Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
		OR
[   ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2003

Commission File No. 33-47472

AIG SUNAMERICA LIFE ASSURANCE COMPANY

Incorporated in Arizona		86-0198983 IRS Employer Identification No.

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 BY 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 AUGUST 14, 2003 WAS AS FOLLOWS:

Common Stock (par value $1,000 per share)           3,511 shares outstanding

     THE 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

Table of Contents

AIG SUNAMERICA LIFE ASSURANCE COMPANY

INDEX

Table of Contents

AIG SUNAMERICA LIFE ASSURANCE COMPANY
BALANCE SHEET
(Unaudited)

See accompanying notes to financial statements

3

Table of Contents

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

See accompanying notes to financial statements

4

Table of Contents

AIG SUNAMERICA LIFE ASSURANCE COMPANY
STATEMENT OF INCOME AND COMPREHENSIVE INCOME
For the three months and six months ended June 30, 2003 and 2002
(Unaudited)

See accompanying notes to financial statements

5

Table of Contents

AIG SUNAMERICA LIFE ASSURANCE COMPANY
STATEMENT OF INCOME AND COMPREHENSIVE INCOME
For the three months and six months ended June 30, 2003 and 2002
(Unaudited)

See accompanying notes to financial statements

6

Table of Contents

AIG SUNAMERICA LIFE ASSURANCE COMPANY
STATEMENT OF CASH FLOWS
For the six months ended June 30, 2003 and 2002
(Unaudited)

See accompanying notes to financial statements

7

Table of Contents

AIG SUNAMERICA LIFE ASSURANCE COMPANY
STATEMENT OF CASH FLOWS (Continued)
For the six months ended June 30, 2003 and 2002
(Unaudited)

See accompanying notes to financial statements

8

Table of Contents

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

1.		BASIS OF PRESENTATION
		AIG SunAmerica Life Assurance Company (FKA 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 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 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”) directed to the institutional marketplace.
		The Company changed its name to SunAmerica National Life Insurance Company on October 5, 2001 and further 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.
		In the opinion of the Company, the accompanying unaudited financial statements contain all adjustments necessary, consisting of normal recurring items, to present fairly the Company’s financial position as of June 30, 2003 and December 31, 2002, the results of its operations and its cash flows for the three months and six months ended June 30, 2003 and 2002. The results of operations for the three months and six months ended June 30, 2003 are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2002, contained in the Company’s 2002 Annual Report on Form 10-K. Certain prior period items have been reclassified to conform to the current period’s presentation.
2.		CONTINGENT LIABILITIES
		The Company has entered into eight agreements 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 June 30, 2003 is $794,930,000. Related to each of these agreements are participation agreements with the Parent under which the Parent will share in $345,333,000 of these liabilities in exchange for a proportionate percentage of the fees received under these agreements. The expiration dates and related amounts of these commitments are as follows: $249,000,000 in 2004, $387,930,000 in 2005 and $158,000,000 in 2006. Management does not anticipate any material losses with respect to these commitments.

9

Table of Contents

		In the third quarter of 2002, the Company began issuing certain variable annuity products which offer an optional Guaranteed Minimum Account Value (“GMAV”) living benefit. As of June 30, 2003, the premiums subject to guarantee totaled approximately $354,658,000, and the estimated fair values of the GMAV benefit were not material.
		Various lawsuits against the Company have arisen in the ordinary course of business. Contingent liabilities arising from litigation, income taxes and other similar types of matters are not considered material in relation to the financial position, results of operations or cash flows of the Company.
3.		RECENTLY ISSUED ACCOUNTING STANDARDS
		In November 2002, FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), which requires that, for guarantees within the scope of FIN 45 issued or amended by the Company after December 31, 2002, a liability for the fair value of the obligation undertaken in issuing the guarantee be recognized. FIN 45 also requires additional disclosures in financial statements starting with the Company’s 2002 year-end financial statements. The adoption of FIN 45 did not have a significant impact on the Company’s results of operations or financial condition.
		In July 2003, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-01, Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-Duration Contracts and for Separate Accounts (“SOP-03-01”). This statement is effective for the Company as of January 1, 2004. Under SOP 03-01, variable annuity assets held in separate accounts will continue to be measured at fair value and reported in summary total on the Company’s financial statements, with an equivalent summary total reported for related liabilities, if the separate account arrangement meets certain specified conditions. Assets underlying the Company’s interest in a separate account (separate account seed money) do not qualify for separate account accounting and reporting. The Company will be required to “look through” the separate account for purposes of accounting for its interest therein, and account for and classify separate account seed money based on its nature as if the assets of the separate account underlying the Company’s interest were held directly by the general account rather than through the separate account structure. The adoption of SOP 03-01 will not have a material impact on the Company’s separate accounts or separate account seed money.
		In addition, SOP 03-01 will require the Company to recognize a liability for guaranteed minimum death benefits, guaranteed minimum income benefits and enhanced earnings benefits. The Company is currently evaluating the provisions of SOP 03-01 and does not currently have an estimate of the liability. However, the one-time cumulative accounting charge is expected to have a material effect on the Company’s results of operations, but is not expected to be material to the Company’s financial position.

