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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2004 Commission File No. 33-47472 AIG SUNAMERICA LIFE ASSURANCE COMPANY Incorporated in Arizona
    
    86-0198983IRS EmployerIdentification No.
 1 SunAmerica Center, Los Angeles, California 90067-6022
Registrants telephone number, including area code: (310) 772-6000 INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS Yes x     No o INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED BY RULE 12b-2 OF THE SECURITIES EXCHANGE ACT OF 1934). Yes o     No x THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANTS COMMON STOCK ON MAY
14, 2004 WAS AS FOLLOWS:  Common Stock (par value $1,000 per share)
    
    3,511 shares outstanding
 REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.




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TABLE OF CONTENTS  CONSOLIDATED BALANCE SHEETCONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOMECONSOLIDATED STATEMENT OF CASH FLOWSNOTES TO CONSOLIDATED FINANCIAL STATEMENTSMANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSPART II  OTHER INFORMATIONItem 1. Legal ProceedingsItem 2. Changes in Securities and Use of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. Submissions of Matters to a Vote of Security HoldersItem 5. Other InformationItem 6. Exhibits and Reports on Form 8-KSIGNATURESExhibit IndexEXHIBIT 10.AEXHIBIT 10.BEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32    Table of Contents  AIG SUNAMERICA LIFE ASSURANCE COMPANY INDEX PageNumber(s)Part I  Financial InformationConsolidated Balance Sheet (Unaudited)  March 31, 2004 and December 31, 2003
    
    
    3-4Consolidated Statement of Operations and Comprehensive Income (Unaudited)  Three Months Ended March 31, 2004 and 2003
    
    
    5-6Consolidated Statement of Cash Flows (Unaudited)  Three Months Ended March 31, 2004 and 2003
    
    
    7-8Notes to Consolidated Financial Statements (Unaudited)
    
    
    9-15Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16-32Quantitative and Qualitative Disclosures About Market Risk
    
    
    33Disclosure Controls and Procedures
    
    
    33Part II  Other Information
    
    
    34Exhibits and Reports on 8-K
    
    
    36




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED BALANCE SHEET  March 31,
    
    December 31,2004
    
    2003(in thousands)ASSETSInvestments and cash:Cash and short-term investments
    
    $
    142,186
    
    
    $
    133,105Bonds, notes and redeemable preferred stocks
available for sale, at market value (amortized
cost: March 31, 2004, $5,240,898; December 31,
2003, $5,351,183)
    
    
    5,484,780
    
    
    
    5,505,800Mortgage loans
    
    
    699,676
    
    
    
    716,846Policy loans
    
    
    195,499
    
    
    
    200,232Mutual funds
    
    
    21,913
    
    
    
    21,159Common stocks available for sale, at market value
(cost: March 31, 2004, $1,625; December 31,
2003, $635)
    
    
    1,632
    
    
    
    727Real estate
    
    
    22,166
    
    
    
    22,166Securities lending collateral
    
    
    668,717
    
    
    
    514,145Other invested assets
    
    
    13,850
    
    
    
    10,453Total investments and cash
    
    
    7,250,419
    
    
    
    7,124,633Variable annuity assets held in separate accounts
    
    
    20,174,729
    
    
    
    19,178,796Accrued investment income
    
    
    76,222
    
    
    
    74,647Deferred acquisition costs
    
    
    1,339,331
    
    
    
    1,345,332Goodwill
    
    
    14,038
    
    
    
    14,038Other assets
    
    
    226,889
    
    
    
    219,161TOTAL ASSETS
    
    $
    29,081,628
    
    
    $
    27,956,607
 See accompanying notes to consolidated financial statements. 3




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED BALANCE SHEET (Continued)
(Unaudited) March 31,
    
    December 31,2004
    
    2003(in thousands)LIABILITIES AND SHAREHOLDERS EQUITYReserves, payables and accrued liabilities:Reserves for fixed annuity contracts
    
    $
    4,170,479
    
    
    $
    4,274,329Reserves for universal life insurance contracts
    
    
    1,587,907
    
    
    
    1,609,233Reserves for guaranteed investment contracts
    
    
    213,487
    
    
    
    218,032Reserve for guaranteed benefits
    
    
    72,123
    
    
    
    12,022Securities lending payable
    
    
    668,717
    
    
    
    514,145Income taxes currently payable to Parent
    
    
    64,755
    
    
    
    5,038Modified coinsurance deposit liability
    
    
    
    
    
    
    4,738Due to affiliates
    
    
    13,546
    
    
    
    19,289Payable to brokers
    
    
    12,420
    
    
    
    1,140Other liabilities
    
    
    233,054
    
    
    
    243,470Total reserves, payables and accrued liabilities
    
    
    7,036,488
    
    
    
    6,901,436Variable annuity liabilities related to separate accounts
    
    
    20,174,729
    
    
    
    19,178,796Subordinated notes payable to affiliates
    
    
    41,520
    
    
    
    41,520Deferred income taxes
    
    
    276,817
    
    
    
    296,931Total liabilities
    
    
    27,529,554
    
    
    
    26,418,683Shareholders equity:Common stock
    
    
    3,511
    
    
    
    3,511Additional paid-in capital
    
    
    1,215,284
    
    
    
    1,215,284Retained earnings
    
    
    213,046
    
    
    
    246,519Accumulated other comprehensive income
    
    
    120,233
    
    
    
    72,610Total shareholders equity
    
    
    1,552,074
    
    
    
    1,537,924TOTAL LIABILITIES AND SHAREHOLDERS
EQUITY
    
    $
    29,081,628
    
    
    $
    27,956,607
 See accompanying notes to consolidated financial statements. 4




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME
For the three months ended March 31, 2004 and 2003
(Unaudited) 2004
    
    2003(in thousands)REVENUESFee income:Variable annuity fees, net of reinsurance
    
    $
    91,004
    
    
    $
    64,406Asset management fees
    
    
    18,108
    
    
    
    10,921Universal life insurance policy fees, net of reinsurance
    
    
    9,192
    
    
    
    8,970Surrender charges
    
    
    6,999
    
    
    
    7,570Other fees
    
    
    3,621
    
    
    
    3,337Total fee income
    
    
    128,924
    
    
    
    95,204Investment income
    
    
    87,170
    
    
    
    96,908Net realized investment losses
    
    
    (11,393
    )
    
    
    (3,272
    )Total revenues
    
    
    204,701
    
    
    
    188,840BENEFITS AND EXPENSESInterest expense:Fixed annuity contracts
    
    
    35,236
    
    
    
    38,765Universal life insurance contracts
    
    
    18,481
    
    
    
    19,102Guaranteed investment contracts
    
    
    1,335
    
    
    
    2,016Subordinated notes payable
    
    
    560
    
    
    
    842Total interest expense
    
    
    55,612
    
    
    
    60,725General and administrative expenses
    
    
    36,224
    
    
    
    29,987Amortization of deferred acquisition costs
    
    
    31,442
    
    
    
    43,962Annual commissions
    
    
    15,014
    
    
    
    14,178Claims on universal life contracts, net of reinsurance recoveries
    
    
    4,823
    
    
    
    5,513Guaranteed minimum death benefits, net of reinsurance recoveries
    
    
    17,774
    
    
    
    21,976Total benefits and expenses
    
    
    160,889
    
    
    
    176,341PRETAX INCOME BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE
    
    
    43,812
    
    
    
    12,499Income tax expense
    
    
    12,196
    
    
    
    1,881INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
    
    
    31,616
    
    
    
    10,618Cumulative effect of accounting change, net of tax
    
    
    (62,589
    )
    
    
    NET INCOME (LOSS)
    
    $
    (30,973
    )
    
    $
    10,618
 See accompanying notes to consolidated financial statements. 5




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (Continued)
For the three months ended March 31, 2004 and 2003
(Unaudited) 2004
    
    2003(in thousands)OTHER COMPREHENSIVE INCOME, NET OF TAX:Net unrealized gains on fixed maturity and equity securities available for
sale identified in the current period less related amortization of deferred
acquisition costs
    
    $
    65,852
    
    
    $
    18,520Less reclassification adjustment for net realized losses included in net income
    
    
    7,414
    
    
    
    1,355Income tax expense
    
    
    (25,643
    )
    
    
    (6,956
    )OTHER COMPREHENSIVE INCOME
    
    
    47,623
    
    
    
    12,919COMPREHENSIVE INCOME
    
    $
    16,650
    
    
    $
    23,537
 See accompanying notes to consolidated financial statements. 6




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
For the three months ended March 31, 2004 and 2003
(Unaudited) 2004
    
    2003(in thousands)CASH FLOW FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    (30,973
    )
    
    $
    10,618Adjustments to reconcile net income (loss) to net
cash provided by operating activities:Cumulative effect of accounting change, net of tax
    
    
    62,589
    
    
    
    Interest credited to:Fixed annuity contracts
    
    
    35,236
    
    
    
    38,765Universal life insurance contracts
    
    
    18,481
    
    
    
    19,102Guaranteed investment contracts
    
    
    1,335
    
    
    
    2,016Net realized investment losses
    
    
    11,393
    
    
    
    3,272Amortization of premium (discount) on securities
    
    
    (3,735
    )
    
    
    4,169Amortization of deferred acquisition costs
    
    
    31,442
    
    
    
    43,962Acquisition costs deferred
    
    
    (76,225
    )
    
    
    (57,874
    )Depreciation of fixed assets
    
    
    427
    
    
    
    348Provision for deferred income taxes
    
    
    (12,055
    )
    
    
    21,736Change in:Accrued investment income
    
    
    (1,575
    )
    
    
    (8,018
    )Other assets
    
    
    (13,616
    )
    
    
    (12,070
    )Income taxes currently payable to Parent
    
    
    59,718
    
    
    
    (9,674
    )Due to affiliates
    
    
    (5,743
    )
    
    
    (30,478
    )Other liabilities
    
    
    (6,917
    )
    
    
    9,609Other, net
    
    
    4,771
    
    
    
    6,388NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    74,553
    
    
    
    41,871CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of:Bonds, notes and redeemable preferred stocks
    
    
    (708,678
    )
    
    
    (855,046
    )Mortgage loans
    
    
    
    
    
    
    (131
    )Other investments, excluding short-term investments
    
    
    (88
    )
    
    
    (8,171
    )Sales of:Bonds, notes and redeemable preferred stocks
    
    
    592,988
    
    
    
    576,332Other investments, excluding short-term investments
    
    
    485
    
    
    
    52Redemptions and maturities of:Bonds, notes and redeemable preferred stocks
    
    
    224,361
    
    
    
    259,602Mortgage loans
    
    
    17,469
    
    
    
    11,213Other investments, excluding short-term investments
    
    
    4,818
    
    
    
    54,973Purchase of fixed assets
    
    
    (45
    )
    
    
    (1,430
    )Sales of fixed assets
    
    
    
    
    
    
    66NET CASH PROVIDED BY INVESTING ACTIVITIES
    
    $
    131,310
    
    
    $
    37,460
 See accompanying notes to consolidated financial statements. 7




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
For the three months ended March 31, 2004 and 2003
(Unaudited) 2004
    
    2003(in thousands)CASH FLOW FROM FINANCING ACTIVITIES:Deposits received on:Fixed annuity contracts
    
    $
    372,567
    
    
    $
    428,057Universal life insurance contracts
    
    
    11,252
    
    
    
    11,310Net exchanges from the fixed accounts of variable
annuity contracts
    
    
    (386,957
    )
    
    
    (58,019
    )Withdrawal payments on:Fixed annuity contracts
    
    
    (104,031
    )
    
    
    (139,659
    )Universal life insurance contracts
    
    
    (17,414
    )
    
    
    (14,100
    )Guaranteed investment contracts
    
    
    (5,583
    )
    
    
    (4,753
    )Claims and annuity payments on:Fixed annuity contracts
    
    
    (28,281
    )
    
    
    (29,313
    )Universal life insurance contracts
    
    
    (31,097
    )
    
    
    (34,172
    )Net payment related to a modified coinsurance transaction
    
    
    (4,738
    )
    
    
    (4,862
    )Dividend paid to Parent
    
    
    (2,500
    )
    
    
    (10,187
    )NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
    
    
    (196,782
    )
    
    
    144,302NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS
    
    
    9,081
    
    
    
    223,633CASH AND SHORT-TERM INVESTMENTS
AT BEGINNING OF PERIOD
    
    
    133,105
    
    
    
    116,882CASH AND SHORT-TERM INVESTMENTS
AT END OF PERIOD
    
    $
    142,186
    
    
    $
    340,515SUPPLEMENTAL CASH FLOW INFORMATION:Interest paid on indebtedness
    
    $
    560
    
    
    $
    842Income taxes paid to Parent
    
    $
    47,424
    
    
    $
    
 See accompanying notes to consolidated financial statements. 8




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)  1.
    
    BASIS OF PRESENTATIONAIG SunAmerica Life Assurance Company (formerly Anchor National Life Insurance
Company) (the Company) is a direct wholly owned subsidiary of SunAmerica Life
Insurance Company (the Parent), which is a wholly owned subsidiary of AIG
Retirement Services, Inc. (AIGRS)(formerly AIG SunAmerica Inc.), a wholly
owned subsidiary of American International Group, Inc. (AIG). AIG is a
holding company which through its subsidiaries is engaged in a broad range of
insurance and insurance-related activities, financial services, retirement
savings and asset management. The Company is an Arizona-domiciled life
insurance company principally engaged in the business of writing variable
annuities directed to the market for tax-deferred, long-term savings products.
It also administers closed blocks of fixed annuities, universal life policies
and guaranteed investment contracts (GICs).The Company changed its name to AIG SunAmerica Life Assurance Company on
January 24, 2002. The Company continued to do business as Anchor National Life
Insurance Company until February 28, 2003, at which time it began doing
business under its new name.Effective January 1, 2004, the Parent contributed to the Company 100% of the
outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset
Management Corp. (SAAMCo) (formerly SunAmerica Asset Management Corp.) which
in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services,
Inc. (SACS) (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica
Fund Services, Inc. (SFS) (formerly SunAmerica Fund Services, Inc.).
Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary
of the Company. This contribution increased the Companys shareholders equity
by $74,507,000. Pretax income from the asset management operation totaled
$5,307,000 for the three months ended March 31, 2004. Assets, liabilities and
shareholders equity at December 31, 2003 were restated to include
$174,756,000, $100,249,000 and $74,507,000, respectively, of SAAMCo balances.
Similarly, the results of operations and cash flows for the three months ended
March 31, 2003 have been restated for the addition to pretax income of $120,000
to reflect the SAAMCo activity.SAAMCo comprises the Companys asset management segment (see Note 6) along with
its wholly owned distributors, SACS and SFS. These companies earn fee income
by distributing and managing a diversified family of mutual funds, managing
certain subaccounts within the Companys variable annuity products and
providing professional management of individual, corporate and pension plan
portfolios.In the opinion of the Company, the accompanying unaudited consolidated
financial statements contain all adjustments necessary, consisting of normal
recurring items, to present fairly the Companys consolidated financial
position as of March 31, 2004 and December 31, 2003 and the results of its
consolidated operations and its consolidated cash flows for the three months
ended March 31, 2004 and 2003. The results of operations for the three months
ended March 31, 2004 are not necessarily indicative of the results to be
expected for the full year. The accompanying unaudited consolidated financial
statements should be read in conjunction with the audited consolidated
financial statements for the year ended December 31, 2003, contained in the
Companys 2003 Annual Report on Form 10-K. Certain prior period amounts have
been reclassified to conform to the current periods presentation.2.
    
    RECENTLY ISSUED ACCOUNTING STANDARDSIn July 2003, the American Institute of Certified Public Accountants issued
Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises
for Certain Nontraditional Long-Duration Contracts and for Separate Accounts
(SOP 03-1). This statement was effective as of January 1, 2004, and requires
the Company to recognize a liability for guaranteed minimum death benefits and
other living benefits related to its variable annuities and modifies certain
disclosures and financial statement presentations for these products. In
addition, SOP 03-1 addresses the presentation and reporting of separate
accounts and the capitalization and amortization of sales inducements. The
Company reported for the first quarter of 2004 a one-time cumulative
accounting charge upon 9




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  2.
    
    RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)adoption of $62,589,000 ($96,291,000 pre-tax) to reflect the liability and the
related impact of deferred acquisition costs (DAC) and reinsurance as of
January 1, 2004.The Company issues variable annuities for which and the investment risk is
generally borne by, the contract holder in all but the fixed-rate account
options. For many of the Companys variable annuities, the Company
contractually guarantees to the contract holder either (a) total deposits made
to the contract less any partial withdrawals plus a minimum return (and in
minor instances, no minimum returns), or (b) the highest contract value on a
specified anniversary date minus any withdrawals following the contract
anniversary. These guarantees include benefits that are payable in the event of
death, annuitization or at specified dates during the accumulation period.
Such benefits are referred to as guaranteed minimum death benefits (GMDB),
guaranteed minimum income benefits (GMIB), and guaranteed minimum account
value benefits (GMAV), respectively. The Company also issues certain
variable annuity products that offer an optional earnings enhancement benefit
(EEB) feature. The EEB provides an additional death benefit amount equal to
a fixed percentage of earnings in the contract, subject to certain maximums.The assets supporting the variable portion of variable annuities are carried at
fair value and reported as summary total variable annuity assets held in
separate accounts with an equivalent summary total reported for liabilities.
Amounts assessed against the contract holders for mortality, administrative,
and other services are included in variable annuity fees and changes in
liabilities for minimum guarantees are included in guaranteed minimum death
benefits, net of reinsurance in the consolidated statement of operations and
comprehensive income. Separate account net investment income, net investment
gains and losses, and the related liability changes are offset within the same
line item in the consolidated statement of operations and comprehensive income.The GMDB liability is determined each period end by estimating the expected
value of death benefits in excess of the projected account balance and
recognizing the excess ratably over the accumulation period based on total
expected assessments. The Company regularly evaluates estimates used and
adjusts the additional liability balance, with a related charge or credit to
benefit expense, if actual experience or other evidence suggests that earlier
assumptions should be revised. As of March 31, 2004, a portion of the GMDB
risk on approximately 18% of the account value with GMDB features had been
reinsured.In addition to GMDB, the Company currently offers to a lesser extent GMIB. The
GMIB liability is determined each period end by estimating the expected value
of the annuitization benefits in excess of the projected account balance at the
date of annuitization and recognizing the excess ratably over the accumulation
period based on total expected assessments. The Company regularly evaluates
estimates used and adjusts the additional liability balance, with a related
charge or credit to benefit expense, if actual experience or other evidence
suggests that earlier assumptions should be revised. As of March 31, 2004,
virtually all of the Companys GMIB exposure was effectively transferred to
several large insurance companies via reinsurance agreements.The Company currently offers GMAV on its variable annuity products. The
Company purchased put options on the S&P 500 index to partially offset this
risk. GMAVs are considered to be derivatives under Financial Accounting
Standards Board Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities, and are
recognized at fair value in the consolidated balance sheet through investment
income in the consolidated statement of operations and comprehensive income.Details concerning the Companys guaranteed benefits exposures as of March 31,
2004 are as follows: 10




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  2.
    
    RECENTLY ISSUED ACCOUNTING STANDARDS (Continued) Highest SpecifiedReturn of Net
    
    Anniversary AccountDeposits
    
    Value MinusPlus a
    
    Withdrawals PostMinimum Return
    
    Anniversary(in thousands)In the event of death (GMDB and EEB):Account value
    
    $
    12,090,330
    
    
    $
    11,441,042Net amount at risk (a)
    
    
    1,169,208
    
    
    
    1,504,131Average attained age of contract holders
    
    
    65
    
    
    
    64Range of guaranteed minimum return rates
    
    
    0%-5
    %
    
    
    0
    %At annuitization (GMIB):Account value
    
    $
    6,123,529Net amount at risk (a)
    
    
    704,002Weighted average period remaining until
expected annuitization
    
    4.1 YearsRange of guaranteed minimum return rates
    
    
    0%-6.5
    %Accumulation at specified date (GMAV):Account value
    
    $
    938,147Net amount at risk (a)
    
    
    604Range of guaranteed minimum return rates
    
    
    0
    %
  (a)
    
    Net amount at risk represents the guaranteed benefit exposure, in excess of the current account
value, if all contract holders died, in the case of GMDB, annuitized, in the case of GMIB, or reached
the specified date, in the case of GMAV, at the same balance sheet date.  The following summarizes the liability for guaranteed benefits on variable
contracts reflected in the general account: (in thousands)Balance at January 1, 2004 (b)
    
    $
    65,423Guaranteed benefits incurred
    
    
    17,774Guaranteed benefits paid
    
    
    (11,074
    )Balance at March 31, 2004
    
    $
    72,123
  (b)
    
    Includes amounts from the one-time cumulative accounting
change resulting from the adoption of SOP 03-1. 11




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  2.
    
    RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)The following assumptions and methodology were used to determine the GMDB
liability at March 31, 2004:  
    
    Data used was 5,000 stochastically generated investment performance scenarios.
    
    Mean investment performance assumption was 10%.
    
    Volatility assumption was 16%.
    
    Mortality was assumed to be 64 percent of the 75-80 ALB table.
    
    Lapse rates vary by contract type and duration and range from 1% to 30%.
    
    The discount rate was approximately 8%.  The Company currently offers enhanced crediting rates or bonus payments to
contract-holders on certain of its products. These sales inducements are
deferred and amortized over the life of the policy using the same methodology
and assumptions used to amortize DAC. The Company previously deferred these
sales inducements as part of DAC and reported the amortization of such amounts
as part of DAC amortization. Upon implementation of SOP 03-1, the Company
reclassified sales inducements of $165.1 million from DAC to deferred sales
inducements, which are reported in other assets on the consolidated balance
sheet. For the three months ended March 31, 2004, sales inducements of $10.6
million were deferred. Amortization of the deferred sales inducements is
reported as part of amortization of deferred acquisition costs on the
consolidated statement of operations and comprehensive income. For the three
months ended March 31, 2004, amortization of sales inducements was $5.5
million. Prior period consolidated balance sheet and consolidated statement of
operations and comprehensive income presentation has been reclassified to
conform to the new presentation.3.
    
    SUBORDINATED NOTES PAYABLE TO AFFILIATESSubordinated notes (including accrued interest of $560,000) payable to
affiliates totaled $41,520,000 at interest rates ranging from 4.25% to 9.5% at
March 31, 2004, and require principal payments of $3,000,000 in 2004 and
$37,960,000 in 2005.4.
    
    CONTINGENT LIABILITIESThe Company has entered into seven agreements in which it has provided
liquidity support for certain short-term securities of municipalities and
non-profit organizations by agreeing to purchase such securities in the event
there is no other buyer in the short-term marketplace. In return the Company
receives a fee. The maximum liability under these guarantees at March 31, 2004
is $557,775,000. Related to each of these agreements are participation
agreements with the Parent under which the Parent will share in $222,524,000 of
these liabilities in exchange for a proportionate percentage of the fees
received under these agreements. The expiration dates of these commitments are
as follows: $21,930,000 in the remainder of 2004, $385,845,000 in 2005 and
$150,000,000 in 2006. The Internal Revenue Service has initiated examinations
into the transactions underlying these commitments, including the Companys
role in the transactions. The Company is fully cooperating with the IRS.
Management does not anticipate any material losses with respect to these
commitments.At March 31, 2004, the Company has a commitment to purchase approximately
$25,000,000 of asset backed securities in the ordinary course of business. The
expiration dates of these commitments are as follows: $16,000,000 in 2004 and
$9,000,000 in 2006.Various lawsuits against the Company have arisen in the ordinary course of
business. Contingent liabilities arising from litigation, income taxes and
other matters are not considered material in relation to the financial
position, results of operations or cash flows of the Company. 12




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##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  4.
    
    CONTINGENT LIABILITIES (Continued)On April 5, 2004, a purported class action captioned NIKITA Mehta, as Trustee
of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case
04L0199, was filed in the Circuit Court, Twentieth Judicial District in St.
Clair County, Illinois. The lawsuit alleges certain improprieties in
conjunction with alleged market timing activities. The probability of any
particular outcome cannot be reasonably estimated at this time.The Companys insurance policy obligations are guaranteed by American Home
Assurance Company (American Home), a subsidiary of AIG, and a member of an
AIG intercompany pool. This guarantee is unconditional and irrevocable, and
the Companys policyholders have the right to enforce the guarantee directly
against American Home.The Company has a support agreement in effect between the Company and AIG (the
Support Agreement), pursuant to which AIG has agreed that AIG will cause the
Company to maintain a policyholders surplus of not less than $1,000,000 or
such greater amount as shall be sufficient to enable the Company to perform its
obligations under any policy issued by it. The Support Agreement also provides
that if the Company needs funds not otherwise available to it to make timely
payment of its obligations under policies issued by it, AIG will provide such
funds at the request of the Company. The Support Agreement is not a direct or
indirect guarantee by AIG to any person of any obligations of the Company. AIG
may terminate the Support Agreement with respect to outstanding obligations of
the Company only under circumstances where the Company attains, without the
benefit of the Support Agreement, a financial strength rating equivalent to
that held by the Company with the benefit of the Support Agreement.
Policyholders have the right to cause the Company to enforce its rights against
AIG and, if the Company fails or refuses to take timely action to enforce the
Support Agreement or if the Company defaults in any claim or payment owed to
such policyholder when due, have the right to enforce the Support Agreement
directly against AIG.American Home does not publish financial statements, although it files
statutory annual and quarterly reports with the New York State Insurance
Department, where such reports are available to the public. AIG is a reporting
company under the Securities Exchange Act of 1934, and publishes annual reports
on Form 10-K and quarterly reports on Form 10-Q, which are available from the
Securities and Exchange Commission.5.
    
    RELATED-PARTY MATTERSOn October 31, 2003, the Company entered into an existing credit agreement
under which the Company agreed to make loans to AIG in an aggregate amount of
$60,000,000. This commitment expires on October 30, 2004. There was no
outstanding balance under this agreement at March 31, 2004.6.
    
    SEGMENT INFORMATIONAs of January 1, 2004, the Company conducted its business through two business
segments, annuity operations and asset management operations. Prior to January
1, 2004, the Company conducted its business through one segment: annuity
operations. Annuity operations consists of the sale and administration of
deposit-type insurance contracts, including fixed and variable annuities,
universal life insurance contracts and GICs. Asset management operations,
which includes the distribution and management of mutual funds, is conducted by
SAAMCo and its subsidiary and distributor, SACS. Following is selected
information pertaining to the Companys business segments. 13




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##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  6.
    
    SEGMENT INFORMATION (Continued) AssetAnnuity
    
    ManagementOperations
    
    Operations
    
    Total(in thousands)THREE MONTHS ENDED
MARCH 31, 2004:REVENUES:Fee income:Variable annuity fees, net of
reinsurance
    
    $
    88,210
    
    
    $
    2,794
    
    
    $
    91,004Asset management fees
    
    
    
    
    
    
    18,108
    
    
    
    18,108Universal life insurance fees, net
of reinsurance
    
    
    9,192
    
    
    
    
    
    
    
    9,192Surrender charges
    
    
    6,999
    
    
    
    
    
    
    
    6,999Other fees
    
    
    
    
    
    
    3,621
    
    
    
    3,621Total fee income
    
    
    104,401
    
    
    
    24,523
    
    
    
    128,924Investment income
    
    
    86,993
    
    
    
    177
    
    
    
    87,170Net realized investment losses
    
    
    (11,393
    )
    
    
    
    
    
    
    (11,393
    )Total revenues
    
    
    180,001
    
    
    
    24,700
    
    
    
    204,701BENEFITS AND EXPENSES:Interest expense
    
    
    55,052
    
    
    
    560
    
    
    
    55,612General and administrative expenses
    
    
    27,328
    
    
    
    8,896
    
    
    
    36,224Amortization of deferred
acquisition costs
    
    
    24,001
    
    
    
    7,441
    
    
    
    31,442Annual commissions
    
    
    15,014
    
    
    
    
    
    
    
    15,014Claims on universal life
contracts, net of
reinsurance recoveries
    
    
    4,823
    
    
    
    
    
    
    
    4,823Guaranteed minimum death benefits,
net of reinsurance recoveries
    
    
    17,774
    
    
    
    
    
    
    
    17,774Total benefits and expenses
    
    
    143,992
    
    
    
    16,897
    
    
    
    160,889Pretax income before cumulative
effect of accounting change
    
    $
    36,009
    
    
    $
    7,803
    
    
    $
    43,812Total assets
    
    $
    28,902,900
    
    
    $
    178,728
    
    
    $
    29,081,628Expenditures for long-lived assets
    
    $
    
    
    
    $
    45
    
    
    $
    45
 14




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##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  6.
    
    SEGMENT INFORMATION (Continued) AssetAnnuity
    
    ManagementOperations
    
    Operations
    
    Total(in thousands)THREE MONTHS ENDED
MARCH 31, 2003:REVENUES:Fee income:Variable annuity fees, net of
reinsurance
    
    $
    62,034
    
    
    $
    2,372
    
    
    $
    64,406Asset management fees
    
    
    
    
    
    
    10,921
    
    
    
    10,921Universal life insurance fees, net
of reinsurance
    
    
    8,970
    
    
    
    
    
    
    
    8,970Surrender charges
    
    
    7,570
    
    
    
    
    
    
    
    7,570Other fees
    
    
    
    
    
    
    3,337
    
    
    
    3,337Total fee income
    
    
    78,574
    
    
    
    16,630
    
    
    
    95,204Investment income
    
    
    96,785
    
    
    
    123
    
    
    
    96,908Net realized investment losses
    
    
    (3,272
    )
    
    
    
    
    
    
    (3,272
    )Total revenues
    
    
    172,087
    
    
    
    16,753
    
    
    
    188,840BENEFITS AND EXPENSES:Interest expense
    
    
    59,883
    
    
    
    842
    
    
    
    60,725General and administrative expenses
    
    
    21,259
    
    
    
    8,728
    
    
    
    29,987Amortization of deferred
acquisition costs
    
    
    38,821
    
    
    
    5,141
    
    
    
    43,962Annual commissions
    
    
    14,178
    
    
    
    
    
    
    
    14,178Claims on universal life
contracts, net of reinsurance
recoveries
    
    
    5,513
    
    
    
    
    
    
    
    5,513Guaranteed minimum death benefits,
net of reinsurance recoveries
    
    
    21,976
    
    
    
    
    
    
    
    21,976Total benefits and expenses
    
    
    161,630
    
    
    
    14,711
    
    
    
    176,341Pretax income before cumulative
effect of accounting change
    
    $
    10,457
    
    
    $
    2,042
    
    
    $
    12,499Total assets
    
    $
    23,738,608
    
    
    $
    173,640
    
    
    $
    23,912,248Expenditures for long-lived assets
    
    $
    
    
    
    $
    2,128
    
    
    $
    2,128
 15




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Managements discussion and analysis of financial condition and results of
operations of AIG SunAmerica Life Assurance Company (formerly Anchor National
Life Insurance Company) (the Company) for the three months ended March 31,
2004 (2004) and March 31, 2003 (2003) follows. Certain prior period
amounts have been reclassified to conform to the current periods presentation. In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions readers regarding certain
forward-looking statements contained in this report and in any other statements
made by, or on behalf of, the Company, whether or not in future filings with
the Securities and Exchange Commission (the SEC). Forward-looking statements
are statements not based on historical information and which relate to future
operations, strategies, financial results, or other developments. Statements
using verbs such as expect, anticipate, believe or words of similar
import generally involve forward-looking statements. Without limiting the
foregoing, forward-looking statements include statements which represent the
Companys beliefs concerning future levels of sales and redemptions of the
Companys products, investment spreads and yields, or the earnings and
profitability of the Companys activities. Forward-looking statements are necessarily based on estimates and
assumptions that are inherently subject to significant business, economic and
competitive uncertainties and contingencies, many of which are beyond the
Companys control and many of which are subject to change. These uncertainties
and contingencies could cause actual results to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company. Whether or not actual results differ materially from forward-looking
statements may depend on numerous foreseeable and unforeseeable developments.
Some may be national in scope, such as general economic conditions, changes in
tax law and changes in interest rates. Some may be related to the insurance
industry generally, such as pricing competition, regulatory developments and
industry consolidation. Others may relate to the Company specifically, such as
credit, volatility and other risks associated with the Companys investment
portfolio. Investors are also directed to consider other risks and
uncertainties discussed in documents filed by the Company with the SEC. The
Company disclaims any obligation to update forward-looking information. CRITICAL ACCOUNTING POLICIES The Company considers among its most critical accounting policies those
policies with respect to valuation of certain financial instruments,
amortization of deferred acquisition costs and valuation of reserves for
guaranteed benefits. In the implementation of each of the
aforementioned policies, management is required to exercise its judgment on
both a quantitative and qualitative basis. Further explanation of how
management exercises that judgment follows. VALUATION OF CERTAIN FINANCIAL INSTRUMENTS: Gross unrealized losses on
debt and equity securities available for sale amounted to $30.9 million at
March 31, 2004. In determining if and when a decline in fair value below
amortized cost is other than temporary, the Company evaluates at each reporting
period the market conditions, offering prices, trends of earnings, price
multiples, and other key measures for investments in debt and equity
securities. In particular, for debt securities, the Company assesses the
probability that all amounts due are collectible according to the contractual
terms of the obligation. When such a decline in value is deemed to be other
than temporary, the Company recognizes an impairment loss in the current period
operating results to the extent of the decline (See also discussion within
Capital Resources and Liquidity herein). Securities in the Companys portfolio with a carrying value of
approximately $1.16 billion at March 31, 2004 do not have readily determinable
market prices. For these securities, the Company estimates the fair value with
internally prepared valuations (including those based on estimates of future
profitability).Otherwise, the Company uses its most recent purchases and
sales of similar unquoted securities, independent broker quotes or comparison
to similar securities with quoted prices when possible to estimate the fair
value of those securities. All such securities are classified as available for
sale. The Companys ability to liquidate its positions in these securities
will be impacted to a significant degree by the lack of an actively traded
market, and may not be able to dispose of 16




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##### Table of Contents



these investments in a timely manner. Although the Company believes its
estimates reasonably reflect the fair value of those securities, the key
assumptions about the risk-free interest rates, risk premiums, performance of
underlying collateral, if any, and other factors may not reflect those of an
active market. AMORTIZATION OF DEFERRED ACQUISITION COSTS: The Company amortizes
deferred acquisition costs (DAC) based on a percentage of expected gross
profits (EGPs) over the life of the underlying policies, and for mutual
funds, over the estimated lives of the fund deposits on a straight line basis.
EGPs are computed based on assumptions related to the underlying policies
written, including their anticipated duration, the growth rate of the separate
account assets (with respect to variable annuities) or general account assets
(with respect to fixed annuities, fixed options of variable annuities and
universal life contracts) supporting the annuity obligations, costs of
providing for policy guarantees and the level of expenses necessary to maintain
the policies. The Company adjusts DAC amortization (a DAC unlocking) when
estimates of current or future gross profits to be realized from its annuity
policies are revised. Approximately 95% of the Companys DAC balance at March
31, 2004 related to variable annuity products and 5% related to fixed annuity
and universal life products. DAC amortization on annuities is sensitive to surrender rates, claims
costs, and the actual and assumed future growth rate of the assets supporting
the Companys obligations under annuity policies. With respect to fixed
annuities, the growth rate depends on the yield on the general account assets
supporting those annuities. With respect to variable annuities, the growth
rate depends on the performance of the investment options available under the
annuity contract and the allocation of assets among these various investment
options. The assumption the Company uses for the long-term annual net growth of the
separate account assets in the determination of DAC amortization with respect
to its variable annuity policies is 10% (the long-term growth rate
assumption). The Company uses a reversion to the mean methodology that
allows it to maintain this 10% long-term growth rate assumption, while also
giving consideration to the effect of short-term swings in the equity markets.
For example, if performance was 15% during the first year following the
introduction of a product, the DAC model would assume that market returns for
the following five years (the short-term growth rate assumption) would be
approximately 9%, resulting in an average annual growth rate of 10% during the
life of the product. Similarly, following periods of below 10% performance,
the model will assume a short-term growth rate higher than 10%. A DAC
unlocking will occur if management deems the short-term growth rate assumption
(i.e., the growth rate required to revert to the mean 10% growth rate over a
five-year period) to be unreasonable. The use of a reversion to the mean
assumption is common within the industry; however, the parameters used in the
methodology are subject to judgment and vary within the industry. RESERVE FOR GUARANTEED BENEFITS: Pursuant to the adoption of Statement of
Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts (SOP 03-1)
on January 1, 2004, the Company is required to recognize a liability for
guaranteed minimum death benefits (GMDB) and other guaranteed benefits. In
calculating the projected liability, five thousand stochastically generated
investment performance scenarios were developed with a mean investment
performance of 10%. Additional assumptions are made for mortality, lapse rates
of return and the volatility of equity markets. BUSINESS SEGMENTS Effective January 1, 2004, SunAmerica Life Insurance Company (the
Parent) contributed to the Company 100% of the outstanding capital stock of
its then wholly owned subsidiary, AIG SunAmerica Asset Management Corp.
(SAAMCo), which in turn has two wholly owned subsidiaries: AIG SunAmerica
Capital Services, Inc. (SACS) and AIG SunAmerica Fund Services, Inc. (SFS).
This capital contribution increased the Companys shareholders equity by
approximately $74.5 million (see Note 1 of Notes to Consolidated Financial
Statements). Effective January 1, 2004, the Companys earnings includes the
asset management operations of SAAMCo, SACS and SFS. Prior year results have
been restated to account for this contribution. The Company has two business segments: annuity operations and asset
management operations. The annuity operations consists of the sale and
administration of deposit-type insurance contracts, such as variable and fixed
annuities and universal life insurance contracts. The Company focuses
primarily on the marketing of variable annuity products. The variable annuity
products offer investors a broad spectrum of fund alternatives, with a choice 17




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##### Table of Contents



of investment managers, as well as guaranteed fixed-rate account options.
The Company earns fee income on investments in the variable account options and
net investment spread on the fixed-rate account options. The asset management operations are conducted by the Companys registered
investment advisor subsidiary, SAAMCo, and its wholly owned distributors, SACS
and SFS. These companies earn fee income by distributing and managing a
diversified family of mutual funds, managing certain subaccounts within the
Companys variable annuity products and providing professional management of
individual, corporate and pension plan portfolios. Premiums from variable
annuities sold by the Company are held in trusts that are owned by the Company,
with the assets directly supporting policyholder obligations. SAAMCo is the
investment advisor for all of the trusts as well as trusts owned by an
affiliate, First SunAmerica Life Insurance Company. RESULTS OF OPERATIONS NET LOSS totaled $31.0 million in 2004, compared to net income of $10.6
million in 2003. CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflected the adoption
of SOP 03-1 on January 1, 2004. The Company recorded a loss of $62.6 million,
net of tax, which is recognized in the consolidated statement of operations and
comprehensive income as a cumulative effect of accounting change for the
quarter ended March 31, 2004. PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $43.8
million in 2004, compared with $12.5 million in 2003. The increase in 2004
compared to 2003 was primarily due to higher variable annuity and asset
management fee income and lower amortization of deferred acquisition costs. INCOME TAX EXPENSE totaled $12.2 million in 2004, compared to income tax
benefit of $1.9 million in 2003, representing effective tax rates of 28% and
15% in 2004 and 2003, respectively. The increase in 2004 is due primarily to
higher pretax income in 2004 without corresponding increase in permanent tax
differences. As discussed above and in Note 1 of Notes of Consolidated Financial
Statements, effective January 1, 2004, the Company has two business segments,
annuity operations and asset management operations. ANNUITY OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $36.0
million in 2004, compared with $10.5 million in 2003. The increase in 2004
compared to 2003 was primarily due to higher variable fee income and lower
amortization of deferred acquisition costs partially offset by higher net
realized investment losses. NET INVESTMENT SPREAD, a non-GAAP measure, which represents investment
income earned on invested assets less interest credited to fixed annuity
contracts, universal life insurance contracts and guaranteed investment
contracts is a key measurement used by the Company in evaluating the
profitability of its business. Accordingly, the Company presents an analysis
of net investment spread because the Company has determined this measure to be
useful and meaningful. In evaluating its investment yield and net investment spread, the Company
calculates average invested assets using the amortized cost of bonds, notes and
redeemable preferred stocks. This basis does not include unrealized gains and
losses, which are reflected in the carrying value (i.e., fair value) of those
investments pursuant to Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities. In the
calculation of average invested assets, the Company excludes cash collateral
received from the securities lending program, which is offset by a securities
lending payable in the same amount. The Company participates in a securities
lending program with an affiliated agent, pursuant to which it lends its
securities and primarily takes cash as collateral with respect to the
securities lent. Participation in securities lending agreements provides
additional net investment income for the Company, resulting from investment
income earned on the collateral, less interest paid on the securities lending
agreements and the related management fees paid to an affiliate to administer
the program. 18




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##### Table of Contents



An analysis of net investment spread and a reconciliation to pretax income is
presented in the following table: Three months ended March 31,2004
    
    2003(in thousands)Investment income
    
    $
    86,993
    
    
    $
    96,785Interest credited to fixed annuity contracts
    
    
    (35,236
    )
    
    
    (38,765
    )Interest credited to universal life insurance contracts
    
    
    (18,481
    )
    
    
    (19,102
    )Interest credited to guaranteed investment contracts
    
    
    (1,335
    )
    
    
    (2,016
    )Net investment spread
    
    
    31,941
    
    
    
    36,902Net realized investment losses
    
    
    (11,393
    )
    
    
    (3,272
    )Fee income, net of reinsurance
    
    
    104,401
    
    
    
    78,574General and administrative expenses, net of deferrals
    
    
    (27,328
    )
    
    
    (21,259
    )Amortization of DAC
    
    
    (24,001
    )
    
    
    (38,821
    )Annual commissions
    
    
    (15,014
    )
    
    
    (14,178
    )Claims on UL contracts, net of reinsurance recoveries
    
    
    (4,823
    )
    
    
    (5,513
    )Guaranteed minimum death benefits, net of reinsurance
recoveries
    
    
    (17,774
    )
    
    
    (21,976
    )Pretax income
    
    $
    36,009
    
    
    $
    10,457
 Net investment spread totaled $31.9 million in 2004 and $36.9 million in
2003. These amounts equal 2.03% on average invested assets (computed on a
daily basis) of $6.28 billion in 2004 and 2.20% on average invested assets of
$6.72 billion in 2003. The decrease in net investment spread in 2004 from 2003
resulted from a lower prevailing interest rate environment. The components of net investment spread were as follows: Three months ended March 31,2004
    
    2003(in thousands)Net investment spread
    
    $
    31,941
    
    
    $
    36,902Average invested assets
    
    
    6,279,002
    
    
    
    6,724,297Average interest-bearing liabilities
    
    
    (6,006,388
    )
    
    
    (6,455,839
    )Yield on average invested assets
    
    
    5.54
    %
    
    
    5.76
    %Rate paid on average interest bearing liabilities
    
    
    3.67
    
    
    
    3.71Difference between yield and interest rate paid
    
    
    1.87
    %
    
    
    2.05
    %Net investment spread as a percentage of average
invested assets
    
    
    2.03
    %
    
    
    2.20
    %
 The decline in average invested assets principally resulted from net
exchanges from fixed accounts into the separate accounts of variable annuity
contracts, partially offset by sales of the fixed account options of the
Companys variable annuity products (Fixed Annuity Deposits). Sales of fixed
annuities and universal life product totaled $383.8 million in 2004 and $439.4
million in 2003, and are largely deposits for the fixed accounts of variable
annuities. On an annualized basis, these deposits represent 26% and 31%,
respectively, of the related reserve balances at the beginning of the
respective periods. Net investment spreads include the effect of income earned or interest
paid on the difference between average invested assets and average
interest-bearing liabilities. Average invested assets exceeded average
interest-bearing liabilities by $272.6 million in 2004, compared with $268.5
million in 2003. The difference between the Companys yield on average
invested assets and the rate paid on average interest-bearing liabilities was
1.87% in 2004 and 2.05% in 2003. 19




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Investment income (and the related yields on average invested assets)
totaled $87.0 million (5.54%) and $96.8 million (5.76%) in 2003. The decrease
in the investment yield primarily reflects an overall lower prevailing interest
rate environment as well as $4.2 million loss from the mark to market of the
GMAV put options and embedded derivatives in 2004, compared to $1.7 million in
2003. Expenses incurred to manage the investment portfolio amounted to $0.7
million in 2004 and $0.6 million in 2003. These expenses are included as a
reduction of investment income in the consolidated statement of operations and
comprehensive income. Interest expense totaled $55.1 million in 2004 and $59.9 million in 2003.
The average rate paid on all interest-bearing liabilities was 3.67% in 2004,
compared with 3.71% in 2003. Interest-bearing liabilities averaged $6.01
billion during 2004 and $6.46 billion during 2003. Despite a lower interest
rate environment, interest rates did not decline significantly because many
contracts were already at or near their contractual minimum rates. NET REALIZED INVESTMENT LOSSES totaled $11.4 million in 2004 and $3.3
million in 2003 and include impairment writedowns of $1.1 million and $5.2
million, respectively. Thus, net realized losses from sales and redemptions of
investments totaled $10.3 million in 2004 and net realized gains from sales and
redemptions of investments totaled $1.9 million in 2003. The Company sold or redeemed invested assets, principally bonds and notes,
aggregating $840.4 million in 2004 and $837.3 million in 2003. Sales of
investments result from the active management of the Companys investment
portfolio. Because redemptions of investments are generally involuntary and
sales of investments are made in both rising and falling interest rate
environments, net gains and losses from sales and redemptions of investments
fluctuate from period to period, and represent 0.66% and 0.10% of average
invested assets for 2004 and 2003, respectively. Active portfolio management
involves the ongoing evaluation of asset sectors, individual securities within
the investment portfolio and the reallocation of investments from sectors that
are perceived to be relatively overvalued to sectors that are perceived to be
relatively undervalued. The intent of the Companys active portfolio
management is to maximize total returns on the investment portfolio, taking
into account credit, option, liquidity and interest-rate risk. Impairment writedowns include $1.1 million and $5.2 million of provisions
principally applied to bonds in 2004 and 2003, respectively. On an annualized
basis, impairment writedowns represent 0.07% and 0.31% of average invested
assets for 2004 and 2003, respectively. For the twenty quarters ended March
31, 2004, impairment writedowns as an annualized percentage of average invested
assets have ranged from 0.07% to 1.95% and have averaged 0.66%. Such
writedowns are based upon estimates of the fair value of invested assets and
recorded when declines in value of such assets are considered to be other than
temporary. Actual realization will be dependent upon future events. VARIABLE ANNUITY FEES, NET OF REINSURANCE are primarily based on the
market value of assets in separate accounts supporting variable annuity
contracts. Such fees totaled $88.2 million in 2004 and $62.0 million in 2003
and are net of reinsurance premiums of $8.5 million and $6.4 million,
respectively. The increased fees in 2004 compared to 2003 reflect the
favorable equity market conditions in 2004 and the latter part of 2003, and the
resulting favorable impact on market values of the assets in the separate
accounts. On an annualized basis, variable annuity fees represent 1.8% and
1.7% of average variable annuity assets in 2004 and 2003, respectively.
Variable annuity assets averaged $19.82 billion during 2004 and $14.48 billion
during 2003. Variable annuity deposits, which exclude deposits allocated to
the fixed accounts of variable annuity products, totaled $742.3 million in 2004
and $328.4 million in 2003. On an annualized basis, these amounts represent
15% and 9% of separate account liabilities at the beginning of the respective
periods. The increase in variable annuity deposits in 2004 reflected increased
demand for variable annuity products due to the improved equity market
conditions in 2004 and the latter part of 2003. Transfers from the fixed
accounts of the Companys variable annuity products to the separate accounts
are not classified as variable annuity deposits. Accordingly, changes in
variable annuity deposits are not necessarily indicative of the ultimate
allocation by customers among fixed and variable account options of the
Companys variable annuity products. Sales of variable annuity products (which include deposits allocated to
the fixed accounts) (Variable Annuity Product Sales) amounted to $1.11
billion and $754.8 million in 2004 and 2003, respectively. Such sales
primarily reflect those of the Companys Polaris and Seasons families of
variable annuity products. The Companys 20




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##### Table of Contents



variable annuity products are primarily multi-manager variable annuities
that offer investors a choice of several variable funds as well as a number of
guaranteed fixed-rate funds. Investors can select from a choice of several
variable funds and up to 7 guaranteed fixed-rate funds depending on the
product. The increase in Variable Annuity Product Sales reflects improving
market conditions since the first quarter of 2003. The Company has encountered increased competition in the variable annuity
marketplace during recent years and anticipates that the market will remain
highly competitive for the foreseeable future. Also, from time to time,
Federal initiatives are proposed that could affect the taxation of annuities
(See Regulation). UNIVERSAL LIFE INSURANCE POLICY FEES, NET OF REINSURANCE amounted to $9.2
million in 2004 and $9.0 million in 2003 and are net of reinsurance premium of
$8.1 million and $8.4 million, respectively. Universal life insurance policy
fees consist of mortality charges, up-front fees earned on deposits received
and administrative fees, net of reinsurance premiums. The administrative fees
are assessed based on the number of policies in force as of the end of each
month. The Company acquired its universal life contracts as part of the
acquisition of business from MBL Life Assurance Corporation on December 31,
1998 and does not actively market such contracts. Such fees annualized
represent 2.3% and 2.2% of average reserves for universal life insurance
contracts in the respective periods. SURRENDER CHARGES on variable annuity and universal life contracts totaled
$7.0 million in 2004 and $7.6 million in 2003. Surrender charge periods range
from zero to nine years from the date a deposit is received. Surrender charges
generally are assessed on withdrawals at declining rates during the first seven
or nine years following receipt of the deposit. GENERAL AND ADMINISTRATIVE EXPENSES totaled $27.3 million in 2004 and
$21.3 million in 2003. The increase in 2004 results from higher information
technology costs and payroll related expenses. General and administrative
expenses remain closely controlled through a company-wide cost containment
program and continue to represent less than 1% of average total assets. AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $24.0 million in 2004,
compared with $38.8 million in 2003. Prior year included accelerated
amortization due to higher than anticipated surrenders on certain products with
features which have been discontinued. ANNUAL COMMISSIONS totaled $15.0 million in 2004, compared with $14.2
million in 2003. Annual commissions represent renewal commissions paid
quarterly in arrears to maintain the persistency of certain of the Companys
variable annuity contracts. Substantially all of the Companys currently
available variable annuity products allow for an annual commission payment
option in return for a lower immediate commission. The vast majority of the
Companys average balances of its variable annuity products are currently
subject to such annual commissions. CLAIMS ON UNIVERSAL LIFE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled
$4.8 million in 2004, compared to $5.5 million in 2003 (net of reinsurance
recoveries of $9.3 million in 2004 and $10.8 million and 2003). The change in
such claims resulted principally from changes in the mortality experience. GUARANTEED MINIMUM DEATH BENEFITS, NET OF REINSURANCE RECOVERIES (Net
GMDB) on variable annuity contracts totaled $17.8 million in 2004, compared
with $22.0 million in 2003 (net of reinsurance recoveries of $2.1 million in
2004 and $3.0 million in 2003). Net GMDB consists primarily of guaranteed
minimum death benefits as well as immaterial amounts of earnings enhancement
benefits and guaranteed minimum income benefits. These guarantees are
described in more detail in the following paragraphs. The decrease in Net GMDB
in 2004 reflects the upturn in the equity markets in 2004 and 2003. Downturns in the
equity markets could increase these expenses. A majority of the Companys variable annuity products are issued with a
death benefit feature which provides that, upon the death of a contractholder,
the contractholders beneficiary will receive the greater of (1) the
contractholders account value, or (2) a guaranteed minimum death benefit that
varies by product. The Company bears the risk that death claims
following a decline in the equity markets may exceed contractholder account
balances, and that the fees collected under the contract are insufficient to
cover the costs of the benefit to be 21




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##### Table of Contents



provided. At March 31, 2004, a portion of the GMDB risk on approximately
18% of the account value with such features had been reinsured. In 2004, a
substantial majority of contracts sold have reinsurance coverage. However, the
Company does not currently have reinsurance coverage on the majority of the
contracts to be sold after December 2004. Reinsurance coverage is subject to
limitations such as caps and deductibles. On January 1, 2004, the Company
recorded a liability for GMDBs (See Note 2 of Notes to Consolidated Financial
Statements) pursuant to adoption of a new accounting standard, SOP 03-1. EARNINGS ENHANCEMENT BENEFIT (EEB): The Company issues certain variable
annuity products that offer an optional EEB feature. For contract-holders who
elect the feature, the EEB provides an additional death benefit amount equal to
a fixed percentage of earnings in the contract, subject to certain maximums.
The Company bears the risk that account values following favorable performance
of the financial markets will result in greater EEB death claims and that the
fees collected under the contract are insufficient to cover the costs of the
benefit to be provided. At March 31, 2004, approximately 8% (calculated based
on current account value) of in-force contracts include EEB coverage, with 91%
of the EEB risk fully reinsured. GUARANTEED MINIMUM INCOME BENEFIT (GMIB): The Company issues certain
variable annuity products that contain or offer a GMIB feature. This feature
provides a minimum annuity payment guarantee for those contract-holders who
choose to receive fixed lifetime annuity payments after a seven, nine, or
ten-year waiting period in their deferred annuity contracts. The Company bears
the risk that the performance of the financial markets will not be sufficient
for accumulated policyholder account balances to support GMIB benefits and that
the fees collected under the contract are insufficient to cover the costs of
the benefit to be provided. Substantially all of the Companys products
containing the GMIB feature have been reinsured. However, the Company does not
have reinsurance coverage on contracts to be sold after July 2004. GUARANTEED MINIMUM ACCOUNT VALUE (GMAV): In the third quarter of 2002,
the Company began issuing certain variable annuity products that offer an
optional GMAV. If elected by the policyholder at the time of contract
issuance, this feature guarantees that the account value under the contract
will at least equal the amount of the initial principal invested, adjusted for
withdrawals, at the end of a ten-year waiting period. The Company bears the
risk that protracted under-performance of the financial markets could result in
GMAV benefits being higher than the underlying contractholder account balance
and that the fees collected under the contract are insufficient to cover the
costs of the benefit to be provided. The Company purchased put options on the
S&P 500 index to partially offset this risk. Changes in the market value of
both the GMAV benefit and the put options are recorded in investment income in
the accompanying consolidated statement of operations and comprehensive income. With respect to its reinsurance agreements, the Company could become
liable for all obligations of the reinsured policies if the reinsurers were to
become unable to meet the obligations assumed under the respective reinsurance
agreements. The Company monitors its credit exposure with respect to these
agreements. Due to the high credit ratings and periodic monitoring of these
ratings of the reinsurers, such risks are considered to be minimal. ASSET MANAGEMENT OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $7.8
million in the 2004 compared to a loss of $2.0 million in 2003. The increase
in 2004 from 2003 resulted from increased asset management fees, partially
offset by decreased DAC amortization. VARIABLE ANNUITY FEES totaled $2.8 million in 2004, compared to $2.4
million in 2003. The increase in variable annuity fees in 2004 principally
reflects the improved equity market conditions since 2003. ASSET MANAGEMENT FEES, which include investment advisory fees and 12b-1
distribution fees, are based on the market value of assets managed in mutual
funds by SAAMCo. Such fees totaled $18.1 million on average assets managed of
$9.64 billion in 2004 and $10.9 million on average assets managed of $7.38
billion in 2003. Asset management fees are not necessarily proportionate to
average assets managed, principally due to changes in product mix. Mutual fund
sales, excluding sales of money market accounts and private accounts, totaled
$698.4 million in 2004, compared to $440.2 million in 2003. Redemptions of
mutual funds, excluding redemptions 22




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##### Table of Contents



of money market accounts, amounted to $362.9 million in 2004 and $422.9
million in 2003, which, annualized, represent 18.6% and 30.8%, respectively, of
average related mutual fund assets. The increase in sales in 2004 principally
reflects increasing demand for equity products, due to the improving stock
market conditions over the past year. GENERAL, ADMINISTRATIVE AND OTHER EXPENSES totaled $8.9 million in 2004
and $8.7 million in 2003. General and administrative expenses remain closely
controlled through a company-wide cost containment program and continue to
represent less than 1% of average total assets. AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $7.4 million in 2004,
compared with $5.1 million in 2003. The increase in amortization was primarily
due to additional mutual fund sales since the first quarter of 2003. CAPITAL RESOURCES AND LIQUIDITY SHAREHOLDERS EQUITY increased to $1.55 billion at March 31, 2004 from
$1.54 billion at December 31, 2003. The increase reflected other comprehensive
income of $47.6 million and a net loss of $31.0 million, respectively. INVESTMENTS AND CASH at March 31, 2004 totaled $7.25 billion, compared
with $7.12 billion at December 31, 2003. The Companys invested assets are
managed by a subsidiary of AIG. The following table summarizes the Companys
Bond Portfolio and other investments and cash at March 31, 2004 and December
31, 2003: March 31, 2004
    
    December 31, 2003Fair
    
    Percent of
    
    Fair
    
    Percent ofValue
    
    Portfolio
    
    Value
    
    Portfolio(in thousands, except for percentages)Bond Portfolio:U.S. government securities
    
    $
    127,326
    
    
    
    1.8
    %
    
    $
    24,292
    
    
    
    0.3
    %Mortgage-backed securities
    
    
    1,055,273
    
    
    
    14.5
    
    
    
    1,191,817
    
    
    
    16.7Securities of public utilities
    
    
    148,743
    
    
    
    2.1
    
    
    
    365,150
    
    
    
    5.1Corporate bonds and notes
    
    
    2,867,553
    
    
    
    39.5
    
    
    
    2,697,142
    
    
    
    37.9Redeemable preferred stocks
    
    
    21,400
    
    
    
    0.3
    
    
    
    22,175
    
    
    
    0.3Other debt securities
    
    
    1,264,485
    
    
    
    17.4
    
    
    
    1,205,224
    
    
    
    16.9Total Bond Portfolio
    
    
    5,484,780
    
    
    
    75.6
    
    
    
    5,505,800
    
    
    
    77.2Mortgage loans
    
    
    699,676
    
    
    
    9.7
    
    
    
    716,846
    
    
    
    10.1Common stocks
    
    
    1,632
    
    
    
    0.0
    
    
    
    727
    
    
    
    0.0Cash and short-term investments
    
    
    142,186
    
    
    
    2.0
    
    
    
    133,105
    
    
    
    1.9Securities lending collateral
    
    
    668,717
    
    
    
    9.2
    
    
    
    514,145
    
    
    
    7.2Other
    
    
    253,428
    
    
    
    3.5
    
    
    
    254,010
    
    
    
    3.6Total investments and cash
    
    $
    7,250,419
    
    
    
    100.0
    %
    
    $
    7,124,633
    
    
    
    100.0
    %
 The Companys general investment philosophy is to hold fixed-rate assets
for long-term investment. Thus, it does not have a trading portfolio.
However, the Company has determined that all of the Bond Portfolio is available
to be sold in response to changes in market interest rates, changes in relative
value of asset sectors and individual securities, changes in prepayment risk,
changes in the credit quality outlook for certain securities, the Companys
need for liquidity and other similar factors. THE BOND PORTFOLIO, which constituted 76% of the Companys total
investment portfolio at March 31, 2004, had an aggregate fair value that was
$243.9 million greater than its amortized cost at March 31, 2004, 23




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##### Table of Contents



compared with $154.6 million at December 31, 2003. The increase in net
unrealized gains on the Bond Portfolio during 2004 principally reflected the
impact of the decrease in prevailing interest rates and the corresponding
effect on the fair value of the Bond Portfolio at March 31, 2004. At March 31, 2004, the Bond Portfolio had an aggregate fair value of $5.48
billion and an aggregate amortized cost of $5.24 billion. At March 31, 2004,
the Bond Portfolio (excluding $21.4 million of redeemable preferred stocks)
included $5.26 billion of bonds rated by Standard & Poors (S&P), Moodys
Investors Service (Moodys), Fitch (Fitch) or the National Association of
Insurance Commissioners (NAIC), and $205.3 million of bonds rated by the
Company pursuant to statutory ratings guidelines established by the NAIC. At
March 31, 2004, approximately $5.10 billion of the Bond Portfolio was
investment grade, including $1.18 billion of mortgage-backed securities (MBS)
and U.S. government/agency securities. At March 31, 2004, the Bond Portfolio included $363.6 million of bonds
that were not investment grade. These non-investment-grade bonds accounted for
approximately 1.2% of the Companys total assets and approximately 5.0% of its
invested assets. Non-investment-grade securities generally provide higher
yields and involve greater risks than investment-grade securities because their
issuers typically are more highly leveraged and more vulnerable to adverse
economic conditions than investment-grade issuers. In addition, the trading
market for these securities is usually more limited than for investment-grade
securities. An economic downturn could produce higher than average issuer
defaults on the non-investment-grade securities, which could cause the
Companys investment returns and net income to decline. At March 31, 2004, the
Companys non-investment-grade portfolio consisted of 96 issues with no issuer
representing more than 10% of the total non-investment grade portfolio. These
non-investment-grade securities are comprised of bonds spanning 11 industries
with 18% of these assets concentrated in financial institutions, 17%
concentrated in utilities, 14% concentrated in telecommunications, 12%
concentrated in noncyclical consumer products and 10% concentrated in
noncyclical consumer products. No other industry concentration constituted
more than 10% of these assets. The table on the next page summarizes the Companys rated bonds by rating
classification as of March 31, 2004. 24




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##### Table of Contents



RATED BONDS BY RATING CLASSIFICATION
(Dollars in thousands) Issues rated by S&P/Moodys/Fitch
    
    Issues not rated by S&P/Moodys/Fitch, by NAIC category
    
    TotalPercentEstimated
    
    NAIC
    
    
    
    
    
    Estimated
    
    
    
    
    
    Estimated
    
    of totalS&P/Moodys/Fitch
    
    Amortized
    
    fair
    
    category
    
    Amortized
    
    fair
    
    Amortized
    
    fair
    
    investedCategory(1)
    
    cost
    
    value
    
    (2)
    
    cost
    
    value
    
    cost
    
    value
    
    assetsAAA+ to
A-
(Aaa to A3)
[AAA to A-]
    
    $
    2,904,370
    
    
    $
    3,048,820
    
    
    
    1
    
    
    $
    445,057
    
    
    $
    459,585
    
    
    $
    3,349,427
    
    
    $
    3,508,405
    
    
    
    48.74
    %BBB+ to
BBB-
(Baa1 to Baa3)
[BBB+ to BBB-]
    
    
    1,255,405
    
    
    
    1,318,128
    
    
    
    2
    
    
    
    260,258
    
    
    
    273,292
    
    
    
    1,515,663
    
    
    
    1,591,420
    
    
    
    28.11
    %BB+ to
BB-
(Ba1 to Ba3)
[BB+ to BB-]
    
    
    116,845
    
    
    
    120,695
    
    
    
    3
    
    
    
    31,826
    
    
    
    35,603
    
    
    
    148,671
    
    
    
    156,298
    
    
    
    2.17
    %B+ to
B-
(B1 to B3)
[B+ to B-]
    
    
    124,192
    
    
    
    118,692
    
    
    
    4
    
    
    
    1,832
    
    
    
    1,636
    
    
    
    126,024
    
    
    
    120,328
    
    
    
    1.67
    %CCC+ to
C
(Caa to C)
[CCC]
    
    
    19,719
    
    
    
    24,451
    
    
    
    5
    
    
    
    8,076
    
    
    
    7,909
    
    
    
    27,795
    
    
    
    32,360
    
    
    
    0.45
    %C1 to D
[DD]
{D}
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    53,177
    
    
    
    54,571
    
    
    
    53,177
    
    
    
    54,571
    
    
    
    0.76
    %TOTAL RATED
ISSUES
    
    $
    4,420,531
    
    
    $
    4,630,786
    
    
    
    
    
    
    $
    800,226
    
    
    $
    832,596
    
    
    $
    5,220,757
    
    
    $
    5,463,382
 Footnotes to the table of Rated Bonds by Rating Classification  (1)
    
    S&P and Fitch rate debt securities in rating categories ranging from AAA
(the highest) to D (in payment default). A plus (+) or minus (-)
indicates the debts relative standing within the rating category. A
security rated BBB- or higher is considered investment grade. Moodys
rates debt securities in rating categories range from Aaa (the highest) to
C (extremely poor prospects of ever attaining any real investment
standing). The number 1, 2 or 3 (with 1 the highest and 3 the lowest)
indicates the debts relative standing within the rating category. A
security rated Baa3 or higher is considered investment grade. Issues are
categorized based on the highest of the S&P, Moodys and Fitch ratings if
rated by multiple agencies.(2)
    
    Bonds and short-term promissory instruments are divided into six quality
categories for NAIC rating purposes, ranging from 1 (highest) to 5
(lowest) for non-defaulted bonds plus one category, 6, for bonds in or
near default. These six categories correspond with the S&P/Moodys/Fitch
rating groups listed above, with categories 1 and 2 considered investment
grade. The NAIC categories include $205.3 million of assets that were
rated by the Company pursuant to applicable NAIC rating guidelines. 25




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##### Table of Contents



The valuation of invested assets involves obtaining a fair value for each
security. The source for the fair value is generally from market exchanges,
with the exception of non-traded securities. Another aspect of valuation pertains to impairment. As a matter of
policy, the determination that a security has incurred an other-than-temporary
decline in value and the amount of any loss recognition requires the judgment
of the Companys management and a continual review of its investments. In
general, a security is considered a candidate for impairment if it meets any of
the following criteria:  
    
    Trading at a significant discount to par, amortized cost (if lower)
or cost for an extended period of time;  
    
    The occurrence of a discrete credit event resulting in: (i) the
issuer defaulting on a material outstanding obligation; (ii) the issuer
seeking protection from creditors under the bankruptcy laws or similar
laws intended for the court supervised reorganization of insolvent
enterprises; or (iii) the issuer proposing a voluntary reorganization
pursuant to which creditors are asked to exchange their claims for cash
or securities having a fair value substantially lower than the par
value of their claims; or  
    
    In the opinion of the Companys management, it is unlikely the
Company will realize a full recovery on its investment, irrespective of
the occurrence of one of the foregoing events. Once a security has been identified as potentially impaired, the amount of
such impairment is determined by reference to that securitys contemporaneous
market price. The Company has the ability to hold any security to its stated maturity.
Therefore, the decision to sell reflects the judgment of the Companys
management that the security sold is unlikely to provide, on a relative value
basis, as attractive a return in the future as alternative securities entailing
comparable risks. With respect to distressed securities, the sale decision
reflects managements judgment that the risk-discounted anticipated ultimate
recovery is less than the value achieved on sale. As a result of these policies, the Company recorded pretax impairment
writedowns of $1.1 million in the 2004 and $5.2 million in 2003. No individual
impairment loss exceeded 10% of the Companys net loss for the three months
ended March 31, 2004. Excluding the impairments noted above, the changes in fair value for the
Companys Bond Portfolio, which constitutes the vast majority of the Companys
investments, were recorded as a component of other comprehensive income in
shareholders equity as unrealized gains or losses. At March 31, 2004, the Companys Bond Portfolio had gross unrealized gains
of $274.8 million and gross unrealized losses of $30.9 million. At December
31, 2003, the Companys Bond Portfolio had gross unrealized gains of $214.7
million and gross unrealized losses of $60.1 million. One issuer accounted for
16% of unrealized losses. No other single issuer accounted for more than 10%
of unrealized losses. At March 31, 2004, the fair value of the Companys Bond Portfolio
aggregated $5.48 billion. Of this aggregate fair value, approximately 0.3%
represented securities trading at or below 75% of amortized cost. The impact
of unrealized losses on net income will be further mitigated upon realization,
because realization will result in current decreases in the amortization of
certain deferred acquisition costs and decreases in income taxes. At March 31, 2004, approximately $656.4 million, at amortized cost, of the
Bond Portfolio had a fair value of $625.5 million resulting in an aggregate
unrealized loss of $30.9 million. Unrealized losses for the Bond Portfolio and
equity securities did not reflect any significant industry concentrations. 26




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##### Table of Contents



The amortized cost of the Bond Portfolio in an unrealized loss position at
March 31, 2004, by contractual maturity, is shown below. AmortizedCost(in thousands)Due in one year or less
    
    $
    26,586Due after one year through five years
    
    
    218,033Due after five years through ten years
    
    
    232,879Due after ten years
    
    
    178,903Total
    
    $
    656,401
 The aging of the Bond Portfolio in an unrealized loss position at March
31, 2004 is shown below: (dollars in
    
    Less than or Equal to 20%
    
    Greater than 20% to 50%
    
    Greater than 50%thousands)
    
    of Amortized Cost
    
    of Amortized Cost
    
    of Amortized Cost
    
    TotalAmortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    UnrealizedMonths
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    ItemsInvestment Grade Bonds0-6
    
    $
    220,327
    
    
    $
    (3,625
    )
    
    
    28
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    220,327
    
    
    $
    (3,625
    )
    
    
    287-12
    
    
    93,963
    
    
    
    (736
    )
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93,963
    
    
    
    (736
    )
    
    
    13>12
    
    
    209,648
    
    
    
    (6,485
    )
    
    
    49
    
    
    
    22,704
    
    
    
    (6,136
    )
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    232,352
    
    
    
    (12,621
    )
    
    
    52Total
    
    $
    523,938
    
    
    $
    (10,846
    )
    
    
    90
    
    
    $
    22,704
    
    
    $
    (6,136
    )
    
    
    3
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    546,642
    
    
    $
    (16,982
    )
    
    
    93Below Investment Grade
Bonds0-6
    
    $
    6,478
    
    
    $
    (87
    )
    
    
    4
    
    
    $
    987
    
    
    $
    (306
    )
    
    
    1
    
    
    $
    599
    
    
    $
    (469
    )
    
    
    1
    
    
    $
    8,064
    
    
    $
    (862
    )
    
    
    67-12
    
    
    8,651
    
    
    
    (230
    )
    
    
    2
    
    
    
    378
    
    
    
    (116
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,029
    
    
    
    (346
    )
    
    
    3>12
    
    
    79,720
    
    
    
    (8,642
    )
    
    
    14
    
    
    
    12,946
    
    
    
    (4,085
    )
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    92,666
    
    
    
    (12,727
    )
    
    
    17Total
    
    $
    94,849
    
    
    $
    (8,959
    )
    
    
    20
    
    
    $
    14,311
    
    
    $
    (4,507
    )
    
    
    5
    
    
    $
    599
    
    
    $
    (469
    )
    
    
    1
    
    
    $
    109,759
    
    
    $
    (13,935
    )
    
    
    26Total Bonds0-6
    
    $
    226,805
    
    
    $
    (3,712
    )
    
    
    32
    
    
    $
    987
    
    
    $
    (306
    )
    
    
    1
    
    
    $
    599
    
    
    $
    (469
    )
    
    
    1
    
    
    $
    228,391
    
    
    $
    (4,487
    )
    
    
    347-12
    
    
    102,614
    
    
    
    (966
    )
    
    
    15
    
    
    
    378
    
    
    
    (116
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    102,992
    
    
    
    (1,082
    )
    
    
    16>12
    
    
    289,368
    
    
    
    (15,127
    )
    
    
    63
    
    
    
    35,650
    
    
    
    (10,221
    )
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    325,018
    
    
    
    (25,348
    )
    
    
    69Total
    
    $
    618,787
    
    
    $
    (19,805
    )
    
    
    110
    
    
    $
    37,015
    
    
    $
    (10,643
    )
    
    
    8
    
    
    $
    599
    
    
    $
    (469
    )
    
    
    1
    
    
    $
    656,401
    
    
    $
    (30,917
    )
    
    
    119
 In 2004, the pretax realized losses incurred with respect to the sale of
fixed securities in the Bond Portfolio were $10.9 million. The aggregate fair
value of securities sold was $74.7 million, which was approximately 87.2% of
amortized cost. The average period of time that securities sold at a loss
during 2004 were trading continuously at a price below amortized cost was
approximately 20 months. As stated previously, the valuation for the Companys Bond Portfolio comes
from market exchanges or dealer quotations, with the exception of non-traded
securities. The Company considers non-traded securities to mean certain fixed
income investments, certain structured securities and limited partnerships.
The aggregate fair value of these securities at March 31, 2004 was
approximately $1.16 billion. The methodology used to estimate fair value of non-traded fixed income
investments is by reference to traded securities with similar attributes and
using a matrix pricing methodology. This technique takes into account such
factors as the industry, the securitys rating and tenor, its coupon rate, its
position in the capital structure of the issuer and other relevant factors.
The change in fair value is recognized as a component of other comprehensive
income. 27




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For certain structured securities, the carrying value is based on an
estimate of the securitys future cash flows pursuant to the requirements of
Emerging Issues Task Force Issue No. 99-20, Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets. The change in carrying value is recognized in income. Each of these investment categories is regularly tested to determine if
impairment in value exists. Various valuation techniques are used with respect
to each category in this determination. Senior secured loans (Secured Loans) are included in the Bond Portfolio
and aggregated $314.7 million at March 31, 2004. Secured Loans are senior to
subordinated debt and equity and are secured by assets of the issuer. At March
31, 2004, Secured Loans consisted of $210.0 million of privately traded
securities and $104.7 million of publicly traded securities. These Secured
Loans are composed of loans to 59 borrowers spanning 10 industries, with 25% of
these assets concentrated in utilities, 17% concentrated in transportation, 16%
concentrated in communications, 11% concentrated in cyclical consumer products
and 10% concentrated in noncyclical consumer products. No other industry
constituted more than 10% of these assets. While the trading market for the Companys privately traded Secured Loans
is more limited than for publicly traded issues, participation in these
transactions has enabled the Company to improve its investment yield. As a
result of restrictive financial covenants, these Secured Loans involve greater
risk of technical default than do publicly traded investment-grade securities.
However, management believes that the risk of loss upon default for these
Secured Loans is mitigated by such financial covenants and the collateral
values underlying the Secured Loans. The Companys Secured Loans are rated by
S&P, Moodys, Fitch, the NAIC or by the Company, pursuant to comparable
statutory ratings guidelines established by the NAIC. MORTGAGE LOANS aggregated $699.7 million at March 31, 2004 and consisted
of 105 commercial first mortgage loans with an average loan balance of
approximately $6.7 million, collateralized by properties located in 31 states.
Approximately 34% of this portfolio was office, 18% was multifamily
residential, 16% was manufactured housing, 11% was industrial, 11% was hotels,
5% was retail, and 5% was other types. At March 31, 2004, approximately 11%,
10% and 10% of this portfolio were secured by properties located in California,
New York and Massachusetts, respectively. No more than 10% of this portfolio
was secured by properties located in any other single state. At March 31,
2004, 16 mortgage loans have an outstanding balance of $10 million or more,
which collectively aggregated approximately 52% of this portfolio. At March
31, 2004, approximately 26% of the mortgage loan portfolio consisted of loans
with balloon payments due before April 1, 2007. During 2004 and 2003, loans
delinquent by more than 90 days, foreclosed loans and structured loans have not
been significant in relation to the total mortgage loan portfolio. Substantially all of the mortgage loan portfolio has been originated by
the Company under its underwriting standards. Commercial mortgage loans on
properties such as offices, hotels and shopping centers generally represent a
higher level of risk than do mortgage loans secured by multifamily residences.
This greater risk is due to several factors, including the larger size of such
loans and the more immediate effects of general economic conditions on these
commercial property types. However, due to the Companys underwriting
standards, the Company believes that it has prudently managed the risk
attributable to its mortgage loan portfolio while maintaining attractive
yields. SECURITIES LENDING COLLATERAL totaled $668.7 million at March 31, 2004,
compared to $514.1 million at December 31, 2003, and consisted of cash
collateral invested in highly rated short-term securities received in
connection with the Companys securities lending program. Although the cash
collateral is currently invested in highly rated short-term securities, the
applicable collateral agreements permit the cash collateral to be invested in
highly liquid short and long-term investment portfolios. At least 75% of the
portfolios short-term investments must have external issue ratings of A-1/P-1,
one of the highest ratings for short-term credit quality. Long-term
investments include corporate notes with maturities of five years or less and a
credit rating by at least two nationally recognized statistical rating
organizations (NRSRO), with no less than a S&P rating of A or equivalent by any
other NRSRO. 28




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ASSET-LIABILITY MATCHING is utilized by the Company in an effort to
minimize the risks of interest rate fluctuations and disintermediation (i.e.
the risk of being forced to sell investments during unfavorable market
conditions). The Company believes that its fixed-rate liabilities should be
backed by a portfolio principally composed of fixed-rate investments that
generate predictable rates of return. The Company does not have a specific
target rate of return. Instead, its rates of return vary over time depending
on the current interest rate environment, the slope of the yield curve, the
spread at which fixed-rate investments are priced over the yield curve, default
rates and general economic conditions. Its portfolio strategy is constructed
with a view to achieve adequate risk-adjusted returns consistent with its
investment objectives of effective asset-liability matching, liquidity and
safety. The Companys fixed-rate products incorporate surrender charges or
other restrictions in order to encourage persistency. Approximately 62% of the
Companys fixed annuity, universal life and GIC reserves had surrender
penalties or other restrictions at March 31, 2004. As part of its asset-liability matching discipline, the Company conducts
detailed computer simulations that model its fixed-rate assets and liabilities
under commonly used interest rate scenarios. With the results of these
computer simulations, the Company can measure the potential gain or loss in
fair value of its interest-rate sensitive instruments and seek to protect its
economic value and achieve a predictable spread between what it earns on its
invested assets and what it pays on its liabilities by designing its fixed-rate
products and conducting its investment operations to closely match the duration
and cash flows of the fixed-rate assets to that of its fixed-rate liabilities.
The fixed-rate assets in the Companys asset-liability modeling include: cash
and short-term investments; bonds, notes and redeemable preferred stocks;
mortgage loans; policy loans; and investments in limited partnerships that
invest primarily in fixed-rate securities. At March 31, 2004, these assets had
an aggregate fair value of $6.58 billion with an option-adjusted duration of
3.3 years. The Companys fixed-rate liabilities include fixed options of
variable annuities, as well as universal life, fixed annuity and GIC contracts.
At March 31, 2004, these liabilities had an aggregate fair value (determined
by discounting future contractual cash flows by related market rates of
interest) of $6.13 billion with an option-adjusted duration of 3.4 years. The
Companys potential exposure due to a relative 10% increase in prevailing
interest rates from its March 31, 2004 levels is a loss of approximately $2.2
million, representing a decrease in fair value of its fixed-rate assets that is
not offset by a decrease in fair value of its fixed-rate liabilities. Because
the Company actively manages its assets and liabilities and has strategies in
place to minimize its exposure to loss as interest rate changes occur, it
expects that actual losses would be less than the estimated potential loss. Option-adjusted duration is a common measure for the price sensitivity of
a fixed-maturity portfolio to changes in interest rates. For example, if
interest rates increase 1%, the fair value of an asset with a duration of 5.0
is expected to decrease in value by approximately 5%. The Company estimates
the option-adjusted duration of its assets and liabilities using a number of
different interest rate scenarios, assuming continuation of existing investment
and interest crediting strategies, including maintaining an appropriate level
of liquidity. Actual company and contract owner behaviors may be different
than was assumed in the estimate of option-adjusted duration and these
differences may be material. The overall interest-credited rate environment has continued to decline in
2004. A significant portion of the Companys fixed annuity contracts
(including the fixed option of variable contracts) has reached or is near the
minimum contractual guaranteed rate (generally 3% or 4%). Continual declines
in interest rates could cause the spread between the yield on the portfolio and
the interest rate credited to policyholders to deteriorate. The Company has had the ability, limited by minimum interest rate
guarantees, to respond to the generally declining interest rate environment in
the last five years by lowering crediting rates in response to lower investment
returns. See the earlier discussion under Managements Discussion and
Analysis of Financial Condition and Results of Operations for additional
information on the calculation of investment yield and net investment spread
used by the Companys management as a key component in evaluating the
profitability of its annuity business. The trends experienced during the three
months ended March 31, 2004 and the three years ended December 31, 2003 in the
Companys yield on average invested assets and rate of interest credited on
average interest-bearing liabilities, compared to the market trend in long-term
interest rates as illustrated by the average ten-year U.S. Treasury bond rate,
are presented in the following table: 29




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Three monthsended March 31,
    
    Years ended December, 312004
    
    2003
    
    2002
    
    200110-year U.S. Treasury bond rate:
    
    
    4.00
    %
    
    
    4.01
    %
    
    
    4.61
    %
    
    
    5.02
    %AIG SunAmerica Life Assurance Company:Average yield on Bond Portfolio
    
    
    5.74
    
    
    
    5.75
    
    
    
    6.23
    
    
    
    6.82Rate paid on average interest-bearingliabilities
    
    
    3.68
    
    
    
    3.73
    
    
    
    3.95
    
    
    
    4.49
 As a component of its asset-liability management strategy, the Company may
utilize interest rate swap agreements (Swap Agreements) to match assets more
closely to liabilities. Swap Agreements are agreements to exchange with a
counterparty interest rate payments of differing character (for example,
variable-rate payments exchanged for fixed-rate payments) based on an
underlying principal balance (notional principal) to hedge against interest
rate changes. The Company seeks to enhance its spread income with dollar roll repurchase
agreements (Dollar Roll Repos). Dollar Roll Repos involve a sale of MBS by
the Company and an agreement to repurchase substantially similar MBS at a later
date at an agreed upon price. The Company also seeks to provide liquidity by
investing in MBSs. MBSs are generally investment-grade securities
collateralized by large pools of mortgage loans. MBSs generally pay principal
and interest monthly. The amount of principal and interest payments may
fluctuate as a result of prepayments of the underlying mortgage loans. There are risks associated with some of the techniques the Company uses to
provide liquidity, enhance its spread income and match its assets and
liabilities. The primary risk associated with the Companys Dollar Roll Repos
and Swap Agreements is counterparty risk. The Company believes, however, that
the counterparties to its Dollar Roll Repos and Swap Agreements are financially
responsible and that the counterparty risk associated with those transactions
is minimal. It is the Companys policy that these agreements are entered into
with counterparties who have a debt rating of A/A2 or better from both S&P and
Moodys. The Company continually monitors its credit exposure with respect to
these agreements. In addition to counterparty risk, Swap Agreements also have
interest rate risk. However, the Companys Swap Agreements are intended to
hedge variable-rate assets or liabilities. The primary risk associated with
MBSs is that a changing interest rate environment might cause prepayment of the
underlying obligations at speeds slower or faster than anticipated at the time
of their purchase. As part of its decision to purchase such a security, the
Company assesses the risk of prepayment by analyzing the securitys projected
performance over an array of interest-rate scenarios. Once such a security is
purchased, the Company monitors its actual prepayment experience monthly to
reassess the relative attractiveness of the security with the intent to
maximize total return. INVESTED ASSETS EVALUATION is routinely conducted by the Company.
Management identifies monthly those investments that require additional
monitoring and carefully reviews the carrying values of such investments at
least quarterly to determine whether specific investments should be placed on a
nonaccrual basis and to determine declines in value that may be other than
temporary. In conducting these reviews for bonds, management principally
considers the adequacy of any collateral, compliance with contractual
covenants, the borrowers recent financial performance, news reports and other
externally generated information concerning the creditors affairs. In the
case of publicly traded bonds, management also considers market value
quotations, if available. For mortgage loans, management generally considers
information concerning the mortgaged property and, among other things, factors
impacting the current and expected payment status of the loan and, if
available, the current fair value of the underlying collateral. For investments
in partnerships, management reviews the financial statements and other
information provided by the general partners. The carrying values of investments that are determined to have declines in
value that are other than temporary are reduced to net realizable value and, in
the case of bonds, no further accruals of interest are made. The provisions
for impairment on mortgage loans are based on losses expected by management to
be realized on transfers of mortgage loans to real estate, on the disposition
and settlement of mortgage loans and on mortgage loans that management believes
may not be collectible in full. Accrual of interest is suspended when principal
and interest payments on mortgage loans are past due more than 90 days.
Impairment losses on securitized assets are recognized 30




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if the fair value of the security is less than its book value, and the net
present value of expected future cash flows is less than the net present value
of expected future cash flows at the most recent (prior) estimation date. DEFAULTED INVESTMENTS, comprising all investments that are in default as
to the payment of principal or interest, totaled $42.4 million of bonds at
March 31, 2004, which constituted approximately 0.6% of total invested assets.
At December 31, 2003, defaulted investments totaled $49.6 million, which
constituted approximately 0.7% of total invested assets. SOURCES OF LIQUIDITY are readily available to the Company in the form of
the Companys existing portfolio of cash and short-term investments, repo
capacity on invested assets and, if required, proceeds from invested asset
sales. The Companys liquidity is primarily derived from operating cash flows.
At March 31, 2004, approximately $4.86 billion of the Companys Bond Portfolio
had an aggregate unrealized gain of $274.8 million, while approximately $625.5
million of the Bond Portfolio had an aggregate unrealized loss of $30.9
million. In addition, the Companys investment portfolio currently provides
approximately $48.0 million of monthly cash flow from scheduled principal and
interest payments. Historically, cash flows from operations and from the sale
of the Companys annuity products have been more than sufficient in amount to
satisfy the Companys liquidity needs. Management is aware that prevailing market interest rates may shift
significantly and has strategies in place to manage either an increase or
decrease in prevailing rates. In a rising interest rate environment, the
Companys average cost of funds would increase over time as it prices its new
and renewing annuities to maintain a generally competitive market rate.
Management would seek to place new funds in investments that were matched in
duration to, and higher yielding than, the liabilities assumed. The Company
believes that liquidity to fund withdrawals would be available through incoming
cash flow, the sale of short-term or floating-rate instruments or repos on the
Companys substantial MBS segment of the Bond Portfolio, thereby avoiding the
sale of fixed-rate assets in an unfavorable bond market. In a declining rate environment, the Companys cost of funds would
decrease over time, reflecting lower interest crediting rates on its fixed
annuities. Should increased liquidity be required for withdrawals, the Company
believes that a significant portion of its investments could be sold without
adverse consequences in light of the general strengthening that would be
expected in the bond market. If a substantial portion of the Companys Bond Portfolio diminished
significantly in value and/or defaulted, the Company would need to liquidate
other portions of its investment portfolio and/or arrange financing. Such
events that may cause such a liquidity strain could be the result of economic
collapse or terrorist acts. Management believes that the Companys liquid assets and its net cash
provided by operations will enable the Company to meet any foreseeable cash
requirements for at least the next twelve months. GUARANTEES AND OTHER COMMITMENTS The Company has entered into seven agreements in which it has provided
liquidity support for certain short-term securities of municipalities and
non-profit organizations by agreeing to purchase such securities in the event
there is no other buyer in the short-term marketplace. In return the Company
receives a fee. In addition, the Company guarantees the payment of these
securities upon redemption. The maximum liability under these guarantees at
March 31, 2004 is $557.8 million. Related to each of these agreements are
participation agreements with the Companys Parent, under which the Parent will
share in $222.5 million of these liabilities in exchange for a proportionate
percentage of the fees received under these agreements. The expiration dates
of these commitments are as follows: $21.9 million in 2004, $385.9 million in
2005 and $150.0 million in 2006. The Internal Revenue Service has initiated
examinations into the transactions underlying these commitments, including the
Companys role in the transactions. The Company is fully cooperating with the
IRS. Management does not anticipate any material losses with respect to these
commitments. At March 31, 2004, the Company held reserves for GICs with maturity dates
as follows: $185.3 million in 2005 and $28.2 million in 2006 and thereafter. 31




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RECENTLY ISSUED ACCOUNTING STANDARDS In July 2003, the American Institute of Certified Public Accountants
issued Statement of Position 03-1, Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts (SOP 03-1). (For further discussion see Note 2 of Notes to
Financial Statements.) REGULATION The Company, in common with other insurers, is subject to regulation and
supervision by the states and jurisdictions in which it does business. Within
the United States, the method of such regulation varies but generally has its
source in statutes that delegate regulatory and supervisory powers to an
insurance official. The regulation and supervision relate primarily to
approval of policy forms and rates, the standards of solvency that must be met
and maintained, including risk based capital measurements, the licensing of
insurers and their agents, the nature of and limitations on investments,
restrictions on the size of risks which may be insured under a single policy,
deposits of securities for the benefit of policyholders, methods of accounting,
periodic examinations of the affairs of insurance companies, the form and
content of reports of financial condition required to be filed, and reserves
for unearned premiums, losses and other purposes. In general, such regulation
is for the protection of policyholders rather than security holders. Risk-based capital (RBC) standards are designed to measure the adequacy
of an insurers statutory capital and surplus in relation to the risks inherent
in its business. The standards are intended to help identify inadequately
capitalized companies and require specific regulatory actions in the event an
insurers RBC is deficient. The RBC formula develops a risk-adjusted target
level of adjusted statutory capital and surplus by applying certain factors to
various asset, premium and reserve items. Higher factors are applied to more
risky items and lower factors are applied to less risky items. Thus, the
target level of statutory surplus varies not only as a result of the insurers
size, but also on the risk profile of the insurers operations. The RBC Model
Law provides four incremental levels of regulatory attention for insurers whose
surplus is below the calculated RBC target. These levels of attention range in
severity from requiring the insurer to submit a plan for corrective action to
actually placing the insurer under regulatory control. The statutory capital
and surplus of the Company exceeded its RBC requirements as of March 31, 2004. The federal government does not directly regulate the business of
insurance, however, the Company and its products are governed by federal
agencies, including the SEC, the Internal Revenue Service, and the
self-regulatory organization, National Association of Securities Dealers, Inc.
(NASD). Federal legislation and administrative policies in several areas,
including financial services regulation, pension regulation and federal
taxation, can significantly and adversely affect the insurance industry. The
federal government has from time to time considered legislation relating to the
deferral of taxation on the accretion of value within certain annuities and
life insurance products, changes in ERISA regulations, the alteration of the
federal income tax structure and the availability of Section 401(k) and
individual retirement accounts. Although the ultimate effect of any such
changes, if implemented, is uncertain, both the persistency of our existing
products and our ability to sell products may be materially impacted in the
future. Recently there has been a significant increase in federal and state
regulatory activity relating to financial services companies, particularly
mutual fund companies and life insurers issuing variable annuity products.
These inquiries have focused on a number of issues including, among other
items, after-hours trading, short-term trading (sometimes referred to as market
timing), revenue sharing arrangements and greater transparency regarding
compensation arrangements. There are several rule proposals pending at the
SEC, the NASD and on a federal level, which, if passed, could have an impact on
the business of the Company and/or its subsidiaries. 32




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The quantitative and qualitative disclosures about market risk are
contained in the Asset-Liability Matching section of Managements Discussion
and Analysis of Financial Condition and Results of Operations on pages 29 to 30
herein. DISCLOSURE CONTROLS & PROCEDURES The Companys disclosure controls and procedures are designed to ensure
that information required to be disclosed in the reports that the Company files
or submits under the Securities Exchange Act of 1934, as amended (Exchange
Act), is recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange Commission.
Disclosure controls and procedures include controls and procedures designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the Companys management, including the Companys Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure. The Companys management, with the participation of the
Companys Chief Executive Officer and Chief Financial Officer, have evaluated
the effectiveness of the Companys disclosure controls and procedures as of the
end of the period covered by this report. Based on that evaluation, the
Companys Chief Executive Officer and Chief Financial Officer concluded that
the disclosure controls and procedures provide reasonable assurance of
effectiveness as of the end of the period covered by this report. In addition,
there has been no change in the Companys internal control over financial
reporting that occurred during the fiscal quarter covered by this report that
has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. 33




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##### Table of Contents



PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings Various lawsuits against the Company have arisen in the ordinary course of
business. Contingent liabilities arising from litigation, income taxes and
other matters are not considered material in relation to the financial
position, results of operations or cash flows of the Company. On April 5, 2004, a purported class action captioned NIKITA Mehta, as Trustee
of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case
04L0199, was filed in the Circuit Court, Twentieth Judicial District in St.
Clair County, Illinois. The lawsuit alleges certain improprieties in
conjunction with alleged market timing activities. The probability of any
particular outcome cannot be reasonably estimated at this time. 
 Item 2. Changes in Securities and Use of Proceeds Not applicable. 
 Item 3. Defaults Upon Senior Securities Not applicable. 
 Item 4. Submissions of Matters to a Vote of Security Holders Not applicable. 
 Item 5. Other Information Not applicable. 
 Item 6. Exhibits and Reports on Form 8-K EXHIBITS None. REPORTS FOR FORM 8-K There were no current reports on Form 8-K filed during the three months ended
March 31, 2004. 34




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. AIG SUNAMERICA LIFE ASSURANCE COMPANY RegistrantDate: May 14, 2004
    /s/ N. SCOTT GILLISN. Scott GillisSenior Vice President,
Chief Financial Officer
and Director Date: May 14, 2004
    /s/ STEWART POLAKOVStewart PolakovSenior Vice President and Controller
(Principal Accounting Officer) 35




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##### Table of Contents



Exhibit Index Exhibit10(a)
    
    Third Amendment to Subordinated Loan Agreement for Equity Capital, dated
as of March 12, 2004, between the Companys affiliate, SACS, and AIGRS,
extending the maturity date to April 30, 2008 and adjusting the interest
rate to 4% per annum for the unpaid principal under the Second Amendment
to Subordinated Loan Agreement for Equity Capital, dated as of February
27, 2003, defining AIGRS rights with respect to the 4.25% notes due April
30, 2005.10(b)
    
    Fourth Amendment to Subordinated Loan Agreement for Equity Capital,
dated as of March 12, 2004, between the Companys affiliate, SACS, and
AIGRS, extending the maturity date to April 30, 2008 and adjusting the
interest rate to 4% per annum for the unpaid principal under the Third
Amendment to Subordinated Loan Agreement for Equity Capital, dated
February 27, 2003, defining AIGRS rights with respect to 4.25% notes due
April 30, 2005.31.1
    
    Rule 13a-14(a)/15d-14(a) Certifications31.2
    
    Rule 13a-14(a)/15d-14(a) Certifications32
    
    Section 1350 Certifications
 36