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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q/A-1

     
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the quarterly period ended September 30, 2002
 
or
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-23625

ANNUITY AND LIFE RE (HOLDINGS), LTD.

(Exact name of registrant as specified in its charter)
     
Bermuda
  Not applicable
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer
Identification Number)
 
Cumberland House, 1 Victoria Street, Hamilton, HM 11, Bermuda
(Address of principal executive offices)

441-296-7667

(Registrant’s Telephone number, including area code)

     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 o          No þ

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)     Yes þ          No o

      The number of the registrant’s Common Shares (par value $1.00 per share) outstanding as of November 5, 2002 was 26,106,328.




TABLE OF CONTENTS

EXPLANATORY NOTE
PART I FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF OPERATIONS
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
CONSOLIDATED STATEMENTS OF CASH FLOWS
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES


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INDEX TO FORM 10-Q/A

             
Page

    PART I — FINANCIAL INFORMATION        
    Explanatory Note     1  
ITEM 1.
  Unaudited Consolidated Financial Statements        
    Consolidated Balance Sheets
September 30, 2002 and December 31, 2001 (as restated)
    2  
    Consolidated Statements of Operations
Three and Nine Months ended September 30, 2002 and 2001 (as restated)
    3  
    Consolidated Statements of Comprehensive (Loss) Income
Three and Nine Months ended September 30, 2002 and 2001 (as restated)
    4  
    Consolidated Statements of Cash Flows
Nine Months ended September 30, 2002 and 2001 (as restated)
    5  
    Consolidated Statements of Changes in Stockholders’ Equity
Nine Months ended September 30, 2002 and 2001 (as restated)
    6  
    Notes to Unaudited Consolidated Financial Statements     7  
ITEM 2.
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     16  
ITEM 3.
  Quantitative and Qualitative Disclosures About Market Risk     40  
ITEM 4.
  Controls and Procedures     40  
    PART II — OTHER INFORMATION        
ITEM 1.
  Legal Proceedings     41  
ITEM 2.
  Changes in Securities and Use of Proceeds     41  
ITEM 5.
  Other Information     41  
ITEM 6.
  Exhibits and Reports on Form 8-K     42  
Signatures     43  
Certifications     44  


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EXPLANATORY NOTE

      This Amendment No. 1 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2002 is being filed to revise and supplement certain information provided in response to Item 1: Unaudited Consolidated Financial Statements and Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations to reflect the completion of the restatement of our financial statements for the fiscal years ended December 31, 2000 and 2001 and the fiscal periods ended March 31, and June 30, 2002. In addition, the certifications required by 18 U.S.C. Section 1350 and Rule 13a-14 promulgated under the Securities Exchange Act of 1934, as amended, accompany this Amendment No. 1.

      Except for Note 10 to the Unaudited Consolidated Financial Statements included in this Amendment No. 1 to our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2002, this amendment does not update information that was presented in our original Quarterly Report on Form 10-Q to reflect developments that have occurred since we filed our original Form 10-Q.

      Additional information about our company can be found in the other filings we have made with the Securities and Exchange Commission.

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PART I

FINANCIAL INFORMATION

ANNUITY AND LIFE RE (HOLDINGS), LTD.

 
CONSOLIDATED BALANCE SHEETS
(U.S. dollars)
                   
September 30, December 31,
2002 2001


(unaudited) (as restated)
Assets
               
Cash and cash equivalents
  $ 120,052,568     $ 104,793,019  
Fixed maturity investments at fair value (amortized cost of $338,889,854 and $312,420,719 at September 30, 2002 and December 31, 2001)
    355,160,595       318,987,432  
Funds withheld at interest
    1,415,120,437       1,489,689,347  
Accrued investment income
    4,063,797       4,897,063  
Receivable for investments sold
    10,814,271       23,815  
Receivable for reinsurance ceded
    94,310,286       97,807,529  
Deposits and other reinsurance receivables
    81,851,829       76,139,222  
Deferred policy acquisition costs
    228,089,222       209,074,192  
Other assets
    11,195,455       9,360,971  
     
     
 
 
Total Assets
  $ 2,320,658,460     $ 2,310,772,590  
     
     
 
Liabilities
               
Reserves for future policy benefits
  $ 280,915,909     $ 221,865,755  
Interest sensitive contracts liability
    1,464,667,709       1,519,596,075  
Other deposit liabilities
    147,000,000       137,000,000  
Other reinsurance liabilities
    22,901,107       17,340,304  
Payable for investments purchased
    10,194,428       2,030,516  
Accounts payable and accrued expenses
    15,737,008       10,751,098  
     
     
 
 
Total Liabilities
  $ 1,941,416,161     $ 1,908,583,748  
     
     
 
Stockholders’ Equity
               
Preferred shares (par value $1.00; 50,000,000 shares authorized; no shares outstanding)
  $     $  
Common shares (par value $1.00; 100,000,000 shares authorized; 26,106,328 and 25,705,328 shares outstanding at September 30, 2002 and December 31, 2001)
    26,106,328       25,705,328  
Additional paid-in capital
    335,334,932       332,447,062  
Notes receivable from stock sales
    (1,603,076 )     (1,317,259 )
Restricted stock (367,625 shares at September 30, 2002)
    (2,747,526 )      
Accumulated other comprehensive income
    16,091,693       6,418,469  
Retained earnings
    6,059,948       38,935,242  
     
     
 
 
Total Stockholders’ Equity
  $ 379,242,299     $ 402,188,842  
     
     
 
 
Total Liabilities and Stockholders’ Equity
  $ 2,320,658,460     $ 2,310,772,590  
     
     
 

See accompanying Notes to Unaudited Consolidated Financial Statements

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

 
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in U.S. dollars)
                                     
For the Three Months Ended For the Nine Months Ended
September 30, September 30,


2002 2001 2002 2001




(as restated) (as restated)
Revenues
                               
Net premiums
  $ 84,934,401     $ 66,813,664     $ 255,007,035     $ 181,955,760  
Investment income, net of related expenses
    31,127,396       24,239,602       82,083,855       66,934,606  
Net realized investment gains
    9,297,351       1,078,933       10,813,315       1,425,183  
Net change in fair value of embedded derivatives
    (13,277,823 )     (5,265,396 )     (18,254,530 )     (3,567,342 )
Surrender fees and other revenues
    3,549,362       5,512,939       13,606,694       13,291,100  
     
     
     
     
 
Total Revenues
  $ 115,630,687     $ 92,379,742     $ 343,256,369     $ 260,039,307  
     
     
     
     
 
Benefits and expenses
                               
Claim and policy benefits
  $ 91,381,831     $ 74,873,807     $ 224,640,576     $ 161,699,922  
Interest credited to interest sensitive products
    18,345,349       14,401,290       57,215,862       30,490,167  
Policy acquisition costs and other insurance expenses
    17,492,342       43,306,421       73,700,329       95,220,905  
Collateral costs
    3,731,580             6,080,321        
Operating expenses
    3,826,602       2,478,698       10,626,666       7,832,813  
     
     
     
     
 
Total Benefits and Expenses
  $ 134,777,704     $ 135,060,216     $ 372,263,754     $ 295,243,807  
     
     
     
     
 
Net (loss) before cumulative effect of a change in accounting principle
  $ (19,147,017 )   $ (42,680,474 )   $ (29,007,385 )   $ (35,204,500 )
Cumulative effect of a change in accounting principle (Note 2)
                      (3,665,735 )
     
     
     
     
 
   
Net (Loss)
  $ (19,147,017 )   $ (42,680,474 )   $ (29,007,385 )   $ (38,870,235 )
     
     
     
     
 
Net (loss) per common share before cumulative effect of a change in accounting principle
                               
 
Basic
  $ (0.74 )   $ (1.66 )   $ (1.13 )   $ (1.38 )
 
Diluted
  $ (0.74 )   $ (1.66 )   $ (1.13 )   $ (1.38 )
Cumulative effect of a change in accounting principle per common share
                               
 
Basic
  $     $     $     $ (0.14 )
 
Diluted
  $     $     $     $ (0.14 )
Net (loss) per common share
                               
 
Basic
  $ (0.74 )   $ (1.66 )   $ (1.13 )   $ (1.52 )
 
Diluted
  $ (0.74 )   $ (1.66 )   $ (1.13 )   $ (1.52 )

See accompanying Notes to Unaudited Consolidated Financial Statements

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(Unaudited and in U.S. dollars)
                                 
For the Three Months Ended For the Nine Months Ended
September 30, September 30,


2002 2001 2002 2001




(as restated) (as restated)
Net (loss) for the period
  $ (19,147,017 )   $ (42,680,474 )   $ (29,007,385 )   $ (38,870,235 )
Other comprehensive income:
                               
Unrealized holding gains on securities arising during the period
    17,633,359       7,740,625       20,486,539       9,652,655  
Less reclassification adjustment for realized gains in net (loss)
    9,297,351       1,078,933       10,813,315       1,425,183  
     
     
     
     
 
Other comprehensive income
  $ 8,336,008     $ 6,661,692     $ 9,673,224     $ 8,227,472  
     
     
     
     
 
Total Comprehensive (Loss)
  $ (10,811,009 )   $ (36,018,782 )   $ (19,334,161 )   $ (30,642,763 )
     
     
     
     
 

See accompanying Notes to Unaudited Consolidated Financial Statements

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in U.S. dollars)
                   
For the Nine Months Ended
September 30,

2002 2001


(as restated)
Cash flows from operating activities
               
Net (loss)
  $ (29,007,385 )   $ (38,870,235 )
Adjustments to reconcile net (loss) to cash provided by operating activities:
               
Cumulative effect of change in accounting principle
          3,665,735  
Net realized investments (gains)
    (10,813,315 )     (1,425,183 )
Net change in fair value of embedded derivatives
    18,254,530       3,567,342  
Unrealized loss on interest rate swap
    2,005,000        
Amortization of restricted stock
    541,344        
Changes in:
               
Accrued investment income
    833,266       (288,492 )
Deferred policy acquisition costs
    (19,015,030 )     4,114,995  
Deposits and other reinsurance receivables
    (2,215,364 )     (19,165,559 )
Other assets
    1,834,484       (1,057,573 )
Reserves for future policy benefits
    59,050,154       39,726,121  
Interest sensitive contracts, net of funds withheld
    1,386,015       (25,777,751 )
Other reinsurance liabilities
    5,560,803       35,146,924  
Accounts payable
    2,980,910       3,329,510  
     
     
 
 
Net cash provided by operating activities
  $ 27,726,444     $ 2,965,834  
     
     
 
Cash flows from investing activities
               
Proceeds from sales of fixed maturity investments
  $ 467,314,155     $ 186,398,746  
Purchase of fixed maturity investments
    (485,627,324 )     (196,561,747 )
     
     
 
 
Net cash (used) by investing activities
  $ (18,313,169 )   $ (10,163,001 )
     
     
 
Cash flows from financing activities
               
Issuance of shares
  $     $ 2,846,205  
Interest accrued on notes receivable
    (74,437 )     (78,540 )
Interest collected on notes receivable
    38,620        
Issuance of note receivable
    (250,000 )      
Dividends paid to stockholders
    (3,867,909 )     (3,834,558 )
Increase in deposit liability
    10,000,000        
     
     
 
 
Net cash provided (used) by financing activities
  $ 5,846,274     $ (1,066,893 )
     
     
 
Increase (decrease) in cash and cash equivalents
  $ 15,259,549     $ (8,264,060 )
Cash and cash equivalents, beginning of period
    104,793,019       52,691,974  
     
     
 
Cash and cash equivalents, end of period
  $ 120,052,568     $ 44,427,914  
     
     
 

See accompanying Notes to Unaudited Consolidated Financial Statements

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited and in U.S. dollars)
                 
For the Nine Months Ended
September 30,

2002 2001


(as restated)
Preferred shares par value $1.00
               
Balance at beginning and end of period
  $     $  
     
     
 
Common shares par value $1.00
               
Balance at beginning of period
  $ 25,705,328     $ 25,499,999  
Issuance of shares
    401,000       185,829  
     
     
 
Balance at end of period
  $ 26,106,328     $ 25,685,828  
     
     
 
Additional paid-in capital
               
Balance at beginning of period
  $ 332,447,062     $ 329,496,091  
Issuance of shares
    2,887,870       2,660,376  
     
     
 
Balance at end of period
  $ 335,334,932     $ 332,156,467  
     
     
 
Notes receivable from stock sales
               
Balance at beginning of period
  $ (1,317,259 )   $ (1,367,241 )
Issuance of note receivable
    (250,000 )      
Interest collected on notes receivable
    38,620        
Accrued interest during period
    (74,437 )     (78,540 )
     
     
 
Balance at end of period
  $ (1,603,076 )   $ (1,445,781 )
     
     
 
Restricted stock
               
Balance at beginning of period
  $     $  
Issuance of shares
    (3,288,870 )      
Amortization of restricted stock
    541,344        
     
     
 
Balance at end of period
  $ (2,747,526 )   $  
     
     
 
Accumulated other comprehensive income
               
Balance at beginning of period
  $ 6,418,469     $ 2,064,971  
Net unrealized gains on securities
    9,673,224       8,227,472  
     
     
 
Balance at end of period
  $ 16,091,693     $ 10,292,443  
     
     
 
Retained earnings
               
Balance at beginning of period
  $ 38,935,242     $ 84,636,497  
Net (loss)
    (29,007,385 )     (38,870,235 )
Stockholder dividends
    (3,867,909 )     (3,834,558 )
     
     
 
Balance at end of period
  $ 6,059,948     $ 41,931,704  
     
     
 
Total Stockholders’ Equity
  $ 379,242,299     $ 408,620,661  
     
     
 

See accompanying Notes to Unaudited Consolidated Financial Statements

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.     Organization

      Annuity and Life Re (Holdings), Ltd. (“Holdings”) was incorporated on December 2, 1997 under the laws of Bermuda. Holdings provides annuity and life reinsurance to insurers and reinsurers through its wholly-owned subsidiaries: Annuity and Life Reassurance, Ltd., which is licensed under the laws of Bermuda as a long term insurer; and Annuity and Life Re America, Inc., an insurance holding company based in the United States, and Annuity and Life Reassurance America, Inc., a life insurance company domiciled in the United States. Holdings, Annuity and Life Reassurance, Annuity and Life Re America and Annuity and Life Reassurance America are collectively referred to herein as the “Company.”

2.     Restatement

      The Company has restated its financial statements for the fiscal year ended December 31, 2001 to reflect the application of Statement of Financial Accounting Standard 133 — Accounting for Derivative Instruments and Hedging Activities, which requires the Company to bifurcate and separately account for embedded derivatives contained in certain of the Company’s annuity reinsurance contracts. The Company is required to carry these embedded derivatives on its balance sheet at fair value and the unrealized changes in the value of these embedded derivatives are reflected in net income as Net change in fair value of embedded derivatives. The fair value of these embedded derivatives at January 1, 2001 was a loss of $3,665,735 and this has been accounted for as a cumulative effect of a change in accounting principle. The change in fair value of the Company’s embedded derivatives during 2001 was a gain of $5,029,027. Additionally, an adjustment of $1,320,184 has been made in 2001 to increase the amortization of deferred acquisition costs to reflect the revised emergence of profits on the affected reinsurance agreements as a result of the change in fair value of the embedded derivatives. For the year ended December 31, 2001, the net impact on reported earnings was a $43,107 gain.

      In the fourth quarter of 2001, the Company recorded a charge of $33,000,000 in connection with minimum interest guarantees associated with its largest annuity reinsurance contract. The $33,000,000 charge was made up of $13,500,000 of estimated minimum interest guarantee payments made in 2001 and a $19,500,000 reserve for estimated future minimum interest guarantee payments. The Company had originally recorded the $19,500,000 reserve component of the $33,000,000 charge as an increase to its Interest sensitive contracts liability. In its restated financial statements for the fiscal year ended December 31, 2001, the Company has reclassified the $19,500,000 as a write down of deferred acquisition costs. The reclassification did not change the Company’s reported net (loss) for the year; however, certain components of the Company’s Consolidated Balance Sheet as of December 31, 2001 and Consolidated Statements of Operations for the year then ended have changed as a result of this restatement.

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Further, based on information now available to the Company, the Company has also restated its financial statements for the fiscal years ended December 31, 2001 and 2000 to recognize approximately $13,500,000 and $2,800,000, respectively, of minimum interest guarantee payments made in the periods in which they were paid. The $13,500,000 of payments made in 2001 were included in the $33,000,000 charge taken in the fourth quarter of 2001. The Company originally recorded the full $13,500,000 expense in the fourth quarter of 2001 because that was the quarter in which the Company first received data that enabled it to estimate the amount of such payments accurately. As part of the restatement of the Company’s financial statements for the fiscal year ended December 31, 2001, the $13,500,000 expense has been reallocated to the quarterly periods in that year in which the payments were made. Similarly, the Company has recognized the $2,800,000 of minimum interest guarantee payments made in 2000 as an expense rather than as a reduction in Interest sensitive contracts liabilities. There was a corresponding decrease of $1,914,853 in the amortization of deferred acquisition costs in 2000 as a result of the minimum interest guarantee payments made in that year. The net effect on the Company’s net income in 2000 was a reduction of $885,459. The decrease in the amortization of deferred acquisition costs in 2000 had the effect of increasing the amount of unamortized deferred acquisition costs as at December 31, 2000. Because the Company determined that deferred acquisition costs on the Company’s largest annuity reinsurance contract should be written down to their estimated recoverable amount during 2001, the write down in costs in 2001 has been adjusted to reflect the increased balance of unamortized deferred acquisition costs that existed at December 31, 2000. The impact of this aspect of the restatement on net income in 2001 was a reduction of $1,914,853. Certain components of the Company’s Consolidated Balance Sheets as of December 31, 2001 and 2000 and Consolidated Statements of Operations for the years then ended have changed as a result of this restatement. Further, the Company has allocated portions of the $19,500,000 reserve component of the $33,000,000 charge taken in the fourth quarter of 2001, and a similar $24,700,000 charge taken in the third quarter of 2001 in connection with the same contract, across prior quarters in that year. This reallocation does not affect the reported net (loss) for the year ended December 31, 2001, but it does affect reported net income (loss) for each of the quarters in that year.

      The following table summarizes the effect of these changes to the Company’s previously issued financial statements for the fiscal year ended December 31, 2001 and for the three and nine month periods ended September 30, 2001. The restatement described above had no net effect on the Company’s cash flows provided by operating activities for the periods then ended, so no information regarding the Company’s Consolidated Statements of Cash Flows is presented in the table.

                                         
Effect of

As Minimum As
Reported FAS 133 Reclassification Guarantee Restated





Consolidated balance sheet at December 31, 2001
                                       
Funds withheld at interest
  $ 1,488,326,056     $ 1,363,291     $     $     $ 1,489,689,347  
Deferred acquisition costs
    229,894,376       (1,320,184 )     (19,500,000 )           209,074,192  
Interest sensitive contracts liability
    1,536,295,763             (19,500,000 )     2,800,312       1,519,596,075  
Stockholders’ Equity
    404,946,046       43,107             (2,800,312 )     402,188,842  

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                         
Effect of

As Minimum As
Reported FAS 133 Reclassification Guarantee Restated





Consolidated statements of operations for the year ended December 31, 2001
                                       
Net change in fair value of embedded derivatives
  $     $ 5,029,027     $     $     $ 5,029,027  
Interest credited to interest sensitive products
    68,758,418             (19,500,000 )           49,258,418  
Policy acquisition and other insurance expenses
    105,045,512       1,320,184       19,500,000       1,914,853       127,780,549  
Cumulative effect of a change in accounting principle
          (3,665,735 )                 (3,665,735 )
Net (Loss)
    (38,709,686 )     43,107             (1,914,853 )     (40,581,431 )
                                         
Consolidated statements of operations for the three month period ended September 30, 2001
                                       
Net change in fair value of embedded derivatives
  $     $ (5,265,396 )   $     $     $ (5,265,396 )
Interest credited to interest sensitive products
    10,001,290                   4,400,000       14,401,290  
Policy acquisition and other insurance expenses
    49,117,632       (269,009 )           (5,542,202 )     43,306,421  
Net (Loss)
    (38,826,289 )     (4,996,387 )           1,142,202       (42,680,474 )
Consolidated statements of operations for the nine month period ended September 30, 2001
                                       
Net change in fair value of embedded derivatives
  $     $ (3,567,342 )   $     $     $ (3,567,342 )
Interest credited to interest sensitive products
    21,190,167                   9,300,000       30,490,167  
Policy acquisition and other insurance expenses
    86,792,638       (1,410,724 )           9,838,992       95,220,905  
Cumulative effect of a change in accounting principle
          (3,665,735 )                 (3,665,735 )
Net (Loss)
    (13,908,890 )     (5,822,353 )           (19,138,992 )     (38,870,235 )

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

3.     Basis of Presentation

      The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and in accordance with Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included in these financial statements. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company’s amended Form 10-K for the fiscal year ended December 31, 2001. In addition to the accounting policies noted in the Company’s amended Form 10-K for the fiscal year ended December 31, 2001, the Company notes the following:

 
Reserves for Guarantees Associated with Variable Annuity Contracts

      The Company reinsures certain minimum guarantees associated with variable annuity contracts. These include guaranteed minimum death benefits, guaranteed minimum income benefits, and enhanced earnings benefits. The Company’s accounting policy is to establish reserves for expected future claims based upon the long term view of expected losses over the life of the underlying policies, based upon the original pricing assumptions. The Company’s reserving policy allows the Company to strengthen reserves if claim amounts or volume exceed what was anticipated in pricing. During the third quarter of 2002, the Company increased its reserves for minimum guarantees associated with variable annuities by approximately $7,760,000 as a result of increasing claim activity over recent quarters. The Company may be required to increase these reserves in future periods if claims activity continues at the current level or higher.

      The Accounting Standards Executive Committee (a committee of the American Institute of Certified Public Accountants) has issued a proposed Statement of Position that could set a new standard for accounting for Certain Nontraditional Long-Duration Contracts and for Separate Accounts that, if adopted, could require the Company to establish additional reserves for certain guarantees associated with variable annuity contracts. These reserve adjustments will likely be volatile because they are influenced by the performance of the financial markets. Had the Company followed these proposed standards, on December 31, 2001, no reserves would have been necessary, while on June 30, 2002, approximately $2 million of reserves would have been required. Given recent fluctuations in the financial markets, the reserve required under the proposed standard would have risen to approximately $22 million by September 30, 2002, and then fallen to approximately $9 million by October 31, 2002. For all of the periods mentioned, the assumptions underlying the reserve calculations are the same. The Company anticipates that this volatility will continue in future periods and, if the proposed standard is adopted as currently written, this volatility will affect the Company’s reported results of operations.

 
Interest Rate Swaps

      In the third quarter of 2002, the Company entered into two interest rate swaps with a nominal value of $67,000,000 to manage interest rate risk associated with a deposit liability whereby the Company is required to pay a variable rate of interest based upon LIBOR. The interest rate swaps do not meet the effectiveness criteria specified in FAS 133 to qualify as a hedge. The swaps are carried at fair value within accounts payable with the change in fair value recorded as an adjustment to the income statement item to which they relate. In the third quarter of 2002, the Company charged approximately $2,155,000 related to these swaps to Collateral costs.

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

4.     (Loss) Per Share

      The following table sets forth the computation of basic and diluted (loss) per share for the three and nine month periods ended September 30:

                                 
Three Months Ended Nine Months Ended
September 30, September 30,


2002 2001 2002 2001




(dollars, as (dollars, as
restated) restated)
Net (loss) available to common shareholders before cumulative effect of a change in accounting principle
  $ (19,147,017 )   $ (42,680,474 )   $ (29,007,385 )   $ (35,204,500 )
Cumulative effect of a change in accounting principle
                      (3,665,735 )
     
     
     
     
 
Net (loss) available to common shareholders
  $ (19,147,017 )   $ (42,680,474 )   $ (29,007,385 )   $ (38,870,235 )
     
     
     
     
 
Basic:
                               
Weighted average number of common shares outstanding
    25,733,141       25,683,328       25,722,016       25,592,914  
Net (loss) per share before cumulative effect of a change in accounting principle
  $ (0.74 )   $ (1.66 )   $ (1.13 )   $ (1.38 )
Cumulative effect of a change in accounting principle
  $     $     $     $ (0.14 )
     
     
     
     
 
Net (loss) per share
  $ (0.74 )   $ (1.66 )   $ (1.13 )   $ (1.52 )
     
     
     
     
 
Diluted:
                               
Weighted average number of common shares outstanding
    25,733,141       25,683,328       25,722,016       25,592,914  
Net (loss) per share before cumulative effect of a change in accounting principle
  $ (0.74 )   $ (1.66 )   $ (1.13 )   $ (1.38 )
Cumulative effect of a change in accounting principle
  $     $     $     $ (0.14 )
     
     
     
     
 
Net (loss) per share
  $ (0.74 )   $ (1.66 )   $ (1.13 )   $ (1.52 )
     
     
     
     
 

5.     Business Segments

      During the first quarter of 2002, the Company’s management began to separately track financial results of the Company’s life and annuity operations in segments, as reflected in this report. Each segment is defined by a dominant risk characteristic inherent in all products in that segment. The life segment consists of all products where the dominant risk characteristic is mortality risk. The annuity segment comprises all products where the dominant risk characteristic is investment risk, including minimum guarantees associated with variable annuity products. In addition, as discussed in Note 2 above, certain of the Company’s modified coinsurance and coinsurance funds withheld annuity reinsurance agreements have features that constitute embedded derivatives that require bifurcation and separate accounting under FAS 133 — Accounting for Derivative Instruments and Hedging Activities. The cumulative effect of the application of FAS 133 to the agreements through January 1, 2001 and the change in the fair value of these embedded derivatives are

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

included in the annuity segment. Both the life and annuity segments have specific assets, liabilities, stockholders’ equity, revenue, benefits and expenses that apply only to them. The corporate segment contains all stockholders’ equity not deployed to the life or annuity segment. In addition, the corporate segment includes all capital gains and losses from sales of securities in our portfolio and investment income on undeployed invested assets. Operating expenses are allocated to the segments proportionately based upon the amount of stockholders’ equity deployed to the segment. The Company believes that investors will better understand the Company’s profitability, risk profile and capital deployment through this change. There are no intersegment transactions. The following table displays several key measurements for each of our business segments.

                                 
Three Months Ended Life Annuity
September 30, 2002 Reinsurance Reinsurance Corporate Consolidated





Revenues
  $ 86,708,167     $ 18,535,565     $ 10,386,955     $ 115,630,687  
Benefits and Expenses
    96,858,456       36,882,014       1,037,234       134,777,704  
     
     
     
     
 
Segment (Loss) Income
  $ (10,150,289 )   $ (18,346,449 )   $ 9,349,721     $ (19,147,017 )
     
     
     
     
 
Total Assets
  $ 655,417,016     $ 1,549,867,709     $ 115,373,735     $ 2,320,658,460  
     
     
     
     
 
                                 
Three Months Ended Life Annuity
September 30, 2001 Reinsurance Reinsurance Corporate Consolidated





(as restated, see Note 2)
Revenues
  $ 65,951,358     $ 22,025,046     $ 4,403,338     $ 92,379,742  
Benefits and Expenses
    86,375,896       47,410,846       1,273,474       135,060,216  
     
     
     
     
 
Segment (Loss) Income
  $ (20,424,538 )   $ (25,385,800 )   $ 3,129,864     $ (42,680,474 )
     
     
     
     
 
Total Assets
  $ 401,683,367     $ 1,713,508,054     $ 218,103,053     $ 2,333,294,474  
     
     
     
     
 
                                 
Nine Months Ended
September 30, 2002

Revenues
  $ 260,319,388     $ 66,846,669     $ 16,090,312     $ 343,256,369  
Benefits and Expenses
    256,829,025       112,065,166       3,369,563       372,263,754  
     
     
     
     
 
Segment Income (Loss)
  $ 3,490,363     $ (45,218,497 )   $ 12,720,749     $ (29,007,385 )
     
     
     
     
 
                                 
Nine Months Ended
September 30, 2001

(as restated, see Note 2)
Revenues
  $ 179,367,569     $ 68,325,130     $ 12,346,608     $ 260,039,307  
Benefits and Expenses
    188,280,834       102,659,123       4,303,850       295,243,807  
     
     
     
     
 
Segment (Loss) Income before cumulative effect of change in accounting principle
    (8,913,265 )     (34,333,993 )     8,042,758       (35,204,500 )
Cumulative effect of a change in accounting principle
          (3,665,735 )             (3,665,735 )
     
     
     
     
 
Segment (Loss) Income
  $ (8,913,265 )   $ (37,999,728 )   $ 8,042,758     $ (38,870,235 )
     
     
     
     
 

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

6.     Accounting Standards

      In July 2001, the FASB issued Statement Number 141 — Business Combinations and Statement Number 142 — Goodwill and Intangible Assets. These statements changed how the Company accounts for business combinations and for purchased goodwill and other intangible assets that arise from these combinations. The Company adopted the new standards on January 1, 2002.

      The standards require that all business combinations be accounted for using the purchase method and establish specific criteria for the recognition of intangible assets separately from goodwill. Under the standards, goodwill is no longer amortized but will be subject to an impairment test on at least an annual basis. At September 30, 2002 and December 31, 2001, Other assets included unamortized goodwill of $2.1 million. Goodwill amortization for the year ended December 31, 2001 was $116,000.

7.     Related Party Transactions

      In the first quarter of 2002, the Company purchased a $10,000,000 excess of loss reinsurance policy from a subsidiary of XL Capital Ltd, a related party, to provide protection against minimum interest guarantee payments under the Company’s annuity reinsurance contract with Transamerica Occidental Life Insurance Company occurring after January 1, 2002, in excess of a $33,000,000 deductible. The premium paid for this protection was $1.5 million.

      Also during the first quarter of 2002, the Company purchased an aggregate catastrophe excess of loss cover from a subsidiary of XL Capital providing protection from a single event, excluding acts of terrorism, causing a claim for more than five policyholders. The premium for this coverage was $1,000,000.

8.     Restricted Stock

      In 2002, the Company adopted a restricted stock incentive compensation program and made two awards to employees. Under the first award to employees, the Company issued 133,500 shares of restricted stock that vest on the third anniversary of the grant date. Under the second award, certain employees of the Company were irrevocably offered an aggregate 267,500 shares of restricted stock, conditioned upon the execution of a retention agreement with the Company. These shares vest in three equal annual installments commencing on the first anniversary of the grant date. The fair value of the restricted stock awards on the date of award and assuming all shares vest was $3,289,000, which is reflected in the Company’s balance sheet as common stock and paid in capital. The fair value of these grants is being amortized on a straight line basis over the three year vesting period. The unamortized balance of the grants is reflected in the balance sheet as restricted stock.

9.     Contingencies

      During the second quarter of 2002, the Company initiated arbitration proceedings in connection with two of its life reinsurance agreements. During the third quarter of 2002, the Company settled its arbitration with one of the ceding companies, resulting in the recapture by that company of the contract that had been the subject of the arbitration. The impact of that contract on the third quarter, including the recapture, was a net loss of $6,189,000. With respect to the remaining life arbitration claim, the Company is seeking monetary damages and/or equitable relief from the ceding company based upon its contention that the ceding company failed to disclose material facts, known to them, about the block of business being reinsured when it was underwritten. No assurance can be given that monetary recovery or equitable relief will occur.

      On January 21, 2002, the Company served written notice of arbitration in connection with the Company’s annuity reinsurance contract with Transamerica Occidental Life Insurance Company. In the arbitration, the Company was seeking monetary damages and/or equitable relief from Transamerica based on the Company’s claim that certain actions and/or omissions by Transamerica deprived the Company of the benefit of the reinsurance transaction. On November 8, 2002, the Company announced that its claim against Transamerica

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

had been denied by the arbitration panel assigned to the matter. The arbitration panel upheld Transamerica’s position that the Company’s annuity reinsurance contract was a valid and enforceable contract and that Transamerica had acted in a commercially reasonable manner.

      Based on the Company’s projections of its ceding companies’ statutory reserve cessions, in order to satisfy its obligations under its existing reinsurance agreements, the Company will need to post up to approximately $210.0 million of additional collateral by December 31, 2002. The Company will seek to meet or reduce these additional security requirements by negotiating the recapture, retrocession or sale of certain of its reinsurance agreements, accessing its collateral funding facility and/or raising capital. The Company has not been able to successfully raise capital or access its collateral funding facility in recent months given, among other things, the uncompleted restatement of the Company’s financial statements for 2000 and 2001. If the Company is unable to meet the security requirements of its cedents, the Company may be required to cease writing new business and the Company may be in violation of its existing reinsurance contracts and become subject to the remedies set forth therein. The Company’s cedents may also ask that the agreements be recaptured. These recaptures could result in losses, but could also improve the Company’s liquidity and its ability to meet the collateral requirements of its remaining cedents.

      The Company currently has unsecured letters of credit of approximately $49,000,000 outstanding under a letter of credit facility with Citibank. In October 2002, Citibank agreed to extend this unsecured letter of credit facility into next year in exchange for the Company’s agreement to secure, or otherwise eliminate, the letter of credit facility by June 30, 2003.

      As of September 30, 2002, the Company had $45,000,000 of unsecured letters of credit outstanding under a letter of credit facility with Manulife Financial that had been posted as security to allow the Company’s United States operating subsidiary to take credit on its statutory financial statements for reinsurance ceded to the Company’s Bermuda operating company. During October of 2002, Manulife requested that the unsecured letters of credit it had issued on the Company’s behalf be secured. Consequently, in November 2002, the Company’s Bermuda operating subsidiary deposited $15,000,000 with the Company’s United States operating subsidiary as funds withheld. Further, one of the Company’s United States operating subsidiary’s ceding companies has recaptured its contracts, reducing the subsidiary’s collateral needs by an additional $15,000,000. The Company has committed to securing or eliminating the remaining $15,000,000 in letters of credit issued by Manulife under the Company’s letter of credit facility by December 31, 2002. Due to Manulife’s request to secure its letter of credit facility and the Company’s inability thus far to post sufficient security for the Company’s United States operating subsidiary, the Connecticut Insurance Department has requested that all financial transactions, except those related to the normal course of business, between the Company and its United States operating subsidiary be preapproved by the insurance department.

10.     Going Concern and Subsequent Events

      The accompanying unaudited consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. However, the Company incurred significant operating losses in the second and third quarters of 2002, and has announced that it anticipates reporting a significant loss for the year 2002. Further, the financial strength ratings of the Company’s operating subsidiaries were downgraded in July, 2002 by A.M. Best, Standard & Poor’s, and Fitch Ratings, and there have been further downgrades since that date. Also, the Company is required to post collateral for the statutory reserves ceded to it by U.S. based insurers and reinsurers. The Company did not have sufficient available cash and investments to satisfy the collateral requirements asserted by its cedents as of December 31, 2002 under certain of its reinsurance treaties. The Company’s cedents now assert that the Company must satisfy additional collateral requirements of approximately $140 million, which includes collateral requirements asserted as of December 31, 2002 and additional collateral requirements asserted since that date. The Company is currently analyzing these asserted collateral

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

requirements and has not concluded that such amounts are in fact required to be posted as collateral under the relevant reinsurance contracts. Certain providers of letters of credit issued on behalf of the Company totaling approximately $59 million have also demanded the return or collateralization of those letters of credit. As a result of the Company’s inability to satisfy its obligations, certain parties have claimed that the Company is in breach of its agreements. As a consequence, certain parties have sought and others may seek remedies for such claimed breaches by the Company, and the Company may be required to enter into arbitration or litigation proceedings with those parties. The Company has also been served with a statutory demand under Bermuda law related to the Company’s alleged failure to satisfy certain obligations. If such statutory demand is held to be valid and the Company is unable to satisfy the related obligations, the party making such demand would be entitled to institute proceedings seeking the liquidation of the Company.

      On November 20, 2002, the State of Connecticut Insurance Department indicated that it is monitoring the financial condition of the Company’s United States operating subsidiary and requested that certain financial transactions entered into by the subsidiary, including the disposal of assets, payment of dividends and settlement of inter-company balances with the Company’s Bermuda operating subsidiary, be pre-approved by the Insurance Department.

      The Company engaged a financial advisor in September 2002 to assist it in seeking to raise capital, but the Company has not been able to successfully raise new capital to date. The Company has ceased to write new business and has notified its existing clients that it will not be accepting any new business under existing treaties on their current terms. These aforementioned factors raise substantial doubt about the Company’s ability to continue as a going concern.

      The Company’s plans involve attempting to meet or reduce the additional collateral requirements of its ceding companies by continuing to negotiate the recapture, retrocession, novation or sale of certain of its reinsurance agreements, although there can be no assurance that the Company will be able to negotiate favorable terms for such transactions. The Company has also announced substantial premium rate increases on all of its non-guaranteed premium yearly renewable term contracts.

      There can be no assurance that the Company’s plans will be successful in improving its operations and liquidity. If the Company is not successful in implementing its plans, management believes that the Company will not be able to satisfy its obligations in 2003. The accompanying unaudited consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

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Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

      Annuity and Life Re (Holdings), Ltd. was incorporated on December 2, 1997 under the laws of Bermuda. We provide annuity and life reinsurance to select insurers and reinsurers through our wholly-owned subsidiaries: Annuity and Life Reassurance, Ltd., which is licensed under the insurance laws of Bermuda as a long term insurer; and Annuity and Life Re America, Inc., an insurance holding company based in the United States, and its subsidiary, Annuity and Life Reassurance America, Inc., a life insurance company authorized to conduct business in over 40 states of the United States and the District of Columbia. We acquired Annuity and Life Reassurance America on June 1, 2000.

      The business of reinsurance generally consists of reinsurers, such as Annuity and Life Re, entering into contractual arrangements (known as treaties) with primary insurers (known as ceding companies or cedents) whereby the reinsurer agrees to indemnify the ceding company for all or a portion of the risks associated with an underlying insurance policy in exchange for a reinsurance premium payable to the reinsurer. Reinsurers also may enter into retrocessional reinsurance arrangements with other reinsurers, which operate in a manner similar to the underlying reinsurance arrangement described above. Under retrocessional reinsurance arrangements, the reinsurer shifts a portion of the risk associated with an underlying reinsurance contract to other reinsurers.

      Reinsurance agreements may be written on an automatic treaty basis or facultative basis. An automatic treaty provides for a ceding company to cede contractually agreed-upon risks on identified types of business that meet established criteria to a reinsurer and binds that reinsurer to accept such risks without obtaining further approval from that reinsurer. Facultative reinsurance is the reinsurance of individual risks, which allows a reinsurer the opportunity to analyze and separately underwrite a risk before agreeing to accept the risk. Both automatic treaty and facultative reinsurance may be written on either a quota share basis, where a percentage of each risk in the reinsured class of risk is assumed by the reinsurer from the ceding company, or an excess of retention basis, where the amount of risk of each life in excess of the ceding company’s retention is reinsured. Under either basis, premiums are paid to the reinsurer in proportion to the risk assumed by the reinsurer. Reinsurance can also be on an excess of loss basis, where a reinsurer indemnifies the ceding company for a portion of claims exceeding a specified amount retained by the ceding company in consideration of non-proportional premiums being paid to the reinsurer. The reinsurer’s obligation under an excess of loss contract may be limited to a specified amount of such excess claim.

      We write reinsurance generally in the form of yearly renewable term, coinsurance, modified coinsurance or coinsurance funds withheld. Under yearly renewable term, we share only in the mortality risk for which we receive a premium. In coinsurance, modified coinsurance and coinsurance funds withheld arrangements, we generally share proportionately in all or a portion of the risks inherent in the underlying policies, including mortality, persistency and fluctuations in investment results. Under such agreements, we agree to indemnify the primary insurer for all or a portion of the risks associated with the underlying insurance policies in exchange for a proportionate share of premiums. Coinsurance differs from modified coinsurance and coinsurance funds withheld with respect to ownership of the assets supporting the reserves. Under our coinsurance arrangements, ownership of these assets is transferred to us, whereas, in modified coinsurance and coinsurance funds withheld arrangements, the ceding company retains ownership of these assets, but we share in the investment income and risk associated with the assets.

      Our reinsurance treaties may provide for recapture rights, permitting the ceding company to reassume all or a portion of the risk ceded to us after an agreed-upon period of time (generally 10 years for our life reinsurance treaties), subject to certain other conditions. Some of our reinsurance treaties allow the ceding company to recapture the ceded risk if we fail to maintain a specified rating or if other financial conditions relating to us are not satisfied. Recapture of business previously ceded does not affect earned premiums paid to us prior to the recapture of such business and may involve the payment to us of a recapture fee. Nevertheless, we may have to liquidate substantial assets in order to return the assets supporting the reserve liabilities. In addition, we would no longer be entitled to receive any investment income from the premiums paid by the policyholders underlying the recaptured business and, consequently, we may have to accelerate the amortiza-

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tion of any unamortized deferred acquisition costs associated with the recaptured business, which would reduce our earnings.

Risks Reinsured

      We write reinsurance predominantly on a direct basis with primary life insurance companies. Our major business lines are traditional life reinsurance and annuity reinsurance, which expose us to the following categories of risks: (i) mortality, (ii) investment, (iii) persistency (or lapse) and (iv) expense.

      Mortality risk is the risk that death claims differ from what we expect. With respect to our life segment, a greater frequency or higher average size of death claims than we expected can cause us to pay greater death benefits, adversely affecting the profitability of our reinsurance contracts. Even if the total death benefits paid over the life of our contracts do not exceed the expected amount, unexpected timing of deaths, such as occurred with the attack on the World Trade Center, can cause us to pay more death benefits in a given time period than expected, adversely impacting profitability in that period. We try to address these risks by analyzing each block of business based on an evaluation of the ceding company’s underwriting efficacy, history, management, target market, concentration of risk, products and underwriting criteria relative to the industry. We target primarily “first dollar” quota share pools of top producing direct writing companies under which we participate proportionately with other reinsurers on all of the ceded risks. We seek to mitigate our risk of exposure to any one block of business or any one individual life by typically requiring our ceding companies to retain at least 10% of every life insurance risk reinsured. We further address the risk of any one large claim by limiting our own net liability on any single-life risk to $1,000,000. Certain of the annuity policies we reinsure are in the payout phase, and are therefore subject to the risk that policyholders will survive for longer periods than we assumed when pricing the reinsurance contract. If policyholders live longer than we assumed, we may be required to pay greater than expected annuity payout benefits in future periods.

      We are subject to investment risk with respect to our own investments and with respect to the assets held and managed by our ceding companies or others under our modified coinsurance and coinsurance funds withheld arrangements. Our investments, which primarily consist of investment grade fixed income securities, are subject to interest rate and credit risk. Significant changes in interest rates expose us to the risk of earning less income during periods when interest rates are falling, or realizing losses if we are forced to sell securities during periods when interest rates are rising. We are also subject to prepayment risk on certain securities in our investment portfolio, including mortgage-backed securities and collateralized mortgage obligations, which generally prepay faster during periods of falling interest rates as the underlying mortgage loans are repaid and refinanced by borrowers in order to take advantage of lower interest rates.

      Our cedents have over $1.4 billion in assets that are held and managed by or for them under our modified coinsurance and coinsurance funds withheld arrangements. While we do not own these assets, they are used to fund our obligations under our annuity reinsurance contracts. We record a receivable called “Funds withheld at interest” based on the amounts due to us under these contracts and are exposed to the risks associated with the securities the assets supporting the receivable are invested in. Those assets are primarily invested in fixed income securities and, with respect to our largest annuity reinsurance contract, in investment grade convertible bonds. The fixed income securities in which the assets are invested are subject to risks similar to those described above with respect to our own investments. The value of convertible bonds in which these assets are invested is a function of their investment value (determined by comparing their yield with the yields of other securities of comparable maturity and quality that do not have a conversion privilege) and their conversion value (their market value if converted into the underlying common stock). The investment value of convertible bonds is influenced by changes in interest rates, with investment value declining as interest rates increase and increasing as interest rates decline, and by the credit standing of the issuer and other factors. The conversion value of convertible bonds is determined by the market price of the underlying common stock. If the conversion price is above the market value of the underlying common stock, the price of the convertible bonds is governed principally by their investment value. To the extent the market price of the underlying common stock approaches or exceeds the conversion price, the price of the convertible bonds will be increasingly influenced by their conversion value. Consequently, the value of convertible bonds may be influenced by changes in the equity markets.

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      We are also subject to investment risk based on the difference between the interest rates earned on the investments managed by us or our ceding companies and the credited interest rates paid under policies reinsured by us. Both rising and declining interest rates can affect the income we derive from these interest rate spreads. During periods in which prevailing market interest rates are falling, any new investments made in fixed income securities to replace investments that mature or are prepaid will likely bear lower interest rates, reducing our investment income. We may not be able to fully offset the decline in our investment income with lower crediting rates on our contracts for the reinsurance of annuities or life insurance policies with cash value components. During periods of rising interest rates, our ceding companies may need to increase the crediting rates on the annuities or life insurance policies with cash value components that we reinsure. We may not, however, be able to acquire investments with interest rates sufficient to offset these increased crediting rates. Significant declines in the financial markets generally also increase our investment risk, because the return we receive on our assets may not be sufficient to fully offset the cost of benefits due under certain reinsured policies. Certain policy benefits, such as guaranteed minimum death benefits, “ratchet” up the death benefit when policyholder account values increase, but do not reduce the death benefit when policyholder account values decrease. During periods in which the general value of the financial markets and policyholder account values are falling, claims from such guaranteed minimum death benefits increase because the spread between the policyholder account value and the ratcheted-up death benefit increases. Further, because the premiums charged for such benefits are based on policyholder account values, we would receive reduced premiums for this benefit when financial markets are declining.

      We may use interest rate swaps and other hedging instruments as tools to mitigate the effects of asset/ liability mismatches or the effect of interest rate changes on our balance sheet. In general, however, we have not hedged our investment risk, but we may do so in the future.

      Persistency or lapse risk is the risk that policyholders maintain their policies for different periods of time than expected. This includes policy surrenders and policy lapses. Surrenders are the voluntary termination of a policy by the policyholder, while lapses are the termination of the policy due to non-payment of premium. Surrender and lapse rates that are higher than what we assumed when pricing a contract can cause us to increase the rate of amortization of our deferred acquisition costs for the annuity policies and certain types of life insurance that we reinsure, which would adversely affect our results of operations. If the actual surrender and lapse rates remain too high for too long, as has been the case with our annuity reinsurance contract with Transamerica Occidental Life Insurance Company, we may conclude that the contract could be unprofitable over its expected lifetime, and we could be required to write down our deferred acquisition costs. Surrenders also usually involve the return of the policy’s cash surrender value to the policyholder, which reduces the asset base on which we earn investment income and, in some cases, premiums. In addition, with respect to our Transamerica contract, a surrendering policyholder is entitled to a guaranteed minimum interest rate on his or her invested premiums, and we are required to pay our proportionate share of any shortfall between that guaranteed amount and the actual value of the policyholder’s account. We have been required to make significant minimum interest guarantee payments under this contract, as discussed below. During periods in which the financial markets are falling, increases in partial surrenders under certain reinsurance policies do not reduce the guaranteed minimum death benefits we are obligated to pay by the same proportion by which the premiums supporting the guaranteed minimum death benefit obligations are reduced. The risk of partial surrenders impacting our guaranteed minimum death benefit obligations may have an effect on the profitability of our largest reinsurance contract reinsuring such benefits.

      Certain of our life reinsurance products provide level premiums to us for a fixed period of time, typically 10 to 20 years. The premiums we receive on these level premium contracts exceed the death benefits payable to the underlying policyholders during the early years of the contract. The death benefits we expect to pay under these contracts generally increase over time, while the premiums we receive are expected to generally remain level, so the death benefits payable under the policy ultimately exceed the premiums we receive in later years. With respect to these level premium contracts, if the surrender and lapse rates of the policies are significantly lower than we assumed when pricing the reinsurance contract, the profitability of the contract may be adversely affected.

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      Expense risk is the risk that our actual expenses will be higher than we anticipated, or that our operations are less efficient than anticipated.

Business Written

      The following table sets forth selected information for the indicated periods concerning our insurance operations:

Policy Revenues, Insurance in Force and Annuity Reinsurance Deposits

                                       
Nine Months Ended Twelve Months Ended December 31,
September 30,
2002 2001 2000 1999




Policy revenues
                               
 
Life reinsurance
                               
   
First year
  $ 71,463,760     $ 94,746,734     $ 55,047,163     $ 72,268,437  
   
Renewal
    175,435,259       141,607,931       96,151,918       28,566,570  
 
Annuity reinsurance
    8,108,016       15,438,572       17,204,941        
     
     
     
     
 
     
Total
  $ 255,007,035     $ 251,793,237     $ 168,404,022     $ 100,835,007  
     
     
     
     
 
Insurance in force at end of period (in thousands)
  $ 150,948,700     $ 117,400,000     $ 77,019,000     $ 45,407,000  
     
     
     
     
 
Annuity reinsurance deposits
  $ 1,464,667,709     $ 1,519,596,075     $ 1,597,928,818     $ 1,603,382,955  
     
     
     
     
 

      Our life reinsurance segment is the reinsurance of ordinary life insurance, primarily for mortality risks. Ordinary life reinsurance generally is the reinsurance of individual term life insurance policies, whole life insurance policies and joint and survivor insurance policies on yearly renewable term basis. In addition, we reinsure the mortality risk inherent in universal life insurance policies, variable universal life insurance policies and variable life insurance policies.

      Our annuity reinsurance segment is the reinsurance of general account fixed deferred annuities, general account payout annuity obligations and certain risks arising from variable annuities. With respect to the general account fixed annuities we reinsure, our agreements generally relate to individual general account single premium deferred annuity policies, which either involve the tax-deferred accumulation of interest on a single premium paid by the policyholder (accumulation phase policies) or are annuities that pay fixed amounts periodically to policyholders over a fixed period of time or their lives (payout phase policies). Accumulation phase policies are subject primarily to investment risk and persistency (lapse) risk, while payout phase policies are primarily subject to investment risk and mortality (longevity) risk. Most of the fixed annuities we reinsure are accumulation phase policies. All of the fixed annuity products we reinsure have minimum interest guarantee provisions required under state law that entitle the policyholder to a specified minimum annual return over the life of the policy. These lifetime guarantees are typically 3% to 3.5% annually. Further, policyholders are typically guaranteed interest rates in excess of the state required minimums for the initial year of the policy. After the expiration of the period in which the crediting rate is guaranteed, the primary insurer has the discretionary ability to adjust the crediting rate annually to any rate at or above the guaranteed minimum rate required under state law. Policyholders are typically permitted to withdraw all or a part of their premium paid, plus an accumulation amount equal to the accrued interest credited to the account, subject to the assessment of a surrender charge for withdrawals in excess of specified limits.

      Certain policies reinsured by us guarantee the policyholder a crediting rate beyond the initial policy year, including those policies covered by our annuity reinsurance contract with The Ohio National Life Insurance Company. In addition to the lifetime minimum guaranteed interest rate required under state law, the Ohio

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National policies reinsured by us guarantee a crediting rate to the policyholders for six years. During that six year period, each year’s crediting rate is guaranteed to exceed the prior year’s actual crediting rate by 0.15%. For the nine months ended September 30, 2002 and the fiscal year ended December 31, 2001, the average crediting rate of the policies underlying the Ohio National contract was 5.3% and 5.6%, respectively. The average yield rate on the assets managed by Ohio National that are funding these policyholder obligations for the nine month period ended September 30, 2002 and the fiscal year ended December 31, 2001 was 7.36% and 7.91%, respectively. The Ohio National reinsurance contract is our second largest annuity reinsurance contract and represented approximately 25% and 15% of our Funds withheld receivable as of September 30, 2002 and December 31, 2001, respectively.

      Under our Transamerica annuity reinsurance contract, the minimum interest guarantee provisions take effect when the policyholder dies, his or her policy annuitizes or his or her policy is surrendered. Our aggregate minimum interest guarantee exposure under this contract equals our proportionate share of the amount by which each policyholder’s premiums deposited compounded at the minimum guarantee interest rate exceeds the policyholder’s actual account value. The actual account value is calculated after expenses are deducted from the gross investment returns and such expenses generally accrue at a rate of approximately 2.75% of the assets annually. Our minimum interest guarantee exposure is calculated on a policyholder by policyholder basis. The amount by which the value of certain policyholder accounts exceeds the minimum guarantee amount with respect to those accounts does not offset our exposure to the amount by which the value of other policyholder accounts is less than the minimum guarantee amount with respect to such other accounts. This exposure generally arises during periods in which investment returns fall near or below the minimum guaranteed rate, as has occurred in recent years.

      If we conclude that we are exposed to these minimum interest guarantees under a reinsurance contract, we then estimate the expected minimum interest guarantee payments that we may be required to make by projecting the anticipated future investment performance of the assets supporting the policyholder accounts and by applying projected surrender, annuitization and mortality assumptions to the exposed amounts. Because we assume that the investment performance of the underlying assets will exceed the minimum guaranteed interest rate on the underlying annuity policies over their life, we anticipate that any minimum interest guarantee exposure we have will decrease over time. The amount of expected minimum interest guarantee payments is therefore dependent upon our estimate of the number of policyholders that will die, annuitize or surrender their policy prior to the value of the underlying assets increasing to a level where it equals or exceeds the policyholders’ minimum guarantee amounts. Our minimum interest guarantee exposure can increase during any period in which the actual investment performance of the underlying assets less expenses lags the minimum guaranteed interest rate.

      We also reinsure certain guarantees associated with variable annuity contracts, including guaranteed minimum death benefits, enhanced earnings benefits and guaranteed minimum income benefits. Under contracts with a guaranteed minimum death benefit, a policyholder’s beneficiary is entitled upon the policyholder’s death to receive the greater of the policyholder’s account value or a guaranteed minimum benefit payment. The majority of the guaranteed minimum death benefit contracts we reinsure are written on a “ratchet” basis, which means that the guaranteed minimum death benefit payable to the policyholder’s beneficiary equals the highest policyholder account value achieved over the course of the contract, as measured annually on each anniversary date of the policy until the policyholder reaches the attained age under the policy (typically 80 years of age). Other guaranteed minimum death benefit contracts are written on a “roll-up” basis, which means that the guaranteed minimum death benefit equals the premiums paid by the policyholder compounded at a defined interest rate (typically 3% to 6%), which accrues until the policyholder reaches the attained age or the roll-up death benefit reaches a predetermined amount, typically double the premiums paid. Some policies offer an enhanced version of the guaranteed minimum death benefit, under which the policyholder’s beneficiary receives the greater of the actual cash value, the ratcheted value or the roll-up value. Such policies may be particularly disadvantageous to us in light of the recent extended decline in the financial markets. Regardless of whether a policy is written on a ratchet or a roll-up basis, if the policyholder survives beyond the policy maturity date, which is typically when the policyholder reaches 90 years of age, he or she is no longer entitled to receive the guaranteed minimum death benefit amount.

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Before that time, the issuer of the policy bears the risk that protracted under-performance of the financial markets could result in guaranteed minimum death benefits payable to the policyholder’s beneficiary upon the policyholder’s death that are higher than the actual policyholder account value. As a reinsurer, we are obligated to reimburse the issuer of such policies for our share of any shortfall between the guaranteed minimum death benefit amount and the actual policyholder account values upon death.

      We have entered into two large contracts reinsuring guaranteed minimum death benefits. As of September 30, 2002, the guaranteed minimum death benefit amount at risk (i.e., the amount by which guaranteed death benefits exceed related account values) under our largest such contract was approximately $1.2 billion. Also as of September 30, 2002, the guaranteed minimum death benefit amount at risk under the other such contract was between $37 million and $175 million, depending on the resolution of a dispute between our ceding company under the contract and one of the primary carriers from which it had assumed risk. These amounts are an aggregate measure of our exposure to guaranteed minimum death benefits assuming 100% mortality experience at September 30, 2002. Our expected liability for future guaranteed minimum death benefit payments, based on our mortality assumptions, is substantially less. Because the premium paid to the ceding company under our largest such reinsurance agreement, and to us under that reinsurance agreement, is derived from asset-based charges levied against the account value, there may be circumstances during periods of reduced performance in the financial markets when we could be under compensated for reinsuring the guaranteed minimum death benefit. Under our largest such reinsurance agreement, we are subject to additional risks beyond those described above when the underlying policies are partially surrendered. Unlike the policies underlying the other such reinsurance contract, the policies underlying our largest such agreement provide that the guaranteed minimum death benefit is not proportionally reduced when a policyholder withdraws some, but not all, of the policy value (a partial surrender), but rather is reduced on a dollar for dollar basis. As a result, partial surrenders of those underlying policies do not reduce the guaranteed minimum death benefits we are obligated to pay by the same proportion by which the premiums supporting the guaranteed minimum death benefit obligations are reduced. However, under that same reinsurance agreement, the maximum amount of guaranteed minimum death benefit payments we would have to make in a calendar year would be limited to no more than 2% of the aggregate account values of all of the underlying policyholders in that calendar year. Any partial surrenders of the underlying policies will reduce the aggregate account value and may lower the amount of payments we could be required to make. The account values would, however, have to decline substantially for the 2% cap to have any meaningful effect.

      Policies with the enhanced earnings benefit provide that if a policyholder dies prior to the maturity date of his or her policy, the issuer of the policy will pay the policyholder’s beneficiary the death benefit otherwise payable under the policy plus an additional amount generally equal to 25% to 40% of the actual increase in the policyholder’s account value. The enhanced earnings benefit is designed to increase the total payments to the policyholder with an amount sufficient to pay income taxes on the increase in the account value. Our net amount at risk under our largest reinsurance contract reinsuring this benefit is less than $250,000.

      Policies providing a guaranteed minimum income benefit entitle a policyholder to purchase a lifetime annuity payment stream after the expiration of a stipulated waiting period of at least 7 years based upon the initial premium paid by the policyholder compounded at a predetermined rate, usually 3% or 6%, depending on the age of the policyholder. The annuity purchase rate used to calculate the income stream the policyholder is entitled to receive is a predetermined rate that is based upon more conservative investment and mortality assumptions than would otherwise be used to calculate prevailing annuity purchase rates following the expiration of the waiting period. We are subject to investment risk to the extent that investment returns on the assets supporting the liabilities under these policies will not be sufficient to fund the payment stream the policyholder is entitled to receive. However, because the annuity purchase rates applicable to the guaranteed minimum income benefits are often less favorable than prevailing annuity purchase rates when the underlying policy annuitizes, policyholders may receive a preferable stream of annuity payments using the actual account value at prevailing annuity purchase rates as opposed to utilizing the predetermined guaranteed minimum income benefit purchase rate under the policy. To the degree this occurs, any difference in annuity purchase rates will offset the investment risk. Because none of the guaranteed minimum income benefit policies we reinsure have reached the end of the stipulated waiting period, we cannot estimate accurately the effect the

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unfavorable annuity purchase rates will have on policyholders’ desire to utilize this benefit under various market conditions.

Critical Accounting Policies

      Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require our management to make estimates and assumptions that affect the amounts of our assets, liabilities, stockholders’ equity and net income. We believe that the following critical accounting policies, as well as those set forth in our amended Form 10-K for the year ended December 31, 2001, detail the more significant estimates and assumptions used in the preparation of our consolidated financial statements.

      In preparing our financial statements, we make assumptions about our proportionate share of future investment income that will be earned from the investment of premiums received from underlying policyholders by our ceding companies and about future rates of lapse of policies underlying our annuity reinsurance contracts when estimating expected gross profits arising from such contracts. These assumptions have a direct impact on the amount of estimated expected gross profits arising from these annuity reinsurance contracts and, therefore, on the recoverability of the deferred acquisition costs carried on our balance sheet for these contracts. While these estimates are based upon historical results and information provided to us by our cedents, actual results could differ (and, in the past, have differed) materially from our estimates for a variety of reasons, including the failure of our ceding companies to report timely information regarding material developments under our reinsurance agreements. Such differences could be material to our future results. If our assumptions for investment returns prove to be inaccurate, or if lapse rates exceed our assumptions, we may be required to record additional charges, which would adversely impact our earnings.

      We have concluded that there are embedded derivatives within the Funds withheld at interest receivable related to certain of our annuity reinsurance contracts written on a modified coinsurance or coinsurance funds withheld basis that require bifurcation and separate accounting under Statement of Financial Accounting Standards No. 133 — Accounting for Derivative Instruments and Hedging Activities. These embedded derivatives are similar to a total return swap arrangement on the underlying assets held by our ceding companies. The net fair value of these embedded derivatives is classified as part of our Funds withheld asset on our Balance Sheet. We have developed a cash flow model with the assistance of outside advisors to arrive at an estimate of the fair value of this total return swap that uses various assumptions regarding future cash flows under the affected annuity reinsurance contracts. The change in fair value of these embedded derivatives is recorded in our statement of operations as Net change in fair value of embedded derivatives, which is a non cash item. The change in fair value of these embedded derivatives also impacts the emergence of expected gross profits for purposes of amortizing deferred acquisition costs associated with these contracts. The application of this accounting policy has increased the volatility of our reported earnings. While we have made an estimate of the fair value of these embedded derivatives using a model that we believe to be appropriate and based upon reasonable assumptions, the assumptions used are subjective and may require adjustment in the future. In addition, as industry standards for estimating the fair value of embedded derivatives develop, it is possible that we may modify our methodology. Changes in our assumptions and industry standards could have a significant impact on the fair value of the embedded derivatives and our reported earnings. We do not bifurcate and separately account for the embedded derivatives contained in certain of our contracts, including our Transamerica annuity reinsurance agreement, because we acquired those agreements prior to the transition date elected by us under FAS 133, as amended by FAS 137. Because of the nature of the assets underlying our Transamerica contract, which were roughly 67% convertible bonds at September 30, 2002, the bifurcation and separate accounting for the embedded derivatives contained in that contract would add significant volatility to our reported results.

      We reinsure certain minimum guarantees associated with variable annuity contracts. These include guaranteed minimum death benefits, guaranteed minimum income benefits, and enhanced earnings benefits. Our accounting policy is to establish reserves for expected future claims based upon the long term view of expected losses over the life of the underlying policies, based upon the original pricing assumptions. Our reserving policy allows us to strengthen reserves if reported claim amounts or volume exceed what was

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anticipated in pricing. During the third quarter of 2002, we increased our reserves for minimum guarantees associated with variable annuities by approximately $7,760,000 as a result of increasing claim activity in recent quarters. We may be required to increase these reserves in future periods if claim activity continues at the current level or higher.

      The Accounting Standards Executive Committee (a committee of the American Institute of Certified Public Accountants) has issued a proposed Statement of Position that could set a new standard for accounting for Certain Nontraditional Long-Duration Contracts and for Separate Accounts that, if adopted, could require us to establish additional reserves for certain guarantees associated with variable annuity contracts. These reserve adjustments will likely be volatile because they are influenced by the performance of the financial markets. Had we followed this proposed standard, on December 31, 2001, no reserves would have been necessary, while on June 30, 2002, approximately $2 million in reserves would have been required. Given recent fluctuations in the financial markets, the reserve required under the proposed standard would have risen to approximately $22 million by September 30, 2002, and then fallen to approximately $9 million by October 31, 2002. For all of the periods mentioned, the assumptions underlying the reserve calculations are the same. We anticipate that this volatility will continue in future periods and, if the proposed standard is adopted, this volatility will affect our reported results of operations.

      If actual events differ significantly from the underlying estimates and assumptions used by us in the application of these accounting policies, there could be a material adverse effect on our results of operations and financial condition.

Operating Results

      Net (Loss). For the three month period ended September 30, 2002, we had a net loss of $(19,147,000) or $(0.74) per basic and fully diluted common share, as compared to a net loss of $(42,680,000) or $(1.66) per basic and fully diluted common share for the three month period ended September 30, 2001. For the nine month period ended September 30, 2002, we had a net loss of $(29,007,000) or $(1.13) per basic and fully diluted common share, as compared to a net loss of $(38,870,000) or $(1.52) per basic and fully diluted common share for the nine month period ended September 30, 2001. The following table summarizes some of the more significant items affecting net income:

                                 
For the Three Months For the Nine Months
Ended September 30, Ended September 30,


2002 2001 2002 2001




Cumulative effect of a change in accounting principle(1)
  $     $     $     $ (3,665,735 )
Net change in fair value of embedded derivative(1)
    (13,277,823 )     (5,265,396 )     (18,254,530 )     (3,567,342 )
Change in amortization of deferred acquisition costs related to embedded derivatives(1)
    5,790,244       269,009       7,292,964       1,410,724  
Transamerica contract deferred acquisition cost write downs(1)
          (19,157,798 )     (24,796,000 )     (34,538,991 )
Variable annuity minimum guarantee reserve strengthening
    (7,760,000 )           (7,760,000 )      
Variable annuity minimum guarantee payments in excess of premiums
    (3,117,100 )     1,364,121       (2,171,700 )     3,735,923  
World Trade Center
          (12,000,000 )           (12,000,000 )
Net realized investment gains
    9,297,351       1,078,933       10,813,315       1,425,183  
Unrealized loss on interest rate swap
    (2,005,000 )           (2,005,000 )      
     
     
     
     
 
Total of significant items
  $ (11,072,328 )   $ (33,711,131 )   $ (36,880,950 )   $ (47,200,238 )
     
     
     
     
 

(1)  Certain of these numbers have been restated. See Note 2 to our Unaudited Consolidated Financial Statements.

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      The cumulative effect of a change in accounting principle reflected in the nine month period ended September 30, 2001 is the result of our implementation of FAS 133 — Accounting for Derivative Instruments and Hedging Activities as of the first quarter of 2001. Under FAS 133, we are required to carry the fair value of the embedded derivatives contained in certain of our annuity reinsurance contracts on our balance sheet, and unrealized changes in the fair value of those embedded derivatives are reflected in our net income. The change in fair value of the embedded derivatives is influenced by changes in credit risk, yield curve shifts, changes in expected future cash flows under the annuity reinsurance contracts and, to a lesser extent, interest rate changes. The change in fair value also impacts the emergence of expected gross profits under the contracts for purposes of amortizing deferred acquisition costs. During the three and nine month periods ended September 30, 2002, the fair value of the embedded derivatives declined significantly because of credit spreads widening in the sectors in which the underlying investments are held, particularly in the telecommunications and energy sectors. The unrealized losses on the fair value of the embedded derivatives in each of the three and nine month periods ended September 30, 2001 and 2002 resulted in lower amortization of deferred acquisition costs in those periods.

      Our net income is significantly affected by our annuity reinsurance contract with Transamerica, which is our largest annuity reinsurance contract and represents approximately $769 million, or 54%, of our Funds withheld at interest receivable as of September 30, 2002. The significant losses associated with the Transamerica contract during the nine months ended September 30, 2002 were the result of a write down of deferred acquisition costs associated with the contract, as well as minimum interest guarantee payments made under the contract. The $24,796,000 write down of deferred acquisition costs associated with the Transamerica Contract in the second quarter of 2002 was the result of the continued poor performance of the financial markets during the first half of 2002, which caused us to reassess the assumptions we used in estimating the impact expected future minimum interest guarantee payments would have on the profits arising from this contract. We recorded similar write downs of our deferred acquisition cost asset of $34,500,000 during the nine month period ended September 30, 2001, $19,158,000 of which was recorded in the three month period ended September 30, 2001. A significant portion of the charges recorded in 2001 related to the high surrender rates on the polices underlying the contract, which caused us to review the recoverability of the deferred acquisition costs associated with this contract, and to expected minimum interest guarantee payments. Minimum interest guarantee payments under the contract for the three and nine month periods ended September 30, 2002 were approximately $9,070,000 and $22,422,000, respectively, as compared with minimum interest guarantee payments of $4,400,000 and $9,300,000, respectively, for the three and nine month periods ended September 30, 2001.

      We also recorded losses associated with our contracts that reinsure guarantees associated with variable annuity contracts, including guaranteed minimum death benefits, of $10,877,000 and $9,932,000 during the three and nine month periods ended September 30, 2002. These losses were the result of the protracted decline in the financial markets, which has caused the guaranteed minimum death benefits payable to the beneficiaries of certain policyholders to exceed the account values for such policyholders upon their death. These losses also include a $7,760,000 increase during the third quarter of 2002 in reserves for these guarantees, which we recorded in light of increasing claims activity in recent quarters.

      The Accounting Standards Executive Committee (a committee of the American Institute of Certified Public Accountants) has issued a proposed Statement of Position that could set a new standard for accounting for Certain Nontraditional Long-Duration Contracts and for Separate Accounts that, if adopted, could require us to establish additional reserves for our variable annuity death benefit guarantee contracts. These reserve adjustments will likely be volatile because they are influenced by the performance of the financial markets. Had we followed this proposed standard, on December 31, 2001, no reserves would have been necessary, while on June 30, 2002, approximately $2 million in reserves would have been required. Given recent fluctuations in the financial markets, the reserves required under the proposed standard would have risen to approximately $22 million by September 30, 2002, and then fallen to approximately $9 million by October 31, 2002. For all of the periods mentioned, the assumptions underlying the reserve calculations are the same. We anticipate that this volatility will continue in future periods and, if the proposed standard is adopted, this volatility will affect our reported results of operations.

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      Our net income for the three and nine month periods ended September 30, 2001 was significantly affected by the World Trade Center tragedy. We recorded an expense of $12,000,000 in the third quarter of 2001 in connection with claims we received as a result of that event.

      Net realized investment gains for the three and nine month periods ended September 30, 2002 were $9,297,000 and $10,813,000, respectively, as compared with $1,079,000 and $1,425,000 for the comparable periods of 2001. These gains resulted from normal management of our investment portfolio intended to improve performance and increase future operating income. We do not consider realized gains and losses resulting from sales of our invested assets to be recurring components of earnings. We make decisions concerning the sales of our invested assets based on a variety of market, business and other factors.

      We also recorded an expense of $2,005,000 in the third quarter of 2002 in connection with the change in fair value of two interest rate swaps entered into during that quarter.

      In addition to each of the items discussed above, our Net loss for the three month period ended September 30, 2002 also increased relative to the comparable prior period of 2001 as a result of higher than anticipated mortality experience under certain of our life reinsurance contracts and variability in the timing of the receipt of premiums. The three and nine month periods ended September 30, 2001 and 2002 were both negatively affected by adverse mortality experience on certain of our life reinsurance contracts, including significant losses on our life reinsurance contract with Lincoln National, which was recaptured in the third quarter of 2002.

      Net Premiums. Net premium revenue for the three and nine month periods ended September 30, 2002 was $84,934,000 and $255,007,000, respectively, as compared to $66,814,000 and $181,956,000 for the three and nine month periods ended September 30, 2001. Substantially all the premium revenue was derived from traditional ordinary life reinsurance. The growth in premium revenue reflects the level of new business written and the increase in the face amount of insurance in force. We expect premium growth to slow following the ratings downgrade by A.M. Best, Standard & Poor’s, and Fitch Ratings. At September 30, 2002, the total face amount of life insurance in force was $151 billion compared with approximately $104 billion at September 30, 2001, a 45% increase. New business writings and premium levels are significantly influenced by the seasonal nature of the life reinsurance marketplace and by large transactions and therefore may fluctuate from period to period.

      Net Investment Income. Net investment income for the three and nine month periods ended September 30, 2002 was $31,127,000 and $82,084,000, respectively, as compared with $24,240,000 and $66,935,000, respectively, for the comparable prior periods of 2001. The increases in investment income are primarily due to investment income on the reinvestment of a deposit of $147,000,000 received from a reinsurer that is used to fund collateral requirements of our ceding companies. The average annualized yield rate earned on our invested assets, excluding Funds withheld, for the nine months ended September 30, 2002 was approximately 5.28%, as compared with 6.34% for the nine months ended September 30, 2001. The decline in yield reflects our higher than normal commitment to cash during the nine months ended September 30, 2002 as a result of receiving a $137,000,000 deposit late in the fourth quarter of 2001 and a generally lower interest rate environment.

      Income earned on Funds Withheld for the three and nine month periods ended September 30, 2002 was $25,282,000 and $63,004,000, respectively, as compared to $19,440,000 and $52,054,000, respectively, for the comparable prior periods of 2001. The increases in investment income on our Funds withheld are primarily due to the growth of our Ohio National reinsurance contract. The average annualized yield rate earned on Funds withheld was approximately 5.90% for the nine months ended September 30, 2002, compared with 4.34% for the nine months ended September 30, 2001. For purposes of calculating the average annualized yield rate earned on our Funds withheld, which are held and managed by our ceding companies, we include net realized capital gains and losses as reported to us by our ceding companies in accordance with statutory accounting principles. The increase in yield on our Funds withheld is primarily due to the increasing size of the asset base underlying our contract with Ohio National relative to the shrinking size of the asset base underlying our contract with Transamerica.

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      Net Change in Fair Value of Embedded Derivatives. Embedded derivative gains and losses represent changes in the value of embedded derivatives hosted by certain of our fixed annuity reinsurance contracts. For the three and nine month periods ended September 30, 2002, the change in fair value of our embedded derivatives was an unrealized loss of $(13,278,000) and $(18,255,000), respectively. For the three and nine month periods ended September 30, 2001, the change in fair value of our embedded derivatives was an unrealized loss of $(5,265,000) and $(3,567,000), respectively. The unrealized loss in the embedded derivatives during the three and nine month periods ended September 30, 2002 was primarily the result of credit spreads widening in the sectors in which the underlying investments are held, particularly in the telecommunications and energy sectors. The unrealized losses in the embedded derivatives during the three and nine month periods ending September 30, 2001 were related to repositioning of the portfolio to increase spreads.

      Surrender Fees and Other Revenue. Surrender fees and other revenue for the three and nine month periods ended September 30, 2002 were $3,549,000 and $13,607,000, respectively, as compared with $5,513,000 and $13,291,000, respectively, for the three and nine month periods ended September 30, 2001. This income is primarily derived from surrender fees related to our fixed annuity products. The decline in revenue for the three months ended September 30, 2002, as compared to the three months ended September 30, 2001, is primarily due to a lower volume of surrenders of policies underlying our Transamerica contract. Similarly, the volume of surrenders during the nine month periods ended September 30, 2002 and September 30, 2001 remained relatively constant, so there was little change in the amount of surrender fees received by us over those comparable periods.

      Claims and Policy Benefits. Claims and policy benefits for the three month periods ended September 30, 2002 and 2001 were $91,382,000 and $74,874,000, or 108% and 112%, respectively, of net premium. For the nine month periods ended September 30, 2002 and 2001, claims and policy benefits were $224,641,000 and $161,700,000, or 88% and 89% of net premium, respectively. During the three months ended September 30, 2002, we experienced an increase in the level of claims reported to us relative to the level of premiums reported to us and strengthened our reserves for guaranteed minimum death benefits by $7,760,000. In addition, we incurred additional costs in connection with Lincoln National’s recapture of business it had previously ceded to us, effective August 1, 2002. We are currently in arbitration on another life reinsurance contract that has generated mortality experience beyond our pricing parameters, and is producing losses. If we are unable to rescind, recapture, reprice, or otherwise restructure this agreement, we may incur additional losses in future periods. Although we expect mortality to be fairly constant over long periods of time, it will fluctuate from period to period. For example, the three and nine months ended September 30, 2001 were adversely impacted by the World Trade Center tragedy. Reserves for future policy benefits are determined by claims reported from ceding companies, our aggregate experience, seasonal claim patterns and overall mortality trends.

      Interest Credited to Interest Sensitive Products. Interest credited to Interest sensitive products, which are liabilities we assume under certain annuity reinsurance agreements, for the three and nine month periods ended September 30, 2002 was $18,345,000 and $57,216,000, respectively, as compared with $14,401,000 and $30,490,000 for the comparable prior periods in 2001. Also included in Interest credited to interest sensitive products for the three and nine month periods ended September 30, 2002 are minimum interest guarantee payments of approximately $9,070,000 and $22,422,000, respectively, as compared to minimum interest guarantee payments of $4,400,000 and $9,300,000 for the comparable prior periods in 2001. The increases in the three and nine month periods ended September 30, 2002 were primarily caused by the aforementioned minimum guarantee payments and by growth in the policyholder liability arising in connection with our reinsurance agreement with Ohio National, partially offset by a decrease in the size of our liability under our reinsurance agreement with Transamerica due to surrenders.

      Policy Acquisition and Other Insurance Expenses. Policy acquisition and other insurance expenses, consisting primarily of allowances and amortization of deferred policy acquisition costs, for the three and nine month periods ended September 30, 2002 were $17,492,000 and $73,700,000, respectively, and $43,306,000 and $95,221,000 for the comparable prior periods in 2001. The nine months ended September 30, 2002 included the write down of $24,796,000 of deferred acquisition costs associated with our annuity reinsurance

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contract with Transamerica in the second quarter of 2002 due to the impact of expected minimum interest guarantee payments on our expected gross profits on the contract. Similarly, the nine month period ended September 30, 2001 included a write down of $34,500,000 of deferred acquisition costs associated with the same contract due to exposure to minimum interest guarantee payments and higher than expected surrender rates on the underlying policies.

      Collateral Costs. Collateral costs comprise fees charged by a reinsurer to provide cash deposits to us. These deposits are used to fund excess statutory reserve requirements of our clients and are recorded on our consolidated balance sheet as a deposit liability. These costs were $3,732,000 and $6,080,000 for the three and nine month periods ended September 30, 2002, respectively. The fees in connection with the facility are determined, in part, by the amount of the deposits received by us. The fees also have a variable component tied to LIBOR rates. In the third quarter of 2002, we entered into two interest rate swaps pursuant to which we effectively transferred a portion of the risk that these variable fees will increase to a third party. The cost of these swaps to us during the third quarter of 2002 was approximately $2,155,000, and is included in our collateral costs. That amount includes $2,005,000 related to the change in the fair value of the swap, which we record as an expense. Because the collateral funding facility was not in place until the fourth quarter of 2001, no costs were incurred for the nine months ended September 30, 2001.

      Operating Expenses. Operating expenses for the three months ended September 30, 2002 were $3,827,000 or 3.0% of total revenue (excluding the net change in fair value of embedded derivatives) compared with $2,479,000 or 2.5% of total revenue (excluding the net change in fair value of embedded derivatives) for three months ended September 30, 2001. Operating expenses for the nine months ended September 30, 2002 were $10,627,000 or 2.9% of total revenue (excluding the net change in fair value of embedded derivatives) compared with $7,833,000 or 3.0% of total revenue (excluding the net change in fair value of embedded derivatives) for the nine months ended September 30, 2001. We have incurred a higher than normal level of legal, consulting, audit, and other expenses during the three and nine month periods ended September 30, 2002 related to our efforts to raise capital and the review of our prior public filings by the Securities and Exchange Commission.

Segment Results

      During the first quarter of 2002, we began to separately track financial results of our life and annuity operations in segments. Each segment is defined by a dominant risk characteristic inherent in all products in that segment. The life segment consists of all products where the dominant risk characteristic is mortality risk. The annuity segment comprises all products where the dominant risk characteristic is investment risk. In addition, as discussed in Note 2 to the financial statements included in this report, certain of our modified coinsurance and coinsurance funds withheld annuity reinsurance agreements have features that constitute embedded derivatives that require bifurcation and separate accounting under FAS 133 — Accounting for Derivative Instruments and Hedging Activities. The cumulative effect of the application of FAS 133 through January 1, 2001 and the change in the fair value of these embedded derivatives since that date are included in the annuity segment. Both the life and annuity segments have specific assets, liabilities, stockholders’ equity, revenue, benefits and expenses that apply only to them. The corporate segment contains all stockholders’ equity not otherwise deployed to the life or annuity segment. In addition, the corporate segment includes all capital gains and losses from sales of securities in our portfolio and investment income on undeployed invested assets. Operating expenses are allocated to the segments proportionately based upon the amount of stockholders’ equity deployed to the segment. We believe that investors will better understand our profitability, risk profile and capital deployment through this change.

      Life Segment. Our life segment is our largest segment as measured by profitability. Our life segment income (loss) for the three and nine month periods ended September 30, 2002 was $(10,150,000) and

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$3,490,000, compared with a loss of $(20,425,000) and $(8,913,000) for the comparable prior periods of 2001. The following table summarizes some of the significant items affecting life segment income:
                                   
For the Three Months Ended For the Nine Months Ended
September 30, September 30,


2002 2001 2002 2001




 
World Trade Center
  $     $ (12,000,000 )   $     $ (12,000,000 )
 
Unrealized loss on interest rate swap
    (2,005,000 )           (2,005,000 )      
     
     
     
     
 
Total of significant items
  $ (2,005,000 )   $ (12,000,000 )   $ (2,005,000 )   $ (12,000,000 )
     
     
     
     
 

      The three and nine month periods ended September 30, 2001 were significantly affected by the World Trade Center tragedy. We recorded an expense of $12,000,000 in the third quarter of 2001 in connection with claims we received as a result of that event. The three and nine month periods ended September 2002 were affected by an unrealized loss of $2,005,000 related to the change in fair value of two interest rate swaps entered into during the third quarter of 2002.

      In the third quarter of 2002, Lincoln National recaptured its life reinsurance contract with us. We incurred losses under this contract of $6,189,000 and $6,988,000 during the three and nine month periods ended September 30, 2002 as a result of mortality experience that was higher than we anticipated when we priced the contract and certain costs we incurred in connection with the recapture of the contract. We had also incurred losses under this contract of $7,883,000 during the three and nine month periods ended September 30, 2001 as a result of higher than anticipated mortality experience. Because the contract has been recaptured by Lincoln National, the contract will not have a negative effect on our net income in future periods.

      Segment Net loss also increased in the three month period ended September 30, 2002 relative to the comparable prior period in 2001 as a result of higher than anticipated mortality experience under certain of our life reinsurance contracts and variability in the timing of the receipt of premiums. We believe that some of the adverse mortality experience may be the result of the late reporting of claims by our cedents. Segment Net income (loss) for the nine month periods ended September 30, 2001 and 2002 were both negatively affected by adverse mortality experience on certain of our life reinsurance contracts, including our life reinsurance contract with Lincoln National.

      Segment revenues grew 31% to $86,708,000 from $65,951,000 in the three months ended September 30, 2002 compared to the comparable period of 2001, and 45% to $260,319,000 from $179,367,000 for the nine months ended September 30, 2002 compared to the comparable period of 2001. Our revenue growth was primarily related to a 42% growth in life premium to $246,899,000 during the nine months ended September 30, 2002, as compared to $174,236,000 during the nine months ended September 30, 2001, reflecting an increase of life reinsurance in force from $117 billion at December 31, 2001 to $151 billion at September 30, 2002. For both the three and nine month periods ended September 30, 2002, the balance of the growth in revenue was derived from investment income earned on the reinvestment of funds deposited with us by a third party reinsurer that we use to fund collateral requirements of our clients. However, diminishing investment returns due to the recent poor performance of the financial markets and our inability to access additional funds under our collateral funding facility due to, among other things, the uncompleted restatement of our financial statements, have caused life segment revenue growth to slow during the quarter ended September 30, 2002, and may adversely affect life segment revenue in the future. In addition, we have significant obligations coming due in the next several weeks and months that will require us to use most or all of any capital raised to satisfy these existing obligations rather than to collateralize new business.

      Segment policy benefits and expenses for the three months ended September 30, 2002 increased 12% to $96,858,000 from $86,376,000 in the comparable prior period of 2001, and 36% for the nine months ended September 30, 2002 to $256,829,000 from $188,281,000 for the comparable prior period of 2001. Both increases reflect the increase in premium volume and face amount of insurance in force. Segment benefits and expenses for the three and nine month periods ended September 30, 2002 include collateral costs of

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$3,732,000 and $6,080,000 associated with our collateral funding facility that were not present for the comparable periods in 2001. Overall expenses and benefits for the three and nine month periods ending September 30, 2002, excluding the impact of Lincoln National and the other life reinsurance contract that is currently in arbitration, were slightly higher than our expectations. A greater frequency or average higher size of death claims than we expected can cause us to pay greater death benefits, adversely affecting the profitability of our life reinsurance contracts. Even if total death benefits paid over the life of our life reinsurance contracts do not exceed the expected amount, unexpected timing of deaths can cause us to pay more death benefits in a given time period than expected, adversely impacting profitability in that period, as happened this quarter.

      For the nine months ended September 30, 2002 the life segment return on equity was 2.5% with a return on revenue of 1.3%.

      Annuity Segment. Our annuity segment contains the majority of our assets. While we would expect it be a small contributor to our net income, it contains significant volatility from two sources. First, under FAS 133 — Accounting for Derivative Instruments and Hedging Activities we must value embedded derivatives in certain of our annuity reinsurance agreements. This unrealized change in the value of the derivative is reported in our income statement each quarter. The change in the value of the derivative can be large, and is driven by financial market conditions, most notably credit risk related changes. Second, our Transamerica annuity reinsurance contract has exhibited volatility due to write downs of our deferred acquisition cost balance which are based upon management’s estimates of future investment performance and lapse experience. In 2001, we determined that our Transamerica annuity contract was in a loss position, and wrote down approximately $46,115,000 of deferred acquisition costs. We also purchased $10.0 million of reinsurance from a subsidiary of XL Capital, a related party, for a premium of $1.5 million, to provide an additional layer of protection against minimum interest guarantee payments under the Transamerica contract. During the second quarter of 2002, we wrote down an additional $24,796,000 of deferred acquisition costs based on revised estimates of expected gross profits on this contract. Our expected gross profits were reduced due to poor investment performance which triggered minimum interest guarantee payments for surrendered policies under the contract. In estimating the $46,115,000 and $24,796,000 write downs, we were required to make estimates, including estimates of future lapse rates on the underlying business and future investment income on the assets supporting this business, each of which impact our estimates of future minimum interest guarantee payments. Our annuity reinsurance contract with Transamerica is not expected to generate net income going forward. There can be no assurance that our estimates will prove to be accurate, and if they do not, we may be required to recognize additional losses.

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      Our annuity segment loss for the three and nine month periods ended September 30, 2002 was $(18,346,000) and $(45,218,000), respectively, compared with a loss of $(25,386,000) and $(38,000,000) for the comparable prior periods of 2001. The following table summarizes the significant items affecting annuity segment income:

                                   
For the Three Months Ended For the Nine Months Ended
September 30, September 30,


2002 2001 2002 2001




 
Cumulative effect of a change in accounting principle(1)
  $     $     $     $ (3,665,735 )
 
Net change in fair value of embedded derivatives(1)
    (13,277,823 )     (5,265,396 )     (18,254,530 )     (3,567,342 )
 
Change in amortization of deferred acquisition costs related to embedded derivatives(1)
    5,790,244       269,009       7,292,964       1,410,724  
 
Transamerica contract deferred acquisition cost write downs(1)
          (19,157,798 )     (24,796,000 )     (34,538,991 )
 
Variable annuity minimum guarantee reserve strengthening
    (7,760,000 )           (7,760,000 )      
 
Variable annuity minimum guarantee payments in excess of premiums
    (3,117,100 )     1,364,121       (2,171,700 )     3,735,923  
     
     
     
     
 
Total of significant items
  $ (18,364,679 )   $ (22,790,064 )   $ (45,689,266 )   $ (36,625,421 )
     
     
     
     
 


(1)  Certain of these numbers have been restated. See Note 2 to our Unaudited Consolidated Financial Statements.

      The cumulative effect of a change in accounting principle reflected in the nine month period ended September 30, 2001 is the result of our implementation of FAS 133 — Accounting for Derivative Instruments and Hedging Activities as of the first quarter of 2001. Under FAS 133, we are required to carry the fair value of the embedded derivatives contained in certain of our annuity reinsurance contracts on our Balance Sheet, and unrealized changes in the fair value of those embedded derivatives are reflected in our net income. The change in fair value of the embedded derivatives is influenced by changes in credit risk, yield curve shifts, changes in expected future cash flows under the annuity reinsurance contracts and, to a lesser extent, interest rate changes. The change in fair value also impacts the emergence of expected gross profits under the contracts for purposes of amortizing deferred acquisition costs. During the three and nine month periods ended September 30, 2002, the fair value of the embedded derivatives declined significantly because of credit spreads widening in the sectors in which the underlying investments are held, particularly in the telecommunications and energy sectors. The unrealized losses on the fair value of the embedded derivatives in each of the three and nine month periods ended September 30, 2001 and 2002 resulted in lower amortization of deferred acquisition costs in those periods.

      The significant losses associated with the Transamerica contract during the nine months ended September 30, 2002 were the result of a write down of deferred acquisition costs of $24,796,000 in the second quarter of 2002. The write down was the result of the continued poor performance of the financial markets during the first half of 2002, which caused us to reassess the assumptions we used in estimating the impact expected future minimum interest guarantee payments would have on the profits arising from this contract. We recorded similar charges against our deferred acquisition cost asset of $34,500,000 during the nine month period ended September 30, 2001, $19,200,000 of which was recorded in the three month period ended September 30, 2001. A significant portion of the charges recorded in 2001 related to the high surrender rates on the polices underlying the contract, which caused us to review the recoverability of the deferred acquisition costs associated with this contract, and to expected minimum interest guarantee payments.

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      We also recorded losses associated with our contracts that reinsure guarantees associated with variable annuity contracts, including guaranteed minimum death benefits, of $10,877,000 and $9,932,000 during the three and nine month periods ended September 30, 2002. These losses were the result of the protracted decline in the financial markets, which has caused the guaranteed minimum death benefits payable to the beneficiaries of certain policyholders to exceed the account values for such policyholders upon their death. These losses also include a $7,760,000 increase during the third quarter of 2002 in reserves for these guarantees, which we recorded in light of increasing claims activity in recent quarters.

      Total segment revenue for the three months ended September 30, 2002 declined 16% to $18,536,000, as compared to $22,025,000 for the three months ended September 30, 2001. Revenue for the nine months ended September 30, 2002 declined 2% to $66,847,000 from $68,325,000 for the nine months ended September 30, 2001. These declines are primarily related to the previously mentioned increases in embedded derivative losses, offset by increased investment income on our annuity reinsurance contract with Ohio National.

      Policy benefits and expenses for the annuity segment includes interest credited to policyholders, minimum interest guarantee charges, guaranteed minimum death benefit payments, segment specific expenses, and other allocated expenses. These expenses declined 22% to $36,882,000 for the three months ended September 30, 2002 compared to $47,411,000 for the three months ended September 30, 2001. For the nine months ended September 30, 2002 these expenses grew 9% to $112,065,000 from $102,659,000 for the nine months ended September 30, 2001. The primary components of these expenses are interest credited to policyholders and amortization of deferred acquisition costs. The nine month period ended September 30, 2001 includes write downs of deferred acquisition costs of approximately $34,500,000, including approximately $19,200,000 incurred in the three month period ended September 30, 2001, related to our Transamerica reinsurance contract because we determined that the deferred acquisition costs were not recoverable. The nine months ended September 30, 2002 includes the $7,760,000 increase in guaranteed minimum death benefit reserves recorded in the third quarter of 2002 and a $24,796,000 write down of deferred acquisition costs associated with our annuity reinsurance agreement with Transamerica recorded in the second quarter of 2002. The increase in policy benefits and expenses in the three and nine months ended September 30, 2002, as compared to the comparable prior period after the aforementioned adjustments, reflects an increase in minimum interest guarantee payments related to our Transamerica contract and interest credited to policyholders on our annuity contract with Ohio National.

      Our annuity segment is not performing well due to losses from embedded derivatives, guaranteed minimum death benefits and the Transamerica fixed annuity contract. Return on equity for the three and nine month periods ended September 30, 2002 was (71)% and (72)%, respectively.

      Corporate Segment. The corporate segment includes all capital gains and losses from our own portfolio, investment income on undeployed invested assets, and a proportionate share of operating expenses based upon how stockholders’ equity is deployed to the life and annuity segments. As a result, the corporate segment, while small relative to our total company, will likely have volatile results. Segment income grew 199% to $9,350,000 for the three months ended September 30, 2002 compared to $3,130,000 for the three months ended September 30, 2001. For the nine months ended September 30, 2002 segment income grew 58% to $12,721,000 from $8,043,000 for the nine months ended September 30, 2001. The growth in corporate segment income was the result of net realized investment gains of $9,297,000 and $10,813,000 for the three and nine month periods ended September 30, 2002, as compared to $1,079,000 and $1,425,000, respectively, for the comparable prior periods of 2001.

      Expenses declined 19% to $1,037,000 for the three months ended September 30, 2002 compared to $1,273,000 for the three months ended September 30, 2001. For the nine months ended September 30, 2002 expenses declined 22% to $3,370,000 from $4,304,000 for the nine months ended September 30, 2001. Both declines were driven by the deployment of stockholders’ equity to the life segment and, consequently, a greater allocation of overhead expenses to that segment.

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Financial Condition

     Investments

      Our investments are governed by investment guidelines established and approved by our board of directors. Our investment objectives are to achieve above average risk-adjusted total returns, maintain a high quality portfolio, maximize current income, maintain an adequate level of liquidity, and match the cash flows of our investments to our related insurance liabilities. Our investment guidelines require our overall fixed income portfolio to maintain a minimum weighted average credit quality of “A.” A fixed income security rated “A” by Standard & Poor’s is considered to be somewhat susceptible to the adverse effects of changes in circumstances and economic conditions, however, the issuer’s capacity to meet its financial commitment on the security is still considered to be strong. As of July 2002, our investment guidelines do not allow us to invest in fixed income securities that are rated below investment grade. We will not invest in any fixed income securities in emerging markets or securities which are not rated by a major rating agency.

      Our investment securities are managed by two professional investment advisors, Alliance Capital Management Corporation and Prudential Investment Corporation, each of which manages a segment of the portfolio. Our agreement with Alliance may be terminated by either party with 30 days notice and our agreement with Prudential may be terminated by either party with 45 days notice. The performance of Alliance and Prudential and the fees associated with the arrangements are periodically reviewed by our board of directors.

      At September 30, 2002, our invested assets, including cash and cash equivalents, had an aggregate fair value of $475,213,000, including unrealized gains of approximately $16,092,000, as compared with an aggregate fair value of $423,780,000, including unrealized gains of $6,418,000 at December 31, 2001. A significant portion of our invested assets are posted as collateral to secure our obligations under reinsurance agreements and letter of credit facilities and are invested predominately in high quality U.S. government and U.S. corporate fixed income securities with low to moderate durations. At September 30, 2002, our portfolio was comprised of fixed income securities with a weighted average credit quality rating of “AA” and a weighted average duration of 3.7 years, as compared with a weighted average credit quality rating of “AA+” and a weighted average duration of 4.2 years at December 31, 2001.

      We do not engage in trading activities to generate realized investment gains and, thus, do not have a trading portfolio. However, we evaluate the desirability of continuing to hold a security when market conditions, creditworthiness or other measurement factors change. These changes may relate to a change in the credit risk of an issuer and a decision to sell may be made to avoid further declines in realizable value. Securities also may be sold prior to maturity to provide liquidity. As a result, our securities are classified as “available for sale” and are carried at fair value on our balance sheet.

      At September 30, 2002, $1,437,000 at fair value, or 0.40%, of our fixed income securities (0.38% of Stockholders Equity), consisted of below investment grade securities, as compared with $3,749,000 at fair value, or 1.2% of our fixed income securities (0.9% of Stockholder’s Equity) at December 31, 2001. The fair value of such investments may vary depending on economic and market conditions, the level of interest rates and the perceived creditworthiness of the issuer. As noted above, our investment guidelines prohibit the purchase of below investment grade securities, as these investments are subject to a higher degree of credit risk than investment grade securities. We monitor the creditworthiness of the portfolio as a whole and when the fair market value of a security declines for reasons other than changes in interest rates or other perceived temporary conditions, the security is written down to its net realizable value. At September 30, 2002, there was one impaired security in our portfolio, which was written down by $900,000 to a fair value of approximately $270,000.

      At September 30, 2002, mortgage backed securities represented approximately 12.4% of our invested assets, including cash and cash equivalents, as compared with approximately 11% of our invested assets, including cash and cash equivalents, at December 31, 2001. Investors in these securities are compensated primarily for reinvestment risk rather than credit quality risk. Investments in mortgage backed securities include collateralized mortgage obligations (“CMO’s”) and mortgage backed pass-through securities.

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Mortgage backed securities generally are collateralized by mortgages issued by the Government National Mortgage Association (“GNMA”), the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FHLMC”). Of these, only GNMA mortgages are backed by the full faith and credit of the U.S. government. Credit risk generally is not a consideration when investing in agency mortgage backed securities. Our mortgage backed securities portfolio had a weighted average investment quality rating of “AAA” at both September 30, 2002 and December 31, 2001.

      Our results of operations and our financial condition are significantly affected by the performance of our investments and by changes in interest rates. During a period of declining interest rates, if our investments are prematurely sold, called, prepaid or redeemed, we may be unable to reinvest the proceeds in securities of equivalent risk with comparable rates of return. During a period of rising interest rates, the fair value of our invested assets could decline. In addition, rising interest rates could also cause disintermediation, which in turn could cause us to sell investments at prices and times when the fair values of such investments are less than their amortized cost. We believe that our traditional life insurance liabilities are not highly interest rate sensitive and, therefore, the effects of fluctuating interest rates on these liabilities are not significant. For interest sensitive liabilities, we are primarily dependent upon asset/liability matching or other strategies to minimize the impact of changes in interest rates. If we do not appropriately match our asset management strategy to our obligations, we could sustain losses. We have engaged in hedging activities to mitigate the effects of asset/liability mismatches or interest rate changes on our balance sheet, and expect to do so in the future. Our results of operations and our financial condition are also significantly affected by the performance of assets held and managed by our ceding companies or others under modified coinsurance and coinsurance funds withheld arrangements, which are discussed below under “Funds Withheld at Interest.”

      The following table summarizes our investment results (excluding investment income on assets held and managed by our ceding companies or others) for the periods indicated.

Investment Results

                                 
Twelve Months Ended December 31,
Nine Months Ended
September 30, 2002 2001 2000 1999




(dollars in thousands)
Total invested assets, including cash and equivalents(1)
  $ 475,213     $ 423,780     $ 321,819     $ 304,060  
Investment income, net of related expenses
  $ 19,080     $ 20,165     $ 20,126     $ 20,483  
Effective yield rate(2)
    5.28 %     5.74 %     6.85 %     6.29 %
Realized investment gains (losses)
  $ 10,813     $ 1,230     $ (4,817 )   $ (1,285 )


(1)  Fair value at end of the indicated period.
 
(2)  The effective yield rate equals (i) net investment income divided by (ii) the average of total adjusted invested assets (fixed maturities at amortized cost, including assets on deposit with reinsurers) at the end of each calendar quarter included in the indicated period.

     Funds Withheld at Interest

      At September 30, 2002, our Funds withheld receivable was $1,415,120,000, compared to $1,489,689,000 at December 31, 2001. When a ceding company enters into an annuity reinsurance contract structured as a modified coinsurance or coinsurance funds withheld arrangement with us, a portion of the ceding company’s liability to the policyholders or, in the case of a retrocessional arrangement, the primary insurer, is ceded to us. Our arrangements are generally on a quota share basis, so the portion that is ceded to us in a fixed percentage of the liabilities arising from the underlying policies. Our share of the ceding company’s liability is included on our Balance Sheet as “Interest sensitive contracts liabilities.” However, unlike other reinsurance arrangements in which we receive cash or investments as consideration for assuming a portion of the ceding company’s

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liability, under these types of arrangements, we establish a receivable called “Funds withheld at interest” that is equal to our fixed portion of the statutory reserves carried by the ceding company. We are then allocated our share of the investment income and realized capital gains and losses that arise from the securities in the investment portfolio underlying the statutory reserve.

      We currently have annuity reinsurance contracts with six ceding companies. At September 30, 2002, the premiums held and managed by our ceding companies were invested in convertible bonds and fixed income securities having a weighted average credit quality of “A” and a weighted average duration of 5.0 years. Also at September 30, 2002, approximately 4.0% of the premiums held and managed by our ceding companies were invested in below investment grade securities. At December 31, 2001, these assets had a weighted average credit quality of “A” and a weighted average duration of 5.0 years. In addition, approximately 4.0% of these assets were invested in below investment grade securities on that date.

      The average annualized yield rate earned on our Funds withheld receivable was approximately 5.90% for the nine months ended September 30, 2002, compared to 4.59% for the year ended December 31, 2001. At September 30, 2002, approximately 54% and 25% of our Funds withheld at interest asset represented receivables from Transamerica and Ohio National, respectively, compared with 65% and 15%, respectively, at December 31, 2001. The average annualized yield rates earned on the assets funding our annuity obligations to Transamerica and Ohio National were approximately 5.30% and 7.36%, respectively, for the nine months ended September 30, 2002, compared with 3.94% and 7.91%, respectively, for the year ended December 31, 2001. For purposes of calculating the average annualized yield rate earned on assets held and managed by our ceding companies, including Transamerica and Ohio National, we include net realized capital gains and losses as reported to us by our ceding companies in accordance with statutory accounting principles.

      The assets underlying the Transamerica contract are managed by AmerUS Capital Management, the investment manager appointed by IL Annuity and Insurance Company, the issuer of the annuity policies. At September 30, 2002, the assets funding the policyholder obligations under the contract had an average credit quality of “A-” and an average duration of 4.1 years, compared to an average credit quality of “A” and an average duration of 4.2 years at December 31, 2001. At September 30, 2002, approximately 67% of the assets underlying the contract were invested in convertible bonds, with the remaining 33% in fixed income securities. At December 31, 2001, approximately 69% of the assets underlying the contract were invested in convertible bonds, with the remainder invested in investment grade bonds, high yield bonds and mortgage backed securities. The value of convertible bonds is a function of their investment value (determined by yield in comparison with the yields of other securities of comparable maturity and quality that do not have a conversion privilege) and their conversion value (at market value, if converted into the underlying common stock). To the extent the market price of the underlying common stock approaches or exceeds the conversion price, the price of the convertible bonds will be increasingly influenced by their conversion value. Consequently, the value of convertible bonds may be influenced by changes in the equity markets.

      According to data provided to us by Transamerica, at September 30, 2002 the assets held by IL Annuity and managed by AmerUS Capital were comprised of:

                         
Type of Security Book Value Market Value % of Total




Convertible bonds
  $ 558,874,974     $ 512,621,786       67.2 %
Investment grade U.S. corporate bonds
    190,248,157       200,218,580       26.2 %
Below investment grade U.S. corporate bonds
    41,097,061       36,312,346       4.8 %
Short term securities
    13,897,670       13,897,670       1.8 %
     
     
     
 
Total invested assets
  $ 804,117,862     $ 763,050,382       100.0 %
     
             
 
Accrued investment income
            6,473,818          
             
         
Total market value, including accrued investment income
          $ 769,524,200          
             
         

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      According to data provided to us by Transamerica, at September 30, 2002 the credit ratings of the assets (excluding accrued investment income) held by IL Annuity and managed by AmerUS Capital were approximately:

                         
Ratings(1) Book Value Market Value % of Total




AAA
  $ 101,531,499     $ 105,221,951       13.8 %
AA
    86,022,763       84,112,943       11.0 %
A
    189,407,112       186,251,135       24.4 %
BBB
    386,009,827       351,142,087       46.0 %
BB and below
    41,146,661       36,322,266       4.8 %
     
     
     
 
Total invested assets
  $ 804,117,862     $ 763,050,382       100.0 %
     
             
 
Accrued investment income
            6,473,818          
             
         
Total market value, including accrued investment income
          $ 769,524,200          
             
         


(1)  As assigned by Standard & Poor’s, or, if unrated by Standard & Poor’s, based on equivalent rating assigned by the National Association of Insurance Commissioners.

      According to data provided to us by Transamerica, at September 30, 2002 the maturity distribution of the assets (excluding accrued investment income) held by IL Annuity and managed by AmerUS Capital was approximately:

                         
Maturity Book Value Market Value % of Total




Within one year
  $ 39,271,587     $ 39,342,099       5.2 %
From one to five years
    232,002,606       230,785,613       30.2 %
From six to ten years
    195,625,045       190,359,956       24.9 %
More than ten years
    337,218,624       302,562,714       39.7 %
     
     
     
 
Total all years
  $ 804,117,862     $ 763,050,382       100.0 %
     
     
     
 

      At September 30, 2002, the assets underlying the Ohio National contract had an average credit quality of “A-” and an average duration of approximately 6.0 years, compared with an average credit quality of “A-” and an average duration of approximately 5.8 years at December 31, 2001.

      According to data provided to us by Ohio National, at September 30, 2002, the assets held and managed by Ohio National were comprised of:

                         
Type of Security Book Value Market Value % of Total




Corporate bonds
  $ 232,050,898     $ 245,665,319       67.5 %
Asset backed securities
    75,618,810       80,973,838       22.2 %
Mortgage backed securities
    27,130,548       29,415,851       8.1 %
Government bonds
    7,243,849       7,951,062       2.2 %
     
     
     
 
Total invested assets
  $ 342,044,105     $ 366,006,070       100.0 %
     
             
 
Accrued investment income
            4,674,586          
             
         
Total market value, including accrued investment income
          $ 368,680,656          
             
         

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      At September 30, 2002 the credit ratings of the assets (excluding accrued investment income) held and managed by Ohio National were approximately:

                         
Ratings(1) Book Value Market Value % of Total




AAA
  $ 45,062,847     $ 47,418,937       13.0 %
AA
    26,470,559       28,768,680       7.9 %
A
    122,424,148       135,247,823       37.2 %
BBB
    133,900,776       141,691,439       38.9 %
Below BBB
    14,185,775       10,879,191       3.0 %
     
     
     
 
Total invested assets
  $ 342,044,105     $ 364,006,070       100.0 %
     
             
 
Accrued investment income
            4,674,586          
             
         
Total market value, including accrued investment income
          $ 368,680,656          
             
         


(1)  As assigned by Standard & Poor’s, or, if unrated by Standard & Poor’s, based on equivalent rating assigned by the National Association of Insurance Commissioners.

      According to data provided to us by Ohio National, at September 30, 2002 the maturity distribution of the assets (excluding accrued investment income) held and managed by Ohio National was approximately:

                         
Maturity Book Value Market Value % of Total




Within one year
  $ 2,930,515     $ 2,930,515       0.8 %
From one to five years
    14,916,040       12,147,255       3.3 %
From six to ten years
    162,185,526       172,431,596       47.4 %
More than ten years
    162,012,024       176,496,704       48.5 %
     
     
     
 
Total all years
  $ 342,044,105     $ 364,006,070       100.0 %
     
     
     
 

      Our remaining four annuity reinsurance contracts guarantee crediting rates that vary in amount and duration. At September 30, 2002, the assets funding the policyholder obligations under these contracts had an average credit quality of “A-” and an average duration of approximately 7.1 years compared to an average credit quality of “A” and an average duration of approximately 6.9 years at December 31, 2001.

      According to information provided by the ceding companies under these four annuity reinsurance contracts, at September 30, 2002 the assets held and managed by those ceding companies were comprised of:

                         
Type of Security Book Value Market Value % of Total




Canadian provincial bonds
  $ 90,364,234     $ 95,318,003       30.0 %
Investment grade US corporate bonds
    85,237,284       88,990,403       28.0 %
Investment grade UK corporate bonds
    82,713,018       82,713,018       26.1 %
Investment grade Canadian corporate bonds
    24,034,560       24,767,271       7.8 %
All other securities
    26,529,494       25,651,668       8.1 %
     
     
     
 
Total invested assets
  $ 308,878,590     $ 317,440,363       100.0 %
     
             
 
Accrued investment income
            6,806,127          
             
         
Total market value, including accrued investment income
          $ 324,246,490          
             
         

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      According to information provided by the ceding companies under these four annuity reinsurance contracts, at September 30, 2002 the credit ratings of the assets (excluding accrued investment income) held and managed by those ceding companies were approximately:

                         
Ratings(1) Book Value Market Value % of Total




AAA
  $ 47,725,488     $ 48,285,677       15.2 %
AA
    29,971,717       30,760,155       9.7 %
A
    166,986,792       174,887,133       55.1 %
BBB
    56,514,218       57,947,273       18.3 %
BB and below
    7,680,375       5,560,125       1.7 %
     
     
     
 
Total invested assets
  $ 308,878,590     $ 317,440,363       100.0 %
     
             
 
Accrued investment income
            6,806,127          
             
         
Total market value, including accrued investment income
          $ 324,246,490          
             
         


(1)  As assigned by Standard & Poor’s, or, if unrated by Standard & Poor’s, based on equivalent rating assigned by the National Association of Insurance Commissioners.

      According to information provided by the ceding companies under these four annuity reinsurance contracts, at September 30, 2002 the maturity distribution of the assets (excluding accrued investment income) held and managed by those ceding companies was approximately:

                         
Maturity Book Value Market Value % of Total




Within one year
  $ 16,101,151     $ 16,337,330       5.1 %
From one to five years
    71,589,567       74,101,141       23.3 %
From six to ten years
    71,928,287       72,720,906       22.9 %
More than ten years
    149,259,585       154,280,686       48.7 %
     
     
     
 
Total all years
  $ 308,878,590     $ 317,440,363       100.0 %
     
     
     
 

     Liquidity and Capital Resources

      Our liquidity and capital resources are a measure of our overall financial strength and our ability to generate cash flows from our operations to meet our operating and growth needs. Our principal sources of funds are premiums received, net investment income, proceeds from investments called, redeemed or sold and cash and short term investments. The principal obligations and uses of the funds are the payment of policy benefits, acquisition and operating expenses and the purchase of investments. In addition, as a Bermuda reinsurer we are required to post collateral for the statutory reserves ceded to us by U.S. based insurers and reinsurers. Under the terms of our reinsurance agreements we are required to provide letters of credit or fund trust accounts with liquid assets to satisfy these collateral requirements. At both September 30, 2002 and December 31, 2001, letters of credit totaling $197 million had been issued by our bankers in favor of certain ceding insurance companies to provide security and meet regulatory requirements. At September 30, 2002 and December 31, 2001 letters of credit totaling $107 million and $101 million, respectively, were fully collateralized by our investments. At September 30, 2002 and December 31, 2001, investments of $310 million and $272 million, respectively, were held in trust for the benefit of certain ceding insurance companies to provide security and to meet regulatory requirements. For the nine months ended September 30, 2002, we generated $27,726,000 from our operating activities, substantially all of which has been posted as collateral to our cedents.

      Based on our projections of our ceding companies’ statutory reserve cessions, in order to satisfy our obligations under our existing reinsurance agreements, we will need to post up to approximately $210.0 million of additional collateral by December 31, 2002. We will seek to meet or reduce these additional security

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requirements by negotiating the recapture, retrocession or sale of certain of our reinsurance agreements, accessing our collateral funding facility and/or by raising capital. We have not been able to successfully raise capital or access our collateral funding facility in recent months given, among other things, the uncompleted restatement of our financial statements for 2000 and 2001. If we are unable to meet the security requirements of our cedents, we may be required to cease writing new business and we may be in violation of our existing reinsurance contracts and become subject to the remedies set forth therein. Our cedents may also ask that the agreements be recaptured. These recaptures could result in losses, but could also improve our liquidity and our ability to meet the collateral requirements of our remaining cedents.

      We currently have unsecured letters of credit of approximately $49,000,000 outstanding under a letter of credit facility with Citibank. In October 2002, Citibank agreed to extend this unsecured letter of credit facility into next year in exchange for our agreement to secure, or otherwise eliminate, the letter of credit facility by June 30, 2003.

      As of September 30, 2002, we had $45,000,000 of unsecured letters of credit outstanding under a letter of credit facility with Manulife Financial that had been posted as security to allow our United States operating subsidiary to take credit on its statutory financial statements for reinsurance ceded to our Bermuda operating company. During October 2002, Manulife requested that the unsecured letters of credit it had issued on our behalf be secured. Consequently, in November 2002, our Bermuda operating subsidiary deposited $15,000,000 with our United States operating subsidiary as funds withheld. Further, one of our United States operating subsidiary’s ceding companies has recaptured its contracts, reducing our subsidiary’s collateral needs by an additional $15,000,000. We have committed to securing or eliminating the remaining $15,000,000 in letters of credit issued by Manulife under our letter of credit facility by December 31, 2002. Due to Manulife’s request to secure its letter of credit facility and our inability thus far to post sufficient security for our United States operating subsidiary, the Connecticut Insurance Department has requested that all financial transactions, except those related to the normal course of business, between us and our United States operating subsidiary be preapproved by the insurance department.

      During 2001, we entered into a reinsurance agreement with a reinsurer to cede excess U.S. Statutory reserves (the amount by which our cedents’ U.S. Statutory reserves exceed our U.S. GAAP reserves for certain life insurance contracts subject to certain state statutory regulations known as Triple-X) to the reinsurer. Under the agreement, the reinsurer is obligated to fund the collateral requirements associated with these excess U.S. Statutory reserves by making cash deposits with us. As of September 30, 2002, we had received deposits of $147 million from the reinsurer. The reinsurer has the right to terminate the agreement with 180 days notice, which would require us to return all deposits. As part of this contract we deposited $41 million with the reinsurer, which is included in Deposits and other reinsurance receivables on our Balance Sheet. We receive the benefit of investment income from the investment of the funds received and our deposit with the reinsurer and we pay the third party reinsurer certain fees associated with the contract. These fees, in part, are determined by the amount of deposits received by us. The fees also have a variable component tied to LIBOR rates. In the third quarter of 2002, we entered into two interest rate swaps pursuant to which we effectively transferred a portion of the risk that these variable fees will increase to a third party. We are not currently able to access additional funds under this collateral funding facility.

      On March 1, 2002 we filed a shelf registration statement on Form S-3 to register under the Securities Act of 1933 $200,000,000 of senior debt to be sold in one or more transactions on a delayed basis. We do not currently expect to issue any of this debt in the near future, as the registration statement is not effective, and therefore, we may not issue any debt under it.

      We have no material commitments for capital expenditures as of September 30, 2002, but as noted above, we have significant obligations coming due in the next several weeks and months that we will not be able to satisfy unless we are able to establish a new collateral funding facility, negotiate the recapture of, sell off or otherwise transfer certain of our reinsurance contracts that have significant collateral requirements or raise additional capital.

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      In September 2002, we engaged Morgan Stanley to assist us in seeking to raise capital, and we have been in discussions with several parties regarding this and other strategic alternatives. There can be no assurances that our efforts to raise capital or pursue other strategic alternatives will be successful.

      On October 30, 2002, our Board of Directors declared a quarterly dividend of $.05 per share payable on November 28, 2002 to shareholders of record on November 15, 2002. The continued payment of dividends is dependent on the ability of our operating subsidiaries to achieve satisfactory underwriting and investment results, generate free cash flow and other factors determined to be relevant by our Board of Directors.

Forward-Looking and Cautionary Statements

      The Company and its representatives may from time to time make written or oral forward-looking statements, including those contained in the foregoing Management’s Discussion and Analysis. In order to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company is hereby identifying certain important factors which could cause the Company’s actual results, performance or achievement to differ materially from those that may be contained in or implied by any forward-looking statement made by or on behalf of the Company. The factors that could cause the actual results of operations or financial condition of the Company to differ include, but are not necessarily limited to, the Company’s ability to attract and retain clients; a decline in the Company’s financial ratings; the Company’s ability to underwrite business; the Company’s ability to raise sufficient capital to meet the collateral requirements associated with its current business and to fund the Company’s continuing operations; changes in market conditions, including changes in interest rate levels; the ability of the Company’s cedents to manage successfully assets they hold on the Company’s behalf; unanticipated withdrawal or surrender activity; changes in mortality, morbidity and claims experience; the Company’s success in managing its investments; the competitive environment; the impact of recent and possible future terrorist attacks and the U.S. government’s response thereto; the loss of a key executive; regulatory changes (such as changes in U.S. tax law and insurance regulation which directly affect the competitive environment for the Company’s products); and a prolonged economic downturn. Further information about these and other factors may be found in our Current Report on Form 8-K filed on November 19, 2002, as well as our other filings with the Securities and Exchange Commission. The Company cautions that the foregoing list of important factors is not intended to be, and is not, exhaustive. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company.

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Item 3.     Quantitative and Qualitative Disclosures About Market Risk

      There have been no material changes since December 31, 2001 with respect to our market risk exposure described in our amended Annual Report on Form 10-K for the year ended December 31, 2001, as supplemented by our Current Report on Form 8-K, filed November 19, 2002. Please refer to “Item 7A: Quantitative and Qualitative Disclosures About Market Risk” in our amended Annual Report on Form 10-K for the year ended December 31, 2001 and to “Item 5: Other Events and Required FD Disclosure — Business — Quantitative and Qualitative Disclosures About Market Risk” in our Current Report on Form 8-K filed November 19, 2002.

Item 4.     Controls and Procedures

      In September 2002, following the resignation of the Company’s Chief Executive Officer, the Company established a Transition Committee to oversee, on an interim basis, the management and operations of the Company pending his permanent replacement. The Transition Committee and the Company’s Chief Financial Officer have conducted a review of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that review, the Transition Committee and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were adequate. In addition, there have been no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls subsequent to the date of their evaluation.

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PART II

OTHER INFORMATION

Item 1.     Legal Proceedings

      On January 21, 2002, we served written notice of arbitration in connection with our annuity reinsurance contract with Transamerica Occidental Life Insurance Company. In the arbitration, we were seeking monetary damages and/or equitable relief from Transamerica based on our claim that certain actions and/or omissions by Transamerica deprived us of the benefit of the reinsurance transaction. On November 8, 2002, we announced that our claim against Transamerica had been denied by the arbitration panel assigned to the matter. The arbitration panel upheld Transamerica’s position that our annuity reinsurance contract was a valid and enforceable contract and that Transamerica had acted in a commercially reasonable manner.

      In May 2002, we served written notice of arbitration in connection with two life reinsurance agreements. During the third quarter of 2002, we settled our arbitration with Lincoln National, which recaptured the contract that had been the subject of the arbitration. The other arbitration is continuing.

Item 2.     Changes in Securities and Use of Proceeds

      On February 25, 2002 and September 30, 2002, we granted 133,500 and 267,500 common shares, respectively, to certain key employees pursuant to the terms of a restricted stock incentive compensation program. Issuance of the restricted stock required no investment decision on the part of the recipients. All award decisions were made by our Compensation Committee, which consists entirely of non-employee directors. If the grants were deemed to be a sale of securities under the Securities Act of 1933 (the “Act”), we believe such sales would be exempt from the Act pursuant to Section 4(2) thereof or Regulation S thereunder.

Item 5.     Other Information

      On September 12, 2002, we announced that Lawrence S. Doyle had retired from his position as our President and Chief Executive Officer and had resigned from his seat on our board of directors. We have engaged an executive search firm to help us identify an appropriate replacement for Mr. Doyle. Until an appropriate replacement is identified, a transition committee consisting of Frederick S. Hammer and Robert M. Lichten, each of whom is a director of our Company, will oversee our management and operations. Half of the supplemental director’s fees payable to Messrs. Hammer and Lichten for their services on the Transition Committee will be paid instead to their regular employer in consideration of the substantial amount of time that each will dedicate to our Company until we secure an appropriate replacement for Mr. Doyle.

      In the third quarter of 2002, A.M. Best downgraded the financial strength ratings of Annuity and Life Reassurance and Annuity and Life Reassurance America from “A-” to “B++.” The financial strength ratings of Annuity and Life Reassurance and Annuity and Life Reassurance America were also downgraded in the third quarter of 2002 by Standard & Poor’s from “A-” to “BBB+” and from “A” to “BBB+” by Fitch Ratings. In addition, on November 22, 2002, Fitch Ratings further reduced our financial strength rating to “CCC.” These downgrades in our ratings have adversely affected our ability to enter into new reinsurance treaties and raise capital. Further downgrades may adversely affect our ability to retain existing business, effectively preclude us from writing new business, and permit some of our ceding companies to terminate certain reinsurance agreements.

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Item 6.      Exhibits and Reports on Form 8-K

      (a) Exhibits —

  10.1  Letter Agreement dated September 9, 2002 by and between Annuity and Life Re (Holdings), Ltd. and Frederick S. Hammer, incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q, filed on November 27, 2002.
 
  10.2  Letter Agreement dated September 9, 2002 by and between Annuity and Life Re (Holdings), Ltd. and Robert M. Lichten, incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q, filed on November 27, 2002.

      (b) Reports on Form 8-K — None

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ANNUITY AND LIFE RE (HOLDINGS), LTD.

 
SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

  Annuity and Life Re (Holdings), Ltd.
 
  /s/ JOHN F. BURKE
 
  Name:     JOHN F. BURKE
  Title:      Chief Executive Officer and
  Chief Financial Officer

Date:     March 20, 2003

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CERTIFICATION

I, John F. Burke, certify that:

        1.     I have reviewed this quarterly report on Form 10-Q of Annuity and Life Re (Holdings), Ltd.
 
        2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
        3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
        4.     I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and I have:

        a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
        b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
        c) presented in this quarterly report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date;

        5.     I have disclosed, based on my most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

        a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
        b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

        6.     I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

  /s/ JOHN F. BURKE
 
  Name: JOHN F. BURKE
  Title:  Chief Executive Officer and
Chief Financial Officer

March 20, 2003

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