10

Table of Contents

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 (FKA Anchor National Life Insurance Company) (the “Company”) for the three months and six months ended June 30, 2003 and June 30, 2002 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 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 debt and equity securities available for sale amounted to $120.7 million at June 30, 2003 and $170.7 million at December 31, 2002. When a decline in fair value below amortized cost is deemed to be other-than-temporary, the Company recognizes an impairment loss in the current period operating results

11

Table of Contents

to the extent of the decline (See also discussion within “Capital Resources and Liquidity” herein).

     Securities in our portfolio with a carrying value of approximately $1.32 billion at June 30, 2003 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 and fixed options of variable annuities) supporting the annuity obligations, the anticipated volume 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.

     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 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.

BUSINESS SEGMENTS

     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

12

Table of Contents

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.

     On June 10, 2002, the Company entered into a profit sharing agreement with AIG SunAmerica Asset Management Corp. (“SAAMCO”), an affiliate, whereby SAAMCO will contribute to the Company on a quarterly basis its profits earned in connection with its role as investment advisor and/or business manager to several open-end investment management companies registered under the Investment Company Act of 1940, as amended, that fund the variable investment options available to investors through the Company’s variable annuity contracts (the “SAAMCO Agreement”). The SAAMCO Agreement was retroactive to January 1, 2002. Amounts paid to or accrued by the Company under this agreement totaled $12.8 million for the second quarter of 2003 and $24.5 million for the six months of 2003. Amounts paid to or accrued by the Company under this agreement totaled $29.8 million for the six months of 2002, approximately half of which related to the first quarter of 2002.

RESULTS OF OPERATIONS

     NET INCOME totaled $22.8 million in the second quarter of 2003, compared to $24.9 million in the second quarter of 2002. For the six months, net income amounted to $33.3 million in 2003, compared to $44.0 million in 2002.

     PRETAX INCOME totaled $24.3 million in the second quarter of 2003, compared to $29.3 million in the second quarter of 2002. For the six months, pretax income totaled $36.7 million in 2003, compared to $51.8 million in 2002. The decrease in 2003 primarily resulted from decreased variable annuity fee income and increased guaranteed minimum death benefits, offset by decreased amortization of deferred acquisition costs and increased investment income.

     NET INVESTMENT SPREAD, which is the spread between the income earned on invested assets and the interest credited to fixed annuity contracts and paid on other interest-bearing liabilities, totaled $39.9 million in the second quarter of 2003, compared to $34.5 million in the second quarter of 2002. These amounts equal 2.22% on average invested assets (computed on a daily basis) of $7.18 billion in the second quarter of 2003 and 2.15% on average invested assets of $6.42 billion in the second quarter of 2002 on an annualized basis. For the six months, net investment spread increased to $76.8 million in 2003 from $71.6 million in 2002, representing 2.12% of average invested assets of $7.22 billion in 2003 and 2.26% of average invested assets of $6.35 billion in 2002 on an annualized basis.

     Growth in average invested assets resulted primarily from sales of the fixed account options of the Company’s variable annuity products (“Fixed Annuity Deposits”), and renewal deposits on its universal life product (“UL Deposits”), partially offset by net exchanges from fixed accounts into the separate accounts of variable annuity contracts. Such deposits totaled $386.7 million in the second quarter of 2003 and $467.6 million in the second quarter of 2002, $826.2 million in the six months of 2003 and $839.9 million in the six months of 2002, and are largely deposits for the fixed accounts of variable annuities. On an annualized basis, these deposits represent 25%,

13

Table of Contents

36%, 28% and 32%, respectively, of the related reserve balances at the beginning of the respective periods.

     Under accounting principles generally accepted in the United States of America, deposits collected on non-traditional life and annuity insurance products, such as those sold by the Company, are not reflected as revenues in the Company’s statement of income, as they are recorded directly upon receipt to reserves for fixed annuity and universal life contracts.

     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 $245.1 million in the second quarter of 2003, compared to $85.9 million in the second quarter of 2002. For the six months, average invested assets exceeded average interest-bearing liabilities by $256.7 million in 2003, compared with $75.9 million in 2002. The increase in 2003 reflected a $200.0 million capital contribution from the Parent in the third quarter of 2002. The difference between the Company’s yield on average invested assets and the rate paid on average interest-bearing liabilities (the “Spread Difference”) was 2.11% in the second quarter of 2003, 2.10% in the second quarter of 2002, 2.00% in the six months of 2003 and 2.21% in the six months of 2002.

     Investment income (and the related yields on average invested assets) totaled $101.6 million (5.66%) in the second quarter of 2003, $94.9 million (5.91%) in the second quarter of 2002, $200.3 million (5.55%) in the six months of 2003 and $191.2 million (6.02%) in the six months of 2002. The decrease in the investment yield in 2003 compared to 2002 primarily reflects a lower prevailing interest rate environment. Investment income has been reduced by expenses incurred to manage the investment portfolio amounted to $0.6 million in the second quarter of 2003, $0.5 million in the second quarter of 2002, $1.1 million in the six months of 2003 and $1.0 million in the six months of 2002.

     Interest expense totaled $61.6 million in the second quarter of 2003 and $60.4 million in the second quarter of 2002. For the six months, interest expense aggregated $123.4 million in 2003, compared with $119.6 million in 2002. The average rate paid on all interest-bearing liabilities was 3.55% in the second quarter of 2003, compared to 3.81% in the second quarter of 2002. For the six months, the average rate paid on all interest-bearing liabilities was 3.55% in 2003 and 3.81% in 2002. Interest-bearing liabilities averaged $6.94 billion during the second quarter of 2003 and $6.34 billion during the second quarter of 2002, $6.96 billion during the six months of 2003 and $6.28 billion during the six months of 2002. The decline in the overall rates paid in 2003 compared to 2002 resulted primarily from the impact of a declining interest rate environment.

     NET REALIZED INVESTMENT LOSSES totaled $5.4 million in the second quarter of 2003 and $10.7 million in 2002 and include impairment writedowns of $10.4 million and $6.4 million, respectively. For the six months, net realized investment losses totaled $8.6 million in 2003, compared with $13.7 million in 2002 and include impairment writedowns of $15.5 million and $11.4 million, respectively. Thus, net realized gains from sales and redemptions of investments totaled $5.0 million in the second quarter of 2003, compared to net realized losses of $4.3 million in the second quarter of 2002. For the six months, net realized gains from sales and redemptions of investments

14

Table of Contents

totaled $6.9 million in 2003, compared to net realized losses of $2.3 million in 2002.

     The Company sold or redeemed invested assets, principally bonds and notes, aggregating $517.6 million in the second quarter of 2003, $275.7 million in the second quarter of 2002, $1.35 billion in the six months of 2003 and $701.9 million in the six months of 2002. 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 on an annualized basis 0.28%, 0.27%, 0.19% and 0.07% of average invested assets in the second quarter of 2003, the second quarter of 2002, the six months of 2003 and the six months of 2002, 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 $10.4 million, $6.4 million, $15.5 million and $11.4 million of provisions applied to bonds, partnerships and other invested assets in the second quarter of 2003, the second quarter of 2002, the six months of 2003 and the six months of 2002, respectively. On an annualized basis, impairment writedowns represent 0.58%, 0.40%, 0.43% and 0.36% of average invested assets in the respective periods. For the twenty quarters ended June 30, 2003, impairment writedowns as an annualized percentage of average invested assets have ranged from 0.03 to 1.95% and have averaged 0.61%. Such writedowns are based upon estimates of the fair value of invested assets and recorded when declines in value of such assets are considered to be other than temporary. Actual realization will be dependent upon future events.

     VARIABLE ANNUITY POLICY FEES are based on the market value of assets in separate accounts supporting variable annuity contracts. Such fees totaled $69.1 million in the second quarter of 2003 and $97.0 million in the second quarter of 2002 and are net of reinsurance premiums of $7.7 million and $5.3 million, respectively. These amounts include $14.6 million attributable to the SAAMCO Agreement for the second quarter of 2003. For the six months, variable annuity fees totaled $133.0 million in 2003, compared to $161.8 million in 2002 and are net of reinsurance premiums of $14.1 million and $9.7 million, respectively. These amounts include $28.2 million and $33.8 million attributable to the SAAMCO Agreement, respectively, with approximately half of the 2002 amount relating to the first quarter of 2002. The decreased fees in the six months of 2003 as compared to the six months of 2002 reflect the unfavorable equity market conditions in 2003 and 2002, and the resulting unfavorable impact on market values of assets in the separate accounts. On an annualized basis, variable annuity fees represent 1.8%, 2.2%, 1.8% and 1.8% of average variable annuity assets in the second quarters and six months of 2003 and 2002, respectively. Variable annuity assets averaged $15.67 billion, $17.75 billion, $15.08 billion and $17.98 billion during the respective periods. Variable annuity deposits, which exclude deposits allocated to the fixed accounts of variable annuity products, totaled $394.3 million and $311.1 million in the second quarters of 2003 and 2002, respectively. For the six months, variable annuity deposits totaled $722.7

15

Table of Contents

million in 2003, compared with $636.7 million in 2002. On an annualized basis, these amounts represent 11%, 7%, 10% and 7% of separate account liabilities at the beginning of the respective periods. 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 $769.5 million, $766.8 million, $1.52 billion and $1.45 billion in the second quarters and six months of 2003 and 2002, respectively. Such sales primarily reflect those of the Company’s Polaris, Seasons and Diversified Strategies variable annuity product lines. The Company’s variable annuity products are multi-manager variable annuities that offer investors a choice of several variable funds as well as a number of guaranteed fixed-rate funds. Investors can select from a choice of 4 to 41 variable funds and up to 7 guaranteed fixed-rate funds depending on the product. The increase in Variable Annuity Product Sales reflect sales of the Company’s new products, primarily Polaris Platinum II, offset by decresed demand for variable annuities in general as a result of unfavorable equity market conditions. Introduced in late 2002, Polaris Platinum II product sales totaled $88.0 million in the second quarter of 2003 and $156.0 million in the six months of 2003.

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

     UNIVERSAL LIFE INSURANCE POLICY FEES amounted to $9.4 million in the second quarter of 2003 and $9.0 million in the second quarter of 2002. For the six months, universal life insurance policy fees totaled $18.3 million in both 2003 and 2002. 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 2.3%, 2.2%, 2.3% and 2.2% of average reserves for universal life insurance contracts in the respective periods.

     SURRENDER CHARGES on fixed annuity, variable annuity and universal life contracts totaled $6.8 million in the second quarter of 2003 and $8.4 million in the second quarter of 2002. For the six months, such surrender charges totaled $14.4 million in 2003 and $14.9 million in 2002. 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 years of a contract. Withdrawal payments, which exclude claims and annuitization benefits, totaled $500.5 million in the second quarter of 2003, compared to $548.8 million in the second quarter of 2002. For the six months, such withdrawal payments totaled $1.05 billion in 2003 and 2002. Annualized, these payments when expressed as a percentage of average related reserves represent 9.3%, 9.7%, 10.0% and 9.2% for the second quarters and six months of 2003 and 2002, respectively. Withdrawals from the

16

Table of Contents

variable annuity separate accounts totaled $383.8 million (annualized representing 9.8% of average variable annuity liabilities), $428.3 million (annualized representing 9.7% of average variable annuity liabilities) $769.9 million (annualized representing 10.3% of average variable annuity liabilities) and $833.8 million (annualized representing 9.3% of average variable annuity liabilities) in the second quarters and six months of 2003 and 2002, respectively. The increase in withdrawal rates in 2003 as compared to 2002 reflects a decrease in the market value of assets in separate accounts supporting variable annuity contracts due to continual unfavorable equity market conditions.

     GENERAL AND ADMINISTRATIVE EXPENSES totaled $19.0 million in the second quarter of 2003 and $19.6 million in the second quarter of 2002. For the six months, general and administrative expenses totaled $40.3 million in 2003 and $38.4 million in 2002. 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 $40.3 million in the second quarter of 2003, compared to $60.7 million in the second quarter of 2002. For the six months, such amortization totaled $79.1 million in 2003, compared to $107.4 million in 2002. The decrease in amortization in 2003 was due to lower income in 2003 as a result of decreased variable annuity policy fee income and increased guaranteed minimum death benefits.

     ANNUAL COMMISSIONS totaled $16.0 million in the second quarter of 2003, compared to $15.8 million in the second quarter of 2002. For the six months, annual commissions amounted to $30.2 million in 2003 and $31.6 million in 2002. 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. These commissions are expected to increase in future periods.

     CLAIMS ON UNIVERSAL LIFE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled $5.7 million in the second quarter of 2003, compared to $3.4 million in the second quarter of 2002 (net of reinsurance recoveries of $7.0 million and $4.8 million in 2002, respectively). For the six months, claims on universal life contracts, net of reinsurance recoveries amounted to $11.2 million in 2003 and $7.9 million in 2002 (net of reinsurance recoveries of $17.8 million and $10.7 million, respectively). The increase in such claims in 2003 resulted principally from increased mortality experience, which fluctuates and cannot necessarily be expected to continue in future periods.

     GUARANTEED MINIMUM DEATH BENEFITS, NET OF REINSURANCE RECOVERIES (“Net GMDB”) totaled $14.5 million in the second quarter of 2003, compared to $10.4 million in the second quarter of 2002 (net of reinsurance recoveries of $2.8 million and $1.2 million, respectively). For the six months, Net GMDB amounted to $36.5 million in 2003 and $17.8 million in 2002 (net of reinsurance recoveries of $5.7 million and $2.7 million, respectively). Net GMDB consists primarily of guaranteed minimum death benefits as well as immaterial amounts of earnings enhancement benefits, guaranteed minimum income benefits and guaranteed minimum account value benefits. These guarantees are described in more detail in the following paragraphs. The

17

Table of Contents

increase in Net GMDB, which is related to the Company’s variable annuity contracts in 2003 reflects the downturn in the equity markets in 2002 and 2003. 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). The Company bears the risk that death claims following a decline in the equity 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. At June 30, 2003, a portion of the GMDB risk on approximately 38% of the account value with such features had been reinsured. Approximately half of this reinsurance will cease at the time the modified coinsurance deposit liability is fully paid down, which is presently estimated to occur in early 2004. A substantial majority of all new contracts sold have reinsurance coverage. However, the Company does not currently have reinsurance coverage on contracts sold after 2003. Reinsurance coverage is subject to limitations such as caps and deductibles. GMDB-related contractholder benefits incurred, net of related reinsurance, were $14.5 million (net of reinsurance recoveries of $2.8 million) for the second quarter of 2003 and $10.4 million (net of reinsurance recoveries of $1.2 million ) for the second quarter of 2002. GMDB-related contractholder benefits incurred, net of related reinsurance, were $36.5 million (net of reinsurance recoveries of $5.7 million) for the six months of 2003 and $17.8 million (net of reinsurance recoveries of $2.7 million) for the six months of 2002. 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. However, effective January 1, 2004, the Company will be required to record a liability for GMDBs (See Note 3 of Notes to Financial Statements).

     EARNINGS ENHANCEMENT BENEFIT (“EEB”): The Company issues certain variable annuity products that offer an optional Earnings Enhancement Benefit (EEB) feature. For contractholders 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 June 30, 2003, approximately 8% (calculated based on current account value) of inforce contracts include EEB coverage, with 97% of the EEB risk fully reinsured.

     GUARANTEED MINIMUM INCOME BENEFIT (“GMIB”): The Company issues certain variable annuity products that contain or offer a Guaranteed Minimum Income Benefit (GMIB) living benefit feature. This feature provides a minimum annuity payment guarantee for those contractholders who choose to receive fixed lifetime annuity payments after a seven 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. Substantially all of the Company’s GMIB risk on contracts sold prior to June 30, 2003 has been reinsured.

18

Table of Contents

     GUARANTEED MINIMUM ACCOUNT VALUE (“GMAV”): In the third quarter of 2002, the Company began issuing certain variable annuity products which offer an optional Guaranteed Minimum Account Value (GMAV) living benefit. If elected by the policyholder at the time of contract issuance, this feature guarantees that the account value under the contract will equal or exceed the amount of the initial principal invested, adjusted for 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 guarantees being higher than the underlying contractholder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. As of June 30, 2003, the premiums subject to guarantee totaled approximately $355 million, and the estimated fair values of the GMAV were not material.

     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. However, due to the credit ratings and continuous monitoring of the ratings of these reinsurers, such risks are considered to be minimal.

     INCOME TAX EXPENSE totaled $1.5 million in the second quarter of 2003, $4.4 million in the second quarter of 2002, $3.4 million in the six months of 2003 and $7.8 million in the six months of 2002, representing effective annualized tax rates of 6%, 15%, 9% and 15%, respectively. The decreases in the effective tax rates for 2003 are due primarily to the lower relative pretax income without corresponding reductions in permanent tax differences.

CAPITAL RESOURCES AND LIQUIDITY

     SHAREHOLDER’S EQUITY increased to $1.42 billion at June 30, 2003 from $1.32 billion at December 31, 2002. The increase reflected net income of $33.3 million and other comprehensive income of $66.1 million.

     INVESTMENTS AND CASH at June 30, 2003 totaled $7.44 billion, compared to $7.19 billion at December 31, 2002. The Company’s invested assets are managed by its affiliates. The following table summarizes the Company’s portfolio of bonds, notes and redeemable preferred stocks (the “Bond Portfolio”) and other investments and cash at June 30, 2003 and December 31, 2002:

19

Table of Contents

     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 79% of the Company’s total investment portfolio at June 30, 2003, had an aggregate fair value that was $175.3 million greater than its amortized cost at June 30, 2003, compared with $35.9 million at December 31, 2002. The increase in net unrealized gains on the Bond Portfolio during 2003 principally reflected the impact of impairment writedowns in 2003 as well as the decrease in prevailing interest rates and the corresponding effect on the fair value of the Bond Portfolio at June 30, 2003.

     At June 30, 2003, the Bond Portfolio had an aggregate carrying value (i.e. fair value) of $5.86 billion and an aggregate amortized cost of $5.69 billion. At June 30, 2003, the Bond Portfolio (excluding $1.4 million of redeemable preferred stocks) included $5.53 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 $332.7 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At June 30, 2003, approximately $5.54 billion of the Bond Portfolio was investment grade, including $1.09 billion of mortgage-backed securities (“MBS”) and U.S. government/agency securities.

     At June 30, 2003, the Bond Portfolio included $322.9 million of bonds that were not rated investment grade. These non-investment-grade bonds accounted for approximately 1.3% of the Company’s total assets and approximately 4.3% of its invested assets. Non-investment-grade securities generally provide higher yields and involve greater risks than investment-

20

Table of Contents

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 June 30, 2003, the Company’s non-investment-grade portfolio consisted of 100 issues with no single issuer representing more than 5.5% of the total Bond Portfolio. These non-investment-grade securities are comprised of bonds spanning 11 industries with 17% of these assets concentrated in financial institutions, 17% concentrated in utilities, 16% concentrated in consumer goods, 15% concentrated in communications and 14% concentrated in transportation. 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 June 30, 2003.

21

Table of Contents

RATED BONDS BY RATING CLASSIFICATION
(Dollars in thousands)

Footnotes appear on the following page.

22

Table of Contents

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 range 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 $332.7 million of assets that were rated by the Company pursuant to applicable NAIC rating guidelines.

23

Table of Contents

     The valuation of invested assets involves obtaining a market value for each security. The source for the market 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; or (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. However, the market price following a significant credit event of any issuer may be volatile after such an event. Factors such as market liquidity, hedge fund activity, sensitivity to “headline” risk, and the widening of bid/ask spreads contribute to price volatility. Because of such volatility, the market price may not be indicative of the fair value or a reasonable estimate of realizable value.

     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 $12.3 million and $11.4 million in the six months of 2003 and 2002, respectively.

     Excluding the impairments noted above, the changes in market 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.

24

Table of Contents

     At June 30, 2003, the Company’s Bond Portfolio had gross unrealized gains of $295.0 million and gross unrealized losses of $119.7 million. One issuer accounted for 11% of unrealized losses. No other single issuer accounted for more than 10% of unrealized losses.

     At June 30, 2003, the fair value of the Company’s Bond Portfolio aggregated $5.86 billion. Of this aggregate fair value, approximately 1.6% represented securities trading at or below 75% of amortized cost. The impact of unrealized losses on net income will be further mitigated upon realization by the impact of the realized losses on DAC amortization and income taxes.

     At June 30, 2003, approximately $794.1 million of the Company’s Bond Portfolio had gross unrealized losses of $119.7 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 June 30, 2003, by contractual maturity, is shown below:

     In the six months ended June 30, 2003, the pretax realized losses incurred with respect to the sale of fixed securities in the Bond Portfolio were $7.0 million. The aggregate fair value of securities sold was $230.7 million, which was approximately 97.1% of amortized cost. The average period of time that securities sold at a loss during 2003 were trading continuously at a price below amortized cost was approximately 6 months.

25

Table of Contents

     The aging of the Bond Portfolio in an unrealized loss position at June 30, 2003, is shown below: