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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2002

OR

Commission File Number 33-85014

FIRST SUNAMERICA LIFE INSURANCE COMPANY

733 Third Avenue, 4th Floor, New York, New York 10017
Registrant’s telephone number, including area code (800) 272-3007

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS               Yes /X/  No  /  /

INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT’S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. /X/

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEINED IN RULE 12B-2 OF THE SECURITIES EXCHANGE ACT OF 1934). Yes /  /  No /X/

AS THE REGISTRANT IS AN INDIRECT WHOLLY OWNED SUBSIDIARY OF AMERICAN INTERNATIONAL GROUP, INC., NONE OF THE REGISTRANT’S COMMON STOCK IS HELD BY NON-AFFILIATES OF THE REGISTRANT.

THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT’S COMMON STOCK ON March 31, 2003 WAS AS FOLLOWS:

Common Stock (par value $10,000 per share) 300 shares outstanding

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

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PART I

ITEM 1. BUSINESS

GENERAL DESCRIPTION

     First SunAmerica 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 SunAmerica Inc.(“SAI”), 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 and retirement savings and asset management.

     The Company is incorporated in New York and maintains its principal offices at 733 Third Avenue, 4th Floor, New York, New York 10017, telephone (800) 996-9786. The Company has one employee; however, employees of the Parent and its other subsidiaries perform various services for the Company. The Parent had approximately 2,000 employees at December 31, 2002, approximately 800 of whom perform services for the Company as well as for certain of its affiliates.

     The Company is a life insurance company principally engaged in the business of writing fixed and variable annuities for retirement savings. The Company believes that demographic trends have produced strong consumer demand for long-term, investment-oriented products. According to U.S. Census Bureau projections, the number of individuals between the ages of 45 to 64 grew from 47 million to 63 million from 1991 to 2001, making this age group the fastest-growing segment of the U.S. population. Between 1991 and 2001, annual industry premiums from fixed and variable annuities and fund deposits increased from $125.7 billion to $250.4 billion.

     Benefiting from continued strong growth of the retirement savings market, industry sales of tax-deferred savings products have represented, for a number of years, a significantly larger source of new premiums for the U.S. life insurance industry than have traditional life insurance products. Recognizing the growth potential of this market, the Company focuses its operations on the sale of annuities.

     The Company’s nine affiliated broker-dealers comprise the largest network of independent registered representatives in the nation and the fifth-largest securities sales force, based on industry data. Its affiliated broker-dealers accounted for approximately 4.8% of the Company’s total annuity sales in 2002. The Company also distributes its products and services through an extensive network of independent broker-dealers, full-service securities firms, independent general insurance agents and major financial institutions.

     The Company and its affiliates have made significant investments in technology over the past several years in order to lower operating costs and enhance their marketing efforts. Its use of optical disk imaging and artificial intelligence has substantially reduced the more traditional paper-intensive life insurance processing procedures, reducing annuity processing and servicing costs and improving customer service. This has also enabled the Company to more efficiently assimilate acquired business. The Company has also implemented technology to interface with both its affiliated and unaffiliated broker-dealers, which enables the Company to more effectively market its products and help the affiliated financial professionals to better serve their clients.

     In recent years, the Company has enhanced its marketing efforts and expanded its offerings of variable annuities through internal growth, resulting in increased fee income. The Company’s variable annuity business

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entails no portfolio credit risk and requires significantly less capital support than its fixed-rate business, which generates net investment income. The Company’s fixed-rate business, comprised of fixed annuities and universal life insurance contracts, has grown significantly in recent years through acquisitions.

     For the year ended December 31, 2002, the Company’s net investment income and net realized investment losses and fee income by primary product line or service are as follows:

NET INVESTMENT AND FEE INCOME

ANNUITY OPERATIONS

     Founded in 1978, the Company is licensed in the States of New York, New Mexico and Nebraska and issues a portfolio of single-premium fixed and flexible-premium variable annuities.

     In addition to distributing its variable annuity products through its nine affiliated broker-dealers, the Company distributes its products through a vast network of independent broker-dealers, full-service securities firms and financial institutions as well as through independent general insurance agents. In total, more than 9,900 independent sales representatives are licensed to sell the Company’s annuity products in three states.

On December 31, 1998, AIG SunAmerica Life Assurance Company (“AIG SALAC”), an affiliate of the Company, acquired the individual life business and the individual and group annuity business of MBL Life Assurance Corporation (“MBL Life”), via a 100% coinsurance transaction. Included in the block of business acquired from MBL Life were policies whose owners are residents of New York State (the “New York Business”). On July 1, 1999, the New York Business was acquired by the Company via an assumption reinsurance agreement.

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ANNUITY OPERATIONS - VARIABLE ANNUITIES - SEPARATE ACCOUNT

     The variable annuity products of the Company 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 through the sale, administration and management of the variable account options of its variable annuity products. The Company also earns investment income on monies allocated to the fixed-rate account options of these products. Variable annuities offer retirement planning features similar to those offered by fixed annuities, but differ in that the contractholder’s rate of return is generally dependent upon the investment performance of the particular equity, fixed-income, money market or asset allocation fund selected by the contractholder. Because the investment risk is borne by the customer in all but the fixed-rate account options, these products require significantly less capital support than fixed annuities.

     The Company’s flagship Polaris variable annuity products are multimanager variable annuities that offer investors a choice of 31 variable funds, 5 fixed account options and 2 dollar cost averaging fixed account options for different time periods. In January 2001, the Company introduced a new product, FSA Advisor, which is a multimanager variable annuity that offers investors a choice of 27 variable funds and a guaranteed fixed-rate fund. Variable annuity product sales have increased in recent years due to enhanced distribution efforts and growing consumer demand for flexible retirement savings products that offer a variety of equity, fixed-income and guaranteed fixed account investment choices. The increase in sales growth in 2002 is primarily due to the marketing of annuities through new distribution relationships. The increase in sales growth in 2001 is principally due to both new and enhanced relationships with New York based investment firms as well as the addition of four new funds offered by Polaris in December 2000.

     At December 31, 2002, total variable product liabilities were $608.3 million, of which $399.0 million were held in separate accounts and $209.3 million were the liabilities of the fixed-rate account options which are held in the general accounts. The Company’s variable annuity products incorporate surrender charges to encourage persistency. At December 31, 2002, 93% of the Company’s variable annuity reserves held in the separate accounts were subject to surrender penalties or other restrictions. The Company’s variable annuity products also generally limit the number of transfers made in a specified period between account options without the assessment of a fee. The average size of a new variable annuity contract sold by the Company in 2002 was approximately $123,000.

ANNUITY OPERATIONS – GENERAL ACCOUNT

     The Company’s general account obligations are fixed-rate products, including fixed annuities as well as universal life contracts issued in prior years and fixed-rate options of its variable annuity contracts. The Company offers single-premium and flexible-premium deferred annuities that provide one, three, five, seven, or ten-year fixed interest rate guarantees. The Company also offers fixed-rate account options on its variable annuity contracts with similar guarantees. Although the Company’s annuity contracts remain in force an average of seven to ten years, a majority (approximately 87% at December 31, 2002) of the annuity and universal life contracts, reprice annually at discretionary rates determined by the Company subject to 3% or 4% minimum rate guarantees, depending on the contract. In repricing, the Company takes into account yield characteristics of its investment portfolio, surrender assumptions and competitive industry pricing, among other factors. Its fixed annuity products offer many of the same features as conventional certificates of deposit from financial institutions, giving investors a choice of interest period and yield as well as additional

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advantages particularly applicable to retirement planning, such as tax-deferred accumulation and flexible payout options (including the option of payout over the life of the annuitant). The average size of a new single-premium fixed annuity contract sold by the Company in 2002 was approximately $42,000.

     The Company designs its fixed-rate annuity products and conducts its investment operations in order to closely match the duration of the assets in its investment portfolio to its fixed annuity and universal life obligations. The Company seeks to achieve a predictable spread between what it earns on its assets and what it pays on its liabilities by investing principally in fixed-rate securities. The Company’s fixed annuity and universal life products incorporate surrender charges or other restrictions in order to encourage persistency. Approximately 65% of the Company’s fixed annuity and universal life reserves had surrender penalties or other restrictions at December 31, 2002.

     Beginning in July 2002, the Company began marketing fixed annuities through a new financial institution partner. The Company’s fixed annuities sales increased significantly in the latter half of 2002 due to the enhanced marketing and distribution efforts.

INVESTMENT OPERATIONS

     The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed-rate investments are priced over the yield curve, default rates and general economic conditions. The majority of the Company’s invested assets are managed by an affiliate. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety.

     As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-rate assets and liabilities under commonly used stress-test interest rate scenarios. With the results of these computer simulations, the Company can measure the potential gain or loss in fair value of its interest-rate sensitive instruments and seek to protect its economic value and achieve a predictable spread between what it earns on its invested assets and what it pays on its liabilities by designing its fixed-rate products and conducting its investment operations to closely match the duration of the fixed-rate assets to that of its fixed-rate liabilities. The Company’s fixed-rate assets include: cash and short-term investments; bonds, notes and redeemable preferred stocks; mortgage loans and policy loans. At December 31, 2002, these assets had an aggregate fair value of $1.73 billion with a duration of 3.9 (See further discussion of duration under Capital Resources and Liquidity-Asset Liability Matching section). The Company’s fixed-rate liabilities include fixed annuity and universal life insurance contracts. At December 31, 2002, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $1.58 billion with a duration of 4.0. For the years ended December 31, 2002, December 31, 2001 and December 31, 2000, the Company’s yields on average invested assets were 6.73%, 7.07% and 7.09%, respectively; its average rates paid on all interest-bearing liabilities were 4.39%, 4.70% and 4.81%, respectively; and it realized net investment spreads on average invested assets of 2.67%, 2.65% and 2.50%, respectively. Net realized investment losses were 0.69%, 1.35% and 1.23% of average invested assets in 2002, 2001 and 2000, respectively.

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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 its portfolio of bonds, notes and redeemable preferred stocks (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 credit quality outlook for certain securities, and the Company’s need for liquidity and other similar factors.

     The following table summarizes the Company’s investment portfolio at December 31, 2002:

SUMMARY OF INVESTMENTS

     At December 31, 2002, the Bond Portfolio included $1.35 billion of bonds rated by Standard & Poor’s, Moody’s Investors Service, Fitch, or the Valuation Office of the National Association of Insurance Commissioners (“NAIC”), and $61.8 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At December 31, 2002, approximately $1.35 billion of the Bond Portfolio was investment grade, including $474.3 million of U.S. government/agency securities and mortgage-backed securities.

     At December 31, 2002, the Bond Portfolio included $55.7 million of bonds that were non-investment grade. These non-investment-grade bonds accounted for 2.5% of the Company’s total assets and 3.3% of its invested assets.

     Senior secured loans (“Secured Loans”) are included in the Bond Portfolio and aggregated $32.3 million at December 31, 2002. Secured Loans are senior to subordinated debt and equity and are secured by assets of the issuer. These Secured Loans are composed of loans to borrowers spanning 6 industries, with 53% of these assets concentrated in energy, 16% concentrated in finance institutions, 11% concentrated in leisure and gaming. No other industry concentration constituted more than 10% of these assets.

     Mortgage loans aggregated $193.0 million at December 31, 2002 and consisted of 88 commercial first mortgage loans with an average loan balance of approximately $2.2 million, collateralized by properties located in 29 states. Approximately 41% of this portfolio was office, 16% was retail, 16% was multifamily residential, 14% was industrial, and 13% was other types. At December 31, 2002, approximately 31% of this portfolio was secured by properties located in California, approximately 13% by properties located in Texas, approximately 11% by properties located in Michigan and no more than 10% of this portfolio was secured by properties located in any other single state.

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     At December 31, 2002, the carrying value, which approximates market value, of all investments in default as to the payment of principal or interest totaled $5.7 million, which constituted less than 1% of total invested assets.

     For more information concerning the Company’s investments, including the risks inherent in such investments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition and Liquidity.”

REGULATION

     The Company, in common with other insurers, is subject to regulation and supervision by the states and other jurisdictions in which it does business. Within the United States, the method of such regulation varies but generally has its source in statutes that delegate regulatory and supervisory powers to a state insurance official. The regulation and supervision relate primarily to approval of policy forms and rates, the standards of solvency that must be met and maintained, including risk based capital measurements, the licensing of insurers and their agents, the nature of and limitations on investments, restrictions on the size of risks which may be insured under a single policy, deposits on securities for the benefit of policyholders, methods of accounting, periodic examinations of the affairs of insurance companies, the form and content of reports of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. In general, such regulation is for the protection of policyholders rather than security holders.

     Risk based capital (“RBC”) standards are designed to measure the adequacy of an insurer’s statutory capital and surplus in relation to the risks inherent in its business. The standards are intended to help identify inadequately capitalized companies and require specific regulatory actions in the event an insurer’s RBC is deficient. The RBC formula develops a risk adjusted target level of adjusted statutory capital and surplus by applying certain factors to various asset, premium and reserve items. Higher factors are applied to more risky items and lower factors are applied to less risky items. Thus, the target level of statutory surplus varies not only as a result of the insurer’s size, but also on the risk profile of the insurer’s operations. The RBC Model Law provides four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to actually placing the insurer under regulatory control. The statutory capital and surplus of the Company exceeded its RBC requirements by a considerable margin as of December 31, 2002.

     In 1998, the NAIC adopted the codification of statutory accounting principles (“Codification”) which replaced the NAIC’s previous primary guidance on statutory accounting, which became effective January 1, 2001. Codification changes prescribed statutory accounting practices and has resulted in changes to the accounting practices that the Company uses to prepare its statutory basis financial statements. Codification has been adopted by all fifty states as the prescribed basis of accounting. New York, however, has made certain modifications (e.g., no deferred taxes will be recorded prior to January 1, 2002 for companies domiciled in the State of New York). The adoption of Codification resulted in a decrease to the Company’s statutory surplus of approximately $14.2 million and was recorded as a cumulative effect of changes in accounting principles in 2001. For periods beginning as of January 1, 2002, the State of New York conformed to NAIC codification relating to deferred income taxes. Accordingly, the Company recorded a charge to surplus of $4.9 million during 2002 relating to a change in accounting principle.

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     Privacy provisions of the Gramm-Leach-Bliley Act became fully effective in 2001 and establish new consumer protections regarding the security, confidentiality, and uses of nonpublic personal information of individuals. The law also requires financial institutions to disclose their privacy policies to their customers. Additional privacy legislation pending in the United States Congress and several states is designed to provide further privacy protections to consumers of financial products and services. These statutes and regulations may result in additional regulatory compliance costs, may limit the Company’s ability to market its products, and may otherwise constrain the nature or scope of the Company’s insurance and financial services operations. The Gramm-Leach-Bliley Act also allows combinations between insurance companies, banks, and other entities. In addition, from time to time, Federal initiatives are proposed that could affect the Company’s businesses. Such initiatives include employee benefit plan regulations and tax law changes affecting the taxation of insurance companies and the tax treatment of insurance and other investment products. Proposals made in recent years to limit the tax deferral of annuities or otherwise modify the tax rules related to the treatment of annuities have not been enacted. While certain of such proposals, if implemented, could have an adverse effect on the Company’s sales of affected products, and, consequently, on its results of operations, the Company believes these proposals have a small likelihood of being enacted, because they would discourage retirement savings and there is strong public and industry opposition to them.

COMPETITION

     The businesses conducted by the Company are highly competitive. The Company competes with other life insurers, and also competes for customers’ funds with a variety of investment products offered by financial services companies other than life insurance companies, such as banks, investment advisors, mutual fund companies and other financial institutions. In 2001, net annuity premiums written among the top 100 companies ranged from approximately $55 million to approximately $19 billion annually. In 2001, the Company together with its affiliates was the largest of this group. The Company believes the primary competitive factors among life insurance companies for investment-oriented insurance products, such as annuities, include product flexibility, net return after fees, innovation in product design, the insurer financial strength rating and the name recognition of the issuing company, the availability of distribution channels and service rendered to the customer before and after a contract is issued. Other factors affecting the annuity business include the benefits (including before-tax and after-tax investment returns) and guarantees provided to the customer and the commissions paid.

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ITEM 2. PROPERTIES

     The Company’s executive offices and its principal office are in leased premises at 733 Third Avenue, New York, New York 10017. The Company, through an affiliate, also leases office space in Los Angeles and Woodland Hills, California.

     The Company believes that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of its business.

ITEM 3. LEGAL PROCEEDINGS

     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 previously reported on a matter, McMurdie et al. v. SunAmerica et al., Case No. BC 194082, filed on July 10, 1998 in the Superior Court for the County of Los Angeles. The lawsuit was settled in September 2002.

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

     No matters were submitted during the quarter ended December 31, 2002 to a vote of security holders, through the solicitation of proxies or otherwise.

PART II

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

     Not applicable.

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ITEM 6. SELECTED FINANCIAL DATA

     The following selected financial data of the Company should be read in conjunction with the financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are included elsewhere herein.

The results of operations of the Company for 1999 are affected by the acquisition of business from MBL Life on July 1, 1999 (See Note 3 of the accompanying financial statements).

In 2001, the Company adopted EITF 99-20 which was recorded as a cumulative effect of accounting change (See Note 2 of the accompanying financial statements).

The results of operations for 2002 are affected by the profit sharing agreement with AIG SunAmerica Asset Management Corp. (See Note 10 of the accompanying financial statements).

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ITEM 6. SELECTED FINANCIAL DATA (continued)

The financial position of the Company as of December 31, 1999 is affected by the acquisition of business from MBL Life which occurred on July 1, 1999. (See Note 3 of the accompanying financial statements.)

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ITEM 7.

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 years ended December 31, 2002 (“2002”), 2001 (“2001”) and 2000 (“2000”) 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 and 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 income on the fixed-rate account options.

CRITICAL ACCOUNTING POLICIES

     The Company considers among its most critical accounting policies those policies with respect to valuation of certain financial instruments and amortization of deferred acquisition costs. 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 the debt and equity securities available for sale amounted to $28.4 million at December 31, 2002. In determining if and when a decline in fair value below

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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 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.

     Securities in our portfolio with a carrying value of approximately $334.9 million at December 31, 2002 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 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: We amortize our 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, the growth rate of the separate account assets (with respect to variable annuities) or general account assets (with respect to fixed annuities) supporting the annuity obligations, the anticipated value of guaranteed minimum death benefits to be paid, and the level of expenses necessary to maintain the policies. The Company adjusts DAC amortization (a “DAC unlocking”) when estimates of current or future gross profits to be realized from its annuity policies are revised. Approximately 60% of the Company’s DAC balance at December 31, 2002 related to fixed annuity products and 40% related to variable annuity products.

     DAC amortization is sensitive to surrender rates 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 we use for the long-term annual net growth of the separate account assets in the determination of DAC amortization with respect to our variable annuity policies is 10% (the “long-term growth rate assumption”). We use a “reversion to the mean” methodology which allows us 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 were 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 approximate 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

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used in the methodology are subject to judgment and vary within the industry.

     On December 9, 2002, the Company entered into a profit sharing agreement with AIG SunAmerica Asset Management Corp. (“SAAMCO”), whereby SAAMCO will pay its profits earned through servicing the Company’s variable annuity contracts to the Company (“SAAMCO Agreement”). SAAMCO is the investment adviser or business manager for certain trusts that hold deposits from the Company’s variable annuity products. Pursuant to the SAAMCO Agreement, SAAMCO will pay to the Company variable annuity fee income earned from acting as the investment adviser or business manager for certain trusts that hold deposits from the Company’s variable annuity products. The SAAMCO Agreement is retroactive to January 1, 2002. Amounts paid or accrued to the Company under this agreement totaled $1.8 million in 2002.

RESULTS OF OPERATIONS

     NET INCOME totaled $6.8 million in 2002, compared with $8.2 million in 2001 and $7.3 million in 2000. The operating results for 2002 include $1.8 million of fees earned by the Company pursuant to the SAAMCO Agreement.

     CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflected the adoption of EITF 99-20 in 2001. The Company recorded a loss of $520,000, net of tax, which is recognized in the statement of income and comprehensive income as a cumulative effect of accounting change for the year ended December 31, 2001 (see Note 2 of Notes to Financial Statements).

     PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $15.8 million in 2002, compared with $14.9 million in 2001 and $11.6 million in 2000. The improvement in 2002 over 2001 primarily resulted from decreased net realized investment losses, increased variable annuity fees and increased net investment income partially offset by increased amortization of deferred acquisition costs, increased general and administrative expenses and increased guaranteed minimum death benefits on variable annuities. The improvement in 2001 over 2000 primarily resulted from decreased amortization of deferred acquisition costs, partially offset by lower net investment income and fee income.

     NET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities and other interest bearing liabilities, totaled $38.7 million in 2002, $37.8 million in 2001 and $42.3 million in 2000. These amounts equal 2.67% on average invested assets (computed on a daily basis) of $1.45 billion in 2002, 2.65% on average invested assets of $1.43 billion in 2001 and 2.50% on average invested assets of $1.69 billion in 2000.

     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 $108.7 million in 2002, compared with $85.6 million in 2001 and $79.6 million in 2000. The difference between the Company’s yield on average invested assets and the rate paid on average interest-bearing liabilities (the “Spread Difference”) was 2.34% in 2002, 2.37% in 2001 and 2.28% in 2000.

     Investment income (and the related yields on average invested assets) totaled $97.4 million (6.73%) in 2002, compared with $101.0 million (7.07%) in 2001 and $119.7 million (7.09%) in 2000. The decrease in the investment yield in 2002 compared to 2001 and 2000 primarily reflects a lower prevailing interest rate environment. Expenses incurred to manage the investment portfolio amounted to $0.6 million in 2002, $1.2 million in 2001 and $1.9 million in 2000. These expenses are included as a reduction of investment income in the statement of income and comprehensive income.

     Interest expense totaled $58.7 million in 2002, $63.1 million in 2001 and $77.5 million in 2000. The average rate paid on all interest-bearing

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liabilities was 4.39% in 2002, compared with 4.70% in 2001 and 4.81% in 2000. Interest-bearing liabilities averaged $1.34 billion during 2002, $1.34 billion during 2001 and $1.61 billion during 2000. The decline in overall rates paid in 2002 compared to 2001 and 2000 resulted primarily from the impact of a declining interest rate environment, the continued reduction of crediting rates on certain closed blocks of business and the impact of securities lending in 2002 at short-term rates.

     CHANGE IN AVERAGE INVESTED ASSETS largely resulted from the surrenders of certain closed blocks of fixed annuity policies. Changes in average invested assets also reflect net exchanges to fixed accounts from the separate accounts of variable annuity contracts, sales of fixed annuities and the fixed account options of the Company’s variable annuity products (“Fixed Annuity Deposits”), and renewal deposits on its universal life products (“UL Deposits”). Fixed Annuity Deposits and UL Deposits totaled $400.0 million in 2002, $80.8 million in 2001 and $63.9 million in 2000. These deposits represents 31%, 6% and 5%, respectively, of the related reserve balances at the beginning of the respective periods. The increase in Fixed Annuity Deposits in 2002 is due primarily to increased sales relating to the marketing of fixed annuities through new distribution relationships. The environment for fixed annuity sales remains very favorable, with alternative fixed income products at very low rates (e.g., bank CDs) and very low surrender rates as investors continue to seek safety and quality away from the equity markets.

     NET REALIZED INVESTMENT LOSSES totaled $10.0 million in 2002, compared with $19.3 million in 2001 and $20.8 million in 2000 and include impairment writedowns of $9.5 million, $17.3 million and $20.8 million, respectively. Thus, net realized losses from sales and redemptions of investments totaled $0.5 million in 2002, compared with $2.0 million of losses in 2001 and $0.03 million of gains in 2000.

     The Company sold or redeemed invested assets, principally bonds and notes, aggregating $370.9 million in 2002, $427.5 million in 2001 and $389.1 million in 2000. 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 0.04%, 0.14% and 0.00% of average invested assets for 2002, 2001 and 2000, 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 $9.5 million, $17.3 million and $20.8 million of provisions applied to bonds in 2002, 2001 and 2000, respectively. Impairment writedowns represent 0.66%, 1.21% and 1.23% of average invested assets for 2002, 2001 and 2000, respectively. For the five years ended December 31, 2002, impairment writedowns as a percentage of average invested assets have ranged from 0.03% to 1.23% and have averaged 0.67%. Such writedowns are based upon estimates of the net realizable 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. The Company recorded $0.8 million ($0.5 million, net of tax) of additional impairments in 2001 pursuant to the implementation of EITF 99-20. This adjustment was recorded as a cumulative effect of accounting change in the accompanying statement of income and comprehensive income for 2001.

     VARIABLE ANNUITY FEES are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $9.0 million in 2002, $8.0 million in 2001 and $9.1 million in 2000. The 2002 amount includes $1.8 million of fees relating to the SAAMCO Agreement. Excluding the impact of the SAAMCO Agreement, the decreased fees in 2002 as compared to 2001 and 2000 reflect the unfavorable equity market conditions

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in 2002, and the resulting unfavorable impact on market values of assets in the separate accounts and additionally from net exchanges from the separate accounts to the fixed accounts of variable annuity contracts. The decline in fees during 2001 is partially offset by net exchanges to the separate accounts from the fixed accounts of variable annuity contracts. Variable annuity fees represent 1.9% of average variable annuity assets in 2002 and 1.5% of average variable annuity assets in 2001 and 2000. The increase in fees as a percentage of average variable assets is due primarily to the $1.8 million in fees related to the SAAMCO Agreement. Excluding the impact of the SAAMCO Agreement, variable annuity fees would have represented 1.6% of average variable annuity assets in 2002. Variable annuity assets averaged $462.3 million, $517.1 million and $591.9 million during the respective periods. Variable annuity deposits, which exclude deposits allocated to the fixed accounts of variable annuity products, totaled $65.0 million in 2002, $34.6 million in 2001 and $39.6 million in 2000. These amounts represent 13%, 6% and 7% of variable annuity reserves at the beginning of the respective periods. The increase in variable annuity deposits in 2002 reflected increased demand for a new product, FSA Advisor, initially marketed in January 2001. The decrease in variable annuity deposits in 2001 reflected lower demand for the variable account options of the Company’s variable annuity products due to the unfavorable equity market conditions discussed above. 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 $101.3 million, $90.5 million, $72.0 million in 2002, 2001 and 2000, respectively. Such sales primarily reflect those of FSA Advisor as well as the Company’s flagship variable annuity line, Polaris. FSA Advisor is a multimanager variable annuity that offers investors a choice of 27 variable funds and a guaranteed fixed-rate fund. Polaris is a multimanager variable annuity that offers investors a choice of 31 variable funds and a number of guaranteed fixed-rate funds. Variable Annuity Product Sales have increased in 2002 and 2001, primarily due to increased demand for the new product, FSA Advisor, which was initially marketed in January 2001. FSA Advisor product sales were approximately $51.3 million in 2002 as compared to $15.9 million in 2001 and zero in 2000. Annuity Product Sales have increased in 2001, primarily due to both new and enhanced relationships with New York based investment firms as well as the addition of four new funds offered by Polaris in December 2000.

     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” in Item 1).

     UNIVERSAL LIFE INSURANCE FEES, NET amounted to $3.3 million, $3.4 million and $2.2 million in 2002, 2001 and 2000, respectively. Universal life insurance fees consist of mortality charges, up-front fees earned on deposits received and administrative fees, net of excess mortality expense on these contracts. 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 which occurred on July 1, 1999 and does not actively market such contracts. Such fees represent 1.34%, 1.39% and 0.84% of average reserves for universal life insurance contracts in the respective periods. The increase in such fees for 2001 resulted principally from improved mortality experience (See Note 3 of the accompanying financial statements.)

     SURRENDER CHARGES on fixed annuity, variable annuity and universal life contracts totaled $1.9 million in 2002, $2.1 million in 2001 and $3.8 million in 2000. Surrender charges generally are assessed on withdrawals at

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declining rates during the first seven years of a contract. Withdrawal payments, which exclude claims and lump-sum annuity benefits, totaled $212.9 million in 2002, compared with $257.3 million in 2001 and $409.2 million in 2000. These payments, when expressed as a percentage of average related reserves, represent 12.1%, 14.2% and 19.1% for 2002, 2001 and 2000, respectively. Withdrawal rates declined in 2002 and 2001 principally due to a lower level of surrenders on certain closed blocks of fixed annuity business due to consumer preference for guaranteed fixed rate investments in light of uncertainty regarding U.S. equity market performance. Withdrawals include variable annuity payments from the separate accounts totaling $61.5 million (13.3% of average variable annuity liabilities), $38.6 million (7.5% of average variable annuity liabilities) and $36.6 million (6.2% of average variable annuity liabilities) in 2002, 2001 and 2000, respectively. The increases in variable annuity withdrawal rates in 2002 and 2001 are due to unfavorable equity market conditions in both years.

     GENERAL AND ADMINISTRATIVE EXPENSES totaled $8.1 million in 2002, $4.3 million in 2001 and $5.0 million in 2000. General and administrative costs were unusually low in 2001 due to certain guarantee fund credits which reduced overall expenses. Excluding the impact of this item, general and administrative expenses increased approximately 20% in 2002, representing the additional costs of selling and servicing a growing fixed annuity block of 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 totaled $16.4 million in 2002, compared with $11.6 million in 2001 and $19.4 million in 2000. The increase in amortization in 2002 was primarily related to the impact of decreased net investment losses while the decrease in amortization in 2001 is principally due to the impact of increased amortization during 2000 of certain closed blocks of fixed annuities.

     ANNUAL COMMISSIONS totaled $0.8 million in 2002, compared with $0.7 million in 2001 and $0.6 million in 2000. 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 Company estimates that approximately 8% of the average balances of its variable annuity products is currently subject to such annual commissions. Based on current sales, this percentage is expected to increase in future periods.

     GUARANTEED MINIMUM DEATH BENEFITS totaled $1.7 million in 2002, compared with $0.5 million in 2001 and $4,000 in 2000. The increase in guaranteed minimum death benefits related to the Company’s variable annuity contracts reflects the downturn in the equity markets since 2000. Further downturns in the 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 “GMDB”). Depending on the product, the GMDB may equal the principal invested, adjusted for withdrawals; or an amount equal to the highest account value in effect on any anniversary date under the contract. These benefits have issue age and other restrictions to reduce mortality risk exposure. 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. In accordance with Generally Accepted Accounting Principles, the Company expenses such benefits in the period incurred, and therefore does not provide reserves for future benefits.

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     INCOME TAX EXPENSE totaled $9.0 million in 2002, $6.2 million in 2001 and $4.3 million in 2000, representing effective tax rates of 57%, 41% and 37%, respectively. The higher rate in 2002 was principally due to the impact of a deferred tax liability adjustment. The lower rate in 2000 was principally due to the impact of lower state income taxes. See Note 9 of the accompanying financial statements for a reconciliation of income tax expense to the federal statutory rate.

CAPITAL RESOURCES AND LIQUIDITY

     SHAREHOLDER’S EQUITY increased to $213.0 million at December 31, 2002 from $193.6 million at December 31, 2001, due principally to $12.7 million in other comprehensive income and $6.8 million of net income recorded in 2002.

     INVESTED ASSETS at December 31, 2002 totaled $1.71 billion, compared with $1.37 billion at December 31, 2001. The majority of the Company’s invested assets are managed by an affiliate. 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 its portfolio of bonds, notes and redeemable preferred stocks (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 83% of the Company’s total investment portfolio at December 31, 2002, had an aggregate fair value that was $35.0 million greater than its amortized cost at December 31, 2002, compared with an aggregate fair value that was $5.6 million greater than its amortized cost at December 31, 2001. The increase in net unrealized gains on the Bond Portfolio during 2002 principally reflects the decline in prevailing interest rates and the corresponding effect on the fair value of the Bond Portfolio at December 31, 2002.

     At December 31, 2002, the Bond Portfolio included $1.35 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 $61.8 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At December 31, 2002, approximately $1.35 billion of the Bond Portfolio was investment grade, including $474.3 million of U.S. government/agency securities and mortgage-backed securities (“MBS”).

     At December 31, 2002, the Bond Portfolio included $55.7 million of bonds that were not investment grade. These non-investment-grade bonds accounted for approximately 2.5% of the Company’s total assets and approximately 3.3% 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. These non-investment-grade securities are comprised of bonds spanning 22 industries with 13% of these assets concentrated in telecommunications and 12% of these assets concentrated in energy. 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 December 31, 2002.

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RATED BONDS BY RATING CLASSIFICATION
(Dollars in thousands)

[Additional columns below]

[Continued from above table, first column(s) repeated]

		Total
										Percent
						Estimated				of total
S&P/Moody’s/Fitch		Amortized				fair				invested
Category (1)		cost				value				assets
AAA + to A- (Aaa to A3) [AAA to A-]		$	1,015,935			$	1,058,699				61.99	%
BBB+ to BBB- (Baa1 to Baa3) [BBB+ to BBB-]			295,171				295,641				17.31	%
BB+ to BB- (Ba1 to Ba3) [BB+ to BB-]			30,405				27,484				1.61	%
B+ to B- (B1 to B3) [B+ to B-]			20,189				15,266				0.89	%
CCC+ to C (Caa to C) [CCC]			10,738				8,368				0.49	%
CI to D [DD] {D}			2,588				4,595				0.27	%
TOTAL RATED ISSUES		$	1,375,026			$	1,410,053

Footnotes appear on the following page.

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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 nondefaulted 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 $61.8 million of assets that were rated by the Company pursuant to applicable NAIC rating guidelines.

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     At December 31, 2002, approximately $194.1 million of the Bond Portfolio had an aggregate unrealized loss of $27.9 million. The gross unrealized losses in the bond portfolio included the following concentrations:

     The amortized cost of the Bond Portfolio in an unrealized loss position at December 31, 2002, by contractual maturity, is shown below.

     Senior secured loans (“Secured Loans”) are included in the Bond Portfolio and aggregated $32.3 million at December 31, 2002. Secured Loans are senior to subordinated debt and equity and are secured by assets of the issuer. At December 31, 2002, Secured Loans consisted of $30.9 million of privately traded securities and $1.4 million of publicly traded securities. These Secured Loans are composed of loans to borrowers spanning 6 industries, with 53% of these assets concentrated in energy, 16% concentrated in finance institutions and 11% concentrated in leisure and gaming. No other industry concentration constituted more than 10% of these assets.

     While the trading market for the Company’s privately traded Secured Loans is more limited than for publicly traded issues, management believes that participation in these transactions has enabled the Company to improve its investment yield. As a result of restrictive financial covenants, these Secured Loans involve greater risk of technical default than do publicly traded investment-grade securities. However, management believes that the risk of loss upon default for these Secured Loans is mitigated by such financial covenants and the collateral values underlying the Secured Loans. The Company’s Secured Loans are rated by S&P, Moody’s, Fitch, the NAIC or by the Company, pursuant to comparable statutory ratings guidelines established by the NAIC.

     MORTGAGE LOANS aggregated $193.0 million at December 31, 2002 and consisted of 88 commercial first mortgage loans with an average loan balance

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of approximately $2.2 million, collateralized by properties located in 29 states. Approximately 41% of this portfolio was office, 16% was retail, 16% was multifamily residential, 14% was industrial, and 13% was other types. At December 31, 2002, approximately 31% of this portfolio was secured by properties located in California, approximately 13% by properties located in Texas, approximately 11% by properties located in Michigan and no more than 10% of this portfolio was secured by properties located in any other single state. At December 31, 2002, 3 mortgage loans have an outstanding balance of $10.0 million or more, which collectively aggregated approximately 25% of this portfolio. At December 31, 2002, approximately 28% of the mortgage loan portfolio consisted of loans with balloon payments due before January 1, 2006. During 2002, 2001 and 2000, loans delinquent by more than 90 days, foreclosed loans and restructured loans have not been significant in relation to the total mortgage loan portfolio.

     At December 31, 2002, approximately 32% of the mortgage loans were seasoned loans underwritten to the Company’s standards and purchased at or near par from other financial institutions. Such loans generally have higher average interest rates than loans that could be originated today. The balance of the mortgage loan portfolio has been originated by the Company under strict underwriting standards. Commercial mortgage loans on properties such as offices, hotels and shopping centers generally represent a higher level of risk than do mortgage loans secured by multifamily residences. This greater risk is due to several factors, including the larger size of such loans and the more immediate effects of general economic conditions on these commercial property types. However, due to the seasoned nature of the Company’s mortgage loan portfolio and its strict underwriting standards, the Company believes that it has prudently managed the risk attributable to its mortgage loan portfolio while maintaining attractive yields.

     POLICY LOANS totaled $36.1 million at December 31, 2002, compared to $37.3 million at December 31, 2001 and primarily represent loans taken against universal life insurance policies.

     OTHER INVESTED ASSETS aggregated $29.6 million at December 31, 2002 and principally included collateral held under a securities lending agreement with an affiliated agent. The Company has entered into such agreement with an affiliated lending agent, which authorizes the agent to lend securities held in the Company’s portfolio to a list of authorized borrowers. The Company receives primarily cash collateral in an amount in excess of the market value of the securities loaned. The Company monitors the daily market value of securities loaned with respect to the collateral value and obtains additional collateral when necessary to ensure that collateral is maintained at a minimum of 102% of the value of the loaned securities. Such collateral is not available for the general use of the Company.

     ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed-rate investments are priced over the yield curve, default rates, and general economic conditions. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety. The Company’s fixed-rate products incorporate surrender charges or other restrictions in order to encourage persistency. Approximately 65% of the Company’s fixed annuity and universal life reserves had surrender penalties or other restrictions at December 31, 2002.

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     As part of its asset-liability matching discipline, the Company conducts detailed computer simulations that model its fixed-rate assets and liabilities under commonly used stress-test interest rate scenarios. With the results of these computer simulations, the Company can measure the potential gain or loss in fair value of its interest-rate sensitive instruments and seek to protect its economic value and achieve a predictable spread between what it earns on its invested assets and what it pays on its liabilities by designing its fixed-rate products and conducting its investment operations to closely match the duration of the fixed-rate assets to that of its fixed-rate liabilities. The Company’s fixed-rate assets include: cash and short-term investments; bonds, notes and redeemable preferred stocks; mortgage loans; and policy loans. At December 31, 2002, these assets had an aggregate fair value of $1.73 billion with a duration of 3.9. The Company’s fixed-rate liabilities include fixed annuity and universal life insurance contracts. At December 31, 2002, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $1.58 billion with a duration of 4.0. The Company’s potential exposure due to a relative 10% decrease in prevailing interest rates from their December 31, 2002 levels is a loss of approximately $1.2 million, representing the increase in fair value of its fixed rate liabilities that is not offset by an increase in fair value of its fixed rate assets. Because the Company actively manages its assets and liabilities and has strategies in place to minimize its exposure to loss as interest rate changes occur, it expects that actual losses would be less than the estimated potential loss.

     Duration is a common option-adjusted measure for the price sensitivity of a fixed-maturity portfolio to changes in interest rates. It measures the approximate percentage change in the market value of a portfolio if interest rates change by 100 basis points (i.e. 1%), recognizing the changes in cash flows resulting from embedded options such as policy surrenders, investment prepayments and bond calls. It also incorporates the assumption that the Company will continue to utilize its existing strategies of pricing its fixed annuity and universal life products, allocating its available cash flow amongst its various investment portfolio sectors and maintaining sufficient levels of liquidity. Because the calculation of duration involves estimation and incorporates assumptions, potential changes in portfolio value indicated by the portfolio’s duration will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material.

     The Company also seeks to provide liquidity by investing in MBSs. MBSs are generally investment-grade securities collateralized by large pools of mortgage loans. MBSs generally pay principal and interest monthly. The amount of principal and interest payments may fluctuate as a result of prepayments of the underlying mortgage loans.

     There are risks associated with some of the techniques the Company uses to provide liquidity, enhance its spread income and match its assets and liabilities. The primary risk associated with MBSs is that a changing interest rate environment might cause prepayment of the underlying obligations at speeds slower or faster than anticipated at the time of their purchase. As part of its decision to purchase an MBS, the Company assesses the risk of prepayment by analyzing the security’s projected performance over an array of interest-rate scenarios. Once an MBS is purchased, the Company monitors its actual prepayment experience monthly to reassess the relative attractiveness of the security with the intent to maximize total return.

     INVESTED ASSETS EVALUATION is routinely conducted by the Company. Management identifies monthly those investments that require additional monitoring and carefully reviews the carrying values of such investments at least quarterly to determine whether specific investments should be placed on a nonaccrual basis and to determine declines in value that may be other than temporary. In making these reviews for bonds, management principally considers the adequacy of any collateral, compliance with contractual

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covenants, the borrower’s recent financial performance, news reports and other externally generated information concerning the creditor’s affairs. In the case of publicly traded bonds, management also considers market value quotations, if available. For mortgage loans, management generally considers information concerning the mortgaged property and, among other things, factors impacting the current and expected payment status of the loan and, if available, the current fair value of the underlying collateral.

     The carrying values of investments that are determined to have declines in value that are other than temporary are reduced to net realizable value and, in the case of bonds, no further accruals of interest are made. The provisions for impairment on mortgage loans are based on losses expected by management to be realized on transfers of mortgage loans to real estate, on the disposition and settlement of mortgage loans and on mortgage loans that management believes may not be collectible in full. Accrual of interest is suspended when principal and interest payments on mortgage loans are past due more than 90 days. Impairment losses on securitized assets are recognized if the fair value of the security is less than its book value, and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent(prior) estimation date.

     DEFAULTED INVESTMENTS, comprising all investments that are in default as to the payment of principal or interest, totaled $5.7 million of bonds at December 31, 2002, and constituted less than 0.3% of total invested assets. At December 31, 2001, defaulted investments totaled $3.4 million of bonds and constituted less than 0.3% of total invested assets.

     SOURCES OF LIQUIDITY are readily available to the Company in the form of the Company’s existing portfolio of cash and short-term investments, and if required, proceeds from invested asset sales. The Company’s liquidity is primarily derived from operating cash flows. At December 31, 2002, approximately $1.22 billion of the Bond Portfolio had an aggregate unrealized gain of $62.9 million while approximately $194.1 million of the Company’s Bond Portfolio had an aggregate unrealized loss of $27.9 million. In addition, the Company’s investment portfolio currently provides approximately $13.2 million of monthly cash flow from scheduled principal and interest payments. Historically, cash flows from operations and from the sale of the Company’s annuity products have been more than sufficient in amount to satisfy the Company’s liquidity needs.

     Management is aware that prevailing market interest rates may shift significantly and has strategies in place to manage either an increase or decrease in prevailing rates. In a rising interest rate environment, the Company’s average cost of funds would increase over time as it prices its new and renewing annuities to maintain a generally competitive market rate. Management would seek to place new funds in investments that were matched in duration to, and higher yielding than, the liabilities assumed. The Company believes that liquidity to fund withdrawals would be available through incoming cash flow, the sale of short-term or floating-rate instruments or Reverse Repos on the Company’s substantial MBS segment of the Bond Portfolio, thereby avoiding the sale of fixed-rate assets in an unfavorable bond market.

     In a declining rate environment, the Company’s cost of funds would decrease over time, reflecting lower interest crediting rates on its fixed annuities. Should increased liquidity be required for withdrawals, the Company believes that a significant portion of its investments could be sold without adverse consequences in light of the general strengthening that would be expected in the bond market.

     If a substantial portion of the Company’s bond portfolio diminished significantly in value and/or defaulted, the Company would need to liquidate other portions of its investment portfolio and/or arrange financing. Such

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events that may cause such a liquidity strain could be the result of economic collapse or terrorist acts.

     GUARANTEES AND OTHER COMMITMENTS: In the ordinary course of business, the Company is obligated to purchase approximately $16.0 million of asset backed securities as of December 31, 2002. The expiration dates of these commitments are as follows: $7.0 million in 2003, $4.0 million in 2004 and $5.0 million in 2006.

     RECENTLY ISSUED ACCOUNTING STANDARDS are discussed in Note 2 of the accompanying financial statements.