SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

OR

For the quarterly period ended September 30, 2004

Commission File No. 33-47472

AIG SUNAMERICA LIFE ASSURANCE COMPANY

1 SunAmerica Center, Los Angeles, California 90067-6022
Registrant’s telephone number, including area code: (310) 772-6000

     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 WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12b-2 OF THE SECURITIES EXCHANGE ACT OF 1934). Yes [   ] No [X]

     THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT’S COMMON STOCK ON NOVEMBER 12, 2004 WAS AS FOLLOWS:

     REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE REDUCED DISCLOSURE FORMAT.

AIG SUNAMERICA LIFE ASSURANCE COMPANY

INDEX

AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED BALANCE SHEET
(Unaudited)

See accompanying notes to consolidated financial statements

2

AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED BALANCE SHEET (Continued)
(Unaudited)

See accompanying notes to consolidated financial statements.

3

AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
For the three months and nine months ended September 30, 2004 and 2003
(Unaudited)

See accompanying notes to consolidated financial statements.

4

AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME (Continued)
For the three months and nine months ended September 30, 2004 and 2003
(Unaudited)

See accompanying notes to consolidated financial statements.

5

AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
For the nine months ended September 30, 2004 and 2003
(Unaudited)

See accompanying notes to consolidated financial statements.

6

AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
For the nine months ended September 30, 2004 and 2003
(Unaudited)

See accompanying notes to consolidated financial statements.

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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.		BASIS OF PRESENTATION
		AIG SunAmerica Life Assurance Company (formerly Anchor National Life Insurance Company) (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 wholly owned 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. The Company is an Arizona-domiciled life insurance company principally engaged in the business of writing variable annuities directed to the market for tax-deferred, long-term savings products. It also administers closed blocks of fixed annuities, universal life policies and guaranteed investment contracts (“GICs”).
		The Company changed its name to AIG SunAmerica Life Assurance Company on January 24, 2002. The Company continued to do business as Anchor National Life Insurance Company until February 28, 2003, at which time it began doing business under its new name.
		Effective January 1, 2004, the Parent contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. (“SAAMCo”) (formerly SunAmerica Asset Management Corp.) which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. (“SACS”) (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica Fund Services, Inc. (“SFS”) (formerly SunAmerica Fund Services, Inc.). Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary of the Company. This contribution increased the Company’s shareholder’s equity by $99,131,000. Included in the contribution of SAAMCo to the Company were tax benefits of $24,624,000 derived from losses incurred by SA Affordable Housing, L.L.C. through December 31, 2003, at which time it was no longer a subsidiary of SAAMCo. Assets, liabilities and shareholder’s equity at December 31, 2003 were restated to include $174,756,000, $75,625,000 and $99,131,000, respectively, of SAAMCo balances. Similarly, the results of operations and cash flows for the nine months ended September 30, 2003 have been restated for the addition to pretax income of $10,034,000 to reflect the SAAMCo activity.
		SAAMCo and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS, are included in the Company’s asset management segment (see Note 5). These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, managing certain subaccounts offered within the Company’s variable annuity products and providing professional management of individual, corporate and pension plan portfolios.
		In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments necessary, consisting of normal recurring items, to present fairly the Company’s consolidated financial position as of September 30, 2004 and December 31, 2003, the results of its consolidated operations for the three months and nine months ended September 30, 2004 and 2003 and its consolidated cash flows for the nine months ended September 30, 2004 and 2003. The results of operations for the three months and nine months ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2003, contained in the Company’s 2003 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to the current period’s presentation.

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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

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 certain other expenses. The Company reported for the first quarter of 2004 a one-time cumulative accounting charge upon adoption of $62,589,000 ($96,291,000 pre-tax) to reflect the liability and the related impact of deferred acquisition costs (“DAC”) and reinsurance as of January 1, 2004.
		The Company issues variable annuities for which the investment risk is generally borne by the contract holder, except with respect to amounts invested in the fixed-rate account options. For many of the Company’s variable annuities, the Company offers contractual guarantees in the event of death, at specified dates during the accumulation period, upon certain withdrawals or at annuitization. Such benefits are referred to as guaranteed minimum death benefits (“GMDB”), guaranteed minimum account value benefits (“GMAV”), guaranteed minimum withdrawal benefits (“GMWB”) and guaranteed minimum income benefits (“GMIB”), respectively. The Company also issues certain variable annuity products that offer an optional earnings enhancement benefit (“EEB”) feature that provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums.
		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, other services and certain features are included in variable annuity policy fees, net of reinsurance, in the consolidated statement of income and comprehensive income. Changes in liabilities for minimum guarantees are included in guaranteed benefits, net of reinsurance, in the consolidated statement of income and comprehensive income. Separate account net investment income, net investment gains and losses and the related liability charges are offset within the same line item in the consolidated statement of income and comprehensive income.
		The Company offers GMDB options that guarantee for virtually all contract holders, that upon death, the contract holder’s beneficiary will receive the greater of (1) the contract holder’s account value, or (2) a guaranteed minimum death benefit that varies by product and election by policy owner. 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 guaranteed benefits, net of reinsurance recoveries, if actual experience or other evidence suggests that earlier assumptions should be revised. As of September 30, 2004, approximately 30% of in-force contracts with GMDB (calculated based on account value) have been reinsured.
		GMAV is a feature offered on certain variable annuity products. If available and elected by the contract holder at the time of contract issuance, GMAV guarantees that the account value under the contract will at least equal the amount of deposits invested during the first ninety days, adjusted for any subsequent withdrawals, at the end of a ten-year waiting period. The Company purchases put options on the S&P 500 index to partially offset this risk. GMAVs are considered to be derivatives under Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities"(“FAS 133”), and are recognized at fair value in the consolidated balance sheet and through investment income in the consolidated statement of income and comprehensive income.
		GMWB is a feature offered on certain variable annuity products. If available and elected by the contract holder at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days adjusted for any subsequent withdrawals (“Eligible Premium”). These guaranteed annual withdrawals of up to 10% of Eligible Premiums, are available after either a three-year or a five-year

