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Table of Contents

FIRST SUNAMERICA LIFE INSURANCE COMPANY

INDEX

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
BALANCE SHEET
(Unaudited)

See accompanying notes to financial statements.

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF INCOME AND COMPREHENSIVE INCOME
For the three months ended March 31, 2004 and 2003
(Unaudited)

See accompanying notes to financial statements.

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF INCOME AND COMPREHENSIVE INCOME
For the three months ended March 31, 2004 and 2003
(Unaudited)

See accompanying notes to financial statements.

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS
For the three months ended March 31, 2004 and 2003
(Unaudited)

See accompanying notes to financial statements.

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS (Continued)
For the three months ended March 31, 2004 and 2003
(Unaudited)

See accompanying notes to financial statements.

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
(Unaudited)

1.		BASIS OF PRESENTATION
		First SunAmerica Life Insurance Company (the “Company”) is a New York-domiciled life insurance company principally engaged in the business of writing fixed and variable annuities for retirement savings in the State of New York. The Company is a direct wholly owned subsidiary of SunAmerica Life Insurance Company (the “Parent”), which is a wholly owned subsidiary of AIG Retirement Services, Inc. (“AIGRS”)(formerly AIG SunAmerica Inc.), a subsidiary of American International Group, Inc. (“AIG”). AIG is a holding company, which through its subsidiaries is engaged in a broad range of insurance and insurance-related activities, financial services, retirement services and asset management.
		In the opinion of the Company, the accompanying unaudited financial statements contain all adjustments necessary, consisting of normal recurring items, to present fairly the Company’s financial position as of March 31, 2004 and December 31, 2003, the results of its operations for the three months ended March 31, 2004 and 2003 and its cash flows for the three months ended March 31, 2004 and 2003. The results of operations for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2003, contained in the Company’s 2003 Annual Report on Form 10-K. Certain prior period items have been reclassified to conform to the current period’s presentation.
2.		RECENTLY ISSUED ACCOUNTING STANDARDS
		In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (“SOP 03-1”). This statement was effective as of January 1, 2004, and requires the Company to recognize a liability for guaranteed minimum death benefits and other living benefits related to its variable annuities and modifies certain disclosures and financial statement presentations for these products. In addition, SOP 03-1 addresses the presentation and reporting of separate accounts and the capitalization and amortization of sales inducements. The Company reported for the first quarter of 2004 a one-time cumulative accounting charge upon adoption of $2,014,000 ($3,098,000 pre-tax) to reflect the liability and the related impact of deferred acquisition costs (“DAC”) as of January 1, 2004.
		The Company issues variable annuities for which the investment risk is generally borne by the contract holder in all, but the fixed-rate account options. For many of the Company’s variable annuities, the Company contractually guarantees to the contract holder either (a) total deposits made to the contract less any partial withdrawals plus a minimum return (and in two minor instances, no minimum returns), or (b) the highest contract value on a specified anniversary date minus any withdrawals following the contract anniversary. These guarantees are payable in the event of death and are referred to as guaranteed minimum death benefits (“GMDB”).
		The assets supporting the variable portion of variable annuities are carried at fair value and reported as summary total “variable annuity assets held in separate accounts” with an equivalent summary total reported for liabilities. Amounts assessed against the contract holders for mortality, administrative, and other services are included in variable annuity fees and changes in liabilities for minimum guarantees are included in guaranteed minimum death benefits, in the statement of income and comprehensive income. Separate account net investment income, net investment gains and losses, and the related liability changes are offset within the same line item in the statement of income and comprehensive income.

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited)

2.		RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)
		The GMDB liability is determined each period end by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised.
		Details concerning the Company’s guaranteed benefits exposures as of March 31, 2004 are as follows:

The following summarizes the liability for guaranteed of benefits on variable contracts reflected in the general account:

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited)

2.		RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)
		The following assumptions and methodology were used to determine the GMDB liability at March 31, 2004:

	•		Data used was 5,000 stochastically generated investment performance scenarios.
	•		Mean investment performance assumption was 10%.
	•		Volatility assumption was 16%.
	•		Mortality was assumed to be 64% of the 75-80 ALB table.
	•		Lapse rates vary by contract type and duration and range from 1% to 30%.
	•		The discount rate was approximately 8%.

		The Company currently offers enhanced crediting rates or bonus payments to contract holders on certain of its products. These sales inducements are deferred and amortized over the life of the policy using the same methodology and assumptions used to amortize DAC. The Company previously deferred these sales inducements as part of DAC and reported the amortization of such amounts as part of DAC amortization. Upon implementation of SOP 03-1, the Company reclassified sales inducements of $18.6 million from DAC to deferred sales inducements, which are reported in other assets on the balance sheet. For the three months ended March 31, 2004, sales inducements of $2.6 million was deferred. Amortization of the deferred sales inducements is reported as part of amortization of deferred acquisition costs on the statement of income and comprehensive income. For the three months ended March 31, 20004, amortization of sales inducements was $0.6 million. Prior period balance sheet and statement of income and comprehensive income presentation has been reclassified to conform to the new presentation.
3.		CONTINGENT LIABILITIES
		Various lawsuits against the Company have arisen in the ordinary course of business. Contingent liabilities arising from litigation, income taxes and other matters are not considered material in relation to the financial position of the Company.
		The Company’s current financial strength and counterparty credit ratings from Standard & Poor’s are based in part on a guarantee (the “Guarantee”) of the Company’s insurance policy obligations by American Home Assurance Company (“American Home”), a subsidiary of AIG, and a member of an AIG intercompany pool, and the belief that the Company is viewed as a strategically important member of AIG. The Guarantee is unconditional and irrevocable, and policyholders have the right to enforce the Guarantee directly against American Home.
		The Company’s current financial strength rating from Moody’s is based in part on a support agreement between the Company and AIG (the “Support Agreement”), pursuant to which AIG has agreed that AIG will cause the Company to maintain a policyholders’ surplus of not less than $1 million or such greater amount as shall be sufficient to enable the Company to perform its obligations under any policy issued by it. The Support Agreement also provides that if the Company needs funds not otherwise available to it to make timely payment of its obligations under policies issued by it, AIG will provide such funds at the request of the Company. The Support Agreement is not a direct or indirect guarantee by AIG to any person of any obligation of the Company. AIG may terminate the Support Agreement with respect to outstanding obligations of the Company only under circumstances where the Company attains, without the benefit of the Support Agreement, a financial strength-rating equivalent to that held by the Company with the benefit of the Support Agreement. Policyholders have the right to cause the Company to enforce its rights against AIG and, if the Company fails or refuses to take timely action to enforce the Support Agreement or if the

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited)

3.		CONTINGENT LIABILITIES (Continued)
		Company defaults in any claim or payment owed to such policyholder when due, have the right to enforce the Support Agreement directly against AIG.
		American Home does not publish financial statements, although it files statutory annual and annual reports with the New York State Insurance Department, where such reports are available to the public. AIG is a reporting company under the Securities Exchange Act of 1934, and publishes annual reports on Form 10-K and annual reports on Form 10-Q, which are available from the Securities and Exchange Commission.
		At March 31, 2004, the Company was obligated to purchase approximately $6,000,000 of asset backed securities in the ordinary course of business. The expiration dates of these commitments are as follows: $1,000,000 in 2004 and $5,000,000 in 2007.
4.		RELATED-PARTY MATTERS
		On October 31, 2003, the Company entered into an existing credit agreement under which the Company agreed to make loans to AIG in an aggregate amount of $5,000,000. This commitment expires on October 30, 2004. There was no outstanding balance under this agreement at March 31, 2004.
		On January 1, 2004, the Company entered into an administrative services agreement with AIG SunAmerica Asset Management Corp. (“SAAMCo”), whereby SAAMCo will pay a percentage on all assets invested through the Company’s variable annuity products in exchange for services performed (“Administrative Service Agreement”). SAAMCo is the investment advisor or business manager for certain trusts that hold deposits from the Company’s variable annuity products. Amounts paid or accrued to the Company under this agreement totaled $0.4 million in 2004 and are included in variable annuity fees in the statement of income and comprehensive income. A fee of $0.4 million was paid under a different agreement in 2003.

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FIRST SUNAMERICA LIFE INSURANCE COMPANY
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Management’s discussion and analysis of financial condition and results of operations of First SunAmerica Life Insurance Company (the “Company”) for the three months ended March 31, 2004 (“2004”) and March 31, 2003 (“2003”) follows. Certain prior period amounts have been reclassified to conform to the current period’s presentation.

     In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission (the “SEC”). Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as “expect,” “anticipate,” “believe” or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent the Company’s beliefs concerning future levels of sales and redemptions of the Company’s products, investment spreads and yields, or the earnings or profitability of the Company’s activities.

     Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable developments. Some may be national in scope, such as general economic conditions, changes in tax law and changes in interest rates. Some may be related to the insurance industry generally, such as pricing, competition, regulatory developments and industry consolidation. Others may relate to the Company specifically, such as credit, volatility and other risks associated with the Company’s investment portfolio. Investors are also directed to consider other risks and uncertainties discussed in documents filed by the Company with the SEC. The Company disclaims any obligation to update forward-looking information.

     The Company has one business segment, annuity operations, which consists of the sale and administration of deposit-type insurance contracts, such as fixed and variable annuities and universal life insurance contracts. The Company focuses primarily on the marketing of fixed annuity products.

CRITICAL ACCOUNTING POLICIES

     The Company considers among its most critical accounting policies those policies with respect to valuation of certain financial instruments, amortization of deferred acquisition costs and valuation of reserves for guaranteed benefits. In the implementation of each of the aforementioned policies, management is required to exercise its judgment on both a quantitative and qualitative basis. Further explanation of how management exercises that judgment follows:

     VALUATION OF CERTAIN FINANCIAL INSTRUMENTS: Gross unrealized losses on debt and equity securities available for sale amounted to $9.2 million at March 31, 2004. In determining if and when a decline in fair value below amortized cost is other-than-temporary, the Company evaluates at each reporting period the market conditions, offering prices, trends of earnings, price multiples, and other key measures for our investments in debt and marketable equity securities. In particular, for debt, the Company assesses the probability that all amounts due are collectible according to the contractual terms of the obligation. When such a decline in value is deemed to be other-than-temporary, the Company recognizes an impairment loss in the current period operating results to the extent of the decline (See also discussion within “Capital Resources and Liquidity” herein).

     Securities in our portfolio with a carrying value of approximately $552.0 million at March 31, 2004 do not have readily determinable market prices. For these securities, we estimate their fair value with internally prepared valuations (including those based on estimates of future profitability). Otherwise, we use our most recent

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purchases and sales of similar unquoted securities, independent broker quotes or comparison to similar securities with quoted prices when possible to estimate the fair value of those securities. All such securities are classified as available for sale. Our ability to liquidate our positions in these securities will be impacted to a significant degree by the lack of an actively traded market, and we may not be able to dispose of these investments in a timely manner. Although we believe our estimates reasonably reflect the fair value of those securities, our key assumptions about the risk-free interest rates, risk premiums, performance of underlying collateral, if any, and other factors may not reflect those of an active market.

     AMORTIZATION OF DEFERRED ACQUISITION COSTS: The Company amortizes deferred acquisition costs (“DAC”) based on a percentage of expected gross profits (“EGPs”) over the life of the underlying policies. EGPs are computed based on assumptions related to the underlying policies written, including their anticipated duration, net spreads earned during the life of the contracts, costs of providing policy guarantees and the level of expenses necessary to maintain the policies. The Company revises future DAC assumptions, referred to herein as a DAC unlocking, when estimates of future gross profits to be realized on its annuity policies are revised. Increases in future EGPs may result from higher interest spread and/or lower surrender rate assumptions, while decreases in future EGPs may result from lower interest spread and/or higher surrender rate assumptions. DAC amortization for the current period is reduced when future EGPs are increased and increased when future EGPs are decreased.

     RESERVE FOR GUARANTEED BENEFITS: Pursuant to the adoption of Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (“SOP 03-1”) on January 1, 2004, the Company is required to recognize a liability for guaranteed minimum death benefits (“GMDB”). In calculating the projected liability, five thousand stochastically generated investment performance scenarios were developed with a mean investment performance of 10%. Additional assumptions are made for mortality, lapse rates of return and the volatility of equity markets.

     On January 1, 2004, the Company entered into an administrative services agreement with AIG SunAmerica Asset Management Corp. (“SAAMCo”), whereby SAAMCo will pay a percentage on all assets invested through the Company’s Variable Annuity products in exchange for services performed. (“Administrative Service Agreement”). SAAMCo is the investment advisor or business manager for certain trusts that hold deposits from the Company’s variable annuity products. . Amounts paid or accrued to the Company under this agreement totaled $0.4 million in 2004 and are included in variable annuity fees in the statement of income and comprehensive income. A fee of $0.4 million was paid under a different agreement in 2003.

RESULTS OF OPERATIONS

     NET INCOME totaled $1.2 million in 2004 compared with $2.5 million in 2003.

     PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $5.5 million in 2004, compared with $4.1 million in 2003. The increase in 2004 compared to 2003 was primarily due to higher net investment spread, partially offset by higher DAC amortization and net realized investment losses.

     INCOME TAX EXPENSE totaled $2.3 million in 2004 and $1.7 million in 2003, representing effective tax rates of 41% in both 2004 and 2003.

     CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflected the adoption of SOP 03-1 on January 1, 2004. The Company recorded a loss of $2.0 million, net of tax, which is recognized in the statement of income and comprehensive income as a cumulative effect of accounting change for the quarter ended March 31, 2004.

     NET INVESTMENT SPREAD, a non-GAAP measure which represents investment income earned on invested assets less interest credited to fixed annuity contracts, is a key measurement used by the Company in evaluating the profitability of its fixed annuity business. Accordingly, the Company presents an analysis of net investment spread because the Company has determined this measure to be useful and meaningful.

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     In evaluating its investment yield and net investment spread, the Company calculates average invested assets using the amortized cost of bonds, notes and redeemable preferred stock. This basis does not include unrealized gains and losses, which are reflected in the carrying value (i.e., fair value) of those investments pursuant to Statement of Financial “Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities”. In the calculation of average invested assets, the Company excludes cash collateral received from the securities lending program, which is offset by a securities lending payable in the same amount. The Company participates in a securities lending program with an affiliated agent, pursuant to which it lends its securities and primarily takes cash as collateral with respect to the securities lent. Participation in securities lending agreements provides additional net investment income for the Company, resulting from investment income earned on the collateral, less interest paid on the securities lending agreements and the related management fees paid to administer the program.

     An analysis of net investment spread and a reconciliation to pretax income is presented in the following table:

     Net investment spread totaled $15.6 million in 2004 and $8.6 million in 2003. These amounts equal 2.06% on average invested assets (computed on a daily basis) of $3.03 billion in 2004 and 2.00% on average invested assets of $1.73 billion in 2003. The increase in the net investment spread rate was primarily due to the decline in overall rates paid in 2004 compared to 2003, as the Company issued new fixed annuities at rates below the prior year average rates. The components of net investment spread were as follows:

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     Growth in average invested assets resulted primarily from increased sales in 2004 and 2003 relating to the marketing of an increased number of fixed annuity distribution partners in New York. Changes in average invested assets also reflect sales of fixed account options of the Company’s variable annuity products, and renewal deposits on its universal life products (“UL Deposits”). Sales of fixed annuities and fixed account options (“Fixed Annuity Deposits”) and UL Deposits totaled $225.7 million in 2004 and $168.0 million in 2003. In the fourth quarter of 2003, Fixed Annuity Deposits totaled $474.0 million. The increase in Fixed Annuity Deposits in 2004 over same quarter in the prior year is due primarily to an increase of over 40% in the number of fixed annuity distribution partners in New York from March 31, 2003 to March 31, 2004. In response to the low interest rate environment, the Company reduced the minimum rate paid on its fixed annuity products below the historically prevailing rate in order to maintain the appropriate margin. The Company does not intend to write business below its targeted rates of return to gain market share and anticipates further declines in Fixed Annuity Deposits in coming months until the interest rate environment improves.

     Investment income (and the related yields on average invested assets) totaled $40.0 million (5.28%) in 2004 compared with $24.9 million (5.77%) in 2003. The decrease in the investment yield in 2004 compared to 2003 primarily reflects a lower prevailing interest rate environment. Investment income has been reduced by expenses incurred to manage the investment portfolio of $0.3 million in 2004 and $0.1 million in 2003. These expenses are included as a reduction of investment income in the statement of income and comprehensive income.

     Interest expense totaled $24.4 million in 2004 and $16.3 million in 2003. The average rate paid on all interest-bearing liabilities was 3.43% in 2004 compared with 4.06% in 2003. Interest-bearing liabilities averaged $2.84 billion during 2004 and $1.60 billion during 2003. The decline in overall rates paid in 2004 compared to 2003 resulted primarily from the impact of a declining interest rate environment, as the Company issued new fixed annuities at rates below the prior year average rates.

     NET REALIZED INVESTMENT GAINS (LOSSES) totaled $1.2 million of losses in 2004, compared with net realized investment gains of $1.2 million in 2003 and include impairment writedowns of $0.4 million and $0, respectively. Thus, net realized losses from sales and redemptions of investments totaled $0.8 million in 2004, compared with net realized gains from sales and redemptions of investments of $1.2 million in 2003.

     The Company sold or redeemed invested assets, principally bonds and notes, aggregating $230.5 million in 2004 and $145.1 million in 2003. Sales of investments result from the active management of the Company’s investment portfolio. Because redemptions of investments are generally involuntary and sales of investments are made in both rising and falling interest rate environments, net gains and losses from sales and redemptions of investments fluctuate from period to period, and represent 0.10% and 0.26% of average invested assets for 2004

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and 2003, respectively. Active portfolio management involves the ongoing evaluation of asset sectors, individual securities within the investment portfolio and the reallocation of investments from sectors that are perceived to be relatively overvalued to sectors that are perceived to be relatively undervalued. The intent of the Company’s active portfolio management is to maximize total returns on the investment portfolio, taking into account credit, option, liquidity and interest-rate risk.

     Impairment writedowns include $0.4 million of provisions applied to bonds in 2004. There were no impairments in 2003. On an annualized basis, impairment writedowns represent 0.06% of average invested assets for 2004. For the twenty quarters ended March 31, 2004, impairment writedowns as a percentage of average invested assets have ranged from 0.00% to 3.99% and have averaged 0.77%. Such writedowns are based upon estimates of the fair value of invested assets and recorded when declines in the value of such assets are considered to be other than temporary. Actual realization will be dependent upon future events.

     VARIABLE ANNUITY FEES are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $2.2 million in 2004 and $1.9 million in 2003. The increased fees in 2004 as compared to 2003 primarily reflects the more favorable equity market conditions since the early part of 2003, and the resulting favorable impact on market values of assets in the separate accounts. Variable annuity fees represent 1.96% and 1.94% of average variable annuity assets in 2004 and 2003, respectively. Variable annuity assets averaged $448.3 million and $389.3 million during the respective periods. Variable annuity deposits, which exclude deposits allocated to the fixed accounts of variable annuity products, totaled $10.1 million in 2004 and $6.0 million in 2003. On an annualized basis, these amounts represent 9% and 6% of variable annuity reserves at the beginning of the respective periods. Transfers from the fixed accounts of the Company’s variable annuity products to the separate accounts (see “Change in Average Invested Assets”) are not classified as variable annuity deposits. Accordingly, changes in variable annuity deposits are not necessarily indicative of the ultimate allocation by customers among fixed and variable account options of the Company’s variable annuity products.

     Sales of variable annuity products (which include deposits allocated to the fixed accounts) (“Variable Annuity Product Sales”) amounted to $28.1 million and $15.8 million in 2004 and 2003, respectively. The increase in Variable Annuity Product Sales reflects the favorable equity market conditions in 2004 and the latter part of 2003.

     The Company has encountered increased competition in the variable annuity marketplace during recent years and anticipates that the market will remain highly competitive for the foreseeable future. Also, from time to time, Federal initiatives are proposed that could affect the taxation of annuities (see “Regulation”).

     UNIVERSAL LIFE INSURANCE FEES, NET OF REINSURANCE amounted to $1.5 million in 2004 and $1.4 million in 2003 and are net of reinsurance premiums of $1.6 million $1.7 million, respectively. Universal life insurance fees consist of mortality charges, up-front fees earned on deposits received and administrative fees, net of reinsurance premiums. The administrative fees are assessed based on the number of policies in force as of the end of each month. The Company acquired its universal life contracts as part of the acquisition of business from MBL Life Assurance Corporation on July 1, 1999 and does not actively market such contracts. Such fees represent 2.7% and 2.4% of average reserves for universal life insurance contracts in the respective periods.

     SURRENDER CHARGES on fixed annuity, variable annuity and universal life contracts totaled $0.5 million in both 2004 and 2003. Surrender charge periods range from zero to nine years from the date a deposit is received. Surrender charges generally are assessed on withdrawals at declining rates. Withdrawal payments, which exclude claims and annuitization payments, totaled $52.4 million in 2004 compared with $48.5 million in 2003. These payments, when expressed as a percentage of average related reserves, represent 6.5% and 9.9% for 2004 and 2003, respectively.

     GENERAL AND ADMINISTRATIVE EXPENSES totaled $3.0 million in 2004 and $2.5 million in 2003. General and administrative expenses remain closely controlled through a company-wide cost containment program and continue to represent less than 1% of average total assets.

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     AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $8.0 million in 2004, compared to $5.3 million in 2003. The increase in amortization in 2004 was primarily related to the increase in investment spread, partially offset by higher net realized investment losses.

     ANNUAL COMMISSIONS totaled $0.5 million in 2004 and $0.2 million in 2003. Annual commissions represent renewal commissions paid quarterly in arrears to maintain the persistency of certain of the Company’s products. Substantially all of the Company’s currently available annuity products allow for an annual commission payment option in return for a lower immediate commission.

     CLAIMS ON UNIVERSAL LIFE INSURANCE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled $1.3 million in both 2004 and 2003 (net of reinsurance recoveries of $1.4 million in 2004 and $1.6 in 2003).

     GUARANTEED MINIMUM DEATH BENEFITS on variable annuity contracts totaled $0.5 million in 2004 compared with $0.2 million in 2003. Downturns in equity markets could increase these expenses.

     A majority of the Company’s variable annuity products are issued with a death benefit feature, which provides that, upon the death of a contractholder, the contractholder’s beneficiary will receive the greater of (1) the contractholder’s account value, or (2) a guaranteed minimum death benefit that varies by product. The Company bears the risk that death claims following a decline in the financial markets may exceed contractholder account balances, and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. On January 1, 2004, the Company recorded a liability for GMDB (see Note 2 to Financial Statements) pursuant to adoption of a new accounting standard, SOP 03-1.

CAPITAL RESOURCES AND LIQUIDITY

     SHAREHOLDER’S EQUITY increased to $378.4 million at March 31, 2004 from $349.5 million at December 31, 2003, due to $1.2 million of net income recorded in 2004 and $27.7 million in other comprehensive income.

     INVESTED ASSETS at March 31, 2004 totaled $3.54 billion, compared with $3.17 billion at December 31, 2003. The following table summarizes the Company’s investment portfolio at March 31, 2004 and December 31, 2003.

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     The Company’s general investment philosophy is to hold fixed-rate assets for long-term investment. Thus, it does not have a trading portfolio. However, the Company has determined that all of the Bond Portfolio is available to be sold in response to changes in market interest rates, changes in relative value of asset sectors and individual securities, changes in prepayment risk, changes in the credit quality outlook for certain securities, the Company’s need for liquidity and other similar factors.

     THE BOND PORTFOLIO, which constituted 82% of the Company’s total investment portfolio at March 31, 2004, had an aggregate fair value that was $94.5 million greater than its amortized cost at March 31, 2004, compared with $40.2 million at December 31, 2003. The increase in net unrealized gains on the Bond Portfolio during 2004 principally reflects the decline in prevailing interest rates and the corresponding effect on the fair value of the Bond Portfolio at March 31, 2004.

     At March 31, 2004, the Bond Portfolio had an aggregate fair value of $2.90 billion and an aggregate amortized cost of $2.81 billion. At March 31, 2004, the Bond Portfolio included $2.70 billion of bonds rated by Standard & Poor’s (“S&P”), Moody’s Investors Services (“Moody’s”), Fitch (“Fitch”) or the National Association of Insurance Commissioners (“NAIC”), and $200.6 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At March 31, 2004, approximately $2.66 billion of the Bond Portfolio was investment grade, including $794.8 million of U.S. government/agency securities and mortgage-backed securities (“MBS”).

     At March 31, 2004, the Bond Portfolio included $237.7 million of bonds that were not investment grade. These non-investment-grade bonds accounted for approximately 5.7% of the Company’s total assets and approximately 6.7% of its invested assets. Non-investment-grade securities generally provide higher yields and involve greater risks than investment-grade securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment-grade issuers. In addition, the trading market for these securities is usually more limited than for investment-grade securities. An economic downturn could produce higher than average issuer defaults on the non-investment-grade securities, which could cause the Company’s investment returns and net income to decline. At March 31, 2004, the Company’s non-investment-grade portfolio consisted of 57 issues with no single issuer representing more than 10% of the total non-investment grade bond portfolio. These non-investment-grade securities are comprised of bonds spanning 11 industries with 21% of these assets concentrated in basic industrial products, 15% concentrated in financial institutions, 14% concentrated in non-cyclical consumer products and 11% concentrated in telecommunications. No other industry concentration constituted more than 10% of these assets.

     The table on the following page summarizes the Company’s rated bonds by rating classification as of March 31, 2004.

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RATED BONDS BY RATING CLASSIFICATION
(Dollars in thousands)

Footnotes to the table of Rated Bonds by Rating Classification

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     The valuation of invested assets involves obtaining a fair value for each security. The source for the fair value is generally from market exchanges, with the exception of non-traded securities.

     Another aspect of valuation pertains to impairment. As a matter of policy, the determination that a security has incurred an other-than-temporary decline in value and the amount of any loss recognition requires the judgment of the Company’s management and a continual review of its investments. In general, a security is considered a candidate for impairment if it meets any of the following criteria:

	•		Trading at a significant discount to par, amortized cost (if lower) or cost for an extended period of time;
	•		The occurrence of a discrete credit event resulting in: (i) the issuer defaulting on a material outstanding obligation; (ii) the issuer seeking protection from creditors under the bankruptcy laws or similar laws intended for the court supervised reorganization of insolvent enterprises; or (iii) the issuer proposing a voluntary reorganization pursuant to which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than the par value of their claims; or
	•		In the opinion of the Company’s management, it is unlikely the Company will realize a full recovery on its investment, irrespective of the occurrence of one of the foregoing events.

     Once a security has been identified as potentially impaired, the amount of such impairment is determined by reference to that security’s contemporaneous market price.

     The Company has the ability to hold any security to its stated maturity. Therefore, the decision to sell reflects the judgment of the Company’s management that the security sold is unlikely to provide, on a relative value basis, as attractive a return in the future as alternative securities entailing comparable risks. With respect to distressed securities, the sale decision reflects management’s judgment that the risk-discounted anticipated ultimate recovery is less than the value achieved on sale.

     As a result of these policies, the Company recorded pretax impairment writedowns of $0.4 million in the 2004 that consisted primarily of one individual impairment loss. No other individual impairment loss exceeded 10% of the Company’s net income for the three months ended March 31, 2004.

     Excluding the impairments noted above, the changes in fair value for the Company’s Bond Portfolio, which constitutes the vast majority of the Company’s investments, were recorded as a component of other comprehensive income in shareholder’s equity as unrealized gains or losses.

     At March 31, 2004, the Company’s Bond Portfolio had gross unrealized gains of $103.7 million and gross unrealized losses of $9.2 million. Four issuers accounted for 48% of unrealized losses.

     At March 31, 2004, the fair value of the Company’s Bond Portfolio aggregated $2.90 billion. Of this aggregate fair value, approximately 0.03% represented securities trading at or below 75% of amortized cost. The impact of unrealized losses on net income will be further mitigated upon realization, because realization will result in current decreases in the amortization of certain deferred acquisition costs and decreases in income taxes.

     At March 31, 2004, approximately $394.8 million, at amortized cost, of the Bond Portfolio had a fair value of $385.6 million resulting in an aggregate unrealized loss of $9.2 million. Unrealized losses for the Bond Portfolio and equity securities did not reflect any significant industry concentrations.

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     The amortized cost of the Bond Portfolio in an unrealized loss position at March 31, 2004, by contractual maturity, is shown below.

     The aging of the Bond Portfolio in an unrealized loss position at March 31, 2004 is shown below: