Source One's valuation
allowance for impairment of their capitalized mortgage loan servicing portfolio.
Source One's 1996 results include a $29.1 million pretax ($25.9 after tax)
write-off of goodwill and certain other intangible assets which was partially
offset by a $10.1 million pretax, $6.6 million after tax, gain on sales of
mortgage servicing rights.

Gross mortgage servicing revenue was $78.1 million for the year ended
December 31, 1998 which compares to $94.9 million in 1997 and $139.6 million in
1996. The decrease in gross mortgage servicing revenue from 1996 to 1998 is
primarily the result of sales of mortgage servicing rights with respect to $10.6
billion and $17.0 billion of mortgage loans during 1998 and 1997, respectively.

Source One's net mortgage servicing revenue was $43.3 million for the year
ended December 31, 1998 which compares to $38.2 million in 1997 and $70.3
million in 1996. Net mortgage servicing revenue for the year ended December 31,
1998 was enhanced by $20.4 million of pretax net gains on financial instruments
versus gains of $11.3 million for 1997 and $9.9 million for 1996.

Source One utilizes interest rate floor contracts, interest rate swap
agreements and principal only swap agreements to mitigate the effect on earnings
of higher amortization and impairment of the capitalized servicing asset caused
by changes in market interest rates. These financial instruments are carried at
fair value on the balance sheet with unrealized and realized gains reported as
net gains on financial instruments on the income statement. Source One's
management believes that these financial instruments have proven to be an
effective means to substantially offset fluctuations in the value of Source
One's mortgage servicing asset caused by changes in market interest rates.

Net gains on sales of mortgages were $86.8 million for the year ended
December 31, 1998, versus $21.5 million in 1997 and $38.3 million in 1996. The
increase in gains from 1997 to 1998 reflects significant increases in Source
One's correspondent production and related mortgage sales volumes during the
period. The decrease in gains from 1996 to 1997 are due primarily to a change in
Source One's loan production mix which included a proportionately higher volume
of correspondent production during 1997 versus 1996 (which generates lower
originated mortgage servicing rights income).

During 1998 Source One sold the rights to service $10.6 billion of
nonrecourse mortgage loans for cash proceeds of $227.9 million, resulting in a
pretax gain of $15.2 million. During 1997 Source One

34

sold the rights to service $17.0 billion of nonrecourse mortgage loans for cash
proceeds of $266.9 million, resulting in a pretax loss of $8.0 million. As part
of the 1998 and 1997 servicing sales, Source One retained the right to
subservice $4.1 billion and $17.0 billion of these loans, respectively, for a
contracted fee through 2001. During 1996 Source One sold the rights to service
$3.3 billion of mortgage loans for net proceeds of $55.9 million, resulting in a
pretax gain of $10.1 million.

Total mortgage loan production for the years ended December 31, 1998, 1997
and 1996, was $10.9 billion, $4.4 billion and $3.8 billion, respectively. The
increase in production from 1996 to 1998 is reflective of overall lower market
interest rates and a corresponding increase in refinancing activities during the
period. Production related to refinancing activities made up 61%, 40% and 33% of
total production during 1998, 1997 and 1996, respectively.

INVESTMENT OPERATIONS

The total return from Fund American's investment activities (excluding net
unrealized investment holding gains and losses from Fund American's investments
in unconsolidated insurance affiliates) is shown below:

Year Ended December 31,
----------------------------------
Millions 1998 1997 1996
- ----------------------------------------------------------------------------

Net investment income:
Mortgage banking operations $ 81.6 $ 43.5 $ 40.8
Insurance operations, reinsurance
operations and other 36.8 21.6 16.5
----------------------------------
Total net investment income 118.4 65.1 57.3
Net unrealized investment holding
gains arising during the period 26.8 86.6 106.5
----------------------------------
Total net investment return, before tax $ 145.2 $ 151.7 $ 163.8
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------

Fund American's investment income is comprised primarily of interest income
earned on mortgage loans originated by Source One, interest income associated
with the fixed maturity investments of its consolidated insurance and
reinsurance operations and dividend income from its equity investments. The
increase in net investment income from mortgage banking operations from 1996 to
1998 is mainly attributable to an increase in interest income from mortgage
loans held for sale due to higher mortgage loan production experienced during

35

those periods, particularly during 1998. The increase in net investment income
from insurance, reinsurance and other from 1997 to 1998 is primarily the result
of the addition of Folksamerica's sizable fixed income portfolio in August 1998.
The increase in net investment income from insurance, reinsurance and other from
1996 to 1997 is a result of increases in investment income from White Mountains'
growing portfolio of fixed maturity investments.

Net realized investment gains of $71.0 million recorded during 1998
resulted principally from the sale of all Fund American's holdings (1,014,250
common shares) of White River Corporation for net proceeds of $92.1 million. The
total cash received by Fund American included the sales proceeds associated with
shares which were being held for delivery upon the exercise of existing employee
stock options (295,432 common shares or $17.8 million) and is payable to the
recipient at a future date pursuant to the Company's nonqualified retirement
plan.

Net realized investment gains of $96.7 million recorded during 1997
included $37.2 million of pretax gains from the sale of 1,980,982 shares of the
common stock of Travelers Property Casualty Corp. for net proceeds of $69.2
million, $24.3 million of pretax gains from the sale of 5,000,000 units of
beneficial interest of San Juan Basin Royalty Trust for net proceeds of $45.7
million, $10.3 million of pretax gains from the sale of 388,140 shares of the
common stock of Mid Ocean Limited ("Mid Ocean") for net proceeds of $22.6
million and $15.5 million of pretax gains from the sale of 834,895 shares of the
common stock of Veritas DGC Inc. for net proceeds of $20.9 million.

Net realized investment gains of $38.5 million recorded during 1996,
before tax, included $27.2 million of pretax gains from the sale of 2,928,100
shares of the common stock of The Louisiana Land & Exploration Company common
stock for net proceeds of $125.1 million, $1.4 million of pretax gains from the
sale of 2,042,572 shares of the common stock of Zurich Reinsurance Centre
Holdings, Inc. for net proceeds of $61.8 million and $9.3 million of pretax
gains from the sale of 600,000 of the shares of common stock of Mid Ocean for
net proceeds of $28.2 million.

EXPENSES

Insurance losses and loss adjustment expenses totalled $174.8 million for
1998 versus $97.1 million for 1997 and $85.9 million for 1996. Insurance and
reinsurance acquisition expenses totalled $54.8 million for 1998 versus $23.2
million for 1997 and $15.2 million for 1996. The increase in these insurance
expenses from 1997 to 1998 is primarily attributable to the inclusion of
Folksamerica in the Company's consolidated results during the 1998 third
quarter. The

36

increase in these insurance expenses from 1996 to 1997 is due to an increase in
insurance premium volumes at Valley, Charter and WMIC. During 1998 and 1996,
losses and loss adjustment expenses relating to prior years developed
unfavorably by $6.7 million and $3.5 million, respectively. During 1997, losses
and loss adjustment expenses relating to prior years developed favorably by $2.5
million pretax.

Compensation and benefits expenses totalled $130.2 million for 1998 versus
$101.8 million for 1997 and $91.3 million for 1996. The increase in compensation
and benefits expense from 1997 to 1998 is due to an increase in
production-related compensation at Source One and the inclusion of $7.1 million
of Folksamerica's compensation and benefits expenses for 1998. The increase in
compensation and benefits expense from 1996 to 1997 is primarily due to an
increase in stock-based compensation accruals associated with certain of the
Company's long-term compensation plans and its qualified and nonqualified
retirement plans. During 1997 the market value of the Company's common stock
rose 26%.

Interest expense of $83.9 million for 1998 compares to $46.0 million for
1997 and $46.3 million for 1996. The increase in interest expense from 1997 to
1998 reflects: (i) an increase in average indebtedness outstanding during 1998
at Source One as a result of significantly higher mortgage loan production
volumes; (ii) the inclusion of $1.4 million of Folksamerica's interest expense
for 1998; and (iii) an increase in average indebtedness under White Mountains'
$50.0 million revolving credit facility associated with its 1998 acquisition of
Folksamerica and its 1998 increase in its investment in MSA.

General expenses of $75.4 million for 1998 compares to $60.5 million for
1997 and $64.9 million for 1996. The increase in compensation and benefits
expense from 1997 to 1998 is due to an increase in production-related general
expenses at Source One and the inclusion of $1.3 million of Folksamerica's
general expenses for 1998.

Source One's provision for mortgage loan losses, included in general
expenses, was $3.8 million in 1998 which compares to $4.7 million for 1997 and
$3.0 million for 1996. The decrease in provision for loan losses from 1996 to
1998 primarily reflects significant reductions in the size of Source One's owned
mortgage servicing portfolio during the period. Source One has established an
allowance for mortgage loan losses which totalled $11.5 million and $12.8
million as of December 31, 1998 and 1997, respectively. In addition, Source One
has established a $5.2 million and $8.2 million pretax reserve for estimated
losses on its principal recourse portfolio as of December 31, 1998 and 1997,
respectively. Source One believes that its total allowances are adequate to
provide for estimated uninsured losses on the mortgage servicing portfolio.

INCOME TAXES

37

The income tax provision related to pretax earnings for 1998, 1997 and 1996
represents an effective tax rate of 36.8%, 37.5% and 68.7%, respectively. The
primary reason for the high effective tax rate experienced in 1996 was the
write-off of goodwill and certain other intangible assets related to Source One.
The total pretax write-off of these assets was $32.6 million and the related tax
benefit was $3.2 million.

Fund American recorded a net deferred Federal income tax asset of $7.8
million as of December 31, 1998. The 1998 net deferred tax asset includes $142.9
million of deferred tax assets (relating primarily to various operating items)
partially offset by $135.1 million of deferred tax liabilities (relating
primarily to net unrealized investment holding gains). Fund American recorded a
net deferred Federal income tax liability of $19.6 million as of December 31,
1997. The 1997 net deferred tax liability includes $108.0 million of deferred
tax liabilities (relating primarily to net unrealized investment holding gains)
partially offset by $88.4 million in net deferred tax assets (relating primarily
to various operating items).

38

On January 2, 1991, the Company sold Fireman's Fund to Allianz of America,
Inc. The $1.3 billion gain from the sale as reported in 1991 included a $75.0
million tax benefit related to the Company's estimated tax loss from the sale.
Since 1991 the Company has carried an estimated reserve related to tax matters
affecting the amount of the deductible tax loss from the sale and other tax
matters. The amount of tax benefit from the sale of Fireman's Fund ultimately
realized by the Company may be significantly more or less than the Company's
current estimate due to possible changes in or new interpretations of tax rules,
possible amendments to Fund American's 1991 or prior years' Federal income tax
returns, the results of further IRS audits and other matters affecting the
amount of the deductible tax loss from the sale.

LIQUIDITY AND CAPITAL RESOURCES

PARENT COMPANY

The primary sources of cash inflows for the Company are investment income,
sales of investment securities and dividends received from its operating
subsidiaries.

In August 1998 the Company entered into a $35.0 million revolving credit
agreement with a syndicate of banks which served to replace an expiring
arrangement in the same amount. Under the agreement, through August 12, 1999,
the Company may borrow up to $35.0 million at short-term market interest rates.
The credit agreement contains certain customary covenants and conditions. At
December 31, 1998 the Company was in compliance with all covenants under the
facility and had no borrowings outstanding under the agreement. At December 31,
1997 the Company had no outstanding borrowings under the former facility.

During 1993 the Company issued $150.0 million in principal amount of
medium-term notes for net cash proceeds of $148.0 million after related costs.
During 1995 and 1994 the Company repurchased $8.8 million and $24.9 million,
respectively, in principal amount of the notes due in February 2003. At December
31, 1998 the $116.3 million of remaining outstanding notes had an average
maturity of 4.4 years and a yield to maturity of 7.82%.

During 1998 and 1997 the Company repurchased 151,916 Shares for $19.8
million and 924,739 Shares for $103.5 million, respectively. All Shares
repurchased during 1998 and 1997 have been retired. During 1998 and 1997 the
Company declared and paid quarterly cash dividends of $.40 per Share and $.20
per share, respectively. The Company's repurchases of Shares and dividends paid
during 1998 and 1997 represent returns of excess capital to its shareholders.

In connection with Source One's 1997 sale of approximately $17.0 billion of
mortgage servicing rights to a third party, the Company has made a collection,
payment and performance guaranty to the buyer for a

39

period of no more than ten years. The aggregate amount of the Company's guaranty
is initially limited to $20.0 million and amortizes down to $15.0 million as
mortgage loans serviced under agreement are repaid. During 1998, the Company
permitted the third party to include an additional $2.9 billion of mortgage
servicing rights that it purchased from Source One during 1998 to be included in
the guaranty, however, the inclusion of the 1998 servicing rights sold did not
serve to change the maximum amount of the guaranty or the original term of the
agreement. The Company estimates that its aggregate guaranty under this
arrangement is currently approximately $15.0 million.

WHITE MOUNTAINS, FOLKSAMERICA, VALLEY AND CHARTER

In November 1996 White Mountains and Valley entered into a five year credit
facility under which they may borrow up to $50.0 million and $15.0 million,
respectively, at market interest rates. The facility contains certain customary
covenants and conditions but does limit White Mountains' ability to pay
dividends to its shareholders. As of December 31, 1998 and 1997, White Mountains
and Valley were in compliance with all covenants under the facility. At December
31, 1998 White Mountains had $50.0 million of borrowings outstanding under the
facility which were used to partially fund White Mountains additional investment
in MSA and its acquisition of Folksamerica during 1998. White Mountains 1998
borrowings had a weighted average interest rate of 6.20%. White Mountains had no
borrowings outstanding at December 31, 1997 under the facility. During 1998 and
1997 Valley had $15.0 million of borrowings outstanding under the facility with
a weighted average interest rate of 6.14% and 6.09%, respectively.

In November 1995 Charter issued two notes totalling $20.2 million. Certain
of the notes were due in 1996 and $3.2 million of notes were extended to be
payable in three equal installments in 1997, 1998 and 1999. As of December 31,
1998 $1.1 million of the notes remained outstanding. The notes are
collateralized by certain assets of Charter.

During 1997 the Company reorganized its structure in order to strengthen
Source One and make it a part of Fund American's operating group under White
Mountains. Pursuant to this reorganization plan, White Mountains was merged into
FAE and the combined entity was immediately renamed White Mountains. In
addition, Source One received $139 million of capital infusions, consisting
primarily of Fund American's investments in FSA, in order to improve Source
One's debt ratings and reduce its borrowing costs. As a result of the
reorganization plan, the Company currently owns 3% of the outstanding common
stock of Source One and White Mountains owns the remaining 97% of the
outstanding common stock of Source One.

As part of the August 18, 1998 Folksamerica acquisition, Fund American
agreed to repay or refinance Folksamerica's $55.6 million of outstanding
long-term indebtedness during February 1999. On February 24, 1999, White
Mountains repayed and replaced its $50.0 million five

40

year credit facility with a new $100 million facility at Folksamerica. The new
credit agreement contains certain customary covenants and conditions.

On February 11, 1999, White Mountains entered into a definitive agreement
to sell VGI (which includes Valley, Charter and WMIC but excludes Valley
National) to Unitrin, Inc. for total proceeds of approximately $215 million
(consisting of approximately $130 million in cash upon closing and a special
dividend consisting primarily of investment securities of approximately $85
million prior to close). The transaction is subject to certain Federal and state
approvals and is expected to close during the 1999 second quarter. White
Mountains expects to record an approximate $90 million pretax gain on the sale
of VGI.

In a separate transaction, White Mountains has entered a definitive
contract to sell Valley National to Executive Risk Indemnity for an amount to be
determined upon closing. The transaction is subject to certain Federal and state
approvals and is expected to close during the 1999 second quarter. White
Mountains expects to record an approximate $8 million pretax gain on the sale of
Valley National.

On March 25, 1999, Fund American and Citicorp Mortgage, Inc. ("Citicorp")
reached a definitive agreement (the "Citicorp Agreement") under which Citicorp
will acquire a substantial amount of Fund American's mortgage-banking related
assets and certain of its mortgage banking liabilities. Fund American will
retain the Source One legal entity which will continue to own all of Fund
American's investments in FSA and certain other mortgage-related and other
assets and liabilities. Fund American will likely sell or run-off the residual
mortgage-banking assets remaining after the sale and extinguish the remaining
liabilities. Fund American expects to record an after tax gain of approximate
$15.0 million gain on the Citicorp Agreement. The amount of prospective gain on
the sale of Source One's residual net mortgage-banking assets cannot be
accurately determined at this time.

Under the insurance laws of the various states under which Folksamerica,
Valley, Charter and WMIC are incorporated or licensed to write business, an
insurer is restricted with respect to the amount of dividends it may pay without
prior approval by state regulatory authorities. Accordingly, there is no
assurance that dividends may be paid by Folksamerica, Valley, Charter and WMIC
in the future.

SOURCE ONE

Source One's primary cash flow requirements relate to funding mortgage loan
production and investments in mortgage servicing rights. To meet these financing
needs, Source One relies on various short-term and long-term credit facilities,
early funding programs and cash flow from operations. Source One's investments,
mortgage loans held for sale and mortgage loan servicing portfolio provide a
liquidity reserve since these assets may be sold to meet cash needs.

41

During 1998 Source One sold the rights to service $10.6 billion of
nonrecourse mortgage loans for cash proceeds of $227.9 million. During 1997
Source One sold the rights to service $17.0 billion of nonrecourse mortgage
loans for cash proceeds of $266.9 million. As part of the 1998 and 1997
servicing sales, Source One retained the right to subservice $4.1 billion and
$17.0 billion, respectively, of these loans for a contracted fee through 2001.
The proceeds of the 1997 and 1998 servicing sales were used by Source One to
retire debt and to distribute its excess capital to common shareholders. During
1996 Source One sold the rights to service $3.3 billion of mortgage loans for
cash proceeds of $55.9 million.

In July 1998 Source One amended and restated its $600.0 million secured
revolving credit agreement to increase its borrowing capacity and flexibility.
The provisions of the amended agreement increased Source One's borrowing
capacity to $800.0 million. The facility expires on July 9, 1999. At December
31, 1998, Source One had $650.5 million of borrowings outstanding under this
facility.

In July 1997 Source One amended and restated its secured revolving credit
agreement to decrease its borrowing capacity from $750.0 million to $600.0
million and to reduce its borrowing costs by lowering the facility fee. At
December 31, 1997, Source One had $559.0 million of borrowings outstanding under
this facility.

During the second quarter of 1998 Source One entered into two additional
secured credit agreements whereby it may borrow up to $35.0 million and $175.0
million through July 1999 and April 1999, respectively. At December 31, 1998,
Source One had a total of $21.6 million in borrowings outstanding under these
agreements.

In April 1998 Source One replaced its existing $15.0 million unsecured
revolving credit agreement under which it can borrow up to $40.0 million through
April 15, 1999. As of December 31, 1998, there was $25.2 million outstanding
under the revolving credit agreement.

In May 1997 Source One entered into a unsecured revolving credit agreement
under which it can borrow up to $15.0 million through June 1, 1998. As of
December 31, 1997, there was $10.5 million outstanding under the revolving
credit agreement.

In December 1995, Source One exchanged and retired 2,239,061 shares of
preferred stock (the "Source One Preferred Stock") for $56.0 million in
principal amount of 9.375% subordinated debentures. The subordinated debentures
are due in 2025 but are redeemable at the option of Source One, in whole or
part, at any time on or after May 1, 1999.

Dividends paid on the Source One Preferred Stock were $3.7 million for
1998, 1997 and 1996. Dividends on the Source One Preferred Stock accrue at an
annual rate of 8.42% or $2.105 per share of Source One Preferred Stock
outstanding.

42

In 1991 Source One issued $160.0 million of 8.875% medium-term notes due in
2001 of which $138.4 million remained outstanding at December 31, 1996. During
1997 Source One repurchased and retired in principal amount $119.7 million of
these notes leaving $18.7 million outstanding at December 31, 1997 and 1998.

In 1992 Source One issued $100.0 million of 9% debentures due in 2012
pursuant to a $250.0 million shelf registration statement. The debentures may
not be redeemed by Source One prior to maturity. The proceeds from issuance were
used for general corporate purposes.

Source One must comply with certain financial covenants provided in its
secured and unsecured revolving credit facilities, including restrictions
relating to tangible net worth and leverage. In addition, the secured facility
contains certain covenants which limit Source One's ability to pay dividends or
make distributions of its capital in excess of preferred stock dividends and
subordinated debt interest requirements each year. Source One is currently in
compliance with all such covenants.

43

MARKET RISK

Fund American's consolidated balance sheet includes a substantial amount of
assets and liabilities whose fair values are subject to market risk. The term
market risk refers to the risk of loss arising from adverse changes in: interest
rates, foreign currency exchange rates, commodity prices, and other relevant
market rates and prices such as prices for common equity securities. Due to Fund
American's sizable investments in fixed maturity investments and common equity
securities at its insurance and reinsurance subsidiaries, derivative securities
and mortgage-related assets and liabilities at its mortgage banking subsidiary
and its use of medium and long-term debt financing at the Company and certain of
its operating companies, market risk can have a significant affect on Fund
American's consolidated financial position.

INTEREST RATE RISK

FIXED MATURITY PORTFOLIO. In connection with the Company's consolidated
insurance and reinsurance subsidiaries, Fund American invests in interest rate
sensitive securities, primarily debt securities. Fund American's strategy is to
purchase fixed maturity investments that are attractively priced in relation to
perceived credit risks. Fund American's investments in fixed maturity
investments are held as available for sale and, accordingly, Fund American
accepts that realized and unrealized losses on these instruments may occur. Fund
American does not use derivative securities to manage its interest rate risk
associated with its fixed maturity investments, rather it manages the average
duration of the fixed maturity portfolio in the anticipation of achieving an
adequate yield without subjecting the portfolio to an unreasonable level of
interest rate risk.

Increases and decreases in prevailing interest rates generally translate
into decreases and increases in fair values of fixed maturity investments,
respectively. Additionally, fair values of interest rate sensitive instruments
may be affected by the credit worthiness of the issuer, prepayment options,
relative values of alternative investments, the liquidity of the instrument and
other general market conditions. These investments are carried at fair value on
the balance sheet with unrealized gains reported net of tax in a separate
component of shareholders equity.

DERIVATIVE SECURITIES. In connection with its mortgage banking operations,
Source One utilizes derivative contracts, consisting of interest rate floor
contracts, interest rate swap agreements and principal-only swap agreements, in
an attempt to offset the effect on earnings of impairment of its capitalized
servicing asset caused by changes in market interest rates. Increases and
decreases in prevailing interest rates generally translate into increases and
decreases in fair values of these financial instruments, respectively. These
financial instruments are carried at fair value on the balance

44

sheet (as other investments) with unrealized and realized gains reported as net
gains on financial instruments on the income statement.

INDEBTEDNESS. Fund American utilizes debt financing at all levels of its
businesses, particularly at Source One. Increases and decreases in prevailing
interest rates generally translate into decreases and increases in fair values
of fixed rate indebtedness, respectively, particularly long-term debt.
Additionally, fair values of interest rate sensitive instruments may be affected
by the credit worthiness of the issuer, prepayment options, relative values of
alternative investments, the liquidity of the instrument and other general
market conditions.

The table below summarizes the estimated effects of hypothetical increases
and decreases in market interest rates on Fund American's fixed maturity
portfolio, derivative securities and long-term fixed rate indebtedness
outstanding. Significant variations in market interest rates could produce
changes in the timing of repayments due to prepayment options available to the
issuer or the holder which are not reflected herein. It is assumed that the
changes occur immediately and uniformly to each category of instrument
containing interest rate risk.

45

Estimated Fair Percentage Increase
Fair Value at Assumed Change Value after Change (Decrease) to
Dollars in Millions December 31, 1998 in Interest Rate in Interest Rate Shareholders' Equity
- -------------------------------------------------------------------------------------------------------------

Fixed maturity investments $929.6 50 bp decrease $946.4 1.6%
50 bp increase $913.2 (1.5)%
100 bp increase $897.1 (3.0)%
200 bp increase $866.2 (5.9)%
- -------------------------------------------------------------------------------------------------------------
Derivative securities $ 17.5 50 bp decrease $31.5 1.3%
50 bp increase $5.4 (1.1)%
100 bp increase $(4.7) (2.1)%
200 bp increase $(20.7) (3.5)%
- -------------------------------------------------------------------------------------------------------------
Fixed rate indebtedness (a) $233.1 50 bp decrease $239.4 (.6)%
50 bp increase $227.0 .6%
100 bp increase $221.2 1.1%
200 bp increase $210.1 2.1%
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------

(a) Excludes short-term indebtedness, long-term indebtedness refinanced or
callable by Fund American during 1999 and variable rate obligations.

MORTGAGE-RELATED ASSETS. Source One's mortgage loan production and
servicing activities are subject to interest rate risk and are generally counter
cyclical in nature. In addition, Source One utilizes various financial
instruments, including derivatives, to manage the interest rate risk related
specifically to its mortgage loan pipeline, mortgage loans held for sale and
gain or loss on sales of mortgage servicing rights. The overall objective of
Source One's interest rate risk management policies is to offset changes in the
values of these items resulting from changes in interest rates.

As part of the interest rate risk management process, Source One performs
various sensitivity analyses that quantify the net financial impact of changes
in interest rate-sensitive assets and commitments. These analyses incorporate
scenarios including assumed shifts in the yield curve. Various modeling
techniques are employed to forecast the value of these assets and commitments.
For pipeline commitments, an option-adjusted spread model is used which
incorporates implied market volatilities and prepayment speeds. For mortgage
servicing rights, a

46

discounted cash flow model is used which incorporates prepayment speeds,
discount rates and credit losses.

Utilizing the sensitivity analyses described above, the table below
summarizes the estimated effects of hypothetical increases and decreases in
market interest rates on Source One's mortgage servicing values:

Estimated Fair Percentage Increase
Carrying Value at Assumed Change Value after Change (Decrease) to
Dollars in Millions December 31, 1998 in Interest Rate in Interest Rate Shareholders' Equity
- --------------------------------------------------------------------------------------------------------------------------

Mortgage servicing rights (a) $171.3 50 bp decrease $156.0 (1.4)%
50 bp increase $183.9 1.2%
Mortgage forward contracts $ - 50 bp decrease $ 11.6 1.1%
50 bp increase $(11.6) (1.1)%
Mortgage loan pipeline $ - 50 bp decrease $(11.7) (1.1)%
50 bp increase $ 11.4 1.1%
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------

(a) Represents the carrying value of capitalized mortgage servicing
excluding $1.6 million of capitalized subservicing.

47

As shown above, the projected increase or decrease in the value of the
mortgage loan pipeline would be expected to be substantially offset by a
decrease or increase in the related mortgage loan forward contracts. In
addition, the projected increase or decrease in the value of the mortgage
servicing rights would be expected to be substantially offset by a decrease or
increase in the value of the related financial instruments as previously
described herein. This analysis is limited by the fact that it was performed at
a specific point in time and does not incorporate other factors that would
impact Source One's financial performance. Actual results would likely vary.

FOREIGN CURRENCY EXCHANGE RATES

Folksamerica operates a branch office in Toronto, Canada to service its
Canadian customers. Net unrealized foreign currency translation gains and
losses, after tax, associated with Folksamerica's Canadian operations are
reported as a net amount in a separate component of shareholders' equity.
Changes in the values of these operations due to currency fluctuations, after
tax, are reported on the income statement as a component of comprehensive net
income. At December 31, 1998, Folksamerica's net assets denominated in Canadian
dollars represented approximately one percent of Fund American's consolidated
shareholders' equity, therefore, any significant change in foreign currency
rates would not have a material impact on Fund American's financial position.

EQUITY PRICE RISK

The carrying values of Fund American's common equity securities, a
significant portion of its other investments (primarily restricted common equity
securities and partnership interests invested in common equity securities) and
its investments in FSA Options and Preferred Stock are based on quoted market
prices or management's estimates of fair value (which is based, in part, on
quoted market prices) as of the balance sheet date. Market prices of common
equity securities are subject to fluctuations which could cause the amount to be
realized upon sale of the investment to differ significantly from the current
reported value. The fluctuations may result from perceived changes in the
underlying economic characteristics of the investee, the relative price of
alternative investments, general market conditions and supply and demand
imbalances for a particular security.

The table below summarizes Fund American's equity price risks as of
December 31, 1998 and shows the effects of a hypothetical 20% increase and a 20%
decrease in market prices as of that date.

48

Estimated Fair Percentage Increase
Fair Value at Assumed Value after Assumed (Decrease) to
Dollars in Millions December 31, 1998 Price Change Price Change Shareholders' Equity
- ------------------------------------------------------------------------------------------------------------------

Common equity securities $241.7 20% increase $290.0 4.5%
20% decrease $193.4 (4.5)%
Other investments (a) $ 77.3 20% increase $ 92.8 1.4%
20% decrease $ 61.8 (1.4)%
FSA Options and $114.4 20% increase $136.6 2.1%
Preferred Stock 20% decrease $ 91.5 (2.1)%
- ------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------

(a) Excludes $17.5 million of derivative securities (see "Interest Rate Risk")
and $2.1 million of other investments which would not be directly affected
by the assumed changes in equity prices.

49

OTHER MATTERS

ACCOUNTING FOR FSA OPTIONS AND CONVERTIBLE PREFERRED STOCK

Fund American currently owns 3,460,200 shares of the common stock of FSA
("FSA Shares") and various fixed price options and shares of convertible
preferred stock of FSA (the "FSA Options and FSA Preferred Stock") which, in
total, give Fund American the right to acquire up to 4,560,607 additional FSA
Shares. Fund American's investment in FSA Shares is accounted for using the
equity method of accounting pursuant to which the investment is reported at
FSA's book value ($35.87 per FSA Share at December 31, 1998). Fund American's
investments in FSA Options and FSA Preferred Stock are currently accounted for
under the provisions of SFAS No. 115 pursuant to which the investments are
reported at fair value ($52.62 per underlying FSA Share at December 31, 1998).

Fund American currently expects to exercise the FSA Options during 1999 and
convert the FSA Preferred Stock during 2004. Assuming that equity accounting
continues to be the proper accounting method for valuing Fund American's
investment in FSA Shares, upon exercise of the FSA Options and conversion of the
FSA Preferred Stock, Fund American expects that it would be required to restate
its historic balance sheets to account for its investments in FSA Options and
FSA Preferred Stock from fair value to their original cost. Upon exercise, Fund
American's original cost basis in the FSA Shares acquired will be increased by
the exercise price paid. Because the new cost basis of Fund American's
investment in FSA Shares is expected to be considerably less than its portion of
the fair value of FSA's net identifiable assets at the date of exercise, Fund
American would be required to record a deferred credit that would be amortized
to income over an anticipated five year period. Assuming the FSA Options were
exercised and the FSA Preferred Stock converted as of December 31, 1998, Fund
American would be required to reduce its book value by $72.9 million ($10.67 per
share) and would record a deferred credit of $35.7 million ($5.23 per share).
This net difference in carrying value of $37.2 million (which represents the
effective write-down of the FSA Options and FSA Preferred Stock from fair value
to FSA's book value) would continue to exist until such time as equity
accounting is no longer appropriate for Fund American's investment in FSA
Shares.

This analysis is based solely on Fund American's current circumstances
concerning its investments in FSA Options and FSA Preferred Stock. Fund
American's actual accounting valuation will be determined at the point of
exercise for the FSA Options and upon the conversion of the FSA Preferred Stock
and will be based on the circumstances concerning such investments existing at
that time.

YEAR 2000

STATUS. Since 1996 Fund American has been identifying, modifying and
testing its internal systems and controls to ensure that these systems can
accurately process transactions involving the Year 2000 and beyond with no
material adverse effects to its customers or disruption to its business
operations. As of December 31, 1998, the Company has substantially completed its
testing phase (the final phase of its Year 2000 remediation plan). Fund American
estimates that its total pretax cost of Year 2000 remediation, excluding its
unconsolidated insurance

50

affiliates, is approximately $3.0 million of which the majority of this amount
has been expensed as of December 31, 1998. This estimate does not include the
cost of hardware and software replacements and upgrades made in the normal
course of business and represents less than 20% of Fund American's total
Information Technology budget.

Fund American has also been closely monitoring the year 2000 issues of its
third party constituents that it voluntarily interacts with (e.g. customers,
suppliers, reinsurers, creditors, borrowers...). Fund American's third party
constituents have been requested to provide Fund American with information
concerning their Year 2000 remediation plans and the status of such plans. For
those constituents who either fail to respond to this inquiry or are deemed to
be unlikely to remedy their own Year 2000 issues in a timely manner, Fund
American is in the process of either replacing that constituent or establishing
similar relationships with new parties that are currently Year 2000 compliant.

As of December 31, 1998, FSA and MSA had also substantially completed the
testing phase of their Year remediation plans and are in the process of
determining their third party exposures in a similar manner to that of Fund
American. Fund American's nominees to the Boards of Directors of FSA and MSA
have received detailed briefings concerning their respective Year 2000 plans and
have determined that these plans appear to be on schedule for a timely
completion and should reduce the risk of Year 2000 issues. Fund American's
portion of the total estimated costs of the Year 2000 issue for its
unconsolidated insurance affiliates are not material and the majority of such
expenses have already been incurred.

RISKS. The failure to identify or correct significant Year 2000 issues
could result in an interruption in, or a failure of, certain normal business
activities or operations concerning the Company, its consolidated insurance and
mortgage banking subsidiaries and its unconsolidated insurance affiliates. Such
failures could adversely affect Fund American's results of operations, liquidity
and financial condition. Due to the general uncertainty inherent in the Year
2000 problem, resulting in part from the uncertainty of potential business
interruptions caused by third party constituents in which Fund American must
interact (including but not limited to suppliers of electrical power, various
private and public markets for equity and debt securities, certain agencies of
the Federal government and the states in which Fund American conducts business),
Fund American is unable to determine at this time whether the consequences of
any Year 2000 failures will have a material impact on its results of operation,
liquidity or financial condition. However, Fund American currently believes
that, with the implementation of its Year 2000 plan (which is in the final
stages of completion), the possibility of significant interruptions of normal
business activities due to the Year 2000 issue should be reduced.

Folksamerica's approach towards underwriting against potential Year 2000
exposures is to seek coverages which contain Year 2000 event exclusions. In
instances where exclusions are not provided, Folksamerica attempts to determine
whether the risk is acceptable based on a variety of factors (a description of
such factors is not provided herein as each situation is unique). Folksamerica
has estimated that less that 9% of its property reinsurance coverage in force
could be subject to Year 2000 exposures. However, these risks generally lie

51

with large corporations who have been aware of the issue for some time and have
invested significant time and resources towards Year 2000 remediation.
Additionally, Folksamerica does not anticipate significant Year 2000 exposures
from its casualty reinsurance coverage in force due to the nature of such
exposures. Further, Folksamerica generally writes such exposures on an excess of
loss basis which provides Folksamerica with additional protections against
potential losses of this nature.

The Company is currently in the process of developing a Year 2000
contingency plan (the "Y2K Plan") which is designed to mitigate, to the extent
possible, any adverse affects the Company may suffer due to any potential
business interruptions caused by third party constituents in which Fund American
must interact (as further explained above). It is expected that the Y2K Plan
will be finalized during the third quarter of 1999.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See "Market Risk Disclosures" contained in Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary data have been filed as a part
of this Annual Report on Form 10-K as indicated in the Index to Financial
Statements and Financial Statement Schedule appearing on page 38 of this report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

On March 10, 1999, the Audit Committee of the Board appointed
PricewaterhouseCoopers LLP ("PWC") as its independent auditors for the fiscal
year ending December 31, 1999, to succeed KPMG LLP ("KPMG") effective upon the
date of their reports on such consolidated financial statements for the year
ended December 31, 1998.

PWC has served as Folksamerica's independent auditors since 1981 and has
served as FSA's independent auditors since 1989. The Audit Committee has
recommended that PWC succeed KPMG as the Company's independent auditors for 1999
due to the growing significance of Folksamerica and FSA to the Company's 1999
financial position and results of operations and the pending disposition of VGI.

In connection with the audits of the years ended December 31, 1998 and
1997, there were no disagreements with KPMG on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope and
procedures which, if not resolved to their satisfaction, would have caused them
to make reference in connection with their opinion to the subject matter of the
disagreement.

The Company has requested KPMG furnish a letter addressed to the Commission
stating whether it agrees with the above statements. A copy of this letter,
dated March 25, 1999, is contained herein as Exhibit 16(a).

52

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

A. DIRECTORS (AS OF MARCH 22, 1999)

Reported under the caption "Election of Directors" on pages 3 through 6 of
the Company's 1999 Proxy Statement, herein incorporated by reference.

B. EXECUTIVE OFFICERS (AS OF MARCH 22, 1999)

Executive officer
Name Position Age since
- ---------------------------------------------------------------------------------------

Raymond Barrette Executive Vice President and 48 1997
Chief Financial Officer

Terry L. Baxter President of White Mountains 53 1994

Reid T. Campbell Vice President and Director 31 1996
of Finance

Morgan W. Davis Executive Vice President of 48 1994
White Mountains

K. Thomas Kemp President and CEO 58 1991

Michael S. Paquette Senior Vice President and 35 1993
Controller

David G. Staples Vice President and Director 38 1997
of Taxation

- ---------------------------------------------------------------------------------------

All executive officers are elected by the Board for a term of one year or
until their successors have been elected and have duly qualified.

MR. BARRETTE joined Fund American in 1997 as the Company's Executive Vice
President and Chief Financial Officer. Mr. Barrette is also Executive Vice
President and Chief Financial Officer of White Mountains. He was formerly a
consultant with Tillinghast-Towers Perrin from 1994 to 1996 and was President of
the Personal Insurance Division of Fireman's Fund from 1991 to 1993. Mr.
Barrette is a director of FAE, MSA, Source One, Folksamerica, White Mountains,
Valley, Charter and WMIC.

MR. BAXTER was elected President of White Mountains in 1997. Mr. Baxter
previously served as Chairman of Source One from 1996 to 1997 and as President
and Secretary of FAE from 1994 to 1997. Prior to joining Fund American in 1994,
Mr. Baxter was Managing Director of the National Transportation Safety Board
from 1990. Prior to that, he was the Assistant Director of OMB during the Reagan
Administration. Mr. Baxter is a director of FAE, MSA, Source One, Folksamerica,
White Mountains, Valley, Charter, WMIC and Sextant Underwriting Plc.

MR. CAMPBELL was elected Vice President and Director of Finance in February
1998 and previously served as Assistant Controller from 1996 to 1998 and
Director of Accounting from 1995 to 1996. Mr. Campbell has been with Fund
American since 1994. Mr. Campbell is also

53

Vice President and Director of Finance of White Mountains. Prior to joining Fund
American, Mr. Campbell was with KPMG Peat Marwick from 1990 to 1994.

MR. DAVIS has served as White Mountains' Executive Vice President since
1997 and served as Senior Vice President since 1994. Mr. Davis is also President
and Chief Executive Officer of WMIC and Chairman and President of VGI. Prior to
joining Fund American in 1994, Mr. Davis was an independent consultant. Mr.
Davis is a director of MSA, White Mountains, Valley, Charter, WMIC, ABRA, Inc.
and CCC Information Services Group Inc. and is a trustee of Azusa Pacific
University.

MR. KEMP was appointed President and Chief Executive Officer in 1997. Mr.
Kemp previously served as Executive Vice President since 1993 and as Vice
President, Treasurer and Secretary from 1991 to 1993. Mr. Kemp also serves as a
director of the Company, Chairman and Chief Executive Officer of White Mountains
and Chairman of WMIC. He is also a director of Folksamerica, FSA, FAE, MSA and
AMLIN Plc.

MR. PAQUETTE was appointed Senior Vice President and Controller in 1997.
Mr. Paquette previously served as Vice President and Controller since 1995 and
as Vice President and Chief Accounting Officer from 1993 to 1995. Mr. Paquette
is also Senior Vice President and Controller of White Mountains and WMIC. Mr.
Paquette has been a member of the Fund American organization since 1989.

MR. STAPLES was elected Vice President and Director of Taxation in 1997 and
has been with Fund American since 1996. Prior to joining Fund American, Mr.
Staples served as Vice President and Director of Taxation for Crum & Forster
Holdings, Inc. from 1993 to 1996, and was with KPMG Peat Marwick from 1983 to
1993.

ITEM 11. EXECUTIVE COMPENSATION

Reported under the captions "Compensation of Executive Officers" on pages 9
through 11, "Reports of the Compensation Committees on Executive Compensation"
on pages 11 though 13, "Shareholder Return Graph" on page 14, and "Compensation
Plans" on page 15 of the Company's 1999 Proxy Statement, herein incorporated by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Reported under the caption "Voting Securities and Principal Holders
Thereof" on pages 7 through 8 of the Company's 1999 Proxy Statement, herein
incorporated by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Reported under the captions "Certain Relationships and Related
Transactions" on page 11 and "Compensation Committee Interlocks and Insider
Participation in Compensation Decisions" on page 16 of the Company's 1999 Proxy
Statement, herein incorporated by reference.

54

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

A. DOCUMENTS FILED AS PART OF THE REPORT

The financial statements and financial statement schedules and reports of
independent auditors have been filed as part of this Annual Report on Form 10-K
as indicated in the Index to Financial Statements and Financial Statement
Schedules appearing on page 38 of this report. A listing of exhibits filed as
part of the report appear on pages 56 through 58 of this report.

B. REPORTS ON FORM 8-K

During the fourth quarter of 1998 the Company filed two amendments to its
Current Report on Form 8-K dated August 18, 1998 which was filed in connection
with its acquisition of Folksamerica on that date. The amendments served to
provide the requisite pro forma financial information concerning the
Folksamerica transaction and were filed on October 16, 1998 and November 13,
1998.

55

C. EXHIBITS

EXHIBIT
NUMBER NAME
- --------------------------------------------------------------------------------

3(i) -- Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference herein to Exhibit
3(a) of the Company's 1993 Annual Report on Form 10-K)

(ii) -- Amended and Restated By-Laws of the Company
(incorporated by reference herein to Exhibit 3(b) of the
Company's 1993 Annual Report on Form 10-K)

4 -- Indenture dated January 1, 1993, with The First National
Bank of Chicago, as trustee, pursuant to the Company's
offering of $150 million of medium-term notes
(incorporated by reference herein to Exhibit (4) of the
Company's Report on Form 8-K dated January 15, 1993)

9 -- Voting Trust Agreement dated September 2, 1994 between
the Company, U S WEST Capital Corporation and First
Chicago Trust Company of New York (incorporated by
reference herein to Exhibit 10(a) of the Company's
Report on Form 8-K dated April 10, 1994)

10(a) -- Second Amended and Restated Credit Agreement dated
August 14, 1998 among the Company, the Lenders (as named
therein) and The First National Bank of Chicago (*)

(b) -- Second Amended and Restated Credit Agreement dated
August 14, 1998 among White Mountains, the Lenders (as
named therein) and The First National Bank of Chicago
(*)

(c) -- Second Amended and Restated Credit Agreement dated
August 14, 1998 among VGI, the Lenders (as named
therein) and The First National Bank of Chicago (*)

(d) -- Amendment No. 1 dated November 20, 1998 to the Second
Amended and Restated Credit Agreement dated August 14,
1998 among the Company, the Lenders (as named therein)
and The First National Bank of Chicago (*)

(e) -- Amendment No. 1 dated November 20, 1998 to the Second
Amended and Restated Credit Agreement dated August 14,
1998 among White Mountains, the Lenders (as named
therein) and The First National Bank of Chicago (*)

(f) -- Amendment No. 1 dated November 20, 1998 to the Second
Amended and Restated Credit Agreement dated August 14,
1998 among VGI, the Lenders (as named therein) and The
First National Bank of Chicago (*)

(g) -- Securities Purchase Agreement dated April 10, 1994
between the Company, U S WEST, Inc., U S WEST Capital
Corporation and FSA (incorporated by reference herein to
Exhibit 10(a) of the Company's Report on Form 8-K dated
April 10, 1994)

(h) -- Folksamerica Stock Purchase Agreement dated as of July
1, 1998 by and among the Company, White Mountains,
Folksam Mutual General Insurance Company, Folksam
International Insurance Co. Ltd, Weiner Staedtische
Allgemeine Versicherung AG, P&V Assurances S.C. and
Samvirke Skadeforsikring AS (incorporated by reference
herein to Exhibit 10(a) of the Company's Report on Form
8-K dated August 18, 1998)

56

(i) -- Assignment and Assumption Agreement dated as of August
18, 1998 by and among Folksam Omsesidig Sakforsakring,
Samvirke Skadeforsikring AS and the Company
(incorporated by reference herein to Exhibit 10(b) of
the Company's Report on Form 8-K dated August 18, 1998)

(j) -- Subscription Agreement dated November 6, 1997 between
Folksamerica, the Company, White Mountains, Folksam
Mutual General Insurance Company, Folksam International
Insurance Co. Ltd, Weiner Staedtische Allgemeine
Versicherung AG, P&V Assurances S.C. and Samvirke
Skadeforsikring AS (incorporated by reference herein to
Exhibit 10(l) of the Company's 1997 Annual Report on
Form 10-K)

(k) -- Securities Purchase Agreement dated March 6, 1996
between the Company and Folksamerica (incorporated by
reference herein to Exhibit 10(a) of the Company's
Report on Form 8-K dated June 19, 1996)

(l) -- Folksamerica Stock Purchase Agreement dated August 8,
1995 between the Company, Skandia U.S. Holding
Corporation, and Skandia America Corporation
(incorporated by reference herein to Exhibit 10(e) of
the Company's 1995 Annual Report on Form 10-K)

(m) -- Guaranty, dated February 28, 1997, by the Company to and
for the benefit of Chemical Mortgage Company
(incorporated by reference herein to Exhibit 10(y) of
the Company's 1996 Annual Report on Form 10-K)

(n) -- VGI Stock Acquisition Agreement dated February 10, 1999
between Unitrin, Inc. and the Company (*)

(o) -- Transition Services Agreement dated March 25, 1999
between the Company and Citicorp Mortgage, Inc. (*)

(p) -- Source One Asset Purchase Agreement dated March 25, 1999
between the Company, Source One and Citicorp Mortgage
Inc.(*)

(q) -- Common Stock Warrant Agreement with respect to shares of
the Company's Common stock between the Company and John
J. Byrne (incorporated by reference herein to Exhibit
10(v) of the Company's Registration Statement on Form
S-1 (No. 33-0199)) (**)

(r) -- The Company's Retirement Plan for Non-Employee Directors
(incorporated by reference herein to Exhibit 10(aa) of
the Company's 1992 Annual Report on Form 10-K) (**)

(s) -- The Company's Voluntary Deferred Compensation Plan, as
amended on November 15, 1996 (incorporated by reference
herein to Exhibit 10(o) of the Company's 1996 Annual
Report on Form 10-K) (**)

(t) -- The Company's Deferred Benefit Plan, as amended on
November 15, 1996 (incorporated by reference herein to
Exhibit 10(p) of the Company's 1996 Annual Report on
Form 10-K) (**)

(u) -- The Company's Long-Term Incentive Plan, as amended
February 15, 1995 (incorporated by reference to Appendix
I of the Company's Notice of 1995 Annual Meeting of
Shareholders and Proxy Statement) (**)

(v) -- Valley Group Employees' 401(k) Savings Plan
(incorporated by reference herein to Exhibit 4(c) of the
Company's Registration Statement on Form S-8 (No.
333-30233) (**)

11 -- Statement Re Computation of Per Share Earnings (***)

16 -- Letter of KPMG LLP dated March 25, 1999 (*)

21 -- Subsidiaries of the Registrant (*)

57

23(a) -- Consent of KPMG LLP dated March 25, 1999 (*)

(b) -- Consent of Ernst & Young LLP dated March 25, 1999 (*)

(c) -- Consent of PricewaterhouseCoopers LLP dated March 25,
1999 relating to Valley, Folksamerica and FSA (*)

24 -- Powers of Attorney (*)

27 -- 1998 Financial Data Schedule (*)

99(a) -- Report of PricewaterhouseCoopers LLP dated February 2,
1999 relating to Folksamerica(*)

(b) -- The Consolidated Financial Statements of FSA and the
related Report of Independent Accountants as of December
31, 1998 and 1997 and for each of the three years in the
period ended December 31, 1998 (*)

(c) -- Report of Coopers & Lybrand L.L.P. dated February 14,
1997 relating to VGI (*)

(*) Included herein.
(**) Management contracts or compensation plans/arrangements required to be
filed as an exhibit pursuant to Item 14(a)3 of Form 10-K.
(***) Not included herein as the information is contained elsewhere within
report. See Note 1 of the Notes to Consolidated Financial Statements.

D. FINANCIAL STATEMENT SCHEDULE

The financial statement schedule and report of independent auditors have
been filed as part of this Annual Report on Form 10-K as indicated in the
Index to Financial Statements and Financial Statement Schedule appearing on
page 61 of this report.

58

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

FUND AMERICAN ENTERPRISES HOLDINGS, INC.

Date: March 26, 1999 By: /s/ MICHAEL S. PAQUETTE
--------------------------------
Senior Vice President and Controller

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

Signature Title Date

RAYMOND BARRETTE* Executive Vice President and March 26, 1999
- -------------------------- Chief Financial Officer
Raymond Barrette

JOHN J. BYRNE* Chairman March 26, 1999
- --------------------------
John J. Byrne

PATRICK M. BYRNE* Director March 26, 1999
- --------------------------
Patrick M. Byrne

HOWARD L. CLARK, JR.* Director March 26, 1999
- --------------------------
Howard L. Clark, Jr.

ROBERT P. COCHRAN* Director March 26, 1999
- --------------------------
Robert P. Cochran

GEORGE J. GILLESPIE, III* Director March 26, 1999
- --------------------------
George J. Gillespie, III

/s/ K. THOMAS KEMP President, Chief Executive March 26, 1999
- -------------------------- Officer and Director
K. Thomas Kemp

GORDON S. MACKLIN* Director March 26, 1999
- --------------------------
Gordon S. Macklin

59

FRANK A. OLSON* Director March 26, 1999
- --------------------------
Frank A. Olson

MICHAEL S. PAQUETTE* Senior Vice President March 26, 1999
- -------------------------- and Controller
Michael S. Paquette

*By: /s/ K. THOMAS KEMP
--------------------------------
K. Thomas Kemp, Attorney-in-Fact

60

FUND AMERICAN ENTERPRISES HOLDINGS, INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

Form
10-K
page(s)
- -----------------------------------------------------------------------------------------------

FINANCIAL STATEMENTS:
Consolidated balance sheets as of December 31, 1998 and 1997.................... F-1
Consolidated income statements for each of the years ended
December 31, 1998, 1997 and 1996........................................... F-2
Consolidated statements of shareholders' equity for each of the years ended
December 31, 1998, 1997 and 1996........................................... F-3
Consolidated statements of cash flows for each of the years ended
December 31, 1998, 1997 and 1996........................................... F-4
Notes to consolidated financial statements...................................... F-5

OTHER FINANCIAL INFORMATION:
Report on management's responsibilities......................................... F-48
Independent auditors' reports................................................... F-49
Selected quarterly financial data (unaudited)................................... F-52

FINANCIAL STATEMENT SCHEDULES:
I. Summary of investments other than investments in related parties......... FS-1
II. Condensed financial information of the Registrant........................ FS-2
III. Reinsurance.............................................................. FS-4
IV. Valuation and qualifying accounts......................................... FS-5
VI. Supplementary insurance information....................................... FS-6

- -----------------------------------------------------------------------------------------------

All other schedules are omitted as they are not applicable or the
information required is included in the financial statements or notes thereto.

61

CONSOLIDATED BALANCE SHEETS

- -------------------------------------------------------------------------------------------------------------------
December 31,
---------------------------
Dollars in millions 1998 1997
- -------------------------------------------------------------------------------------------------------------------

ASSETS
Fixed maturity investments, at fair value (cost $916.1 and $165.4) $ 929.6 $ 168.3
Common equity securities, at fair value (cost $195.4 and $64.7) 241.7 104.2
Other investments (cost $88.5 and $103.1) 96.9 167.9
Short-term investments, at amortized cost (which approximated fair value) 79.0 62.8
---------------------------
Total investments 1,347.2 503.2
Cash 22.4 7.0
Mortgage loans held for sale 676.3 519.3
Capitalized mortgage servicing, net of accumulated amortization 169.7 181.0
Pool loan purchases 165.0 149.8
Mortgage claims receivable and real estate acquired 33.1 41.2
Receivable from sale of mortgage servicing 73.8 27.3
Investments in unconsolidated insurance affiliates 354.3 360.1
Insurance and reinsurance balances receivable 124.7 56.1
Reinsurance recoverable on paid and unpaid losses 137.3 9.6
Other assets 176.9 155.7
---------------------------
Total assets $ 3,280.7 $ 2,010.3

LIABILITIES
Short-term debt $ 748.5 $ 571.4
Long-term debt 359.7 304.3
Loss and loss adjustment expense reserves 811.7 71.9
Unearned insurance and reinsurance premiums 153.1 78.0
Deferred credit 37.1 -
Accounts payable and other liabilities 424.1 281.8
---------------------------
Total liabilities 2,534.2 1,307.4
- -------------------------------------------------------------------------------------------------------------------
MINORITY INTEREST - PREFERRED STOCK OF SUBSIDIARY 44.0 44.0
- -------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common stock - authorized 125,000,000 shares,
issued 30,863,547 and 31,015,463 shares 30.9 31.0
Paid-in surplus 354.2 355.9
Retained earnings 1,063.2 1,008.9
Common stock in treasury, at cost: 25,034,939 shares (871.0) (871.0)
Accumulated other comprehensive net income, after tax 125.2 134.1
---------------------------
Total shareholders' equity 702.5 658.9
- -------------------------------------------------------------------------------------------------------------------
Total liabilities, minority interest and shareholders' equity $ 3,280.7 $ 2,010.3
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

See Notes to Consolidated Financial Statements.

F-1

CONSOLIDATED INCOME STATEMENTS

- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
---------------------------------------
Millions, except per share amounts 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------

REVENUES:
Earned property and casualty insurance premiums $246.0 $145.3 $ 109.7
Earnings from unconsolidated insurance affiliates 24.3 21.3 12.0
Other insurance operations revenue 12.2 7.8 9.4

Net investment income 118.4 65.1 57.3

Gross mortgage servicing revenue 78.1 94.9 139.6
Amortization and impairment of capitalized mortgage servicing (55.2) (68.0) (79.2)
Net gain on financial instruments 20.4 11.3 9.9
---------------------------------------

Net mortgage servicing revenue 43.3 38.2 70.3

Net gain on sales of mortgages 86.8 21.5 38.3
Gain (loss) on sales of mortgage servicing rights and assumption of subservicing 15.2 (8.0) 10.1
Other mortgage operations revenue 31.9 19.1 18.1
---------------------------------------

Total revenues 578.1 310.3 325.2
- --------------------------------------------------------------------------------------------------------------------------------
EXPENSES:
Insurance losses and loss adjustment expenses 174.8 97.1 85.9
Compensation and benefits 130.2 101.8 91.3
Interest expense 83.9 46.0 46.3
General expenses 75.4 60.5 64.9
Insurance and reinsurance acquisition expenses 54.8 23.2 15.2
Write-off of goodwill and other intangible assets - - 32.6
---------------------------------------
Total expenses 519.1 328.6 336.2
- --------------------------------------------------------------------------------------------------------------------------------
Pretax operating earnings (loss) 59.0 (18.3) (11.0)
Net realized investment gains 71.0 96.7 38.5
---------------------------------------
Pretax earnings 130.0 78.4 27.5
Income tax provision 47.8 29.4 18.9
---------------------------------------
AFTER TAX EARNINGS 82.2 49.0 8.6
Loss on early extinguishment of debt, after tax - (6.0) -
---------------------------------------
NET INCOME 82.2 43.0 8.6
Net unrealized investment holdings gains and other, after tax 37.2 104.6 79.6
Reclasses of realized gains included in net income, after tax (46.1) (62.9) (25.0)
---------------------------------------
COMPREHENSIVE NET INCOME 73.3 84.7 63.2
Preferred stock dividends of subsidiary (3.7) (3.7) (3.7)
---------------------------------------
Comprehensive net income applicable to common stock $ 69.6 $ 81.0 $ 59.5
---------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER COMMON SHARE:
After tax earnings $13.38 $ 6.89 $ .66
Loss on early extinguishment of debt, after tax - (.91) -
---------------------------------------
Net income $13.38 $ 5.98 $ .66
---------------------------------------
---------------------------------------
Comprehensive net income $11.87 $12.33 $ 8.01
---------------------------------------
---------------------------------------
DILUTED EARNINGS PER COMMON SHARE:
After tax earnings $11.94 $ 6.22 $ .60
Loss on early extinguishment of debt, after tax - (.82) -
---------------------------------------
Net income $11.94 $ 5.40 $ .60
---------------------------------------
---------------------------------------
Comprehensive net income $10.58 $11.15 $ 7.33
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------

See Notes to Consolidated Financial Statements.

F-2

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Common Net Foreign
stock and Common unrealized currency
paid-in Retained stock in investment translation
Millions Total surplus earnings treasury gains adjustment
- -------------------------------------------------------------------------------------------------------------------

Balances at January 1, 1996 $699.7 $408.2 $1,124.6 $(871.0) $ 37.9 $ -
- -------------------------------------------------------------------------------------------------------------------

Net income 8.6 - 8.6 - - -
Dividends to shareholders (9.6) - (9.6) - - -
Purchases of common stock retired (66.3) (9.8) (56.5) - - -
Change in net unrealized investment
gains and losses, after tax 54.6 - - - 54.6 -
- -------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 687.0 398.4 1,067.1 (871.0) 92.5 -
- -------------------------------------------------------------------------------------------------------------------

Net income 43.0 - 43.0 - - -
Dividends to shareholders (9.0) - (9.0) - - -
Purchases of common stock retired (103.7) (11.5) (92.2) - - -
Change in net unrealized investment
gains and losses, after tax 41.6 - - - 41.6 -
- -------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 658.9 386.9 1,008.9 (871.0) 134.1 -
- -------------------------------------------------------------------------------------------------------------------

Net income 82.2 - 82.2 - - -
Dividends to shareholders (13.1) - (13.1) - - -
Purchases of common stock retired (19.8) (1.8) (18.0) - - -
Change in net unrealized investment
gains and losses and other, after tax (8.9) - - - (8.0) (.9)
Other 3.2 - 3.2 - - -
- -------------------------------------------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 1998 $702.5 $385.1 $1,063.2 $(871.0) $126.1 $(.9)
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

See Notes to Consolidated Financial Statements.

F-3

CONSOLIDATED STATEMENTS OF CASH FLOWS

Year Ended December 31,
---------------------------------------
Millions 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------

Net income $ 82.2 $ 43.0 $ 8.6
Reconciliation of net income to cash flows from operating activities:
Undistributed earnings from unconsolidated insurance affiliates (19.1) (14.7) (8.2)
Net realized investment gains (71.0) (96.7) (38.5)
Net unrealized gains on financial instruments (12.1) (11.1) (1.7)
Depreciation and amortization of servicing assets, goodwill and other 63.1 71.0 92.8
Amortization of deferred credit (2.7) - -
Write-off of goodwill and other intangible assets - - 32.6
Mortgage loan production (10,866.3) (4,403.3) (3,831.6)
Mortgage loan sales and amortization 10,709.2 4,198.9 3,897.7
(Gain) loss on sales of mortgage servicing rights (15.2) 8.0 (10.1)
(Decrease) increase in unearned insurance premiums (7.0) 5.4 37.6
Increase in insurance premiums receivable (2.4) (3.9) (6.9)
Decrease (increase) in deferred insurance policy acquisition costs 2.5 (1.1) (6.5)
Increase in insurance loss reserves 13.7 6.5 21.2
Net change in current and deferred income taxes receivable and payable 12.0 4.5 11.8
Change in other assets 26.4 55.9 (29.3)
Change in accounts payable and other liabilities 120.5 11.1 33.7
Other, net (5.0) 17.4 (1.4)
---------------------------------------
Net cash provided from (used for) operating activities 28.8 (109.1) 201.8
- -------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net decrease in short-term investments 47.0 4.7 36.1
Sales of common stocks and other investments 168.5 207.9 231.6
Sales of fixed maturity investments 132.8 92.5 131.7
Purchases of common stocks and other investments (61.1) (54.8) (85.0)
Purchases of fixed maturity investments (122.7) (102.6) (180.8)
Acquisitions of consolidated insurance affiliates, net of cash balances acq(167.5) - (13.2)
Investments in unconsolidated insurance affiliates (70.3) (44.4) (107.6)
Collections on other mortgage origination and servicing assets 278.4 274.2 175.3
Additions to capitalized mortgage servicing rights (249.1) (139.5) (88.6)
Proceeds from sales of mortgage servicing rights 182.8 242.6 11.7
Additions to other mortgage origination and servicing assets (296.9) (285.1) (205.7)
Collections on notes receivable 7.0 - -
Net purchases of fixed assets (5.4) (2.9) (7.3)
---------------------------------------
Net cash (used for) provided from investing activities (156.5) 192.6 (101.8)
- -------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net issuances (repayments) of short-term debt 176.8 162.4 (36.2)
Issuances of long-term debt - - 15.0
Repayments of long-term debt (1.1) (131.0) -
Purchases of common stock retired (19.5) (103.7) (66.3)
Cash dividends paid to common and preferred shareholders (13.1) (9.0) (9.6)
Other - - (.8)
---------------------------------------
Net cash provided from (used for) financing activities 143.1 (81.3) (97.9)
- -------------------------------------------------------------------------------------------------------------------
Net increase in cash during year 15.4 2.2 2.1
Cash balance at beginning of year 7.0 4.8 2.7
---------------------------------------
Cash balance at end of year $ 22.4 $ 7.0 $ 4.8
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

See Notes to Consolidated Financial Statements.

F-4

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries and have been prepared in accordance with
Generally Accepted Accounting Principles ("GAAP"). All significant intercompany
transactions have been eliminated in consolidation. The financial statements
include all adjustments considered necessary by management to fairly present the
financial position, results of operations and cash flows of Fund American. The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates. Certain amounts in the prior year financial
statements have been restated to conform with the current year presentation.

INVESTMENT SECURITIES

Fund American's portfolio of fixed maturity investments, common equity
securities and other investments are mainly classified as available for sale and
are reported at fair value as of the balance sheet date. Net unrealized
investment gains and losses, after tax, associated with such investments are
reported as a net amount in a separate component of shareholders' equity.
Changes in net unrealized investment gains and losses, after tax, are reported
on the income statement as a component of comprehensive net income.

Premiums and discounts on fixed maturity investments are accreted to income
over the anticipated life of the investment.

Other investments include: (i) equity securities having no established
public market value which are recorded at an internally appraised fair value;
(ii) securities which, due to restrictions regarding resale, are recorded at a
discount to the quoted market value for similar unrestricted securities; (iii)
investment limited partnership interests which are recorded using the equity
method of accounting; (iv) mortgage loans held for investment which are recorded
at the lower of cost or fair value, determined on an individual loan basis; and
(v) financial instruments which are classified as trading securities and are
recorded at fair value with realized and unrealized gains and losses reported on
the income statement as gains or losses on financial instruments.

Realized gains and losses resulting from sales of investment securities or
from other than temporary impairments of value are accounted for using the
specific identification method.

Short-term investments are carried at amortized cost, which approximated
fair value as of December 31, 1998 and 1997, and comprise securities which
mature or become available for use within one year.

Fund American's consolidated insurance operations are required to maintain
deposits with insurance regulators of certain states in order to maintain their
insurance licenses. The total fair value of such

F-5

deposits totalled $12.0 million and $11.3 million as of December 31, 1998 and
1997, respectively.

INSURANCE AND REINSURANCE OPERATIONS

Premiums written are recognized as revenues as earned ratably over the
terms of the related policies or reinsurance treaties. Unearned premiums
represent the portion of premiums applicable to future insurance or reinsurance
coverage provided by policies or treaties in force.

Deferred policy acquisition costs represent commissions, premium taxes,
brokerage expenses and other costs which are directly attributable to and vary
with the production of new business and are deferred and amortized over the
applicable premium recognition period. Deferred acquisition costs are limited to
the amount expected to be recovered from future earned premiums and anticipated
investment income.

F-6

Losses and loss adjustment expenses are charged against income as incurred.
Unpaid insurance losses and loss adjustment expenses are based on estimates by
claims adjusters, legal counsel and actuarial staff of the ultimate costs of
settling claims, including the effects of inflation and other societal and
economic factors. Unpaid reinsurance losses and loss adjustment expenses are
based on reports received from ceding companies. Unpaid loss and loss adjustment
expense reserves represent management's best estimate of ultimate losses and
loss adjustment expenses net of estimated salvage and subrogation recoveries, if
applicable. Such estimates are regularly reviewed and updated and any
adjustments resulting therefrom are reflected in current operations. The process
of estimating loss and loss adjustment expenses involves a considerable degree
of judgement by management and the ultimate amount of expense to be incurred
could be considerably greater than or less than the amounts currently reflected
in the financial statements.

In the normal course of business, Fund American's insurance subsidiaries
seek to limit losses that may arise from catastrophes or other events that may
cause unfavorable underwriting results by reinsuring certain levels of risk in
various areas of exposure with other insurance enterprises or reinsurers. Fund
American remains contingently liable for risks reinsured with third parties to
the extent that the reinsurer is unable to honor its obligations under
reinsurance contracts at the time of loss.

Amounts recoverable from reinsurers are estimated in a manner consistent
with the claim liability associated with the reinsured policy. Reinsurance
premiums, commissions, expense reimbursements and reserves related to reinsured
business are accounted for on a basis consistent with those used in accounting
for the original policies issued and the terms of the reinsurance contracts.
Premiums ceded to other companies have been reported as a reduction of premiums
written. Amounts applicable to reinsurance ceded for unearned premium reserves
and loss and loss adjustment expense reserves (e.g., prepaid reinsurance
premiums and reinsurance recoverable on unpaid losses, respectively) are not
material and have been included as a component of other assets. Expense
allowances received in connection with reinsurance ceded have been accounted for
as a reduction of the related policy acquisition costs and are deferred and
amortized accordingly.

MORTGAGE BANKING OPERATIONS

Fund American acquired Source One in 1986. The purchase price paid for
Source One in 1986 was in excess of the estimated fair value of the net assets
acquired on that date and was allocated to goodwill. Prior to December 1996
Source One's goodwill was being amortized over 20 years. During 1996 Fund
American re-assessed the recoverability of goodwill and certain other intangible
assets related to Source One and determined that it should write-off all such
assets related to Source One. This resulted in a $32.6 million pretax write-off
of goodwill and other intangible assets. Factors considered in the determination
to write-off all Source One's goodwill and other assets were (i) increased
competition and industry consolidation during 1996 which had adversely impacted
the value of both the mortgage loan production and servicing operations of
Source One and (ii) the attainment of a definitive agreement in the fourth
quarter of 1996 to sell the majority of Source One's mortgage servicing
portfolio at essentially book value.

F-7

Mortgage loans held for sale are stated at the lower of aggregate cost or
fair value, including the fair value of commitments to originate and sell
mortgage loans. Conventional mortgage loans are placed on a non-accrual basis
when delinquent 90 days or more as to interest or principal. Interest on
delinquent FHA insured loans is accrued at the insured rate beginning on the
sixty-first day of delinquency. Interest on delinquent VA guaranteed loans is
accrued at the loan rate during the period of delinquency.

Gains and losses from sales of mortgage loans are recognized when the
proceeds are received. Loan origination fees, net of certain direct costs, are
deferred and recognized as income when the related mortgage loans are sold.
Discounts from the origination of mortgage loans held for sale are deferred and
recognized as adjustments to gains or losses on sales.

F-8

Capitalized mortgage servicing includes certain costs incurred in the
origination and acquisition of mortgage servicing rights which are deferred and
amortized over the expected life of the loan. The total cost of acquiring
mortgage loans, either through origination activities or purchase transactions,
is allocated between the mortgage servicing rights and the loans based on their
relative fair values. The fair values of mortgage servicing rights are estimated
by calculating the present value of the expected future net cash flows
associated with such rights, incorporating assumptions that market participants
would use in their estimates of future servicing income and expense. A current
market rate is used to discount estimated future cash flows. Impairment of
capitalized mortgage servicing rights is measured on a disaggregated basis by
stratifying the mortgage servicing rights based on one or more predominant risk
characteristics of the underlying loans. Impairment is recognized through a
valuation allowance for each individual stratum. The valuation allowance for
Source One's principal recourse portfolio includes a reserve for estimated
losses on the corresponding loans.

Pool loan purchases, which are carried at cost, represent FHA insured, VA
guaranteed and conventional loans which were either delinquent or in the process
of foreclosure at the time they were purchased from GNMA, FNMA or FHLMC
mortgage-backed security pools which Source One services. Interest is accrued on
these purchased loans at a rate based on expected recoveries.

Mortgage claims receivable represent claims filed primarily with FHA and
VA. These receivables are carried at cost less an estimated allowance for
amounts that are not fully recoverable from the claims filed with the underlying
mortgage insuring agencies.

Real estate acquired is stated at the lower of fair value less estimated
selling costs or the recorded balance satisfied at the date of acquisition, as
determined on an individual property basis. Costs related to maintaining the
properties are charged to expense as incurred.

Mortgage servicing revenue represents fees earned for servicing real estate
mortgage loans owned by investors and late charge income. The servicing fees are
calculated based on the outstanding principal balances of the loans serviced and
are recognized together with late charge income when received.

FOREIGN CURRENCY TRANSLATION

Folksamerica operates a branch office in Toronto, Canada to service its
Canadian customers. Net unrealized foreign currency translation gains and
losses, after tax, associated with Folksamerica's Canadian operation are
reported as a net amount in a separate component of shareholders' equity.
Changes in the values of these operations due to currency fluctuations, after
tax, are reported on the income statement as a component of comprehensive net
income.

EARNINGS PER SHARE

Basic earnings per share amounts are based on the weighted average number
of Shares outstanding. In the basic earnings per share calculation, net income
is reduced by preferred stock dividends to arrive at earnings applicable to
common stock.

Diluted earnings per share amounts are based on the weighted average number
of Shares and potential dilutive Shares outstanding. Potential

F-9

dilutive Shares include stock options, warrants and preferred stock redeemable
for Shares. In the diluted earnings per share calculation, net income is reduced
by preferred stock dividends to arrive at earnings applicable to common stock.

F-10

The following table outlines the Company's computation of earnings per
share for the years ended December 31, 1998, 1997 and 1996:

- -------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
-----------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------

BASIC EARNINGS PER SHARE NUMERATORS (IN MILLIONS):
After tax earnings $ 82.2 $ 49.0 $ 8.6
Preferred stock dividends of subsidiary (3.7) (3.7) (3.7)
-----------------------------------
After tax earnings applicable to common stock 78.5 45.3 4.9
Loss on early extinguishment of debt, after tax - (6.0) -
-----------------------------------
Net income available applicable to common stock $ 78.5 $ 39.3 $ 4.9
-----------------------------------
-----------------------------------
Comprehensive net income applicable to common stock $ 69.6 $ 81.0 $ 59.5
- -------------------------------------------------------------------------------------------------------------------

DILUTED EARNINGS PER SHARE NUMERATORS (IN MILLION):
After tax earnings applicable to common stock $ 78.5 $ 45.3 $ 4.9
After tax dilution to earnings from unconsolidated insurance affiliates (.4) (.2) -
-----------------------------------
Diluted after tax earnings available applicable to common stock 78.1 45.1 4.9
Loss on early extinguishment of debt, after tax - (6.0) -
-----------------------------------
Diluted net income available applicable to common stock $ 78.1 $ 39.1 $ 4.9
-----------------------------------
-----------------------------------
Diluted comprehensive net income applicable to common stock $ 69.2 $ 80.8 $ 59.5
-----------------------------------
- -------------------------------------------------------------------------------------------------------------------

EARNINGS PER SHARE DENOMINATORS (IN THOUSANDS):
Basic earnings per share numerator (average common shares outstanding) 5,866 6,570 7,429
Dilutive stock options and warrants to acquire common stock (a) 669 674 681
-----------------------------------
Diluted earnings per share denominator 6,535 7,244 8,110
-----------------------------------
- -------------------------------------------------------------------------------------------------------------------

BASIC EARNINGS PER SHARE (IN DOLLARS):
After tax earnings $13.38 $ 6.89 $ .66
Loss on early extinguishment of debt, after tax - (.91) -
-----------------------------------
Net income applicable to common stock $13.38 $ 5.98 $ .66
-----------------------------------
-----------------------------------
Comprehensive net income $11.87 $12.33 $ 8.01
-----------------------------------
- -------------------------------------------------------------------------------------------------------------------

DILUTED EARNINGS PER SHARE (IN DOLLARS):
After tax earnings $11.94 $ 6.22 $ .60
Loss on early extinguishment of debt, after tax - (.82) -
-----------------------------------
Net income applicable to common stock and assumed conversions $11.94 $ 5.40 $ .60
-----------------------------------
-----------------------------------
Comprehensive net income $10.58 $11.15 $ 7.33
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

(a) See Note 11 for detailed information concerning the Company's outstanding
dilutive stock options and warrants to acquire common stock.

F-11

ACCOUNTING STANDARDS RECENTLY ADOPTED AND ISSUED

In December 1996 the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of
SFAS No. 125" which deferred the adoption of certain transfer and collateral
provisions of SFAS No. 125 to periods beginning after December 31, 1997. The
adoption of SFAS No. 127, did not have a material effect on Fund American's
current financial position or results of operations.

In June 1997 the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprises and Related Information" which establishes new standards for
reporting information about operating segments. The required information under
SFAS No. 131 is contained in Note 14.

In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position ("SOP") 98-1 entitled "Accounting For the
Cost of Computer Software Developed or Obtained for Internal Use" which requires
the capitalization of certain prospective costs in connection with developing or
obtaining software for current use. The adoption of SOP 98-1 is not expected to
have a material impact on Fund American's financial position or results of
operations.

In June 1998 the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which requires companies to record all
derivatives on the balance sheet as either assets or liabilities and measure
those instruments at fair value. The manner in which companies are to record
gains and losses resulting from changes in the values of those derivatives
depends on the use of the derivative and whether it qualifies for hedge
accounting. SFAS No. 133 is effective beginning in 2000 with earlier adoption
permitted. The adoption of SFAS No. 133, is not expected to have a material
effect on Fund American's financial position or results of operations.

In October 1998, the AICPA issued SOP 98-7 entitled "Deposit Accounting:
Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Risk".
SOP 98-7 provides guidance on how to account for all insurance and reinsurance
contracts that do not transfer insurance risk, except for long-duration life and
health insurance contracts. SOP 98-7 is effective for periods beginning January
1, 2000, with early adoption permitted. Fund American is currently evaluating
the impact of the adoption of SOP 98-7 and the potential effects on its
financial position and results of operations.

NOTE 2. REINSURANCE OPERATIONS

On August 18, 1998, Fund American acquired all of the remaining outstanding
shares of Folksamerica Common Stock for $169.1 million thereby causing
Folksamerica to become a consolidated subsidiary of the

F-12

Company as of that date. Before the August 18th transaction, Fund American owned
a 50% non-consolidated interest in Folksamerica, primarily through the
Folksamerica Preferred Stock with fixed price warrants to acquire common stock.
As a result of the Folksamerica transaction, Fund American has restated its
December 31, 1997 balance sheet and its income statement for the year ended
December 31, 1997 to account for the portion of its investment in Folksamerica
that was reported at fair value in accordance with SFAS No. 115 entitled
"Accounting for Certain Investments in Debt and Equity Securities" to its
original cost in accordance with the purchase accounting principles of
Accounting Principles Board Opinion ("APB") No. 18 entitled "The Equity Method
of Accounting for Investments in Common Stock". Because the cost of Fund
American's investment in Folksamerica was less than the fair value of
Folksamerica's net identifiable assets at August 18, 1998, Fund American
recorded a $39.8 million deferred credit ($37.1 million as of December 31, 1998)
that will be amortized to income over 5 years.

Supplemental condensed pro forma financial information for the year ended
December 31, 1998, which assumes that Fund American's acquisition of all the
outstanding Folksamerica Common Stock had occurred as of January 1, 1998,
follows:

- ---------------------------------------------------------------------------------------------------------------------
PRO FORMA
YEAR ENDED
Millions, except per share amounts DECEMBER 31, 1998
- ---------------------------------------------------------------------------------------------------------------------

Total revenues $756.0

Net income $ 98.7

Comprehensive net income $ 99.5

BASIC EARNINGS PER SHARE:
Net income $16.19
Comprehensive net income $16.33

DILUTED EARNINGS PER SHARE:
Net income $14.46
Comprehensive net income $14.59
- ---------------------------------------------------------------------------------------------------------------------

The pro forma information presented does not purport to represent what Fund
American's results of operations actually would have been had Fund American
acquired all the outstanding common stock of Folksamerica as of January 1, 1998,
or to project Fund American's results of operations for any future date or
period.

LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE ACTIVITY

The following table summarizes Fund American's loss and loss adjustment
expense reserve activity relating to Folksamerica for the interim period from
August 18, 1998 to December 31, 1998:

F-13

- -------------------------------------------------------------------------------------------------------------------
Millions YEAR ENDED
DECEMBER 31, 1998
- -------------------------------------------------------------------------------------------------------------------

Beginning balance $ -
Gross loss and loss adjustment expenses acquired 726.1
Less beginning reinsurance recoverable (124.1)
-----------------
Net loss and loss adjustment expenses acquired 602.0 Losses and loss adjustment
expenses incurred relating to:
Current year losses 58.6
Prior year losses 1.1
Loss and loss adjustment expenses paid relating to:
Current year losses (13.0)
Prior year losses (54.5)
-----------------
Net ending balance 594.2
Plus ending reinsurance recoverable 129.0
-----------------
Gross ending balance $ 723.2
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

As of December 31, 1998, Folksamerica carried reported case reserves for
environmental and asbestos exposures of $14.9 million ($10.9 million net of
reinsurance) and $29.5 million ($17.9 million net of reinsurance), respectively.
Folksamerica also holds IBNR for these exposures of $25.2 million ($19.2 million
net of reinsurance).

ADDITIONAL REINSURANCE OPERATIONS INFORMATION

For the period from August 18, 1998 to December 31, 1998, Fund American
recorded $73.7 million of premiums written, $85.4 million of premiums earned,
$29.1 million of reinsurance acquisition costs and $59.7 million of loss and
loss adjustment expenses relating to Folksamerica. These amounts are shown net
of reinsurance ceded by Folksamerica of $9.4 million of premiums written, $8.7
million of premiums earned, $.9 million of reinsurance acquisition costs and
$18.9 million of loss and loss adjustment expenses.

Folksamerica's policyholders' surplus, as reported to various regulatory
authorities as of December 31, 1998 was $328.5 million and its statutory net
income for the period from August 18, 1998 to December 31, 1998 was $9.0
million. The principal differences between Folksamerica's statutory amounts and
the amounts reported in accordance with GAAP (Folksamerica's stand-alone
shareholders' equity was $302.0 million at December 31, 1998 and its net income
was $5.5 million for the year then ended) include deferred taxes, deferred
acquisition costs and market value adjustments for debt securities.
Folksamerica's statutory policyholders' surplus at December 31, 1998 was in
excess of the minimum requirements of relevant state insurance regulations.

Under the insurance laws of the states under which Folksamerica is
incorporated or licensed to write business, an insurer is restricted with
respect to the amount of dividends it may pay without prior
approval by state regulatory authorities. Accordingly, there is no assurance
that dividends may be paid by Folksamerica in the future. At December 31, 1998,
Folksamerica had the ability to pay dividends to its shareholders of $32.9
million without prior approval of regulatory authorities.

F-14

NOTE 3. INSURANCE OPERATIONS

CONSOLIDATED INSURANCE OPERATIONS

In 1995 White Mountains created WMIC and commenced its operations. On
December 1, 1995, White Mountains acquired Valley and Charter for $41.7 million
in cash less $3.0 million of purchase price adjustments. The purchase price paid
for Valley and Charter was $.9 million less than the aggregate book value and
estimated fair value of the net assets of the companies on the date of
acquisition. The resulting negative goodwill is being amortized to income on a
straight-line basis over five years. On January 19, 1996, VIC purchased Valley
National for $13.2 million, net of cash balances acquired. Assets acquired
pursuant to the Valley National acquisition included an investment portfolio,
consisting principally of fixed maturity investments, totalling $6.7 million.
The excess purchase price of $6.4 million is being amortized over a five year
period.

In 1998, 1997 and 1996, Valley, Charter and WMIC had $167.8 million, $157.5
million and $154.3 million of gross written premiums, respectively, primarily in
California, Oregon, Texas and Washington. In 1998, 1997 and 1996 Valley, Charter
and WMIC had $160.6 million, $145.3 million and $109.7 million of earned
premiums.

LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE ACTIVITY

The following table summarizes Valley, Charter and WMIC's loss and loss
adjustment expense reserve activity for the years ended December 31, 1998, 1997
and 1996:

- -------------------------------------------------------------------------------------------------------------------
Year Ended
Millions December 31,
---------------------------
1998 1997 1996
---------------------------

Beginning balance $ 71.9 $ 65.4 $ 44.1
Less beginning reinsurance recoverable (8.7) (9.2) (7.3)
---------------------------
Net loss and loss adjustment reserve 63.2 56.2 36.8
Losses and loss adjustment expenses incurred relating to:
Current year losses 108.4 99.6 82.1
Prior year losses 6.7 (2.5) 3.5
Loss and loss adjustment expenses paid relating to:
Current year losses (65.5) (59.7) (47.8)
Prior year losses (33.2) (30.4) (18.4)
---------------------------
Net ending balance 79.6 63.2 56.2
Plus ending reinsurance recoverable 8.9 8.7 9.2
---------------------------
Ending balance $ 88.5 $ 71.9 $ 65.4
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

F-15

ADDITIONAL INSURANCE OPERATIONS INFORMATION

Total policyholders' surplus of Valley, Charter and WMIC, as reported to
various regulatory authorities, as of December 31, 1998 and 1997, was $105.7
million and $97.7 million, respectively. Statutory net income for the years
ended December 31, 1998 and 1997 for Valley, Charter and WMIC totalled $8.4
million and $11.0 million, respectively. For the year ended December 31, 1996,
Valley had a statutory net loss of $6.4 million. The principal differences
between Valley, Charter and WMIC's statutory amounts and the amounts reported in
accordance with GAAP (VGI's stand-alone shareholders' equity was $109.4 million
at December 31, 1998 and its net income was $4.8 million for the year then
ended) include deferred taxes, surplus debentures and deferred acquisition
costs. Valley, Charter and WMIC's statutory policyholders' surplus at December
31, 1998 and 1997, was in excess of the minimum requirements of relevant state
insurance regulations.

Under the insurance laws of the various states under which Valley, Charter
and WMIC are incorporated or licensed to write business, an insurer is
restricted with respect to the amount of dividends it may pay without prior
approval by state regulatory authorities. Accordingly, there is no assurance
that dividends may be paid by Valley, Charter and WMIC in the future. At
December 31, 1998 and 1997, $1.1 million and $9.8 million, respectively, of
Valley, Charter and WMIC's statutory surplus was available for the payment of
dividends to its shareholders without prior approval of regulatory authorities.

NOTE 4. INVESTMENT SECURITIES

Fund American's net investment income is comprised primarily of interest
income earned on mortgage loans held for sale (gross of related interest expense
on short-term borrowings used to finance such loans), interest income from its
fixed maturity investments, dividend income from its equity investments and
interest income from its short-term investments. Net investment income consisted
of the following:

- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------------
Millions 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

Investment income:
Mortgage loans held for sale $ 81.4 $ 43.1 $ 39.3
Fixed maturity investments 28.4 11.3 10.4
Common equity securities 3.6 7.3 4.3
Short-term investments 3.5 3.9 6.6
Other 2.3 - (2.3)
-------------------------------------
Total investment income 119.2 65.6 58.3
Less investment expenses and other charges (.8) (.5) (1.0)
-------------------------------------
Net investment income, before tax $118.4 $ 65.1 $ 57.3
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

F-16

Total net investment gains, before tax, associated with Fund American's
investment portfolio consisted of the following:

- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------------
Millions 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

Gross realized investment gains $ 74.0 $ 98.6 $ 43.3
Gross realized investment losses (3.0) (1.9) (4.8)
-------------------------------------
Net realized investment gains 71.0 96.7 38.5
Change in net unrealized investment holding gains (a) (44.2) (10.1) 68.0
-------------------------------------
Total net investment gains, before tax $ 26.8 $ 86.6 $ 106.5
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

(a) Excludes net unrealized investment gains and losses recorded from Fund
American's investments in unconsolidated insurance affiliates.

The components of Fund American's ending net unrealized investment gains
and losses on its investment portfolio and its investments in unconsolidated
insurance affiliates were as follows:

- ---------------------------------------------------------------------------------------------------------------------
December 31,
------------------------
Millions 1998 1997
- ---------------------------------------------------------------------------------------------------------------------

Investment securities:
Gross unrealized investment gains $ 68.4 $ 112.1
Gross unrealized investment losses (2.5) (2.0)
------------------------
Net unrealized gains from investment securities 65.9 110.1
Net unrealized gains from investments in unconsolidated insurance affiliates 128.1 96.2
------------------------
Total net unrealized investment gains, before tax $ 194.0 $ 206.3
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

F-17

The cost or amortized cost, gross unrealized investment gains and losses,
and carrying values of Fund American's fixed maturity investments as of December
31, 1998 and 1997, were as follows:

- ---------------------------------------------------------------------------------------------------------------------
December 31, 1998
---------------------------------------------------------
Cost or Gross Gross
amortized unrealized unrealized Carrying
Millions cost gains losses value
- ---------------------------------------------------------------------------------------------------------------------

Debt securities issued by industrial corporations $351.9 $ 7.0 $(1.0) $357.9
U. S. Government and agency obligations 217.6 4.7 (.3) 222.0
Municipal obligations 189.1 2.8 (.1) 191.8
GNMA Mortgage-backed securities 79.0 .9 (.7) 79.2
MediaOne redeemable preferred stock 49.8 - - 49.8
Foreign government obligations 26.7 .3 (.1) 26.9
Aggregate of holdings less than $10 million 2.0 - - 2.0
---------------------------------------------------------
Total fixed maturity investments $916.1 $15.7 $(2.2) $929.6
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

December 31, 1997
---------------------------------------------------------
Cost or Gross Gross
amortized unrealized unrealized Carrying
Millions cost gains losses value
- ---------------------------------------------------------------------------------------------------------------------

MediaOne redeemable preferred stock $ 49.4 $ - $ - $ 49.4
Municipal obligations 33.3 .6 - 33.9
Debt securities issued by industrial corporations 32.4 1.0 (.7) 32.7
U. S. Government and agency obligations 32.3 .9 - 33.2
GNMA Mortgage-backed securities 15.4 1.0 - 16.4
Aggregate of holdings less than $10 million 2.6 .1 - 2.7
---------------------------------------------------------
Total fixed maturity investments $165.4 $3.6 $(.7) $168.3
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

The cost or amortized cost and carrying value of Fund American's fixed
maturity investments at December 31, 1998 and 1997, are presented below by
contractual maturity. Actual maturities could differ from contractual maturities
because borrowers have the right to call or prepay certain obligations with or
without call or prepayment penalties.

- ---------------------------------------------------------------------------------------------------------------------
December 31, 1998
--------------------------
Cost or
Amortized Carrying
Millions Cost Value
- ---------------------------------------------------------------------------------------------------------------------

Due in one year or less $109.4 $108.1
Due after one year through five years 278.9 279.9
Due after five years through ten years 352.8 365.9
Due after ten years 98.0 99.1
GNMA Mortgage-backed securities 77.0 76.6
----------------------------
Total $916.1 $929.6
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

F-18

Sales of investments, excluding short-term investments, totalled $301.3
million, $300.4 million and $363.3 million for the years ended December 31,
1998, 1997 and 1996, respectively. A non-cash exchange of investment securities
totalling $2.3 million is not reflected in the 1996 Consolidated Statement of
Cash Flows. There were no non-cash exchanges of investment securities during
1998 or 1997.

Fund American adopted the provisions of SFAS No. 130 during 1997 and now
reports the change in net unrealized investment gains, after tax, on its income
statement to arrive at comprehensive net income. All prior period income
statements have been restated to reflect application of this statement. The
components of the change in net unrealized investment gains, after tax, are as
follows:

- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
Millions 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

Net realized investment gains $ 71.0 $ 96.7 $ 38.5
Income tax expense applicable to net realized investment gains (24.9) (33.8) (13.5)
--------------------------------------
Net realized investment gains, after tax $ 46.1 $ 62.9 $ 25.0
--------------------------------------
--------------------------------------
Net unrealized investment holding gains arising during the year $ 58.6 $ 160.9 $ 122.5
Income tax expense applicable to net unrealized investment holding gains (20.5) (56.3) (42.9)
--------------------------------------
Net unrealized investment holding gains arising during the year, after tax 38.1 104.6 79.6
Net unrealized gains reclassed to realized gains for investments sold, after tax(46.1) (62.9) (25.0)
--------------------------------------
Change in net unrealized investment gains, after tax $(8.0)(a) $ 41.7 $ 54.6
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

(a) Excludes a $.9 million after tax unrealized loss associated with foreign
currency translation adjustments

NOTE 5. CAPITALIZED MORTGAGE SERVICING

Source One estimates the fair values of its mortgage servicing rights by
calculating the present value of the expected future net cash flows associated
with such rights. In making those estimates, Source One incorporates assumptions
that market participants would use in their estimates of future servicing income
and expense.

To measure impairment of its owned mortgage servicing rights, Source One
has determined that the predominant risk characteristics inherent in the
portfolio are prepayment risk, risk of default and operational risk. As a
result, Source One has stratified its owned mortgage loan servicing portfolio by
interest rate, loan type (investor), original term to maturity and principal
recourse.

In estimating the fair value of its owned mortgage loan servicing
portfolio, Source One uses market consensus prepayment rates and discounts
future net cash flows using representative market interest rates which were
10.5% for conventional loans, 12.0% for insured loans, and 21.0% for recourse
loans. The fair value of each stratum is computed and compared to its recorded
book value to determine if an

F-19

impairment valuation allowance, or recovery of a previously established
valuation allowance, is required.

As a result of the 1997 servicing sale, Source One's recourse portfolio has
become a significant component of its total remaining owned servicing portfolio.
Included in Source One's calculation for measuring impairment of its capitalized
servicing asset is an $5.2 million and $8.2 million pretax reserve for estimated
recourse losses on the corresponding loans in determining the fair value of its
principal recourse portfolio as of December 31, 1998 and 1997, respectively.

The discount rate and prepayment assumptions are significant factors used
in estimating the fair value of Source One's mortgage servicing rights.
Accordingly, the value of mortgage servicing rights can be significantly
impacted by changes in interest rates.

Source One adopted certain provisions of SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
in the 1997 first quarter. SFAS No. 125 served to eliminate the distinction
between "normal" servicing rights and excess servicing receivables. Source One
estimated the fair value of its portfolio during 1997 in accordance with SFAS
No. 125 which did not materially effect Source One's 1997 results.

Prior to the adoption of SFAS No. 125, Source One estimated the fair value
of its capitalized excess servicing asset by discounting the anticipated future
cash flows over the estimated life of the related loans. Source One uses
"interest only strip" interest rates to determine the appropriate discount rates
and prepayment speed assumption rates that are based on interest rates, loan
types (investor) and original term to maturity. The discount rate used to
capitalize excess servicing for the year ended December 31, 1996, ranged from
12.0% to 12.6%. For the year ended December 31, 1996, the weighted average
discount rate inherent in the carrying amount of the capitalized excess
servicing asset was 10.4%.

The following table summarizes the fair value of mortgage servicing rights
and certain characteristics of Source One's servicing portfolio related to such
mortgage servicing rights by loan type as of December 31, 1998:

- ---------------------------------------------------------------------------------------------------------------------
Fair value Principal Weighted Weighted Weighted
of mortgage balance average average average
servicing rights serviced(a) interest maturity service
(millions) (millions) rate (months) fee
- ---------------------------------------------------------------------------------------------------------------------

Loan Type:
Insured $117.4 $4,901 7.47% 334 .50%
Conventional 33.0 1,573 7.78 271 .39
Recourse 25.9 1,787 8.43 202 .47
Adjustable 1.7 106 7.89 256 .41
--------------------------------
Total servicing portfolio $178.0 $8,367 7.74% 293 .47%
- ---------------------------------------------------------------------------------------------------------------------

F-20

(a) Excludes $635 million of principal balance of mortgage servicing rights not
capitalized prior to the adoption of an accounting standard implemented by
Source One in 1995 and $195 million of originations funded but not yet
capitalized.

The following table summarizes changes in Source One's capitalized servicing
asset:

- ---------------------------------------------------------------------------------------------------------------------
Deferred
gain on Total
Mortgage Valuation sale of capitalized
Millions servicing allowance Subservicing servicing servicing
- ---------------------------------------------------------------------------------------------------------------------

Balances at January 1, 1996 $438.1 $(28.0) $ - $(13.0) $397.1
Additions 125.5 - - - 125.5
Scheduled amortization (69.9) - - - (69.9)
Impairment/unscheduled amortization (1.1) (8.2) - - (9.3)
Amortization of deferred gain - - - 6.1 6.1
Recourse loan losses - 7.3 - - 7.3
Sales (45.9) - - - (45.9)
- ---------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 446.7 (28.9) - (6.9) 410.9
Additions 90.4 (1.2) - - 89.2
Scheduled amortization (37.5) - (8.9) - (46.4)
Impairment/unscheduled amortization - (21.2) (.5) - (21.7)
Amortization of deferred gain - - - 6.9 6.9
Recourse loan losses - 3.9 - - 3.9
Sales (273.7) 2.3 9.6 - (261.8)
- ---------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 225.9 (45.1) .2 - 181.0
Additions 240.8 - - - 240.8
Scheduled amortization (38.6) - (1.8) - (40.4)
Impairment/unscheduled amortization - (14.7) - - (14.7)
Recourse loan losses - 2.7 - - 2.7
Sales (221.2) 21.5 - - (199.7)
- ---------------------------------------------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 1998 $206.9 $(35.6) $(1.6) $ - $169.7
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

F-21

During 1998 Source One sold the rights to service $10.6 billion of
nonrecourse mortgage loans for cash proceeds of $227.9 million resulting in a
pretax gain on sale of $15.2 million. During 1997 Source One sold the rights to
service $17.0 billion of nonrecourse mortgage loans for cash proceeds of $266.9
million resulting in a pretax loss on sale of $8.0 million including a related
loss on the assumption of subservicing. During 1996 Source One sold the rights
to service $3.3 billion of mortgage loans for net proceeds of $55.9 million,
resulting in a pretax gain of $10.1 million. As part of the 1998 and 1997
servicing sales, Source One retained the right to subservice $4.1 billion and
$17.0 billion of these loans, respectively, for a contracted fee through 2001.
Subservicing assets are amortized on a straight-line basis over the subservicing
period and are tested for impairment.

During 1994 Source One sold the rights to service $3.9 billion of mortgage
loans to a third party and retained the rights to subservice those loans
pursuant to a subservicing agreement. In connection with the servicing sale, a
pretax gain of $19.9 million was deferred in 1994 and was to be recognized as
income over the five-year life of the subservicing agreement. In 1996, the third
party sold the rights to service approximately $1.0 billion of these loans
subserviced by Source One which resulted in Source One recognizing $2.4 million
of the deferred gain on an accelerated basis. In 1997, the third party sold the
remainder of the loans subserviced by Source One which resulted in Source One
recognizing the remaining balance of the deferred gain during 1997.

NOTE 6. MORTGAGE SERVICING

Source One services loans throughout the United States. Source One's
portfolio of mortgage loans serviced (including loans subserviced, interim
servicing contracts and portfolios under contract to acquire but excluding loans
sold but not transferred) totalled $25.1 billion and $26.5 billion as of
December 31, 1998 and 1997, respectively. The following table summarizes the
mortgage loan servicing portfolio as of December 31, 1998:

- ---------------------------------------------------------------------------------------------------------------------
Weighted average
---------------------------------------------------------------
Principal Remaining
balance Loan contractual
serviced balance Interest Net servicing life
Loan type (millions) (thousands) rate fee rate (months)
- ---------------------------------------------------------------------------------------------------------------------

Residential
Conventional $ 3,929 $ 64 8.14% .396% 237
FHA 2,486 75 7.74 .398 334
VA 2,736 81 7.26 .400 331
Commercial 46 927 7.16 .189 173
-------------
Owned servicing portfolio $ 9,197 $ 72 7.76% .397% 291
Subservicing portfolio 15,915
-------------
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

Total mortgage servicing portfolio $25,112
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

The servicing fee rates in the preceding table are shown after deducting
applicable guarantee fees. Guarantee fees, when applicable, range from 6 basis
points for governmental loans to approximately 30 basis points for certain
conventional loans. Certain loans sold to private investors have no guarantee
fees.

F-22

The following tables summarize Source One's owned mortgage loan servicing
portfolio by interest rate range and by location of property:

- ---------------------------------------------------------------------------------------------------------------------
December 31, 1998 December 31, 1997
------------------------------------------- --------------------------------------------
Aggregate Weighted Aggregate Weighted
Number principal average Number principal average
Interest rate of balance interest of balance interest
range loans (millions) rate loans (millions) rate
- --------------------- ------------------------------------------- --------------------------------------------

5.99% and lower 438 35 5.17% 843 $ 66 5.41%
6.00% - 6.49% 1,193 127 6.22 1,823 159 6.13
6.50% - 6.99% 10,870 1,111 6.64 4,166 319 6.66
7.00% - 7.49% 28,036 2,337 7.08 12,968 729 7.17
7.50% - 7.99% 30,928 2,550 7.58 29,240 2,455 7.63
8.00% - 8.49% 15,778 1,155 8.12 27,989 2,280 8.13
8.50% - 8.99% 17,999 809 8.62 32,178 1,867 8.59
9.00% - 9.49% 5,934 275 9.12 13,452 722 9.07
9.50% - 9.99% 7,580 339 9.64 29,142 1,420 9.55
10% and above 9,574 459 10.73 32,488 1,610 10.49
------------------------------------------- --------------------------------------------
Total 128,330 $9,197 7.76% 184,289 $11,627 8.52%
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

- ---------------------------------------------------------------------------------------------------------------------
December 31, 1998 December 31, 1997
------------------------------------------- ---------------------------------------------
Aggregate Aggregate
Number principal Percentage Number principal Percentage
of balance of servicing of balance of servicing
State loans (millions) portfolio loans (millions) portfolio
- --------------------- ------------------------------------------- ---------------------------------------------

California 17,617 $1,795 19.5% 20,459 $ 1,889 16.3%
New York 17,572 935 10.2 22,118 1,162 10.0
Texas 11,448 676 7.4 15,655 736 6.3
Washington 5,033 486 5.3 7,889 690 5.9
Florida 7,849 471 5.1 12,894 663 5.7
Michigan 7,810 393 4.3 10,773 520 4.5
Maryland 4,159 377 4.1 5,020 362 3.1
New Jersey 5,145 364 4.0 7,088 503 4.3
Ohio 4,461 298 3.2 6,658 357 3.1
Illinois 3,441 260 2.8 6,335 420 3.6
Other 43,795 3,142 34.1 69,400 4,325 37.2
------------------------------------------- ---------------------------------------------
Total 128,330 $9,197 100.0% 184,289 $11,627 100.0%
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

Escrow funds of approximately $207.9 million and $196.8 million as of
December 31, 1998 and 1997, respectively, relating to mortgages serviced and
subserviced, were held in non-interest bearing accounts at non-affiliated banks
and are not included in the consolidated financial statements.

F-23

NOTE 7. MORTGAGE LOANS HELD FOR SALE AND POOL LOAN PURCHASES

The following tables summarize Source One's mortgage loans held for sale
and pool loan purchases:

- ---------------------------------------------------------------------------------------------------------------------
December 31,
---------------------------
Millions 1998 1997
- ---------------------------------------------------------------------------------------------------------------------

Adjustable rate mortgage loans, weighted average
interest rates of 6.39% and 6.36% $ 15.1 $ 51.6
Fixed rate 5 year through 25 year mortgage loans,
weighted average interest rates of 7.10 and 7.68% 240.0 60.4
Fixed rate 30 year mortgage loans, weighted average
interest rates of 7.33% and 7.76% 420.3 405.0
---------------------------
Total principal amount 675.4 517.0
Net premiums .9 2.3
---------------------------
Total mortgage loans held for sale $676.3 $ 519.3

- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

- ---------------------------------------------------------------------------------------------------------------------
December 31,
----------------------------------------------------
Principal balance Number of loans
---------------------- ---------------------
Dollars in Millions 1998 1997 1998 1997
- --------------------------------------------------------------------------------------- ---------------------

Loan type: FHA $119.6 $103.1 1,640 1,781
VA 45.3 43.3 550 669
Conventional .1 3.4 4 45
---------------------- ---------------------
Total pool loan purchases $165.0 $149.8 2,194 2,495
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

F-24

NOTE 8. DEBT

SHORT-TERM DEBT

Short-term debt outstanding consisted of the following:

- ---------------------------------------------------------------------------------------------------------------------
December 31,
----------------------------
Millions 1998 1997
- ---------------------------------------------------------------------------------------------------------------------

White Mountains: Credit facility $ 50.0 $ -
Charter: Notes payable and lease obligations 1.5 2.0
Source One:
Credit agreement borrowings 697.3 569.5
Less net discounts (.3) (.1)
----------------------------
Total Source One 697.0 569.4
----------------------------
Total short-term debt $748.5 $ 571.4
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

The weighted average interest rates of short-term debt outstanding during
the year ended December 31, 1998 and 1997 were as follows:

- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------
1998 1997
- ---------------------------------------------------------------------------------------------------------------------

White Mountains: Credit facility 6.20% 6.04%
Charter: Notes payable 6.50% 6.50%
Source One:
Credit agreement borrowings 5.79% 6.34%
Commercial paper and short-term borrowings - % 5.81%
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

In August 1998 the Company entered into a $35.0 million revolving credit
agreement with a syndicate of banks which served to replace an expiring
arrangement in the same amount. Under the agreement, through August 12, 1999 the
Company may borrow up to $35.0 million at short-term market interest rates. The
credit agreement contains certain customary covenants and conditions. At
December 31, 1998 the Company was in compliance with all covenants under the
facility and had no borrowings outstanding under the agreement. At December 31,
1997 the Company had no outstanding borrowings under the former facility.

In November 1996 White Mountains entered into a five year revolving credit
facility under which it may borrow up to $50.0 million at market interest rates.
At December 31, 1998 White Mountains had $50.0 million of borrowings outstanding
under the facility which was used to partially fund White Mountains additional
investment in MSA and its acquisition of Folksamerica during 1998. White
Mountains had no borrowings outstanding at December 31, 1997 under the facility.

During 1996 Charter extended $3.2 million of notes payable to be repaid in
three equal installments in 1997, 1998 and 1999. As of December 31, 1998 $1.1
million of the notes remained outstanding. The notes are collateralized by
certain assets of Charter.

F-25

In July 1998 Source One amended and restated its $600.0 million secured
revolving credit agreement to increase its borrowing capacity and flexibility.
The provisions of the amended agreement increased Source One's borrowing
capacity to $800.0 million. The facility expires on July 9, 1999. At December
31, 1998, Source One was in compliance with all covenants under the agreement
and had $650.5 million of borrowings outstanding under this agreement.

During the second quarter of 1998 Source One entered into two additional
secured credit agreements whereby it may borrow up to $35.0 million and $175.0
million through July 1999 and April 1999, respectively. At December 31, 1998,
Source One had a total of $21.6 million in borrowings outstanding under these
agreements.

In April 1998 Source One replaced its existing $15.0 million unsecured
revolving credit agreement under which it can borrow up to $40.0 million through
April 15, 1999. As of December 31, 1998, there was $25.2 million outstanding
under the revolving credit agreement.

In July 1997 Source One amended and restated its secured revolving credit
agreement to reflect a reduction in its borrowing requirements resulting from
the 1997 servicing sale. The provisions of the amended agreement decreased
Source One's revolving credit facility from $750.0 million to $600.0 million and
reduced Source One's borrowing costs by lowering the facility fee. At December
31, 1997, Source One was in compliance with all covenants and had $559.0 million
of borrowing outstanding under this facility.

In May 1997 Source One entered a unsecured revolving credit agreement under
which it can borrow up to $15.0 million through June 1, 1998. As of December 31,
1997, there was $10.5 million outstanding under the revolving credit agreement.

Source One must comply with certain financial covenants provided in its
secured and unsecured revolving credit facilities, including restrictions
relating to tangible net worth and leverage. In addition, the secured facility
contains certain covenants which limit Source One's ability to pay dividends or
make distributions of its capital in excess of preferred stock dividends and
subordinated debt interest requirements each year. Source One is currently in
compliance with all such covenants.

F-26

LONG-TERM DEBT

Long-term debt outstanding consisted of the following:

- ---------------------------------------------------------------------------------------------------------------------
December 31,
----------------------------
Millions 1998 1997
- ---------------------------------------------------------------------------------------------------------------------

Parent Company:
Medium-term notes $116.3 $116.3
Less net discounts (.6) (.7)
----------------------------
Total Parent Company 115.7 115.6
----------------------------
Folksamerica: Medium-term notes 55.6 -
Valley: Medium-term notes 15.0 15.0
Charter: Notes payable in 1999 - 1.1
Source One:
Medium-term notes, 8.875% due in 2001 18.7 18.7
Debentures, 9.0% due in 2012 100.0 100.0
Subordinate debentures, 9.375% due in 2025 56.0 56.0
Less net discounts (1.3) (2.1)
----------------------------
Total Source One 173.4 172.6
----------------------------
Total long-term debt $359.7 $304.3
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

At December 31, 1998, the Parent Company had $116.3 million of outstanding
medium-term notes with an average maturity of 4.4 years and a yield to maturity
of 7.82%.

Folksamerica has $55.6 million of medium-term notes outstanding which are
guaranteed by one of the European Mutuals. As part of the August 18, 1998
Folksamerica acquisition, Fund American guaranteed Folksamerica's debt to the
former owner and agreed to repay or refinance the obligation during the 1999
first quarter. The Folksamerica medium-term notes had scheduled maturities from
2001 to 2005 and had a weighted average interest rate of approximately 5.65%
from August 18, 1998 to December 31, 1998.

Valley has a five year credit facility under which it may borrow up to
$15.0 million at market interest rates. During 1998 and 1997 Valley had $15.0
million of borrowings outstanding under the facility with a weighted average
interest rate of 6.14% and 6.09%, respectively.

In 1991 Source One issued $160.0 million of 8.875% medium-term notes due in
2001 of which $138.4 million remained outstanding at December 31, 1996. During
1997 Source One repurchased and retired in principal amount $119.7 million of
these notes leaving $18.7 million outstanding at December 31, 1997 and 1998.

In 1992 Source One issued $100.0 million of 9% debentures due in 2012
pursuant to a $250.0 million shelf registration statement. The debentures may
not be redeemed by Source One prior to maturity. The proceeds from issuance were
used for general corporate purposes.

In December 1995, Source One exchanged and retired 2,239,061 shares Source
One Preferred Stock for $56.0 million in principal amount of 9.375% subordinated
debentures. The subordinated debentures are due in

F-27

2025 but are redeemable at the option of Source One, in whole or part, at any
time on or after May 1, 1999.

In connection with Source One's February 28, 1997 sale of approximately
$17.0 billion of mortgage servicing rights to a third party, the Company has
made certain collection, payment and performance guarantees to the buyer for a
period of no more than ten years. The aggregate amount of the Company's guaranty
is initially limited to $20.0 million and amortizes down to $15.0 million as
mortgage loans serviced under agreement are repaid. During 1998, the Company
permitted the third party to include an additional $2.9 billion of mortgage
servicing rights that it purchased from Source One during 1998 to be included in
the guaranty, however, the inclusion of the 1998 servicing rights sold did not
serve to change the maximum amount of the guarantee or the original term of the
agreement.

Total interest paid by Fund American for both short-term and long-term debt
was $83.5 million, $51.9 million and $51.5 million in 1998, 1997 and 1996,
respectively.

Fund American's long-term debt maturities, including the current portion of
long-term debt, for 1999, 2000, 2001, 2002, 2003 and beyond are $57.7 million,
$6.0 million, $20.7 million, $10.0 million, $102.3 million and $166.0 million,
respectively.

NOTE 9. INCOME TAXES

The Company and its subsidiaries file a consolidated Federal income tax
return. The Federal income tax provision is computed on the consolidated taxable
income of the Company and those subsidiaries.

The total income tax provision consisted of the following:

- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
Millions 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

Tax on pretax earnings:
Federal $ 45.2 $26.7 $ 18.1
State and local 2.6 2.7 .8
---------------------------------------------
Income tax provision on pretax earnings 47.8 29.4 18.9
Tax benefit from loss on early extinguishment of debt - 3.2 -
---------------------------------------------
Total income tax provision $ 47.8 $32.6 $ 18.9
---------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
Net income tax payments $ 35.7 $24.9 $ 7.0
---------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
Tax provision recorded directly to shareholders' equity related to:
Changes in net unrealized investment gains and losses $(4.3) $22.5 $ 29.4
Changes in net foreign currency translation gains and losses $ (.5) $ - $ -
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

F-28

The components of the income tax provision (benefit) on pretax earnings
follow:

- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
---------------------------------------------
Millions 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

Current provision $ 49.0 $33.5 $ 22.5
Deferred benefit (1.2) (4.1) (3.6)
---------------------------------------------
Total income tax provision on pretax earnings $ 47.8 $29.4 $ 18.9
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax return purposes. Fund American
recorded a net deferred Federal income tax asset of $7.8 million as of December
31, 1998 and a net deferred Federal income tax liability of $19.6 million as of
December 31, 1997. Significant components of Fund American's net deferred
Federal income tax asset and liability follow:

- ---------------------------------------------------------------------------------------------------------------------
December 31,
Millions 1998 1997
- ---------------------------------------------------------------------------------------------------------------------

Deferred tax assets related to:
Employee compensation and benefit accruals $ 51.1 $ 39.1
Discounting of loss reserves 40.1 2.9
Capitalized mortgage servicing 21.1 26.2
Unearned insurance premiums 10.5 5.3
Allowance for mortgage loan losses 4.3 4.8
Other items 15.8 10.1
--------------------------
Total deferred tax assets $ 142.9 $ 88.4
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

F-29

- ---------------------------------------------------------------------------------------------------------------------
December 31,
--------------------------
Millions 1998 1997
- ---------------------------------------------------------------------------------------------------------------------

Deferred tax liabilities related to:
Net unrealized investment holding gains $ 83.0 $ 71.4
Earnings from insurance affiliates 17.5 11.8
Deferred acquisition costs 12.4 5.0
Purchase accounting adjustments 4.8 5.5
Unrealized gains on financial instruments 4.3 4.6
Other items 13.1 9.7
--------------------------
Total deferred tax liabilities $135.1 $108.0
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

A reconciliation of taxes calculated using the 35% Federal statutory rate
to the income tax provision on pretax earnings follows:

- ---------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
---------------------------------------
Millions 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

Tax provision at Federal statutory rate $45.4 $27.4 $ 9.6
Differences in taxes resulting from:
Dividends received deduction (2.6) (3.1) (2.3)
Nonconventional fuel source tax credits (1.1) (2.4) -
Tax reserve adjustments 5.4 5.1 4.2
State income taxes 1.7 1.8 .5
Write-off of goodwill and other intangible assets - - 8.1
Other, net (1.0) .6 (1.2)
---------------------------------------
Total income tax provision on pretax earnings $47.8 $29.4 $18.9
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

The Company believes that it is more likely than not that results of future
operations will generate sufficient taxable income to realize the deferred tax
asset balances carried as of December 31, 1998 and 1997.

NOTE 10. RETIREMENT AND POST-RETIREMENT PLANS

The Company has an unfunded, nonqualified defined contribution plan for a
select group of management employees for the purpose of providing retirement
benefits (the "Deferred Benefit Plan"). The amount of annual contribution to the
Deferred Benefit Plan is determined using actuarial assumptions. At December 31,
1998 and 1997, Fund American's liability to participants pursuant to the
Deferred Benefit Plan was $4.8 million and $3.9 million, respectively.

The Company also has an unfunded, nonqualified plan for a select group
of management employees for the purpose of deferring current compensation for
retirement savings (the "Deferred Compensation Plan"). Pursuant to the
Deferred Compensation Plan, participants may voluntarily defer all or a
portion of qualifying remuneration payable by Fund American. At December 31,
1998 and 1997, Fund American's liability to participants pursuant to the
Deferred Compensation Plan was $65.1 million and $37.6 million, respectively.

Source One, Folksamerica and Valley have defined contribution employee
savings plans for the benefit of substantially all their employees. The costs of
these plans are not material to Fund American's financial statements.

F-30

Fund American also has various defined benefit pension plans for the
benefit of the majority of its employees. Benefits under these plans are based
on years of service and each employee's highest average eligible compensation
over five consecutive years in his or her last ten years of employment. Cash
contributions made by Fund American totalled less than $1.0 million for the
years ended December 31, 1998 and 1997 and the projected benefit obligation of
such plans totalled $11.0 million and $11.3 million, respectively, as of those
dates.

Fund American's postretirement benefit costs, included in accounts payable
and other liabilities, were $3.8 million and $3.7 million at December 31, 1998
and 1997, respectively.

NOTE 11. EMPLOYEE STOCK PLANS

Fund American's Long-Term Incentive Plan (the "Incentive Plan") provides
for granting to executive officers and other key employees of the Company (and
certain of its subsidiaries) various types of stock-based incentive awards
including stock options and performance shares. At December 31, 1998, 329,200
Shares remained available for grants under the Incentive Plan.

Performance shares are conditional grants of a specified maximum number of
Shares or an equivalent amount of cash. The grants are generally payable,
subject to the attainment of a specified after tax return on equity at the end
of a three year period or as otherwise determined by the Compensation Committee
of the Board. The Compensation Committee consists solely of disinterested,
non-management directors.

Pursuant to the Incentive Plan 47,800, 50,000 and 73,000 performance shares
were granted in 1998, 1997 and 1996, respectively, of which 5,150, 4,300 and
14,000 of the performance shares granted, respectively, remain unallocated to
participants as of December 31, 1998 and are not deemed to be outstanding.
During 1998, 1997 and 1996, 47,129, 22,944 and 0 performance shares were paid in
cash, respectively. At December 31, 1998, 147,350 performance shares were
outstanding. The financial goal for full payment of the performance shares is
the achievement of a 13% annual after tax return on equity as measured over the
applicable performance periods.

As of December 31, 1998, 1997 and 1996 there were 2,000, 2,000 and 3,000
stock options outstanding, respectively, which had exercise prices ranging from
$24.82 to $32.60 per Share. All Fund American stock options outstanding during
the three year period ended December 31, 1998, were fully vested and
exercisable. No new stock options have been issued to Fund American employees
since 1990.

In 1985 the Company's Chairman purchased warrants (the "Warrants") from
American Express Company ("American Express") entitling him to buy 1,700,000
Shares for $25.75 per Share. Warrants to purchase 420,000 Shares, 130,000 Shares
and 150,000 Shares were exercised by the Chairman during 1992, 1994 and 1995,
respectively, leaving Warrants to purchase 1,000,000 Shares outstanding at
December 31, 1995. Pursuant to a proposal approved by shareholders at the
Company's 1995 Annual Meeting, the expiration date with respect to the Warrants
was extended from January 2, 1996, to January 2, 2002. In accordance with APB
No. 25, the

F-31

extension of the Warrants resulted in a $46.2 million pretax charge to
compensation expense which was recorded in the second quarter of 1995. No
Warrants were exercised by the Chairman during 1998 and 1997. Pursuant to
certain anti-dilution adjustments related to the distribution of White River
Shares to the Company's shareholders, the exercise price for the Warrants to
purchase Fund American Shares was reduced to $21.66 per Share.

All employees (other than employees of Source One, FAE and Folksamerica are
eligible to participate in an employee savings plan qualified under Section
401(k) of the Internal Revenue Code ("IRC") (the "Valley 401(k) Plan").
Contributions to the Valley 401(k) Plan can be invested in various investment
options including Shares. There is an employer match provision to the Valley
401(k) Plan which is equal to 50% of the first 6% of employee compensation
contributed to the plan, subject to IRC limits. Fund American added Shares to
the investment options offered under the Valley 401(k) Plan as of July 1, 1997.
As of December 31, 1998 participants of the Valley 401(k) Plan owned a total of
3,949 Shares.

All employees of Folksamerica are eligible to participate in an employee
savings plan qualified under Section 401(k) of the Internal Revenue Code ("IRC")
(the "Folksamerica 401(k) Plan"). Contributions to the Folksamerica 401(k) Plan
can be invested in various investment options. The Folksamerica 401(k) Plan does
not currently provide for investments in Shares. There is an employer match
provision to the Folksamerica 401(k) Plan which is equal to 100% of the first 6%
of employee compensation contributed to the plan, subject to IRC limits.

Source One also has a qualified employee savings plan (the "Source One
401(k) Plan"). Contributions to the Source One 401(k) Plan can be invested in
various investments including Shares. In 1997, Source One added a matching
contribution feature to the Source One 401(k) Plan which is equal to a certain
percentage of employee contributions, up to a maximum of 5%, dependent upon
Source One's return on equity. As of December 31, 1998, participants of the
Source One 401(k) Plan owned a total of 38,046 Shares.

SFAS No. 123, "Accounting for Stock Based Compensation," requires
disclosure regarding all employee stock options and encourages companies to
recognize compensation expense for stock-based awards based on the fair value of
such awards on the date of grant. Alternatively, companies may continue
following existing accounting standards provided that disclosures are made
regarding the net income and earnings per share impact as if the value
recognition and measurement criteria of SFAS No. 123 had been adopted. Fund
American has not adopted the recognition and measurement criteria of SFAS No.
123 and alternatively has chosen to disclose the pro forma effects of SFAS No.
123 as it relates to outstanding Warrants and performance shares granted in
1998, 1997 and 1996, as follows:

F-32

- -------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------------
Millions, except per share amounts 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------

Net income:
As reported $ 82.2 $43.0 $ 8.6
Pro forma 77.4 39.4 -
- -------------------------------------------------------------------------------------------------------------------
Basic net income per share:
As reported $13.38 $5.98 $ .66
Pro forma 12.56 5.99 -
- -------------------------------------------------------------------------------------------------------------------
Diluted net income per share:
As reported $11.94 $5.40 $ .60
Pro forma 11.20 5.41 -
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

SFAS No. 123 provides for the expense of Warrants, stock options and
performance shares over the life of the award using the Black Scholes option
pricing model. Significant assumptions used include a 5.0% risk-free interest
rate, an expected Share volatility of .167 and an expected life of five years
for Warrants and three years for performance shares. In determining the pro
forma effects of SFAS No. 123, the Company recognizes the pro forma expense of
the Warrants over time. The pro forma net income figures disclosed above may not
be representative of the effects on reported net income to be reported in future
years.

NOTE 12. MINORITY INTEREST - PREFERRED STOCK OF SUBSIDIARY

In 1994 Source One issued 4,000,000 shares of 8.42% Source One Preferred
Stock, having a liquidation preference of $25.00 per share, for net cash
proceeds of $96.8 million. On December 8, 1995, Source One exchanged and retired
2,239,061 shares of Source One Preferred Stock for $56.0 million in principal
amount of subordinated debentures. The Source One Preferred Stock is not
redeemable prior to May 1, 1999.

NOTE 13. SHAREHOLDERS' EQUITY

COMMON SHARE REPURCHASES

During 1998, 1997 and 1996 the Company repurchased 151,916 Shares, 924,739
Shares and 779,077 Shares, respectively, for $19.8 million, $103.7 million and
$66.3 million, respectively. All Shares repurchased during 1998, 1997 and 1996
have been retired. At December 31, 1998, the Company had outstanding
authorization to purchase an additional 41,501 Shares.

CAPITAL STOCK DIVIDENDS

During 1998 and 1997 the Company declared and paid quarterly cash dividends
of $.40 per Share and $.20 per Share, respectively. During 1998 and 1997 Source
One declared and paid quarterly cash dividends of $2.105 per share of Source One
Preferred Stock.

F-33

NOTE 14. SEGMENT INFORMATION

Fund American has determined that its reportable segments include Mortgage
Banking (Source One), Property and Casualty Insurance (Valley, Charter and
WMIC), Reinsurance (Folksamerica), Investments in Unconsolidated Insurance
Affiliates and other (primarily the Company, FAE and White Mountains, all on a
stand-alone basis). This determination was based on the provisions of SFAS No.
131, "Disclosure About Segments of an Enterprise and Related Information" which
was adopted by Fund American in December 1998. Prior year segment information
has been restated to conform to the current presentation under SFAS No. 131.
Investment results are included within the segment to which the investments
relate. The Company has made this determination based on consideration of the
following criteria: (i) the nature of the business activities of each of the
Company's subsidiaries and affiliates; (ii) the manner in which the Company's
subsidiaries and affiliates are organized; (iii) the existence of primary
managers responsible for specific subsidiaries and affiliates; and (iv) the
organization of information provided to the Board. There are no significant
intercompany transactions among Fund American's segments.

Revenues, pretax earnings and ending assets for Fund American's segments
are shown below:

- -------------------------------------------------------------------------------------------------------------------
Property and Investments in
Casualty Unconsolidated
Mortgage Insurance Affiliates
Millions Banking Reinsurance Other Total
- -------------------------------------------------------------------------------------------------------------------
1998
- -------------------------------------------------------------------------------------------------------------------

Revenues for external customers $212.0 $170.0 $ 85.4 $ - $ - $467.4
Net investment income 81.6 8.2 18.1 3.8 6.7 118.4
Equity in earnings of unconsolidated affiliates - - - 24.3 - 24.3
Amortization of deferred credit - - 2.7 - - 2.7
Other (34.8)(a) - - - .1 (34.7)
----------------------------------------------------------------------
Total revenues 258.8 178.2 106.2 28.1(b) 6.8578.1
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
1997
- -------------------------------------------------------------------------------------------------------------------

Revenues for external customers 127.5 153.1 - - - 280.6
Net investment income 43.5 8.9 - 3.8 8.9 65.1
Equity in earnings of unconsolidated affiliates - - - 21.3 - 21.3
Other (56.7)(a) - - - - (56.7)
----------------------------------------------------------------------
Total revenues 114.3 162.0 - 25.1(b) 8.9310.3
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
1996
- -------------------------------------------------------------------------------------------------------------------

Revenues for external customers 206.2 119.1 - - - 325.3
Net investment income 40.8 7.5 - 3.7(a) 5.2 57.2
Equity in earnings of unconsolidated affiliates - - - 12.0 - 12.0
Other (69.3)(a) - - - - (69.3)
----------------------------------------------------------------------
Total revenues $177.7 $126.6 $ - $15.7(b) $5.2$325.2
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

(a) Represents amortization and impairment of capitalized mortgage servicing of
$55.2 million, $68.0 million and $79.2 million for 1998, 1997 and 1996,
respectively, partially offset of net gains on financial instruments of
$20.4 million, $11.3 million and $9.9 million, respectively.

(b) Includes interest income on Fund American's investment in MediaOne
preferred stock (considered to be related to Fund American's investment in
FSA) of $3.8 million for 1998, 1997 and 1996.

F-34

- -------------------------------------------------------------------------------------------------------------------
Property and Investments in
Casualty Unconsolidated
Mortgage Insurance Affiliates
Millions Banking Reinsurance Other Total
- -------------------------------------------------------------------------------------------------------------------
1998
- -------------------------------------------------------------------------------------------------------------------

Income (loss) before realized gains, taxes and $123.7 $ 5.3 $ 8.9 $28.1 $(16.6) $149.4
certain other expenses
Net realized investment gains (losses) 2.2 5.4 (.8) - 64.2 71.0
Interest expense (70.2) (1.1) (1.4) - (11.2) (83.9)
Depreciation and amortization (3.1) (3.0) - - (.4) (6.5)
----------------------------------------------------------------------
Pretax earnings 52.6 6.6 6.7 28.1 36.0 130.0
----------------------------------------------------------------------
----------------------------------------------------------------------
Income tax expense (19.3) (1.8) (1.2) (7.6) (17.9)(47.8)
- -------------------------------------------------------------------------------------------------------------------
1997
- -------------------------------------------------------------------------------------------------------------------

Income (loss) before realized gains, taxes and 18.2 11.5 - 25.1 (18.7) 36.1
certain other expenses
Net realized investment gains (losses) (.7) 4.1 - - 93.3 96.7
Interest expense (35.4) (1.2) - - (9.4) (46.0)
Depreciation and amortization (5.0) (3.0) - - (.4) (8.4)
----------------------------------------------------------------------
Pretax earnings (loss) (22.9) 11.4 - 25.1 64.8 78.4
----------------------------------------------------------------------
----------------------------------------------------------------------
Income tax (expense) benefit 7.0 (4.3) - (6.1) (26.0) (29.4)
----------------------------------------------------------------------
Loss on early extinguishment of debt (6.0) - - - - (6.0)
- -------------------------------------------------------------------------------------------------------------------
1996
- -------------------------------------------------------------------------------------------------------------------

Income (loss) before realized gains, taxes and 44.1 (2.7) - 15.7 (9.3) 47.8
certain other expenses
Net realized investment gains (losses) (.2) (.3) - - 39.0 38.5
Interest expense (36.0) (.7) - - (9.6) (46.3)
Depreciation and amortization (6.5) (3.2) - - (2.8) (12.5)
----------------------------------------------------------------------
Pretax earnings (loss) 1.4 (6.9) - 15.7 17.3 27.5
----------------------------------------------------------------------
----------------------------------------------------------------------
Income tax (expense) benefit $ (9.5) $ 3.4 $ - $(3.5) $ (9.3) $ (18.9)
- -------------------------------------------------------------------------------------------------------------------

F-35

- -------------------------------------------------------------------------------------------------------------------
Millions Property and Investments in
Casualty Unconsolidated
Mortgage Insurance Affiliates
Ending assets: Banking Reinsurance Other Total
- -------------------------------------------------------------------------------------------------------------------

December 31, 1998 $1,234.1 $311.5 $1,220.5 $404.1 $110.5 $3,280.7
December 31, 1997 1,063.1 288.8 - 409.6 248.8 2,010.3
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------

NOTE 15. INVESTMENTS IN UNCONSOLIDATED AFFILIATES

INVESTMENT IN FSA

Fund American owned 3,460,200 shares of FSA Common Stock at December 31,
1998, 1997 and 1996. This represented approximately 11.6%, 12.1% and 11.5%,
respectively, of the total shares of FSA Common Stock outstanding at those
times. Fund American had voting rights to an additional 3,893,940 shares of FSA
Common Stock at December 31, 1998, 1997 and 1996, raising Fund American's voting
control of FSA to approximately 23.1%, 24.0% and 23.0%, respectively. At
December 31, 1998, 1997 and 1996, Fund American also owned FSA Options and
Preferred Stock which, in total, give Fund American the right to acquire up to
4,560,607 additional shares of FSA Common Stock for aggregate consideration of
$125.7 million. As of December 31, 1998, 1997 and 1996, Fund American's economic
interest in FSA was 25.1%, 26.2% and 25.1%, respectively.

Fund American's investment in FSA Common Stock is accounted for using the
equity method. FSA Common Stock is publicly traded on the NYSE. The market value
of the FSA Common Stock as of December 31, 1998 and 1997, as quoted on the NYSE,
exceeded Fund American's carrying value of

F-36

the FSA Common Stock on the equity method. Fund American's investments in FSA
Options and Preferred Stock are accounted for under the provisions of SFAS No.
115 whereby the investments are reported at fair value as of the balance sheet
date, with related unrealized investment gains and losses, after tax, reported
as a net amount in a separate component of shareholders' equity and reported on
the income statement as a component of comprehensive net income.

The following table summarizes financial information for FSA:

- ---------------------------------------------------------------------------------------------------------------------
Millions 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

FSA BALANCE SHEET DATA:
Total investments $ 1,874.8 $ 1,431.6 $1,154.4
Total assets 2,405.5 1,900.6 1,537.7
Deferred premium revenue 721.7 595.2 511.2
Loss and loss adjustment expense reserve 63.9 75.4 72.1
Preferred shareholder's equity .7 .7 .7
Common shareholders' equity 1,072.7 881.7 800.6
FSA INCOME STATEMENT DATA:
Gross premiums written $ 319.3 $ 236.4 $ 177.0
Net premiums written 219.9 172.9 121.0
Net premiums earned 137.9 109.5 90.4
Net investment income 78.8 72.1 65.1
Net income 117.0 100.5 80.8

- ---------------------------------------------------------------------------------------------------------------------
AMOUNTS RECORDED BY FUND AMERICAN:
Investment in FSA Common Stock $ 119.7 $ 104.3 $ 92.3
Investment in FSA Options and Preferred Stock 114.4 87.8 19.8
------------------------------------
Total Investment in FSA $ 234.1 $ 192.1 $ 112.1
------------------------------------
------------------------------------
Equity in earnings from FSA Common Stock (a) $ 13.8 $ 11.4 $ 7.8
Equity in net unrealized investment gains (losses) from FSA's investment
portfolio, before tax (b) 3.1 2.1 (1.0)
Unrealized investment gains on FSA Options and Preferred Stock, before tax (b) 26.6 68.0 17.3
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

(a) Recorded net of related amortization of goodwill.

(b) Recorded directly to shareholders' equity (after tax) with related changes
in net unrealized investment gains and losses (after tax) reported on the
income statement as a component of comprehensive net income.

At December 31, 1998 and 1997, Fund American's consolidated retained
earnings included $35.9 million and $23.6 million, respectively, of

F-37

accumulated undistributed earnings of FSA (net of related amortization of
goodwill).

INVESTMENT IN MSA

At December 31, 1998, 1997 and 1996, Fund American owned 222,093, 90,606
and 90,606 shares of MSA Common Stock. This represented approximately 50.0%,
33.1% and 33.1% of the total shares of MSA Common Stock outstanding at those
times. Fund American's investment in MSA is accounted for using the equity
method. The following tables summarize financial information for MSA:

- ---------------------------------------------------------------------------------------------------------------------
Millions 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

MSA BALANCE SHEET DATA:
Total investments $ 465.9 $280.1 $ 249.4
Total assets 588.6 337.2 316.2
Unearned premium reserve 113.0 71.8 64.0
Loss and loss adjustment expense reserves 212.2 123.7 120.1
Shareholders' equity 232.5 120.6 101.4
MSA INCOME STATEMENT DATA:
Net premiums written $ 258.5 $156.6 $ 147.2
Net premiums earned 226.3 148.7 141.6
Net investment income 22.1 15.4 14.9
Net income 13.4 11.9 9.7
- ---------------------------------------------------------------------------------------------------------------------
AMOUNTS RECORDED BY FUND AMERICAN:
Investment in MSA Common Stock $ 120.2 $ 40.9 $ 34.7
Equity in earnings from MSA Common Stock (a) 4.9 3.8 1.5
Equity in net unrealized investment gains (losses) from MSA's
investment portfolio, before tax (b) 4.1 2.4 (.5)
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

(a) Recorded net of related amortization of goodwill.

(b) Recorded directly to shareholders' equity (after tax) with related changes
in net unrealized investment gains and losses (after tax) reported on the
income statement as a component of comprehensive net income.

At December 31, 1998 and 1997, Fund American's consolidated retained
earnings included $14.2 million and $9.3 million, respectively, of

F-38

accumulated undistributed earnings of MSA (net of related amortization of
goodwill).

INVESTMENT IN FOLKSAMERICA

On August 18, 1998, Fund American acquired all of the remaining outstanding
shares of the common stock of Folksamerica for $169.1 million which resulted in
Folksamerica becoming a consolidated subsidiary of the Company as of that date.
As of December 31, 1997 and 1996, Folksamerica was an unconsolidated subsidiary
of Fund American.

Prior to the consolidation of Folksamerica in 1998, White Mountains owned
6,920,000 shares of Folksamerica Preferred Stock at December 31, 1997 and 1996
and owned 1,563,907 shares of Folksamerica Common Stock at December 31, 1997.
White Mountains ownership percentage of Folksamerica at December 31, 1997 and
1996 represented 50.0% of the total Folksamerica voting shares outstanding at
those times. At December 31, 1997 and 1996, White Mountains also owned ten year
Folksamerica Warrants to purchase up to 6,920,000 shares of Folksamerica Common
Stock for aggregate consideration of $79.4 million. Fund American acquired its
investment in Folksamerica Preferred Stock and Folksamerica Warrants on June 19,
1996. White Mountains acquired its investment in Folksamerica Common Stock on
November 20, 1997.

Prior to the consolidation of Folksamerica in 1998, White Mountains'
investment in Folksamerica Common Stock was accounted for using the equity
method and Fund American's investment in Folksamerica Preferred Stock and
Folksamerica Warrants were accounted for under the provisions of SFAS No. 115
whereby the investments were reported at fair value as of the balance sheet
date, with related unrealized investment gains and losses, after tax, reported
as a net amount in a separate component of shareholders' equity and reported on
the income statement as a component of comprehensive net income. Dividends
earned on Folksamerica Preferred Stock were recorded as earnings from
unconsolidated insurance affiliates on the income statement.

F-39

The following table summarizes financial information for Folksamerica:

- ---------------------------------------------------------------------------------------------------------------------
Millions 1997 1996
- ---------------------------------------------------------------------------------------------------------------------

FOLKSAMERICA BALANCE SHEET DATA:
Total investments $ 926.2 $ 711.4
Total assets 1,213.6 994.8
Unearned premium reserve 96.5 61.5
Loss and loss adjustment expense reserve 739.1 628.9
Preferred shareholder's equity 79.4 79.4
Common shareholders' equity 175.6 88.2
FOLKSAMERICA INCOME STATEMENT DATA:
Gross premiums written $ 251.0 $ 187.2
Net premiums written 232.4 171.9
Net premiums earned 238.0 181.4
Net investment income 46.7 32.4
Net income 35.9 17.1
- ---------------------------------------------------------------------------------------------------------------------
AMOUNTS RECORDED BY FUND AMERICAN:
Investment in Folksamerica Common Stock $ 23.5 $ -
Investment in Folksamerica Preferred Stock and Warrants 80.0 80.0
-------------------------
Total Investment in Folksamerica $ 103.5 $ 80.0

-------------------------
Equity in earnings from Folksamerica Common Stock (a) $ .9 $ -
Dividends from Folksamerica Preferred Stock (a) 5.2 2.7
Equity in net unrealized investment gains from Folksamerica's investment portfolio, before tax (b)1.8 .2
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

(a) Recorded net of related amortization of goodwill and accretion of discount.

(b) Recorded directly to shareholders' equity (after tax) with related changes
in net unrealized investment gains and losses (after tax) reported on the
income statement as a component of comprehensive net income.

At December 31, 1997, Fund American's consolidated retained earnings
included $1.0 million of accumulated undistributed earnings of Folksamerica.

INVESTMENT IN AMLIN (FORMERLY MURRAY LAWRENCE)

F-40

At December 31, 1997 White Mountains owned 38,651,270 shares of the common
stock of Murray Lawrence which it had acquired on December 8, 1997 for $23.6
million. This represented approximately 15.8% of the total shares of Murray
Lawrence common stock outstanding at that time. At December 31, 1997 White
Mountains carried its investment in Murray Lawrence as an "investment in
unconsolidated insurance affiliate" and valued the investment at its original
cost of $23.6 million which approximated its fair value at that date..

During 1998 Murray Lawrence merged with Angerstein Underwriting which
resulted in the creation of Amlin. White Mountains owns 13,980,861 shares of the
common stock of Amlin, which represents an approximate 6.5% ownership stake as
of December 31, 1998 . As a result of White Mountains' decreased ownership
percentage of this investment resulting from the merger, White Mountains
recharacterized its investment in Amlin as an "other investment" and carried the
investment at its fair value of $25.1 million at December 31, 1998.

NOTE 16. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

Source One utilizes derivative financial instruments in the management of
interest rate risk. Source One's use of derivative financial instruments is
primarily limited to (i) commitments to extend credit, (ii) mandatory forward
commitments and (iii) interest rate floor contracts, interest rate swap
agreements and principal-only swap agreements. Although SFAS No. 115 requires
that these financial instruments be classified as held for trading purposes,
Fund American does not consider these investments to be speculative holdings.

Source One is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers
and to reduce its exposure to fluctuations in interest rates. These financial
instruments primarily include commitments to extend credit and mandatory forward
commitments. Those instruments involve, to varying degrees, elements of credit
and market interest rate risk in excess of the amounts recognized in the
consolidated balance sheets. The contract or notional amounts of those
instruments reflect the extent of risk Source One has related to the
instruments.

Source One's exposure to credit loss in the event of nonperformance by the
other party for commitments to extend credit is represented by the contractual
notional amount of those commitments. Source One's locked mortgage loan
commitments expected to close totalled $608.3 million and $284.5 million at
December 31, 1998 and 1997, respectively. Fixed rate commitments result in
Source One having market interest rate risk as well as credit risk. Variable
rate commitments result primarily in credit risk. The amount of collateral
required upon extension of credit is based on management's credit evaluation of
the mortgagor and consists of the mortgagor's residential property.

F-41

Source One obtains mandatory forward commitments of up to 120 days to sell
mortgage-backed securities to hedge the market interest rate risk associated
with a substantial portion of the Pipeline that is expected to close and all
mortgage loans receivable. At December 31, 1998 and 1997, Source One had
$1,805.3 million and $776.8 million, respectively, of mandatory forward
commitments outstanding. If secondary market interest rates decline after Source
One commits to an interest rate for a loan, the loan may not close and Source
One may incur a loss from the cost of covering its obligations under a related
mandatory forward commitment. If secondary market interest rates increase after
Source One commits to an interest rate for a loan and Source One has not
obtained a forward commitment, Source One may incur a loss when the loan is
subsequently sold.

Source One's risk management function closely monitors the Pipeline to
determine appropriate forward commitment coverage on a daily basis in order to
manage the risk inherent in these off-balance-sheet financial instruments. In
addition, the risk management area seeks to reduce counterparty risk by
committing to sell mortgage loans only to approved dealers with no dealer having
in excess of 20% of current commitments.

Source One sells loans through mortgage-backed securities issued pursuant
to programs of GNMA, FNMA and FHLMC, or through institutional investors. Most
loans are aggregated in pools of $1.0 million or more which are purchased by
institutional investors after having been guaranteed by GNMA, FNMA or FHLMC.
Substantially all GNMA securities are sold by Source One without recourse for
loss of principal in the event of a subsequent default by the mortgagor due to
the FHA and VA insurance underlying such securities. Prior to December 1992,
substantially all conventional securities were sold with recourse to Source One,
to the extent of insufficient proceeds from private mortgage insurance,
foreclosure and other recoveries. Since December 1992 all conventional loans
have been sold without recourse to Source One.

Servicing agreements relating to mortgage-backed securities issued pursuant
to programs of GNMA, FNMA or FHLMC require Source One to advance funds to make
the required payments to investors in the event of a delinquency by the
borrower. Source One expects that it would recover most funds advanced upon cure
of default by the borrower or foreclosure. However, funds advanced in connection
with VA partially guaranteed loans and certain conventional loans (which are at
most partially insured by private mortgage insurers) may not be fully recovered
due to potential declines in collateral value. Source One is subject to limited
amounts of risk with respect to these loans since the insurer has the option to
reimburse the servicer for the lower of fair value of the property or the
mortgage loan outstanding, in addition to the VA guarantee on the loan. In
addition, most of Source One's servicing agreements for mortgage-backed
securities typically require the payment to investors of a full month's interest
on each loan although the loan may be paid off (by optional prepayment or
foreclosure) other than on a month-end basis. In this instance, Source One is
obligated to pay the investor interest at the pass-thru rate from the date of
loan payoff through the end of the calendar month without reimbursement.

F-42

At December 31, 1998 and 1997, Source One serviced approximately $4.0
billion and $5.4 billion of GNMA loans (without substantial recourse),
respectively, and $1.7 billion and $2.5 billion of conventional loans (with
recourse), respectively. To cover loan losses that may result from these
servicing arrangements and other losses, Source One has provided an allowance
for loan losses of $11.5 million and $12.8 million at December 31, 1998 and
1997, respectively. In addition, the valuation allowance for Source One's
capitalized servicing asset related to its principal recourse portfolio includes
a $5.3 million and $8.2 million reserve for estimated losses at December 31,
1998 and 1997, respectively. Source One's management believes the allowance for
loan losses is adequate to cover unreimbursed foreclosure advances and principal
losses, including losses on loans with recourse.

In order to offset changes in the value of Source One's capitalized
servicing asset and to mitigate the effect on earnings of higher amortization
and impairment of such rights which results from increased prepayment activity,
Source One invests in various financial instruments. As interest rates decline,
prepayment activity increases, thereby reducing the value of the capitalized
servicing asset, while the value of the financial instrument increases.
Conversely, as interest rates increase, the value of the capitalized servicing
asset increases while the value of the financial instrument decreases. The
financial instruments utilized by Source One include interest rate floor
contracts, interest rate swap agreements and principal-only swap agreements.

Source One's interest rate floor contracts derive their value from
differences between the floor strike rate specified in the contract and
prevailing market interest rates and are not subject to total losses in excess
of their original cost. As of December 31, 1998, Source One's open interest rate
contracts had a fair value of $9.9 million, an original cost of $5.3 million and
a total notional value of $1.1 billion. The interest rate contracts have
remaining terms ranging from 5 to 10 years with floor rates ranging from 3.54%
to 5.05%. Source One's interest rate swap agreements, which were entered into in
the 1998 third quarter, entitle Source One to receive interest at fixed rates
and pay interest at variable rates based on a contracted notional amount. As of
December 31, 1998, Source One's open interest rate swap agreements had a fair
value of $4.8 million and had remaining terms ranging from 5 to 10 years. Source
One's exposure to losses on the interest rate swap agreements is related to the
differences between the contracted fixed interest rates assumed and the
contracted variable interest rates ceded over the life of the contract. Source
One's principal-only swap agreements derive their value from changes in the
value of referenced principal-only securities. As of December 31, 1998, Source
One's open principal-only swap agreements had a fair value of $2.7 million, a
notional value of $50.0 million and had a remaining term of 5 years. Source
One's exposure to losses on the principal-only swap agreements is related to
changes in the market value of the underlying principal-only securities over the
life of the contract.

Contingent liabilities exist with respect to reinsurance ceded, which would
become an ultimate liability of Folksamerica in the event that the

F-43

assuming companies were unable to meet their obligations under reinsurance
agreements in force. Folksamerica evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk arising from similar
activities or economic characteristics of the reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies. At December 31,
1998, reinsurance recoverables with a carrying value of $41.7 million were
associated with a single reinsurer. Folksamerica holds collateral from this
reinsurer in the form of a letter of credit totalling $21.4 million and funds
withheld totalling $23.4 million that can be drawn on for amounts that remain
unpaid.

White Mountains' insurance subsidiaries extend credit to their
policyholders in the normal course of business, perform credit evaluations and
maintain allowances for potential credit losses. Concentration of credit risk
with respect to receivables is limited due to the large number of policyholders
and their dispersion across a multi-state area.

NOTE 17. FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of Fund American's financial instruments have
been determined by using appropriate market information and valuation
methodologies. Considerable judgement is required to develop the estimates of
fair value. Therefore, the estimates provided herein are not necessarily
indicative of the amounts that could be realized in a current market exchange.
Carrying value equals or approximates fair value for FIXED MATURITY INVESTMENTS,
COMMON EQUITY SECURITIES, FINANCIAL INSTRUMENTS (DERIVATIVES), SHORT-TERM
INVESTMENTS, CASH, OTHER FINANCIAL ASSETS AND OTHER FINANCIAL LIABILITIES. For
each other class of financial instrument for which it is practicable to estimate
fair value, the following methods and assumptions were used to estimate such
value:

OTHER INVESTMENTS. Mortgage loans held for investment are carried at fair
value. Financial instruments are carried at fair value which is estimated based
on quoted market prices for those or similar investments. For all other
securities classified as other investments, fair values have been determined
using quoted market values or internal appraisal techniques.

MORTGAGE LOANS HELD FOR SALE. Fair values are estimated using quoted market
prices for securities backed by similar loans.

POOL LOAN PURCHASES. Fair values are estimated based on discounted cash
flow analyses using Source One's short-term incremental borrowing rate, quoted
market prices for securities backed by similar loans or actual prices at which
the loans were subsequently sold.

MORTGAGE CLAIMS RECEIVABLE. Fair values are estimated by discounting
anticipated future cash flows using Source One's short-term incremental
borrowing rate.

F-44

DEBT. Fair value is estimated by discounting future cash flows using
incremental borrowing rates for similar types of borrowing arrangements or
quoted market prices.

OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS. Fair value for commitments to sell
mortgage loans is based on current settlement values for those commitments, net
of the face amounts of the commitments. Fair value for commitments to extend
credit is based on current quoted market prices for securities backed by similar
loans, net of the principal amounts of the commitments.

The carrying amounts and estimated fair values of Fund American's financial
instruments were as follows:

- ---------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1998 December 31, 1997
-------------------------- -------------------------
CARRYING FAIR Carrying Fair
Millions AMOUNT VALUE amount value
- ---------------------------------------------------------------------------------------------------------------------

FINANCIAL ASSETS:
Fixed maturity investments $929.6 $929.6 $168.3 $168.3
Common equity securities 241.7 241.7 104.2 104.2
Other investments (excluding derivative instruments) 79.4 85.9 147.2 156.7
Derivative instruments:
Interest rate floor contracts 9.9 9.9 8.2 8.2
Interest rate swaps 4.9 4.9 - -
Principal-only swaps 2.7 2.7 12.5 12.5
Short-term investments 79.0 79.0 62.8 62.8
Cash 22.4 22.4 7.0 7.0
Mortgage loans held for sale 676.3 680.0 519.3 529.3
Pool loan purchases 165.0 165.1 149.8 150.2
Mortgage claims receivable, net (a) 27.2 26.5 35.6 34.9
Receivables from sales of servicing 73.8 73.8 27.3 27.3
Other financial assets 39.6 39.6 43.4 43.4

FINANCIAL LIABILITIES:
Short-term debt 748.5 748.5 571.4 571.4
Long-term debt 359.7 370.0 304.3 326.5
Other financial liabilities 5.9 5.9 22.3 22.3
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS:
Mandatory forward commitments - .6 - 1.6
Commitments to extend credit expected to close - 11.1 - 6.5
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------

(a) Excludes $5.9 million and $5.6 million of real estate owned in 1998 and
1997, respectively.

OTHER FINANCIAL ASSETS includes investment income receivable, accounts
receivable from securities sales, notes receivable and, for 1997, White River
Shares held for delivery upon exercise of existing employee stock options.

OTHER FINANCIAL LIABILITIES includes accrued interest payable, accounts
payable on securities purchases, dividends payable to

F-45

shareholders and, for 1997, liability for existing employee stock options to
purchase White River Shares.

Fund American's investments in FSA Options and Preferred Stock,
Folksamerica Preferred Stock and Folksamerica Warrants are not presented in the
table above. These financial instruments are accounted for under the provisions
of SFAS No. 115 and are carried on the balance sheet at fair value. See Note 15.

The estimated fair value amounts for Fund American's financial instruments
have been determined using available market information and valuation
methodologies. Such estimates provided herein are not necessarily indicative of
the amounts that would be potentially realized in a current market exchange.

NOTE 18. RELATED PARTY TRANSACTIONS

For corporate travel purposes Fund American jointly owns two short-range
aircraft with Haverford Utah, LLC ("Haverford"). Messrs. Jack Byrne, Patrick M.
Byrne, a director of the Company and White Mountains, and Kemp are principals of
Haverford. Both aircraft were acquired from unaffiliated third parties during
1996. In exchange for Haverford's 20% ownership interest in the aircraft,
Haverford contributed capital equal to 20% of the total initial cost of the
aircraft and Haverford bears the full costs of its usage and maintenance of the
aircraft pursuant to a Joint Ownership Agreement dated September 16, 1996.

Prior to the Joint Ownership Agreement, Fund American was a party to a "dry
lease" agreement dated January 2, 1995, for the use of aircraft owned by
Haverford Transportation Inc. ("HTI") for corporate travel purposes. Messrs.
Jack Byrne and Kemp are the sole shareholders of HTI. During 1996 Fund American
paid HTI a total of $279,739 pursuant to the dry lease arrangement. The terms of
the agreement provided for the use of HTI's aircraft (excluding pilot and fuel)
for a fixed hourly charge of $200 for a single engine piston aircraft and $800
to $1,000 for a twin engine turbine aircraft. Based on the Company's experience
in operating comparable aircraft, the hourly operating charges incurred pursuant
to the HTI dry lease are considered to be representative of the actual hourly
costs of operating HTI's aircraft.

In September 1998 Fund American sold its 25% joint ownership interest in a
private jet operated by a third party to Haverford for cash proceeds of
$500,000. The purchase price received from Haverford represented a payment of
$437,500 for Fund American's joint ownership interest (which resulted in Fund
American recognizing a pretax gain on sale of approximately $75,000) and $62,500
for reimbursement of prepaid aircraft expenses which were required to be paid to
the operator prior to the sale to Haverford.

Mr. Howard Clark, Jr., a director of the Company, is Vice Chairman of
Lehman Brothers Inc. Lehman Brothers Inc. has, from time to time,

F-46

provided various services to Fund American including investment banking
services, brokerage services, underwriting of debt and equity securities and
financial consulting services.

Mr. George J. Gillespie, III, a director of the Company, is a Partner in
the firm Cravath, Swaine & Moore, which has been retained by Fund American from
time to time to perform legal services.

Fund American believes that all the above transactions were on terms that
were reasonable and competitive. Additional transactions of this nature may be
expected to take place in the ordinary course of business in the future.

NOTE 19. SUBSEQUENT EVENT - SALE OF VGI

On February 11, 1999, White Mountains entered into a definitive agreement
to sell VGI (which includes Valley, Charter and WMIC but excludes Valley
National) to Unitrin, Inc.

The transaction is expected to close during the 1999 second quarter and is
subject to state regulatory approvals.

NOTE 20. SUBSEQUENT EVENT - SALE OF MORTGAGE BANKING ASSETS

On March 25, 1999 Fund American and Citicorp reached a definitive agreement
under which Citicorp will acquire a substantial amount of Fund American's
mortgage-banking related assets and certain of its mortgage banking liabilities.
Fund American will retain the Source One legal entity which will continue to own
all of Fund American's investments in FSA and certain other mortgage-related and
other assets and liabilities.

The transaction is expected to close during the 1999 second quarter and is
subject to various Federal, state and other regulatory approvals.

F-47

REPORT ON MANAGEMENT'S RESPONSIBILITIES

The financial information included in this annual report, including the
audited consolidated financial statements, has been prepared by the management
of Fund American. The consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and, where necessary,
include amounts based on informed estimates and judgments. In those instances
where there is no single specified accounting principle or standard, management
makes a choice from reasonable, accepted alternatives which are believed to be
most appropriate under the circumstances. Financial information presented
elsewhere in this report is consistent with that shown in the financial
statements.

Fund American maintains internal financial and accounting controls designed
to provide reasonable and cost effective assurance that assets are safeguarded
from loss or unauthorized use, that transactions are recorded in accordance with
management's policies and that financial records are reliable for preparing
financial statements. The internal controls structure is documented by written
policies and procedures which are communicated to all appropriate personnel and
is updated as necessary. Fund American's business ethics policies require
adherence to the highest ethical standards in the conduct of its business.
Compliance with these controls, policies and procedures is continuously
maintained and monitored by management.

KPMG LLP have audited the consolidated financial statements of Fund
American as of December 31, 1998 and 1997 and for each of the two years in the
period ended December 31, 1998, and issued their unqualified report thereon
dated February 12, 1999, which appears on page F-49. Ernst & Young LLP served as
Fund American's independent auditors as of December 31, 1996 and for the year
then ended, and issued their unqualified report thereon dated March 21, 1997,
which appears on page F-51. PricewaterhouseCoopers LLP served as the independent
auditors of Folksamerica during 1998 and Valley during 1996. The unqualified
reports issued with respect to 1998 audit of Folksamerica and the 1996 audit of
Valley have been included as exhibits to this report.

In connection with their audits, the independent auditors provide an
objective, independent review and evaluation of the structure of internal
controls to the extent they consider necessary. Management reviews all
recommendations of the independent auditors concerning the structure of internal
controls and responds to such recommendations with corrective actions, as
appropriate.

The Audit Committee of the Board, which is comprised solely of
non-management directors, has general responsibility for the oversight and
surveillance of the accounting, reporting and financial control practices of
Fund American. The Audit Committee, which reports to the full Board, annually
reviews the effectiveness of the independent auditors, Fund American's internal
auditors and management with respect to the financial reporting process and the
adequacy of internal

F-48

controls. Both the internal auditors and the independent auditors have, at all
times, free access to the Audit Committee, without members of management
present, to discuss the results of their audits, the adequacy of internal
controls and any other matter that they believe should be brought to the
attention of the Audit Committee.

K. Thomas Kemp Raymond Barrette Michael S. Paquette
Director, President Executive Vice President Senior Vice President
and Chief Executive Officer and Chief Financial Officer and Controller

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders
Fund American Enterprises Holdings, Inc.

We have audited the accompanying consolidated balance sheets of Fund American
Enterprises Holdings, Inc. and Subsidiaries (the "Company") as of December 31,
1998 and 1997, and the related consolidated income statements, statements of
shareholders' equity , and cash flows for the years then ended (collectively,
the "consolidated financial statements"). In connection with our audits of the
consolidated financial statements, we also have audited the 1998 and 1997
financial information in Schedule I Summary of investments other than
investments in related parties, Schedule II Condensed financial information of
the registrant, Schedule III Reinsurance, Schedule IV Valuation and qualifying
accounts, and Schedule VI Supplementary insurance information (collectively, the
"financial statement schedules"). These consolidated financial statements and
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and financial statement schedules based on our audits. We
did not audit the consolidated financial statements of Folksamerica Holding
Company, Inc. ("Folksamerica"), a wholly-owned subsidiary and Financial Security
Assurance Holdings, Ltd. ("FSA"), an 11.6 percent owned equity investee company.
The financial statements of Folksamerica reflect total assets constituting 37.2
percent and total revenues of 18.4 percent in 1998 of the related consolidated
totals. The Company's equity investment in FSA at December 31, 1998 and 1997 was
$119.7 million and $104.3 million, respectively, and its equity in earnings of
FSA were $13.8 million and $11.4 million for the years 1998 and 1997
respectively. The financial statements of Folksamerica and FSA were audited by
other auditors, PricewaterhouseCoopers LLP, whose reports were furnished to us,
and our opinion, insofar as it relates to the amounts included for Folksamerica

F-49

and FSA, is based solely on the reports of other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports other auditors provide a reasonable
basis for our opinion.

In our opinion, based on our audits and the reports of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Fund American Enterprises Holdings,
Inc. and Subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles. Also in our opinion, based on our
audits and the reports of other auditors, the 1998 and 1997 information in the
related financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.

/s/ KPMG LLP

February 12, 1999
Providence, Rhode Island
except for Note 20
which is as of
March 25, 1999

F-50

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders
Fund American Enterprises Holdings, Inc.

We have audited the accompanying consolidated income statement of Fund
American Enterprises Holdings, Inc. and the related statements of shareholders'
equity and cash flows for the year ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our audit also
included the financial statement schedules listed at Item 14(d). Our
responsibility is to express an opinion on these financial statements and
schedules based on our audits. We did not audit the consolidated financial
statements of Valley Group, Inc., a wholly-owned subsidiary, representing
substantially all of the Company's consolidated insurance operations, which
statements reflected total revenues of $126.9 million for the year ended
December 31, 1996, and the consolidated financial statements of Financial
Security Assurance Holdings Ltd. ("FSA"), an equity method investee. The
Company's equity in FSA's earnings represents $7.8 million of total revenues
for the year ended December 31, 1996. Those statements were audited by other
auditors, PricewaterhouseCoopers LLP, whose reports have been furnished to us,
and our opinion, insofar as it relates to data included for Valley Group, Inc.
and FSA, with respect to the amounts in the two preceding sentences, is based
solely on the reports of the other auditors.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, based on our audit and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
Fund American Enterprises Holdings, Inc.'s consolidated results of operations
and its cash flows for the year ended December 31, 1996, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedules when considered in relation to the basic financial
statements taken as a whole presents fairly in all material respects the
information set forth therein.

/s/ Ernst & Young LLP
New York, New York
March 21, 1997

F-51

SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

Selected quarterly financial data for 1998 and 1997 is shown in the
following table. The quarterly financial data includes, in the opinion of
management, all recurring adjustments necessary for a fair presentation of the
results of operations for the interim periods. Certain 1998 and 1997 items have
been restated as a result of the Folksamerica transaction, see Note 2.

- --------------------------------------------------------------------------------------------------------------------
1998 Three Months Ended (a) 1997 Three Months Ended (b)
---------------------------------- -----------------------------------
Millions, except per share amounts Dec. 31Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31
- --------------------------------------------------------------------------------------------------------------------

Revenues $197.2 $ 153.6 $ 117.6 $109.7 $ 81.9 $78.0 $ 69.5 $ 80.9
Expenses 187.2 130.0 106.7 95.2 91.0 76.4 80.9 80.3
------------------------------------------------------------------------
Pretax operating earnings (loss) 10.0 23.6 10.9 14.5 (9.1) 1.6 (11.4) .6
Net realized investment gains 5.2 61.6 1.7 2.5 49.1 21.8 16.2 9.6
------------------------------------------------------------------------
Pretax earnings 15.2 85.2 12.6 17.0 40.0 23.4 4.8 10.2
Income tax provision 5.5 30.1 5.0 7.2 14.7 7.1 3.2 4.4
------------------------------------------------------------------------
AFTER TAX EARNINGS 9.7 55.1 7.6 9.8 25.3 16.3 1.6 5.8
Loss on early extinguishment of debt, after tax - - - - - - (6.0) -
------------------------------------------------------------------------
NET INCOME (LOSS) 9.7 55.1 7.6 9.8 25.3 16.3 (4.4) 5.8
Other comprehensive net income, after tax 26.7 (73.1) 11.2 26.3 (20.1) 30.1 39.6 (7.9)
------------------------------------------------------------------------
COMPREHENSIVE NET INCOME (LOSS) $ 36.4 $(18.0) $ 18.8 $ 36.1 $ 5.2 $46.4 $ 35.2 $(2.1)
------------------------------------------------------------------------
------------------------------------------------------------------------

BASIC EARNINGS PER COMMON SHARE:
After tax earnings $ 1.51 $ 9.28 $ 1.13 $ 1.50 $ 3.89 $2.41 $ .09 $ .71
Net income (loss) 1.51 9.28 1.13 1.50 3.89 2.41 (.80) .71
Comprehensive net income (loss) 6.08 (3.22) 3.02 5.94 .68 7.12 5.10 (.43)
DILUTED EARNINGS PER COMMON SHARE:
After tax earnings 1.33 8.31 1.00 1.33 3.50 2.18 .08 .65
Net income (loss) 1.33 8.31 1.00 1.33 3.50 2.18 (.73) .65
Comprehensive net income (loss) 5.44 (2.90) 2.70 5.32 .61 6.44 4.63 (.40)
- --------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------

(a) The quarterly amounts for the three month periods ended September 30, 1998
and December 31, 1998 reflect the consolidation of Folksamerica which
became a wholly-owned subsidiary on August 18, 1998. The quarterly amounts
for the three month period ended September 30, 1998 include $61.6 million
of pretax realized investment gains which served to increase third quarter
1998 net income by $40.0 million.
(b) The quarterly amounts for the three month period ended June 30, 1997
include a $9.2 million pretax loss on early extinguishment of Source One's
debt which served to decrease second quarter 1997 net income by $6.0
million. The quarterly amounts for the three month period ended December
31, 1997 include $49.1 million of pretax realized investment gains which
served to increase fourth quarter 1997 net income by $31.9 million.

F-52

SCHEDULE I

FUND AMERICAN ENTERPRISES HOLDINGS, INC.

SUMMARY OF INVESTMENTS -- OTHER THAN
INVESTMENTS IN RELATED PARTIES
AT DECEMBER 31, 1998

- -------------------------------------------------------------------------------------------------
Fair
Millions Cost Value
- -------------------------------------------------------------------------------------------------

Fixed maturities:
Bonds:
United States Government and government agencies and authorities $ 217.6 $ 222.0

States, municipalities and political subdivisions 189.1 191.8
Foreign governments 26.7 26.9
All other (primarily corporate bonds) 430.8 437.1
Redeemable preferred stock 51.8 51.8
----------------------
Total fixed maturities 916.1 929.6
----------------------
Common equity securities:
Banks, trust and insurance companies 28.3 35.5
All other 167.1 206.2
----------------------
Total common equity securities 195.4 241.7
Other investments 88.5 96.9
Short-term investments 79.0 79.0
- -------------------------------------------------------------------------------------------------
Total investments $ 1,279.0 $ 1,347.2
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------

NOTE - fair value was equal to carrying value at December 31, 1998.

FS-1

SCHEDULE II

FUND AMERICAN ENTERPRISES HOLDINGS, INC.
(PARENT COMPANY ONLY)

CONDENSED BALANCE SHEETS

- ---------------------------------------------------------------------------
December 31,
--------------------
Millions 1998 1997
- ---------------------------------------------------------------------------

Assets:
Common equity securities and other investments $ - $ 49.2
Short-term investments, at amortized cost 10.8 2.3
Other assets 37.8 40.4
Investments in consolidated affiliates 972.2 843.1
--------------------
Total assets $ 1,020.8 $ 935.0
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
Liabilities:
Long-term debt with third parties $ 115.7 $ 115.6
Intercompany borrowings 53.0 30.0
Accounts payable and other liabilities 149.6 130.5
--------------------
Total liabilities 318.3 276.1
Shareholders' equity 702.5 658.9
--------------------
Total liabilities and shareholders' equity $ 1,020.8 $ 935.0
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------

CONDENSED INCOME STATEMENTS

- --------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------
Millions 1998 1997 1996
- --------------------------------------------------------------------------------------

Revenues $ 2.2 $ 8.5 $ 11.7
Expenses 23.2 21.2 15.5
-------------------------------
Pretax operating loss (21.0) (12.7) (3.8)
Net realized investment gains (losses) 26.7 44.2 (3.1)
-------------------------------
Pretax earnings (loss) 5.7 31.5 (6.9)
Income tax provision (benefit) 8.3 16.3 .5
-------------------------------
Parent company only operating income (loss) (2.6) 15.2 (7.4)
Earnings from consolidated affiliates 84.8 27.8 16.0
-------------------------------
Consolidated net income 82.2 43.0 8.6
-------------------------------
Consolidated change in net unrealized investment gains,
after tax (8.9) 41.7 54.6
-------------------------------
Consolidated comprehensive net income $ 73.3 $ 84.7 $ 63.2
-------------------------------
-------------------------------

FS-2

SCHEDULE II
(CONTINUED)

FUND AMERICAN ENTERPRISES HOLDINGS, INC.
(PARENT COMPANY ONLY)

CONDENSED STATEMENTS OF CASH FLOWS

Year Ended December 31,
1998
---------------------------------
Millions 1998 1997 1996
- -------------------------------------------------------------------------------------------------

Net income $ 82.2 $ 43.0 $ 8.6
Reconciliation of net income to net cash from operating
activities:
Net realized investment (gains) losses (26.7) (44.2) 3.1
Undistributed earnings from consolidated subsidiaries (78.0) (24.1) (12.3)
Undistributed earnings from unconsolidated insurance - (.4) (1.1)
affiliates
Changes in current income taxes receivable and 8.5 5.1 28.4
payable
Deferred income tax provision (benefit) .1 (3.7) .1
Dividends and return of capital distributions received - - 65.0
from subsidiaries
Other, net 1.7 (1.3) (19.6)
---------------------------------
Net cash (used for) provided from operating activities (12.2) (25.6) 72.2
- -------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net (increase) decrease in short-term investments (8.5) (2.0) 28.2
Sales of investment securities - 119.4 134.4
Purchases of investment securities - - (108.9)
Investments in consolidated affiliates - (12.7) (25.2)
Investments in unconsolidated affiliates - - (27.7)
Sale of securities carried in other assets 26.8 - -
Purchases of fixed assets - - (.8)
---------------------------------
Net cash (used for) provided from investing activities 18.3 104.7 -
- -------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Purchases of common stock retired (19.5) (103.8) (66.3)
Intercompany borrowings from subsidiaries 23.0 30.0 -
Cash dividends paid to common shareholders (9.4) (5.3) (5.9)
---------------------------------
Net cash used for financing activities (5.9) (79.1) (72.2)
- -------------------------------------------------------------------------------------------------
Net increase in cash during year .2 - -
Cash balance at beginning of year - - -
- -------------------------------------------------------------------------------------------------
Cash balance at end of year $ .2 $ - $ -
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------

FS-3

SCHEDULE III

FUND AMERICAN ENTERPRISES HOLDINGS, INC.

REINSURANCE

- ----------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F
- ----------------------------------------------------------------------------------------------
Percentage
Ceded to Assumed of amount
Premiums earned Gross other from other Net assumed to
(Dollars in millions) amount companies companies amount net
- ----------------------------------------------------------------------------------------------

Years ended:

December 31, 1998:
Property and casualty insurance $ 153.9 $ (6.7) $ -- $ 160.6 -- %
Reinsurance (a) 2.4 (8.7) 91.7 85.4 107.4%

December 31,1997:
Property and casualty insurance 152.1 (6.8) -- 145.3 -- %

December 31,1996:
Property and casualty insurance 116.7 (7.0) -- 109.7 -- %
- ----------------------------------------------------------------------------------------------

(a) Amounts shown in columns B through F represent activity for Folksamerica
from August 18, 1998 through December 31,1998.

FS-4

SCHEDULE IV

FUND AMERICAN ENTERPRISES HOLDINGS, INC.

VALUATION AND QUALIFYING ACCOUNTS

- --------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- --------------------------------------------------------------------------------------------------------------
Additions
--------------------
Balance at Charged to Charged Balance
beginning costs and to other Deductions at end
Millions of period expenses accounts described of period
- --------------------------------------------------------------------------------------------------------------

Years ended:
December 31,1998:
Reinsurance recoverable:
Allowance for reinsurance balances (a) $ 1.2 $ -- $ -- $ -- (b) $ 1.2
Property and casualty insurance:
Allowance for uncollectible accounts .3 1.9 -- (1.8)(b) .4
Mortgage banking:
Allowance for mortgage loan losses 12.8 3.8 .1 (5.2)(b) 11.5
Impairment allowance for mortgage servicing 45.1 14.8 -- (24.3)(c) 35.6
December 31,1997:
Property and casualty insurance:
Allowance for uncollectible accounts .4 1.1 -- (1.2)(b) .3
Mortgage banking:
Allowance for mortgage loan losses 15.4 4.7 -- (7.3)(b) 12.8
Impairment allowance for mortgage servicing 28.9 22.4 -- (6.2)(c) 45.1
December 31,1996:
Property and casualty insurance:
Allowance for uncollectible accounts .8 .7 -- (1.1)(b) .4
Mortgage banking:
Allowance for mortgage loan losses 13.5 3.0 1.7 (2.8)(b) 15.4

Impairment allowance for mortgage servicing 28.0 8.2 -- (7.3)(c) 28.9

- --------------------------------------------------------------------------------------------------------------

(a) Represents allowances acquired from Folksamerica on August 18, 1998.

(b) Represents charge-offs of balances receivable.

(c) Represents charge-offs of balances receivable relating to recourse mortgage
loans and allowance reductions for mortgage servicing sales.

FS-5

SCHEDULE V

FUND AMERICAN ENTERPRISES HOLDINGS, INC.

SUPPLEMENTARY INSURANCE INFORMATION
MILLIONS

Column A Column B Column C Column D Column E Column F
- -----------------------------------------------------------------------------------------
Future
policy Other
Deferred benefits, policy
policy losses, claims
acquisition and loss Unearned benefits Premiums
Segment cost expenses premiums payable earned
- -----------------------------------------------------------------------------------------

Years ended:
December 31, 1998:
Reinsurance (a) $20.7 $723.2 $71.2 $ -- $ 85.4
Property casualty insurance 14.7 88.5 81.9 -- 160.6
December 31, 1997:
Property and casualty insurance 14.3 71.9 78.0 -- 145.3
December 31, 1996:
Property and casualty insurance 13.2 65.4 72.6 -- 109.7
- -----------------------------------------------------------------------------------------

Column A Column G Column H Column I Column J Column K
- -----------------------------------------------------------------------------------------
Benefits,
claims,
losses, Amortization
Net and of deferred Other
investment settlement acquisition operating Premiums
Segment income (b) expenses costs expenses written
- ---------------------------------------------------------------------------------------------

Years ended:
December 31, 1998:
Reinsurance (a) $18.1 $ 59.7 29.1 $36.0 $ 73.7
Property casualty insurance 8.3 115.1 30.0 62.3 164.9
December 31, 1997:
Property and casualty insurance 9.0 97.1 27.5 58.9 150.8
December 31, 1996:
Property and casualty insurance 7.8 85.9 19.9 53.9 147.0
- ---------------------------------------------------------------------------------------------

(a) The amounts shown for Reinsurance in columns F through K represent activity
for Folksamerica from August 18, 1998 through December 31, 1998.

(b) The amounts shown exclude net investment income relating to non-insurance
operations of $92.0 million, $56.1 million and $49.5 million for the twelve
months ended December 31,1 998, 1997 and 1996,respectively.

FS-6