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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

2.		RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)
		waiting period as elected by the contract holder at time of contract issuance, without reducing the future amounts guaranteed. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will realize an additional 10% or 20%, respectively, of Eligible Premium after all other amounts guaranteed under this benefit have been paid. GMWBs are considered to be derivatives under FAS 133 and are recognized at fair value in the consolidated balance sheet and through investment income in the consolidated statement of income and comprehensive income.
		If available and elected by the contract holder, GMIB provides a minimum fixed annuity payment guarantee after a seven, nine or ten-year waiting period. As there is a waiting period to annuitize using the GMIB, there are virtually no policies eligible to receive this benefit at September 30, 2004. The GMIB liability is determined each period end by estimating the expected value of the annuitization benefits in excess of the projected account balance at the date of annuitization 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 guaranteed benefits, net of reinsurance recoveries, if actual experience or other evidence suggests that earlier assumptions should be revised. As of June 30, 2004, virtually all of the Company’s GMIB exposure was effectively transferred to several large insurance companies via reinsurance agreements. However, the Company does not have reinsurance coverage on contracts sold after July 2004.

10

AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

2.		RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)
		Details concerning the Company’s guaranteed benefit exposures as of September 30, 2004 are as follows:

(a)		Net amount at risk represents the guaranteed benefit exposure in excess of the current account value, net of applicable reinsurance, if all contract holders died, in the case of GMDB, annuitized, in the case of GMIB, or reached the specified date, in the case of GMAV, at the same balance sheet date.
(b)		Net amount at risk represents the guaranteed benefit exposure in excess of the current account value if all contract holders exercise the maximum withdrawal benefits at the same balance sheet date. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will realize an additional 10% or 20% of Eligible Premium, respectively, after all other amounts guaranteed under this benefit have been paid. The additional 10% or 20% enhancement increases the net amount at risk by $17,814,000 payable no sooner than 13 or 15 years from contract issuance for the 3 or 5 year waiting periods, respectively.

11

AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

2.		RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)
		The following summarizes the reserve for guaranteed benefits, net of reinsurance, on variable contracts reflected in the general account:

(c)

Includes amounts from the one-time cumulative accounting change resulting from the adoption of SOP 03-1.

The following assumptions and methodology were used to determine the reserve for guaranteed benefits at September 30, 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. Such amounts 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 expenses 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 $160.0 million of these expenses from DAC to other deferred expenses, which is reported on the consolidated balance sheet. For the nine months ended September 30, 2004, $29.1 million of these expenses were deferred. For the nine months ended September 30, 2004, amortization of these deferred expenses was $6.7 million. Amortization of other deferred expenses is reported as part of amortization of deferred acquisition costs and other deferred expenses on the consolidated statement of income and comprehensive income. Prior period consolidated balance sheet and consolidated statement of income and comprehensive income presentation has been reclassified to conform to the new presentation.
3.		CONTINGENT LIABILITIES
		The Company has six agreements outstanding in which it has provided liquidity support for certain short-term securities of municipalities and non-profit organizations by agreeing to purchase such securities in the event there is no other buyer in the short-term marketplace. In return the Company receives a fee. In addition, the Company guarantees the payment of these securities upon redemption. The maximum liability under these guarantees at September 30, 2004 is $195,439,000. These commitments have contractual maturity dates as follows: $20,500,000 in the remainder of 2004 and $174,939,000 in 2005. Related to each of these agreements are participation agreements with the Parent under which the Parent will share in $62,599,000 of these liabilities in exchange for a proportionate percentage of the fees received under these agreements. The Internal Revenue Service has completed

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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

3.		CONTINGENT LIABILITIES (Continued)
		its examinations into the transactions underlying these commitments, including the Companys’s role in the transactions. The examination did not result in a material loss to the Company.
		At September 30, 2004, the Company has commitments to purchase a total of approximately $24,000,000 of asset-backed securities in the ordinary course of business. The expiration dates of these commitments are as follows: $15,000,000 in 2004 and $9,000,000 in 2006.
		Various federal, state and other regulatory agencies are reviewing certain transactions and practices of the Company and its subsidiaries in connection with industry-wide and other inquiries. In the opinion of the Company’s management and based on the current status of these inquiries, it is not likely that any of these inquiries will have a material adverse effect on the Company’s consolidated financial condition or operation.
		Various lawsuits against the Company have arisen in the ordinary course of business. Contingent liabilities arising from litigation, income taxes and regulatory and other matters are not considered material in relation to the financial position, results of operations or cash flows of the Company.
		On April 5, 2004, a purported class action captioned Nitika Mehta, as Trustee of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case 04L0199, was filed in the Circuit Court, Twentieth Judicial District in St. Clair County, Illinois. The lawsuit alleges certain improprieties in conjunction with alleged market timing activities. The probability of any particular outcome cannot be reasonably estimated at this time.
4.		RELATED-PARTY MATTERS
		Subordinated notes (including accrued interest of $523,000) payable to affiliates totaled $41,483,000 at interest rates ranging from 4.00% to 9.5% at September 30, 2004, and require principal payments of $3,000,000 in 2004 and $37,960,000 in 2008.
		On October 31, 2003, the Company became a party to an existing credit agreement under which the Company agreed to make loans to AIG in an aggregate amount of up to $60,000,000. This commitment expires on October 28, 2005. There was no outstanding balance under this agreement at September 30, 2004.
		At September 30, 2004, a receivable of $5,000,000 was included in due to affiliates on the consolidated balance sheet. This balance is due from AIGRS under the short-term financing arrangement that is discussed in the Related-Party Matters footnote of the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
		On February 1, 2004, SAAMCo entered into an administrative services agreement with its affiliate, First SunAmerica Life Insurance Company (“FSA”), whereby SAAMCo will pay to FSA a fee based on a percentage of all assets invested through FSA’s variable annuity products in exchange for services performed. SAAMCo is the investment advisor for certain trusts that serve as investment options for FSA’s variable annuity products. Amounts earned by FSA under this agreement totaled $1.3 million in 2004 and are included in asset management fees in the statement of income and comprehensive income. A fee of $1.2 million was paid to FSA under a different agreement in 2003.
		On October 1, 2001, SAAMCo entered into two administrative services agreements with business trusts established by its affiliate, The Variable Annuity Life Insurance Company (“VALIC”), whereby the trust pays to SAAMCo a fee based on a percentage of average daily net assets invested through VALIC’s annuity products in exchange for services performed. Amounts earned by SAAMCo under this agreement totaled $6.7 million in 2004 and $5.4 million in 2003 and are included in other fees in the consolidated statement of income and comprehensive income.
		SAAMCo and VALIC have an agreement pursuant to which SAAMCo pays a fee based on a percentage of each funds’ average daily net assets invested through VALIC’s annuity products for certain administrative costs incurred by VALIC. Amounts paid by SAAMCo totaled $1.9 million in 2004 and $1.6 million in 2003 and are included in other fees in the consolidated statement of income and comprehensive income.

13

AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

4.		RELATED-PARTY MATTERS (Continued)
		The Company has a support agreement in effect between the Company and AIG (the “Support Agreement”), pursuant to which AIG has agreed that AIG will cause the Company to maintain a policyholder’s surplus of not less than $1,000,000 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 obligations 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 Company defaults in any claim or payment owed to such policyholder when due, have the right to enforce the Support Agreement directly against AIG.
		The Company’s insurance policy obligations are guaranteed by American Home Assurance Company (“American Home”), a subsidiary of AIG, and a member of an AIG intercompany pool. This guarantee is unconditional and irrevocable, and the Company’s policyholders have the right to enforce the guarantee directly against American Home.
		American Home does not publish financial statements prepared on the basis of U.S. generally accepted accounting principles, although it files statutory annual and quarterly 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 files annual reports on Form 10-K and quarterly reports on Form 10-Q, which are available from the Securities and Exchange Commission.
5.		SEGMENT INFORMATION
		As of January 1, 2004, the Company began conducting its business through two business segments, annuity operations and asset management operations. Prior to January 1, 2004, the Company conducted its business through one segment: annuity operations. Annuity operations consists of the sale and administration of deposit-type insurance contracts, including fixed and variable annuities, universal life insurance contracts and GICs. Asset management operations, which includes the management, distribution and administration of mutual funds, is conducted by SAAMCo and its subsidiary and distributor, SACS, and its subsidiary and servicing administrator, SFS. Following is selected information pertaining to the Company’s business segments.

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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

5.

SEGMENT INFORMATION (Continued)

15

AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

5.

SEGMENT INFORMATION (Continued)

16

AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

5.

SEGMENT INFORMATION (Continued)

17

AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

5.

SEGMENT INFORMATION (Continued)

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AIG SUNAMERICA LIFE ASSURANCE 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 AIG SunAmerica Life Assurance Company (formerly Anchor National Life Insurance Company) (the “Company”) for the three months and nine months ended September 30, 2004 and 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 and 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.

CRITICAL ACCOUNTING POLICIES

     The Company considers its most critical accounting policies those policies with respect to valuation of certain financial instruments, amortization of deferred acquisition costs and other deferred expenses and the reserve 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 $35.5 million at September 30, 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 investments in debt and equity securities. In particular, for debt securities, 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 the Company’s portfolio with a carrying value of approximately $892.1 million at September 30, 2004 do not have readily determinable market prices. For these securities, the Company estimates the fair value with internally prepared valuations (including those based on estimates of future profitability). Otherwise, the Company uses its most recent 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. The Company’s ability to liquidate its positions in these securities will be impacted to a significant degree by the lack of an actively traded market, and the Company may not be able

19

to dispose of these investments in a timely manner. Although the Company believes its estimates reasonably reflect the fair value of those securities, the 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 AND OTHER DEFERRED EXPENSES: Approximately 79% of the amortization of deferred acquisition costs (“DAC”) and other deferred expenses was attributed to policy acquisition costs deferred by the annuity operations and 21% was attributed to the distribution costs deferred by the asset management operations. For the annuity operations, the Company amortizes DAC and other deferred expenses based on a percentage of expected gross profits (“EGPs”) over the life of the underlying policies over the estimated lives of the fund deposits on a straight-line basis. EGPs are computed based on assumptions related to the underlying policies written, including their anticipated duration, the growth rate of the separate account assets (with respect to variable annuities) or general account assets (with respect to fixed annuities, fixed options of variable annuities and universal life contracts) supporting the annuity obligations, costs of providing policy guarantees and the level of expenses necessary to maintain the policies. The Company adjusts amortization of DAC and other deferred expenses (a “DAC unlocking”) when current or estimates of future gross profits to be realized from its annuity policies are revised. Approximately 96% of the DAC balance attributed to annuity operations at September 30, 2004 related to variable annuity products and 4% related to fixed annuity and universal life products.

     DAC amortization on annuities is sensitive to surrender rates, claims costs, and the actual and assumed future growth rate of the assets supporting the Company’s obligations under annuity policies. With respect to fixed annuities, the growth rate depends on the yield on the general account assets supporting those annuities. With respect to variable annuities, the growth rate depends on the performance of the investment options available under the annuity contract and the allocation of assets among these various investment options.

     The assumption the Company uses for the long-term annual net growth of the separate account assets in the determination of DAC amortization with respect to its variable annuity policies is 10% (the “long-term growth rate assumption”). The Company uses a “reversion to the mean” methodology that allows it to maintain this 10% long-term growth rate assumption, while also giving consideration to the effect of short-term swings in the equity markets. For example, if performance was 15% during the first year following the introduction of a product, the DAC model would assume that market returns for the following five years (the “short-term growth rate assumption”) would be approximately 9%, resulting in an average annual growth rate of 10% during the life of the product. Similarly, following periods of below 10% performance, the model will assume a short-term growth rate higher than 10%. A DAC unlocking will occur if management deems the short-term growth rate assumption (i.e., the growth rate required to revert to the mean 10% growth rate over a five-year period) to be unreasonable. The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry.

     For the asset management operations, the Company defers distribution costs that are directly related to the sale of mutual funds which have a 12b-1 distribution plan and/or a contingent deferred sales charge feature, (collectively, “Distribution Fee Revenue”). These costs are amortized on a straight-line basis, adjusted for redemptions, over a period ranging from one year to eight years depending on share class. The carrying value of the deferred asset is subject to continuous review based on projected Distribution Fee Revenue. Amortization of deferred distribution costs is increased if at any reporting period the value of the deferred amount exceeds the projected Distribution Fee Revenue. The projected Distribution Fee Revenue is sensitive to estimated future withdrawal rates and the rates of market return. Management uses historical activity to estimate future withdrawal rates and average annual performance of the equity markets to estimate the rates of market return.

     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”) and other guaranteed benefits. In calculating the projected liability, five thousand stochastically generated investment performance scenarios were developed using the Company’s best estimates. These assumptions included, among others, mean equity return and volatility, mortality rates and lapse rates. The estimation of cash flow and the determination of the assumptions used require judgment, which can, at times, be subjective.

20

     Several of the guaranteed benefits are sensitive to equity market conditions. The Company uses the purchase of reinsurance and capital market hedging strategies to mitigate the risk of paying benefits in excess of account values as a result of significant downturns in equity markets. Risk mitigation may or may not reduce the volatility of net income resulting from equity market volatility. Reinsurance or hedges are secured when the cost is less than the risk reduction. The Company expects to use either additional reinsurance or capital market hedges for risk mitigation on an opportunistic basis. Despite the purchase of reinsurance or hedges, the reinsurance or hedge secured may be inadequate to completely offset the effects of changes in equity markets.

RESULTS OF OPERATIONS

     NET INCOME totaled $43.1 million in the third quarter of 2004, compared with $18.2 million in the third quarter of 2003. For the nine months ended September 30, 2004, net income amounted to $50.0 million, compared to $49.4 million in 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 $62.6 million, net of tax, which is recognized in the consolidated statement of income and comprehensive income as a cumulative effect of accounting change for the nine months ended September 30, 2004.

     PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $51.5 million in the third quarter of 2004, compared with $23.6 million in the third quarter of 2003. For the nine months, pretax income before cumulative effect of accounting change totaled $148.4 million in 2004, compared to $64.1 million in 2003. The increase in both the third quarter and the nine months of 2004 was primarily due to higher variable annuity and asset management fee income and decreased amortization of deferred acquisition costs and other deferred expenses partially offset by lower investment income and higher general and administrative expenses.

     INCOME TAX EXPENSE totaled $8.4 million in the third quarter of 2004, $5.4 million in the third quarter of 2003, $35.8 million in the nine months of 2004 and $14.7 million in the nine months of 2003, representing effective tax rates of 16%, 23%, 24% and 23%, respectively. The decrease in the third quarter of 2004 results from the recognition of certain tax credits and a decrease in state taxes.

BUSINESS SEGMENTS

     Effective January 1, 2004, SunAmerica Life Insurance Company (the “Parent”) contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. (“SAAMCo”), which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. (“SACS”) and AIG SunAmerica Fund Services, Inc. (“SFS”). This contribution increased the Company’s shareholder’s equity by approximately $99.1 million (see Note 1 of Notes to Consolidated Financial Statements). Effective January 1, 2004, the Company’s earnings include the asset management operations of SAAMCo, SACS and SFS. Prior year results have been restated to account for this contribution as if it had occurred at the beginning of the earliest period presented.

     The Company has two business segments: annuity operations and asset management operations. The annuity operations consist of the sale and administration of deposit-type insurance contracts, such as variable and fixed annuities, universal life insurance and guaranteed investment contracts. The Company focuses primarily on the marketing of variable annuity products. The variable annuity products offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as guaranteed fixed-rate account options. The Company earns fee income on investments in the variable account options and net investment spread on the fixed-rate account options.

     The asset management operations are conducted by the Company’s registered investment advisor subsidiary, SAAMCo, and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS. These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, managing certain subaccounts offered within the Company’s variable annuity products and providing professional

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management of individual, corporate and pension plan portfolios.

ANNUITY OPERATIONS

     PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $42.4 million in the third quarter of 2004, compared with $15.1 million in the third quarter of 2003. For the nine months, pretax income before cumulative effect of accounting change totaled $123.8 million in 2004, compared to $47.8 million in 2003. The increase in 2004 compared to 2003 was primarily due to higher variable annuity policy fee income and lower amortization of deferred acquisition costs and other deferred expenses partially offset by higher general and administrative and other expenses.

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

     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 stocks. 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 a 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 an affiliate to administer the program.

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     An analysis of net investment spread and a reconciliation to pretax income before cumulative effect of accounting change is presented in the following table:

     Net investment spread totaled $32.1 million in the third quarter of 2004, compared to $39.3 million in the third quarter of 2003. These amounts equal 2.06% on average invested assets (computed on a daily basis) of $6.23 billion in the third quarter of 2004 and 2.35% on average invested assets of $6.69 billion in the third quarter of 2003. For the nine months, net investment spread totaled $106.4 million in 2004 and $116.1 million in 2003, representing 2.27% of average invested assets of $6.25 billion in 2004 and 2.30% of average invested assets of $6.72 billion in 2003 on an annualized basis.

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     The components of net investment spread were as follows (percentages represent annualized rates):

     The decline in average invested assets resulted primarily from net exchanges from fixed accounts into the separate accounts of variable annuity contracts, partially offset by sales of the fixed account options of the Company’s variable annuity products. Sales of fixed annuities and fixed annuity options (“Fixed Annuity Deposits”) and renewal deposits on its universal life product totaled $323.1 million in the third quarter of 2004, $389.3 million in the third quarter of 2003, $1.12 billion in the nine months of 2004 and $1.22 billion in the nine months of 2003, and are largely deposits for the fixed account options of variable annuities. On an annualized basis, Fixed Annuity Deposits represent 22%, 25%, 25% and 27%, respectively, of the related reserve balances at the beginning of the respective periods.

     Net investment spreads include the effect of income earned or interest paid on the difference between average invested assets and average interest-bearing liabilities. Average invested assets exceeded average interest-bearing liabilities by $258.9 million in the third quarter of 2004, compared with $245.4 million in the third quarter of 2003. For the nine months, average invested assets exceeded average interest-bearing liabilities by $267.5 million in 2004, compared with $252.9 million in 2003. The difference between the Company’s yield on average invested assets and the rate paid on average interest-bearing liabilities was 1.91% in the third quarter of 2004, 2.21% in the third quarter of 2003, 2.11% in the nine months of 2004 and 2.16% in the nine months of 2003.

     Investment income (and the related yields on average invested assets) totaled $87.9 million (5.65%) in the third quarter of 2004, $99.1 million (5.93%) in the third quarter of 2003, $272.7 million (5.81%) in the nine months of 2004 and $295.9 million (5.87%) in the nine months of 2003. The decrease in the investment yield primarily reflects the historically low prevailing interest rate environment that has persisted throughout 2003 and 2004, as well as $1.7 million in losses from the mark to market of the S&P 500 put options and the GMAV embedded derivatives in the third quarter of 2004, compared to a $1.5 million income in the third quarter of 2003. Excluding the impact of the put options and embedded derivatives, investment income would have been $89.6 million (5.76%) and $97.6 (5.84%) in the third quarters of 2004 and 2003, respectively. Expenses incurred to manage the investment portfolio amounted to $0.5 million in the third quarter of 2004, $0.6 million in the third quarter of 2003, $1.8 million in the nine months of 2004 and $1.7 million in the nine months of 2003. These expenses are included as a reduction of investment income in the consolidated statement of income and comprehensive income.

     Interest expense totaled $55.8 million in the third quarter of 2004 and $59.8 million in the third quarter of 2003. For the nine months, interest expense aggregated $166.3 million in 2004, compared with $179.8 million in 2003. The average rate paid on all interest-bearing liabilities was 3.74% in the third quarter of 2004, compared with 3.72% in the third quarter of 2003. For the nine months, the average rate paid on all interest-bearing liabilities was 3.70% in 2004 and 3.71% in 2003. Interest-bearing liabilities averaged $5.97 billion during the third quarter of 2004, $6.44 billion during the third quarter of 2003, $5.99 billion during the nine months of 2004 and $6.47 billion during the nine months of 2003.

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     NET REALIZED INVESTMENT LOSSES totaled $15.2 million in the third quarter of 2004, compared with $17.9 million in the third quarter of 2003 and include impairment writedowns of $15.4 million and $20.3 million, respectively. For the nine months, net realized investment losses totaled $24.9 million in 2004, compared with $26.6 million in 2003 and include impairment writedowns of $17.9 million and $35.9 million, respectively. Thus, net realized gains from sales and redemptions of investments totaled $0.2 million in the third quarter of 2004 and $2.4 million in the third quarter of 2003. For the nine months, net realized losses from sales and redemptions of investments totaled $7.0 million in 2004, compared to net realized gains of $9.3 million in 2003.

     The Company sold or redeemed invested assets, principally bonds and notes, aggregating $320.3 million in the third quarter of 2004, $265.4 million in the third quarter of 2003, $1.50 billion in the nine months of 2004 and $1.62 billion in the nine months of 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 0.01%, 0.14%, 0.15% and 0.17% of average invested assets in the third quarter of 2004, the third quarter of 2003, the nine months of 2004 and the nine months of 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 $15.4 million, $20.3 million, $17.9 million and $35.9 million of provisions principally applied to bonds in the third quarter of 2004, the third quarter of 2003, the nine months of 2004 and the nine months of 2003, respectively. On an annualized basis, impairment writedowns represent 0.99%, 1.21%, 0.38% and 0.71% of average invested assets in the respective periods. For the twenty quarters ended September 30, 2004, impairment writedowns as an annualized percentage of average invested assets have ranged from 0.07% to 1.95% and have averaged 0.69%. 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 POLICY FEES, NET OF REINSURANCE are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $91.9 million in the third quarter of 2004 and $72.2 million in the third quarter of 2003 and are net of reinsurance premiums of $6.7 million and $8.9 million, respectively. For the nine months, variable annuity policy fees totaled $270.5 million in 2004 and $201.2 million in 2003 and are net of reinsurance premiums of $21.7 million and $23.0 million, respectively. The increased fees in 2004 as compared to 2003 primarily reflect the improved equity market conditions in early 2004 and the latter part of 2003, and the resulting favorable impact on market values of the assets in the separate accounts. On an annualized basis, variable annuity policy fees represent 1.8%, 1.7%, 1.8% and 1.7% of average variable annuity assets in the third quarters and nine months of 2004 and 2003, respectively. Variable annuity assets averaged $20.13 billion, $16.88 billion, $20.03 billion and $15.68 billion during the respective periods. Variable annuity deposits, which exclude deposits allocated to the fixed accounts of variable annuity products, totaled $586.0 million in the third quarter of 2004 and $484.1 million in the third quarter of 2003. For the nine months, variable annuity deposits totaled $2.09 billion in 2004, compared with $1.21 billion in 2003. On an annualized basis, these amounts represent 11%, 12%, 15% and 11% of variable annuity reserves at the beginning of the respective periods. The increase in variable annuity deposits in the nine months of 2004 reflected increased demand for variable annuity products due to the improved equity market conditions in early 2004 and the latter part of 2003. Transfers from the fixed accounts of the Company’s variable annuity products to the separate accounts 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 $898.2 million, $863.2 million, $3.17 billion and $2.39 billion in the third quarters and the nine months of 2004 and 2003, respectively. Such sales primarily reflect those of the Company’s Polaris and Seasons families of variable annuity products. The Company’s variable annuity products are primarily multi-manager variable annuities that offer investors a choice of several variable funds as well as a number of

25

guaranteed fixed-rate funds. Investors can select from a choice of several variable funds and up to 7 guaranteed fixed-rate funds, depending on the product. The increase in Variable Annuity Product Sales for the nine months reflects the generally improved equity market conditions in early 2004 and the latter part of 2003. The 23% decrease in Variable Annuity Product Sales in the third quarter of 2004 compared to the prior quarter primarily reflects generally difficult equity market conditions during the third quarter.

     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 POLICY FEES, NET OF REINSURANCE amounted to $7.5 million in the third quarter of 2004 and $8.2 million in the third quarter of 2003 and are net of reinsurance premiums of $9.3 million and $9.1 million, respectively. For the nine months, universal life insurance policy fees totaled $25.2 million in 2004 and $26.5 million in 2003 and are net of reinsurance premiums of $25.7 million and $25.4 million, respectively. Universal life insurance policy 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 December 31, 1998 and does not actively market such contracts. Such fees annualized represent 2.0%, 2.1%, 2.2% and 2.2% of average reserves for universal life insurance contracts in the respective periods.

     SURRENDER CHARGES on variable annuity and universal life insurance contracts totaled $6.5 million in the third quarter of 2004 and $6.9 million in the third quarter of 2003. For the nine months, such surrender charges totaled $20.0 million in 2004 and $21.2 million in 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 during the first seven or nine years following receipt of the deposit.

     GENERAL AND ADMINISTRATIVE EXPENSES totaled $23.3 million in the third quarter of 2004 and $19.0 million in the third quarter of 2003. For the nine months, general and administrative expenses totaled $75.9 million in 2004 and $59.3 million in 2003. The increase in 2004 results from higher information technology costs and payroll related expenses resulting from higher sales and the servicing of such additional business. 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.

     AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES totaled $21.2 million in the third quarter of 2004, compared to $44.4 million in the third quarter of 2003. For the nine months, such amortization totaled $90.5 million in 2004 and $123.5 million in 2003. The prior year included accelerated amortization due to impairments of certain products and higher than anticipated surrenders on certain products with features which have been discontinued.

     ANNUAL COMMISSIONS totaled $15.1 million in the third quarter of 2004, compared with $11.4 million in the third quarter of 2003. For the nine months, annual commissions totaled $45.2 million in 2004 and $41.6 million in 2003. Annual commissions represent renewal commissions paid quarterly in arrears to maintain the persistency of certain of the Company’s variable annuity contracts. Substantially all of the Company’s currently available variable annuity products allow for an annual commission payment option in return for a lower immediate commission. The vast majority of the Company’s average balances of its variable annuity products are currently subject to such annual commissions.

     CLAIMS ON UNIVERSAL LIFE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled $3.6 million in the third quarter of 2004, compared to $4.0 million in the third quarter of 2003 and are net of reinsurance recoveries of $5.9 million and $9.0 million, respectively. For the nine months, such claims totaled $13.5 million in 2004 and $15.3 million in 2003 and are net of reinsurance recoveries of $28.6 million and $26.8 million, respectively. The change in such claims resulted principally from changes in mortality experience.

     GUARANTEED BENEFITS, NET OF REINSURANCE RECOVERIES on variable annuity contracts totaled $17.3 million in the third quarter of 2004, compared with $14.7 million in the third quarter of 2003 and are

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net of reinsurance recoveries of $0.1 million and $1.3 million, respectively. For the nine months, guaranteed benefits paid or accrued, net of reinsurance recoveries amounted to $48.2 million in 2004 and $51.2 million in 2003 and are net of reinsurance recoveries of $2.5 million and $7.1 million, respectively. These guaranteed benefits consist primarily of guaranteed minimum death benefits as well as immaterial amounts of earnings enhancement benefits and guaranteed minimum income benefits. These guarantees are described in more detail in the following paragraphs. The decrease during the nine months of 2004 reflects the generally improved equity market conditions in early 2004 and the latter part of 2003. Downturns in the equity markets could increase these expenses.

     Guaranteed minimum death benefits (“GMDB”) are issued on a majority of the Company’s variable annuity products. GMDB provides that, upon the death of a contract holder, the contract holder’s beneficiary will receive the greater of (1) the contract holder’s account value, or (2) a guaranteed minimum death benefit that varies by product and election by contract holder. The Company bears the risk that death claims following a decline in the equity markets may exceed contract holder account balances and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. As of September 30, 2004, the Company has reinsurance coverage on approximately 30% of in-force contracts with GMDB (calculated based on account value) and will be ceding only a small number of new contracts through the end of 2004. The Company does not currently have reinsurance coverage on any contracts to be sold after December 2004. Reinsurance coverage is subject to limitations such as caps and deductibles. On January 1, 2004, the Company recorded a liability for GMDB (see Note 2 of Notes to Consolidated Financial Statements) pursuant to adoption of a new accounting standard, SOP 03-1.

     Earnings enhancement benefit (“EEB”) is a feature the Company offers on certain variable annuity products. For contract holders who elect the feature, the EEB provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The Company bears the risk that account values following favorable performance of the financial markets will result in greater EEB death claims and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. At September 30, 2004, based on current account value, approximately 8% of in-force contracts include EEB coverage and 86% of the contracts with EEB are reinsured.

     Guaranteed minimum income benefit (“GMIB”) is a feature the Company offers on certain variable annuity products. This feature provides a minimum fixed annuity payment guarantee for those contract holders who choose to receive fixed lifetime annuity payments after a seven, nine, or ten-year waiting period in their deferred annuity contracts. The Company bears the risk that the performance of the financial markets will not be sufficient for accumulated policyholder account balances to support GMIB benefits and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The majority of the Company’s products containing the GMIB feature have been reinsured. However, the Company does not have reinsurance coverage on contracts sold after July 2004. As there is a waiting period to annuitize using the GMIB, there are virtually no policies eligible to receive this benefit at September 30, 2004.

     Guaranteed minimum account value (“GMAV”) is a feature the Company began offering on certain variable annuity products in the third quarter of 2002. If available and elected by the contract holder at the time of contract issuance, this feature guarantees that the account value under the contract will at least equal the amount of the deposits invested during the first ninety days of the contract, adjusted for any subsequent withdrawals, at the end of a ten-year waiting period. The Company bears the risk that protracted under-performance of the financial markets could result in GMAV benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The Company purchased put options on the S&P 500 index to partially offset this risk. Changes in the market value of both the GMAV benefit and the put options are recorded in investment income in the accompanying consolidated statement of income and comprehensive income.

     Guaranteed minimum withdrawal benefit (“GMWB”) is a feature the Company began offering on certain variable annuity products in May of 2004. If available and elected by the contract holder at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days adjusted for any subsequent withdrawals (“Eligible Premium”). These guaranteed annual withdrawals of up to 10% of Eligible Premium, are available after either a three-year or a five-year waiting period, as elected by the contract holder at the time of contract issuance, without reducing the future amounts guaranteed. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will

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realize an additional 10% or 20%, respectively, of Eligible Premium after all other amounts guaranteed under this benefit have been paid. The Company bears the risk that protracted under-performance of the financial markets could result in GMWB benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The Company is in the process of implementing a capital market hedging strategy for this feature.

     As of September 30, 2004, substantially all of the Company’s near-term exposure to guaranteed benefits relates to GMDB and EEB. However, as sales of products with other guaranteed benefits increase, the Company expects these newer guarantees to have a potential impact on operating results in periods when equity market returns are inadequate to support those contractual guarantees.

     With respect to its reinsurance agreements, the Company could become liable for all obligations of the reinsured policies if the reinsurers were to become unable to meet the obligations assumed under the respective reinsurance agreements. The Company monitors its credit exposure with respect to these agreements. Due to the high credit ratings and periodic monitoring of these ratings of the reinsurers, such risks are considered to be minimal.

ASSET MANAGEMENT OPERATIONS

     PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $9.1 million in the third quarter of 2004 compared to an $8.5 million in the third quarter of 2003. For the nine months, pretax income before cumulative effect of accounting change amounted to $24.6 million in 2004 and $16.4 million in 2003. The increases in the third quarter and nine months of 2004 from 2003 resulted from increased asset management fees, partially offset by increased amortization of DAC and other deferred expenses.

     ASSET MANAGEMENT FEES, which include investment advisory fees and 12b-1 distribution fees, are based on the market value of assets managed in mutual funds by SAAMCo. Such fees totaled $23.0 million on average assets managed of $9.53 billion in the third quarter of 2004 and $17.6 million on average assets managed of $8.42 billion in the third quarter of 2003. For the nine months, asset management fees amounted to $66.5 million on average assets managed of $9.59 billion in 2004 and $46.4 million on average assets managed of $7.88 billion in 2003. The increase in asset management fees is primarily the result of a higher average asset base and higher margin on account servicing fees. Mutual fund sales, excluding sales of money market accounts and private accounts, totaled $466.6 million in the third quarter of 2004, compared to $572.6 million in the third quarter of 2003. For the nine months, mutual fund sales amounted to $1.70 billion in 2004 and $1.57 billion in 2003. Redemptions of mutual funds, excluding redemptions of money market accounts, amounted to $386.1 million in the third quarter of 2004, $340.8 million in the third quarter of 2003, $1.13 billion in the nine months of 2004 and $1.11 billion in the nine months of 2003, which, annualized, represent 20%, 21%, 19% and 25%, respectively, of average related mutual fund assets. The increase in sales in the nine months of 2004 principally reflects increasing demand for equity products, due to generally improved equity market conditions in early 2004 and the latter part of 2003. The 13% decrease in mutual fund sales in the third quarter of 2004 compared to the prior quarter primarily reflects generally difficult equity market conditions during the third quarter.

     GENERAL AND ADMINISTRATIVE EXPENSES totaled $9.4 million in the third quarter of 2004, $7.3 million in the third quarter of 2003, $28.4 million in the nine months of 2004 and $25.3 million in the nine months of 2003. General and administrative expenses increased in 2004 due primarily to increased costs associated with higher sales and the servicing of such additional business.

     AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES includes amortization of distribution costs which totaled $8.1 million in the third quarter of 2004, compared with $5.9 million in the third quarter of 2003. For the nine months, such amortization totaled $23.5 million in 2004 and $16.3 million in 2003. The increase in amortization was primarily due to additional mutual fund sales since the third quarter of 2003 and amortization of the deferred commissions thereon.

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CAPITAL RESOURCES AND LIQUIDITY

     SHAREHOLDER’S EQUITY increased to $1.61 billion at September 30, 2004 from $1.56 billion at December 31, 2003. The increase reflected $50.0 million of net income partially offset by $3.2 million decrease in unrealized gains, net of the effect of taxes and DAC, and a $2.5 million dividend to the Parent.

     INVESTMENTS AND CASH at September 30, 2004 totaled $7.78 billion, compared with $7.12 billion at December 31, 2003. The Company’s invested assets are managed by an affiliate. The following table summarizes the Company’s portfolio of bonds, notes and redeemable preferred stocks (the “Bond Portfolio”) and other investments and cash at September 30, 2004 and December 31, 2003:

     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 68% of the Company’s total investment portfolio at September 30, 2004, had an aggregate fair value that was $152.6 million greater than its amortized cost at September 30, 2004, compared with $154.6 million at December 31, 2003.

     At September 30, 2004, the Bond Portfolio had an aggregate fair value of $5.27 billion and an aggregate amortized cost of $5.12 billion. At September 30, 2004, the Bond Portfolio (excluding $21.6 million of redeemable preferred stocks) included $5.17 billion of bonds rated by Standard & Poor’s (“S&P”), Moody’s Investors Service (“Moody’s”), Fitch (“Fitch”) or the National Association of Insurance Commissioners (“NAIC”), and $71.5 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At September 30, 2004, approximately $4.86 billion of the Bond Portfolio was investment grade, including $1.04 billion of mortgage-backed securities and U.S. government/agency securities.

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     At September 30, 2004, the Bond Portfolio included $383.4 million of bonds that were not investment grade. These non-investment-grade bonds accounted for approximately 1.3% of the Company’s total assets and approximately 4.9% 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 September 30, 2004, the Company’s non-investment-grade bond portfolio consisted of 174 issues with no single issuer representing more than 10% of the total non-investment-grade portfolio. These non-investment-grade securities are comprised of bonds spanning 10 industries with 22% of these assets concentrated in telecommunications, 19% concentrated in utilities, 14% concentrated in financial services and 10% concentrated in noncyclical consumer products. No other industry concentration constituted more than 10% of these assets.

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     The table below summarizes the Company’s rated bonds by rating classification as of September 30, 2004.

RATED BONDS BY RATING CLASSIFICATION
(Dollars in thousands)

Footnotes to the table of Rated Bonds by Rating Classification

(1)		S&P and Fitch rate debt securities in rating categories ranging from AAA (the highest) to D (in payment default). A plus (+) or minus (-) indicates the debt’s relative standing within the rating category. A security rated BBB- or higher is considered investment grade. Moody’s rates debt securities in rating categories ranging from Aaa (the highest) to C (extremely poor prospects of ever attaining any real investment standing). The number 1, 2 or 3 (with 1 the highest and 3 the lowest) indicates the debt’s relative standing within the rating category. A security rated Baa3 or higher is considered investment grade. Issues are categorized based on the highest of the S&P, Moody’s and Fitch ratings if rated by multiple agencies.
(2)		Bonds and short-term promissory instruments are divided into six quality categories for NAIC rating purposes, ranging from 1 (highest) to 5 (lowest) for non-defaulted bonds plus one category, 6, for bonds in or near default. These six categories correspond with the S&P/Moody’s/Fitch rating groups listed above, with categories 1 and 2 considered investment grade. The NAIC categories include $71.5 million of assets that were rated by the Company pursuant to applicable NAIC rating guidelines.

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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 $17.9 million and $35.9 million in the nine months of 2004 and 2003, respectively. No individual impairment loss, net of DAC and taxes, exceeded 10% of the Company’s net income for the nine months ended September 30, 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 September 30, 2004, the fair value of the Company’s Bond Portfolio aggregated $5.27 billion. Of this aggregate fair value, approximately 0.3% 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 September 30, 2004, approximately $4.20 billion, at amortized cost, of the Bond Portfolio had a fair value of $4.39 billion resulting in an aggregate unrealized gain of $188.1 million. At September 30, 2004, approximately $915.8 million, at amortized cost, of the Bond Portfolio had a fair value of $880.3 million resulting in an aggregate unrealized loss of $35.5 million. One issuer accounted for 11% of unrealized losses. No other single issuer accounted for more than 10% of unrealized losses. Approximately 27%, 25% and 12% of unrealized losses were from the financial services, transportation and noncyclical consumer products industries, respectively. No other industry accounted for more than 10% of unrealized losses.

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     The amortized cost of the Bond Portfolio in an unrealized loss position at September 30, 2004, by contractual maturity, is shown below.

     The aging of the Bond Portfolio in an unrealized loss position at September 30, 2004 is shown below: