##### Table of Contents



UNITED STATES
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
 For the quarterly period ended March 31, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from             to Commission File Number 33-47472 AIG SUNAMERICA LIFE ASSURANCE COMPANY Incorporated in Arizona
    
    86-0198983I.R.S. 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 þ No o INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE
12b-2 OF THE EXCHANGE ACT). Yes o No þ INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUERS CLASSES OF COMMON STOCK, AS
OF MAY 13, 2005: 3,511




---



AIG SUNAMERICA LIFE ASSURANCE COMPANY INDEX PageNumber(s)Part I  Financial InformationItem 1. Financial StatementsConsolidated Balance Sheet (Unaudited)  March 31, 2005 and December 31, 2004
    
    
    2-3Consolidated Statement of Operations and Comprehensive Income (Unaudited)  Three Months Ended March 31, 2005 and 2004
    
    
    4-5Consolidated Statement of Cash Flows (Unaudited)  Three Months Ended March 31, 2005 and 2004
    
    
    6-7Notes to Consolidated Financial Statements (Unaudited)
    
    
    8-11Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12-29Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4. Controls and Procedures
    
    
    29Part
II  Other InformationItem 1. Legal Proceedings
    
    
    30Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    30Item 3. Defaults Upon Senior Securities
    
    
    30Item 4. Submission of Matters to a Vote of Security Holders
    
    
    30Item 5. Other Information
    
    
    30Item 6. Exhibits
    
    
    30Exhibit 31.1Exhibit 31.2Exhibit 32
  1




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY 
   March 31,
    
    
    December 31,2005
    
    
    2004(in thousands)ASSETSInvestments and cash:Cash and short-term investments
    
    $
    363,187
    
    
    $
    201,117Bonds, notes and redeemable preferred stocks
available for sale, at fair value (amortized
cost: March 31, 2005, $4,846,125; December 31,
2004, $4,987,728)
    
    
    4,912,725
    
    
    
    5,139,477Mortgage loans
    
    
    638,870
    
    
    
    624,179Policy loans
    
    
    180,801
    
    
    
    185,958Mutual funds
    
    
    20,694
    
    
    
    6,131Common stocks available for sale, at fair value
(cost: March 31, 2005, $25,015; December 31,
2004, $25,015)
    
    
    27,513
    
    
    
    26,452Securities lending collateral
    
    
    825,030
    
    
    
    883,792Other invested assets
    
    
    38,191
    
    
    
    58,880Total investments and cash
    
    
    7,007,011
    
    
    
    7,125,986Variable annuity assets held in separate accounts
    
    
    22,291,190
    
    
    
    22,612,451Accrued investment income
    
    
    74,371
    
    
    
    73,769Deferred acquisition costs
    
    
    1,378,568
    
    
    
    1,349,089Other deferred expenses
    
    
    257,920
    
    
    
    257,781Income taxes currently receivable from Parent
    
    
    19,404
    
    
    
    9,945Goodwill
    
    
    14,038
    
    
    
    14,038Other assets
    
    
    52,317
    
    
    
    52,956TOTAL ASSETS
    
    $
    31,094,819
    
    
    $
    31,496,015
 See accompanying notes to consolidated financial statements. 2




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED BALANCE SHEET (Continued)
(Unaudited) March 31,
    
    
    December 31,2005
    
    
    2004(in thousands)LIABILITIES AND SHAREHOLDERS EQUITYReserves, payables and accrued liabilities:Reserves for fixed annuity and fixed accounts of
variable annuity contracts
    
    $
    3,860,908
    
    
    $
    3,948,158Reserves for universal life insurance contracts
    
    
    1,517,159
    
    
    
    1,535,905Reserves for guaranteed investment contracts
    
    
    216,052
    
    
    
    215,331Reserves for guaranteed benefits
    
    
    77,182
    
    
    
    76,949Securities lending payable
    
    
    825,030
    
    
    
    883,792Due to affiliates
    
    
    19,621
    
    
    
    21,655Payable to
brokers
    
    
    118,922
    
    
    
    Other liabilities
    
    
    168,383
    
    
    
    190,198Total reserves, payables and accrued liabilities
    
    
    6,803,257
    
    
    
    6,871,988Variable annuity liabilities related to separate accounts
    
    
    22,291,190
    
    
    
    22,612,451Deferred income taxes
    
    
    264,269
    
    
    
    257,532Total liabilities
    
    
    29,358,716
    
    
    
    29,741,971Shareholders equity:Common stock
    
    
    3,511
    
    
    
    3,511Additional paid-in capital
    
    
    760,990
    
    
    
    758,346Retained earnings
    
    
    940,241
    
    
    
    919,612Accumulated other comprehensive income
    
    
    31,361
    
    
    
    72,575Total shareholders equity
    
    
    1,736,103
    
    
    
    1,754,044TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    31,094,819
    
    
    $
    31,496,015
 See accompanying notes to consolidated financial statements. 3




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY 
    2005
    
    
    2004(in thousands)REVENUESFee income:Variable annuity policy fees, net of reinsurance
    
    $
    102,605
    
    
    $
    87,015Asset management fees
    
    
    20,733
    
    
    
    22,097Universal life insurance policy fees, net of reinsurance
    
    
    8,558
    
    
    
    9,192Surrender charges
    
    
    6,555
    
    
    
    6,999Other fees
    
    
    3,718
    
    
    
    3,621Total fee income
    
    
    142,169
    
    
    
    128,924Investment income
    
    
    82,433
    
    
    
    90,954Net realized investment gains (losses)
    
    
    17,687
    
    
    
    (15,177
    )Total revenues
    
    
    242,289
    
    
    
    204,701BENEFITS AND EXPENSESInterest expense:Fixed annuity and fixed accounts of variable annuity contracts
    
    
    31,831
    
    
    
    35,236Universal life insurance contracts
    
    
    17,672
    
    
    
    18,481Guaranteed investment contracts
    
    
    1,971
    
    
    
    1,335Subordinated notes payable to affiliates
    
    
    
    
    
    
    560Total interest expense
    
    
    51,474
    
    
    
    55,612Amortization of bonus interest
    
    
    3,209
    
    
    
    1,938Claims on universal life contracts, net of reinsurance recoveries
    
    
    5,356
    
    
    
    4,823Guaranteed minimum death benefits, net of reinsurance recoveries
    
    
    11,203
    
    
    
    17,774General and administrative expenses
    
    
    33,690
    
    
    
    36,224Amortization of deferred acquisition costs and other deferred expenses
    
    
    51,997
    
    
    
    29,504Annual commissions
    
    
    18,353
    
    
    
    15,014Total benefits and expenses
    
    
    175,282
    
    
    
    160,889PRETAX INCOME BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE
    
    
    67,007
    
    
    
    43,812Income tax expense
    
    
    19,275
    
    
    
    12,196INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
    
    
    47,732
    
    
    
    31,616Cumulative effect of accounting change, net of tax
    
    
    
    
    
    
    (62,589
    )NET INCOME (LOSS)
    
    $
    47,732
    
    
    $
    (30,973
    )
 See accompanying notes to consolidated financial statements. 4




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (Continued)
For the three months ended March 31, 2005 and 2004
(Unaudited) 2005
    
    
    2004(in thousands)OTHER COMPREHENSIVE INCOME, NET OF TAX:Net unrealized gains (losses) on debt and equity
securities available for sale identified in the
current period less related amortization of
deferred acquisition costs and other deferred
expenses
    
    $
    (56,489
    )
    
    $
    65,852Less reclassification adjustment for net realized
(gains) losses included in net income
    
    
    (6,602
    )
    
    
    7,414Net unrealized losses on foreign currency
    
    
    (316
    )
    
    
    Income tax (expense) benefit
    
    
    22,193
    
    
    
    (25,643
    )OTHER COMPREHENSIVE INCOME (LOSS)
    
    
    (41,214
    )
    
    
    47,623COMPREHENSIVE INCOME
    
    $
    6,518
    
    
    $
    16,650
 See accompanying notes to consolidated financial statements. 5




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY 
    2005
    
    
    2004(in thousands)CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    47,732
    
    
    $
    (30,973
    )Adjustments to reconcile net income (loss) to net cash provided by
operating activities:Cumulative effect of accounting change, net of tax
    
    
    
    
    
    
    62,589Interest credited to:Fixed annuity and fixed accounts of variable annuity contracts
    
    
    31,831
    
    
    
    35,236Universal life insurance contracts
    
    
    17,672
    
    
    
    18,481Guaranteed investment contracts
    
    
    1,971
    
    
    
    1,335Net realized investment (gains) losses
    
    
    (17,687
    )
    
    
    15,177Amortization of net premium/accretion of net discount on investments
    
    
    2,574
    
    
    
    (235
    )Amortization of deferred acquisition costs and other expenses
    
    
    55,206
    
    
    
    31,442Acquisition costs deferred
    
    
    (54,503
    )
    
    
    (65,611
    )Other expenses deferred
    
    
    (8,821
    )
    
    
    (10,614
    )Provision for deferred income taxes
    
    
    28,930
    

    
    
    (12,055
    )Change in:Accrued investment income
    
    
    (602
    )
    
    
    (1,575
    )Other assets
    
    
    478
    
    
    
    (13,189
    )Income taxes currently payable to/receivable from Parent
    
    
    (9,459
    )
    
    
    59,718Due from/to affiliates
    
    
    (2,034
    )
    
    
    (5,743
    )Other liabilities
    
    
    (11,184
    )
    
    
    (14,619
    )Other, net
    
    
    (1,369
    )
    
    
    4,725NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    80,735
    
    
    
    74,089CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of:Bonds, notes and redeemable preferred stocks
    
    
    (214,823
    )
    
    
    (708,678
    )Mortgage loans
    
    
    (32,575
    )
    
    
    Other investments, excluding short-term investments
    
    
    (25,448
    )
    
    
    (88
    )Sales of:Bonds, notes and redeemable preferred stocks
    
    
    266,714
    
    
    
    592,988Other investments, excluding short-term investments
    
    
    36,577
    
    
    
    485Redemptions and maturities of:Bonds, notes and redeemable preferred stocks
    
    
    207,365
    
    
    
    224,361Mortgage loans
    
    
    18,120
    
    
    
    17,469Other investments, excluding short-term investments
    
    
    5,243
    
    
    
    5,237NET CASH PROVIDED BY INVESTING ACTIVITIES
    
    $
    261,173
    
    
    $
    131,774
 See accompanying notes to consolidated financial statements. 6




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
For the three months ended March 31, 2005 and 2004
(Unaudited) 2005
    
    
    2004(in thousands)CASH FLOWS FROM FINANCING ACTIVITIES:Deposits received on:Fixed annuity and fixed accounts of variable annuity contracts
    
    $
    296,835
    
    
    $
    372,567Universal life insurance contracts
    
    
    10,814
    
    
    
    11,252Net exchanges from the fixed accounts of variable annuity
contracts
    
    
    (260,709
    )
    
    
    (386,957
    )Withdrawal payments on:Fixed annuity and fixed accounts of variable annuity contracts
    
    
    (134,730
    )
    
    
    (104,031
    )Universal life insurance contracts
    
    
    (17,233
    )
    
    
    (17,414
    )Guaranteed investment contracts
    
    
    (1,250
    )
    
    
    (5,583
    )Claims and annuity payments, net of reinsurance, on:Fixed annuity and fixed accounts of variable annuity contracts
    
    
    (26,124
    )
    
    
    (28,281
    )Universal life insurance contracts
    
    
    (22,441
    )
    
    
    (31,097
    )Net payment related to a modified coinsurance transaction
    
    
    
    
    
    
    (4,738
    )Dividend paid to Parent
    
    
    (25,000
    )
    
    
    (2,500
    )NET CASH USED IN FINANCING ACTIVITIES
    
    
    (179,838
    )
    
    
    (196,782
    )NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS
    
    
    162,070
    
    
    
    9,081CASH AND SHORT-TERM INVESTMENTS
AT BEGINNING OF PERIOD
    
    
    201,117
    
    
    
    133,105CASH AND SHORT-TERM INVESTMENTS
AT END OF PERIOD
    
    $
    363,187
    
    
    $
    142,186SUPPLEMENTAL CASH FLOW INFORMATION:Interest paid on indebtedness
    
    $
    
    
    
    $
    560Income taxes (received from) paid to Parent
    
    $
    (196
    )
    
    $
    47,424
 See accompanying notes to consolidated financial statements. 7




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY 
    1.
    BASIS OF PRESENTATIONThese statements are unaudited. In the opinion of management, all adjustments consisting only of
normal recurring accruals have been made for a fair statement of the results presented herein.
Certain amounts have been reclassified in the 2004 financial statements to conform to their 2005
presentation. For further information, refer to the Annual Report on Form 10-K of AIG SunAmerica
Life Assurance Company (the Company) for the year ended December 31, 2004.2.
    COMMITMENTS AND CONTINGENT LIABILITIESThe Company has six agreements outstanding in which it has provided liquidity support for certain
short-term securities of municipalities and non-profit organizations by agreeing to purchase such
securities in the event there is no other buyer in the short-term marketplace. In return the
Company receives a fee. In addition, the Company guarantees the payment of these securities upon
redemption. The maximum liability under these guarantees at March 31, 2005 is $195,442,000. The
expiration dates of these commitments are as follows: $81,012,000 in the remainder of 2005 and
$114,430,000 in 2006. Related to each of these agreements are participation agreements with
SunAmerica Life Insurance Company, the Companys immediate
parent, (the Parent) under which the Parent will share in $62,590,000
of these liabilities in exchange for a proportionate percentage of the fees received under these
agreements.At March 31, 2005, the Company has a commitment to purchase a total of approximately $4,000,000 of
asset-backed securities in the ordinary course of business. This commitment has a contractual
maturity date in 2006.A purported class action captioned Nitika Mehta, as Trustee
of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance
Company, Case 04L0199, was filed on April 5, 2004 in the Circuit
Court, Twentieth Judicial District in St. Clair County,
Illinois. The action has been transferred to and is currently pending
in the United States District Court for the District of Maryland,
Case No. 04-md-15863, as part of a Multi-District Litigation
proceeding. 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.Various federal, state and other regulatory agencies are reviewing certain transactions and
practices of the Company and its subsidiaries in connection with industry-wide and other inquiries.
In the opinion of the Companys management, based on the current status of these inquiries, it is
not likely that any of these inquiries will have a material adverse effect on the Companys
consolidated financial position, results of operations or cash flows of the Company.Various lawsuits against the Company and its subsidiaries have arisen in the ordinary course of
business. Contingent liabilities arising from litigation, income taxes and regulatory and other
matters are not considered material in relation to the consolidated financial position, results of
operations or cash flows of the Company.3.
    RELATED PARTY TRANSACTIONOn May 1, 2005, American International Group, Inc. (AIG), the Companys ultimate parent, publicly
expressed its intent to include in its restated financial statements for 2000 through 2003 and its financial
statements for 2004 to be included in AIGs Annual Report on Form 10-K for the year ended December 31,
2004 when filed, adjustments attributable to compensation expense related to the SICO Deferred
Compensation Profit Participation Plan (the SICO Plan). As a result of AIGs expressed intent to record
such compensation expense, the Company has determined that, as a subsidiary of AIG, it is appropriate to
record the compensation expense related to its employees participation in the SICO Plan.As total SICO compensation expense for each prior year would not have been material to any such prior
year, in the first quarter of 2005, the Company has recorded the total amount of compensation expense
related to the SICO Plan that would have been recorded in all prior periods through December 31, 2004 as
a reduction of retained earnings on the consolidated balance sheet of $2,103,000, with a corresponding
increase to additional paid-in capital, and with no effect on total shareholders equity or cash flows.
Compensation expense related to the SICO Plan for the first quarter of 2005 was $541,000 and included in
general and administrative expenses in the consolidated statement of operations and comprehensive
income. The Company will record compensation expense related to the SICO Plan for all future periods.In making this determination, the Company has evaluated the impact that expense recognition would have
had on all prior years to which SICO Plan compensation would have applied. In addition, these amounts
have been calculated as variable stock awards, which consider the fair market value of AIG common stock
at each measurement date, and would include any distributions made under the SICO Plan.In 1975, the voting shareholders and Board of Directors of Starr International Company (SICO), a private
holding company whose principal asset consists of approximately 12% of AIGs outstanding common
stock as of January 31, 2005, decided that a portion of the capital value of SICO (AIG shares of their cash
equivalent) should be used to provide an incentive plan for the current and succeeding managements of all
AIG companies, including the Company. None of the costs of the various benefits provided under the
SICO Plan were paid by the Company. 8




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  4.
    SUBSEQUENT EVENTAIG has announced that it
has delayed filing its Annual Report on form 10-K for the year ended December 31, 2004 to allow
AIGs Board of Directors and new management adequate time to complete an extensive review of AIGs
books and records. The review includes issues arising from pending investigations into
non-traditional insurance products and certain assumed reinsurance transactions by the Office of
the Attorney General for the State of New York and the Securities and Exchange Commission and from
AIGs decision to review the accounting treatment of certain
additional items. AIG has announced that the findings of that review
have resulted in AIGs decision to
restate its financial statements for the years ended
December 31, 2003, 2002, 2001 and 2000, the quarters ended
March 31, June 30 and September 30, 2004 and 2003 and the
quarter ended December 31, 2003. Circumstances
affecting AIG can have an impact on the Company. For example,
beginning in March 2005, the major rating agencies downgraded the
ratings of AIG in a series of actions which resulted in downgrades
and ratings actions being taken with respect to the Companys
financial strength ratings. Accordingly,
management can give no assurance that any further changes in
circumstances for AIG will not impact the Company.5.
    SEGMENT INFORMATIONThe Company conducts its business through two business segments, annuity operations and asset
management operations. Annuity operations consists of the sale and administration of deposit-type
insurance contracts, including fixed and variable annuity contracts, universal life insurance
contracts and guaranteed investment contracts. Asset management operations, which includes the
managing, distributing and administering a diversified family of mutual funds, managing certain
subaccounts offered within the Companys variable annuity products and providing professional
management of individual, corporate and pension plan portfolios, is conducted by AIG SunAmerica
Asset Management Corp. and its subsidiary and distributor, AIG SunAmerica Capital Services, Inc.,
and its subsidiary and servicing administrator, AIG SunAmerica Fund Services, Inc.. Following is
selected information pertaining to the Companys business segments. 9




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  5.
    SEGMENT INFORMATION (Continued) AssetAnnuity
    
    
    ManagementOperations
    
    
    Operations
    
    
    Total(in thousands)THREE MONTHS ENDED
MARCH 31, 2005:REVENUES:Fee income:Variable annuity policy fees, net of reinsurance
    
    $
    102,605
    
    
    $
    
    
    
    $
    102,605Asset management fees
    
    
    
    
    
    
    20,733
    
    
    
    20,733Universal life insurance policy fees, net of reinsurance
    
    
    8,558
    
    
    
    
    
    
    
    8,558Surrender charges
    
    
    6,555
    
    
    
    
    
    
    
    6,555Other fees
    
    
    
    
    
    
    3,718
    
    
    
    3,718Total fee income
    
    
    117,718
    
    
    
    24,451
    
    
    
    142,169Investment income
    
    
    81,897
    
    
    
    536
    
    
    
    82,433Net realized investment gains (losses)
    
    
    17,841
    
    
    
    (154
    )
    
    
    17,687Total revenues
    
    
    217,456
    
    
    
    24,833
    
    
    
    242,289BENEFITS AND EXPENSES:Interest expense
    
    
    51,474
    
    
    
    
    
    
    
    51,474Amortization of bonus interest
    
    
    3,209
    
    
    
    
    
    
    
    3,209Claims on universal life contracts, net of reinsurance recoveries
    
    
    5,356
    
    
    
    
    
    
    
    5,356Guaranteed benefits, net of reinsurance recoveries
    
    
    11,203
    
    
    
    
    
    
    
    11,203General and administrative expenses
    
    
    24,296
    
    
    
    9,394
    
    
    
    33,690Amortization of deferred acquisition costs and other deferred expenses
    
    
    44,291
    
    
    
    7,706
    
    
    
    51,997Annual commissions
    
    
    18,353
    
    
    
    
    
    
    
    18,353Total benefits and expenses
    
    
    158,182
    
    
    
    17,100
    
    
    
    175,282Pretax income before cumulative effect of accounting change
    
    $
    59,274
    
    
    $
    7,733
    
    
    $
    67,007Total assets
    
    $
    30,886,653
    
    
    $
    208,166
    
    
    $
    31,094,819Expenditures for long-lived assets
    
    $
    
    
    
    $
    16
    
    
    $
    16
 10




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  5.
    BUSINESS SEGMENTS (Continued) AssetAnnuity
    
    
    ManagementOperations
    
    
    Operations
    
    
    Total(in thousands)THREE MONTHS ENDED
MARCH 31, 2004:REVENUES:Fee income:Variable annuity policy fees, net of reinsurance
    
    $
    87,015
    
    
    $
    
    
    
    $
    87,015Asset management fees
    
    
    
    
    
    
    22,097
    
    
    
    22,097Universal life insurance policy fees, net of reinsurance
    
    
    9,192
    
    
    
    
    
    
    
    9,192Surrender charges
    
    
    6,999
    
    
    
    
    
    
    
    6,999Other fees
    
    
    
    
    
    
    3,621
    
    
    
    3,621Total fee income
    
    
    103,206
    
    
    
    25,718
    
    
    
    128,924Investment income
    
    
    90,777
    
    
    
    177
    
    
    
    90,954Net realized investment losses
    
    
    (15,177
    )
    
    
    
    
    
    
    (15,177
    )Total revenues
    
    
    178,806
    
    
    
    25,895
    
    
    
    204,701BENEFITS AND EXPENSES:Interest expense
    
    
    55,052
    
    
    
    560
    
    
    
    55,612Amortization of bonus interest
    
    
    1,938
    
    
    
    
    
    
    
    1,938Claims on universal life contracts, net of reinsurance recoveries
    
    
    4,823
    
    
    
    
    
    
    
    4,823Guaranteed benefits, net of reinsurance recoveries
    
    
    17,774
    
    
    
    
    
    
    
    17,774General and administrative expenses
    
    
    27,328
    
    
    
    8,896
    
    
    
    36,224Amortization of deferred acquisition costs and other deferred expenses
    
    
    22,063
    
    
    
    7,441
    
    
    
    29,504Annual commissions
    
    
    15,014
    
    
    
    
    
    
    
    15,014Total benefits and expenses
    
    
    143,992
    
    
    
    16,897
    
    
    
    160,889Pretax income before cumulative effect of accounting change
    
    $
    34,814
    
    
    $
    8,998
    
    
    $
    43,812Total assets
    
    $
    28,902,900
    
    
    $
    178,728
    
    
    $
    29,081,628Expenditures for long-lived assets
    
    $
    
    
    
    $
    45
    
    
    $
    45
 11




---



##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY 
   Managements discussion and analysis of financial condition and results of operations of AIG
SunAmerica Life Assurance Company (the Company) for the three months ended March 31, 2005
(2005), and March 31, 2004 (2004) 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. OVERVIEW The Companys primary activities are retirement services, herein discussed as annuity
operations and asset management operations. The annuity operations consist of the sale and
administration of deposit-type insurance contracts, such as variable and fixed annuity contracts,
universal life insurance contracts and guaranteed investment contracts (GICs). The asset
management operations are conducted by the Companys registered investment advisor subsidiary, AIG
SunAmerica Asset Management Corp (SAAMCo), and its wholly owned distributor, AIG SunAmerica
Capital Services, Inc. (SACS), and its wholly owned servicing administrator, AIG SunAmerica Fund
Services, Inc. (SFS). The Company ranks among the largest U.S. issuers of variable annuity contracts. The Company
distributes its products and services through an extensive network of independent broker-dealers,
full-service securities firms and financial institutions. In prior years, GICs were marketed
directly to banks, municipalities, asset management firms and direct plan sponsors and through
intermediaries, such as managers or consultants servicing these groups. In addition to distributing
its variable annuity products through its nine affiliated broker-dealers, the Company distributes
its products through a vast network of independent broker-dealers, full-service securities firms
and financial institutions. In total, more than 84,000 independent sales representatives are
appointed to sell the Companys annuity products. The Companys nine affiliated broker-dealers are
among the largest networks of registered representatives in the nation. The Company believes that demographic trends have produced strong consumer demand for
long-term, investment-oriented products. According to U.S. Census Bureau projections, the number of
individuals between the ages of 45 to 64 grew from 51 million to 69 million from 1994 to 2003,
making this age group the fastest-growing segment of the U.S. population. Between 1994 and 2003,
annual industry premiums from fixed and variable annuities increased from $155 billion to $267
billion. Benefiting from continued strong growth of the retirement savings market, industry sales of
tax-deferred savings products have represented, for a number of years, a significantly larger
source of new premiums for the U.S. life insurance industry than have traditional life insurance
products. Recognizing the growth potential of this market, the Company focuses its life operations
on the sale of variable annuity contracts. In recent years, the Company has enhanced its marketing
efforts and expanded its offerings of fee-based variable annuity contracts. Variable accounts
within the Companys variable annuity business entail no portfolio credit risk and requires
significantly less capital support than the fixed accounts of variable annuity contracts (Fixed
Options), which generate net investment income. RECENT DEVELOPMENTS The
Companys ultimate parent, American International Group, Inc.
(AIG), has announced that it has delayed filing its
Annual Report on Form 10-K for the year ended December 31,
2004 to allow AIGs Board of Directors and new management
adequate time to complete an extensive review of AIGs books and
records. The review includes issues arising from pending
investigations into non-traditional insurance products and certain
assumed reinsurance transactions by the Office of the Attorney
General for the State of New York and the Securities and Exchange
Commission and from AIGs decision to review the accounting
treatment of certain additional items. AIG has announced that the
findings of that review have resulted in AIGs decision to
restate its financial statements for the years ended
December 31, 2003, 2002, 2001 and 2000, the quarters ended
March 31, June 30 and September 30, 2004 and 2003 and
the quarter ended December 31, 2003. Circumstances affecting AIG
can have an impact on the Company. For example, beginning in
March 2005, the major rating agencies downgraded the ratings of
AIG in a series of actions which resulted in downgrades and ratings
actions being taken with respect to the Companys financial strength ratings. Accordingly, management can give no assurance that
any further changes in circumstances for AIG will not impact the
Company. 12




---



##### Table of Contents



CRITICAL ACCOUNTING ESTIMATES The
Company considers its most critical accounting estimates those used with respect to
valuation of certain financial instruments, amortization of deferred acquisition costs (DAC) and
other deferred expenses and valuation of the reserve for guaranteed benefits. In the
implementation of each of the aforementioned policies, management is required to exercise its
judgment on both a quantitative and qualitative basis. Further explanation of how management
exercises that judgment follows. VALUATION OF CERTAIN FINANCIAL INSTRUMENTS: Gross unrealized losses on debt and equity
securities available for sale amounted to $43.7 million at March 31, 2005. 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 $729.4 million at
March 31, 2005 do not have readily determinable market prices. For these securities, the Company
estimates the fair value with internally prepared valuations (including those based on estimates of
future profitability). Otherwise, the Company uses its most recent purchases and sales of similar
unquoted securities, independent broker quotes or comparison to similar securities with quoted
prices when possible to estimate the fair value of those securities. All such securities are
classified as available for sale. The Companys ability to liquidate its positions in these
securities will be impacted to a significant degree by the lack of an actively traded market, and
the Company may not be able to dispose of these investments in a timely manner. Although the
Company believes its estimates reasonably reflect the fair value of those securities, the key assumptions about the risk-free interest rates,
risk premiums, performance of underlying collateral, if any, and other factors may not reflect
those of an active market. AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES: Policy acquisition
costs include commissions and other costs that vary with, and are primarily related to, the
production or acquisition of new business. Such costs are deferred and amortized over the
estimated lives of the annuity contracts. Approximately 85% of the amortization of DAC and other
deferred expenses was attributed to policy acquisition costs deferred by the annuity operations and
15% was attributed to the distribution costs deferred by the asset management operations. For the
annuity operations, the Company amortizes DAC and other deferred expenses based on a percentage of
expected gross profits (EGPs) over the life of the underlying policies. 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 options of the variable
annuity contracts) or general account assets (with respect to fixed annuity contracts, Fixed Options and universal life insurance contracts)
supporting these obligations, costs of providing contract guarantees and the level of expenses
necessary to administer the policies. The Company adjusts amortization of DAC and other deferred
expenses (a DAC unlocking) when current or estimates of future gross profits to be realized from
its annuity contracts are revised as more fully described below. Substantially all of the DAC
balance attributed to annuity operations at March 31, 2005 related to variable annuity contracts. DAC amortization on annuities is impacted by 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 Options, the growth rate depends on the yield on the general
account assets supporting those annuity contracts. With respect to the variable options of the
variable annuity contracts, 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 rate of the separate
account assets in the determination of DAC amortization with respect to its variable annuity
contracts is 10% (the long-term growth rate assumption). The Company uses a reversion to the
mean methodology that allows it to maintain this 10% long-term growth rate assumption, while also
giving consideration to the effect of short-term swings in the equity markets. For example, if
performance was 15% during the first year following the introduction of a product, the DAC model
would assume that market returns for the following five years (the short-term growth rate
assumption) would be approximately 9%, resulting in an average annual growth rate of 10% during
the life of the product. Similarly, following periods of below 10% performance, the model will
assume a short-term growth rate higher than 10%. A DAC unlocking will occur if management deems
the short-term growth rate assumption (i.e., the growth rate required to revert to the mean 10%
growth rate over a five-year period) to be unreasonable. The use of a reversion to the mean
assumption is common within the industry; however, the parameters used in the methodology are
subject to judgment and vary within the industry. For the asset management operations, the Company defers distribution costs that are directly
related to the sale of mutual funds that have a 12b-1 distribution plan and/or a contingent
deferred sales charge feature (collectively, Distribution Fee Revenue). These costs are
amortized on a straight-line basis, adjusted for redemptions, over a period ranging from one year
to eight years depending on share class. The carrying value of the deferred asset is subject to
continuous review based on projected Distribution Fee Revenue. Amortization of deferred
distribution costs is increased if at any reporting period the value of the deferred amount exceeds
the projected Distribution Fee Revenue. The projected Distribution Fee Revenue is impacted by
estimated future withdrawal rates and the rates of market return. Management uses historical
activity to estimate future withdrawal rates and average annual performance of the equity markets
to estimate the rates of market return. RESERVE FOR GUARANTEED BENEFITS: Pursuant to the adoption of Statement of Position 03-1,
Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts (SOP 03-1) which was adopted on January 1, 2004, the Company
is required to recognize a liability for guaranteed minimum death benefits and other guaranteed
benefits. In calculating the projected liability, five thousand stochastically generated
investment performance scenarios were developed using the Companys bestestimates. These
assumptions included, among others, mean equity return and volatility, mortality rates and lapse 13




---



##### Table of Contents



rates. The estimation of cash flow and the determination of the assumptions used require
judgment, which can, at times, be subjective. Several of the guaranteed benefits are sensitive to equity market conditions. The Company
uses the purchase of reinsurance and capital market hedging strategies to mitigate the risk of
paying benefits in excess of account values as a result of significant downturns in equity markets.
Risk mitigation may or may not reduce the volatility of net income resulting from equity market
volatility. Reinsurance or hedges are secured when the cost is less than the risk reduction. The
Company expects to use either additional reinsurance or capital market hedges for risk mitigation
on an opportunistic basis. Despite the purchase of reinsurance or hedges, the reinsurance or hedge
secured may be inadequate to completely offset the effects of changes in equity markets. BUSINESS SEGMENTS The Company has two business segments: annuity operations and asset management operations.
The annuity operations consist of the sale and administration of deposit-type insurance contracts,
such as variable and fixed annuity contracts, universal life insurance contracts and guaranteed
investment contracts. The Company focuses primarily on the marketing of variable annuity products.
The variable annuity products offer investors a broad spectrum of fund alternatives, with a choice
of investment managers, as well as Fixed Options. The Company earns fee income on amounts invested
in the variable account options and net investment spread on the Fixed Options. The asset management operations are conducted by the Companys registered investment advisor
subsidiary, SAAMCo, and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS. These companies earn fee income by managing, distributing
and administering a diversified family of mutual funds, servicing as investment advisor to certain
variable investment portfolios offered within the Companys variable annuity products and providing
professional management of individual, corporate and pension plan portfolios. RESULTS OF OPERATIONS NET
INCOME totaled $47.7 million in 2005, compared with net loss of $ 31.0 million in 2004. 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 $67.0 million in 2005,
compared with $43.8 million in 2004. The increase in 2005 compared to 2004 was primarily due to
higher variable annuity policy fees and net investment gains, partially offset by higher
amortization of DAC and other deferred expenses. INCOME TAX EXPENSE totaled $19.3 million in 2005 and $12.2 million in 2004 representing
effective tax rates of 29% and 28%, respectively. ANNUITY OPERATIONS PRETAX
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $59.3 million in 2005,
compared with $34.8 million in 2004. The increase in 2005 compared to 2004 was primarily due to
higher variable annuity policy fee income, higher net realized investment gains and lower expenses,
partially offset by higher amortization of DAC and other expenses. NET INVESTMENT SPREAD, a non-GAAP measure, represents investment income less interest credited
to Fixed Options, fixed annuity contracts, guaranteed investment contracts and universal life
insurance contracts (collectively Fixed-Rate Products) is a key measurement used by the Company
in evaluating the profitability of its annuity business. Investment income includes income earned
on invested assets, as well as the mark-to-market on 14




---



##### Table of Contents



both purchased derivatives and embedded derivatives inherent in certain product guarantees.
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 collateral received from a securities lending
program, which is offset by a securities lending payable in the same amount. The Company
participates in a securities lending program with an affiliated agent, pursuant to which it lends
its securities and primarily takes cash as collateral with respect to the securities lent.
Participation in securities lending agreements provides additional net investment income for the
Company, resulting from investment income earned on the collateral, less interest paid on the
securities lending agreements and the related management fees paid to an affiliate to administer
the program. An analysis of net investment spread and a reconciliation to pretax income before cumulative
effect of accounting change is presented in the following table: Three months ended March 31,2005
    
    
    2004(in thousands)Investment income
    
    $
    81,897
    
    
    $
    90,777Interest credited to fixed annuity contracts and Fixed
Options
    
    
    (31,831
    )
    
    
    (35,236
    )Interest credited to universal life insurance contracts
    
    
    (17,672
    )
    
    
    (18,481
    )Interest credited to guaranteed investment contracts
    
    
    (1,971
    )
    
    
    (1,335
    )Net investment spread
    
    
    30,423
    
    
    
    35,725Net realized investment gains (losses)
    
    
    17,841
    
    
    
    (15,177
    )Amortization of bonus interest
    
    
    (3,209
    )
    
    
    (1,938
    )Claims on UL contracts, net of reinsurance recoveries
    
    
    (5,356
    )
    
    
    (4,823
    )Guaranteed benefits, net of reinsurance recoveries
    
    
    (11,203
    )
    
    
    (17,774
    )Fee income, net of reinsurance
    
    
    117,718
    
    
    
    103,206General and administrative expenses
    
    
    (24,296
    )
    
    
    (27,328
    )Amortization of DAC and other deferred expenses
    
    
    (44,291
    )
    
    
    (22,063
    )Annual commissions
    
    
    (18,353
    )
    
    
    (15,014
    )Pretax income before cumulative effect of accounting
change
    
    $
    59,274
    
    
    $
    34,814
 Net
investment spread totaled $30.4 million in 2005, compared with
$35.7 million in 2004.
These amounts equal 2.05% on average invested assets (computed on a daily basis) of $5.93 billion
in 2005 and 2.28% on average invested assets of $6.28 billion in 2004. The
decrease in the spread reflects the reinvesting in the historically low prevailing interest rate
environment that persisted for most of 2004. 15




---



##### Table of Contents



The components of net investment spread were as follows: Three months ended March 31,2005
    
    
    2004(in thousands)Net investment spread
    
    $
    30,423
    
    
    $
    35,725Average invested assets
    
    
    5,925,825
    
    
    
    6,279,002Average interest-bearing liabilities
    
    
    5,622,317
    
    
    
    6,006,388Yield on average invested assets
    
    
    5.53
    %
    
    
    5.78
    %Rate paid on average interest bearing liabilities
    
    
    3.66
    
    
    
    3.67Difference between yield and interest rate paid
    
    
    1.87
    %
    
    
    2.11
    %Net investment spread as a percentage of average
invested assets
    
    
    2.05
    %
    
    
    2.28
    %
 The decline in average invested assets resulted primarily from net exchanges from Fixed
Options into the separate accounts of variable annuity contracts, partially offset by new deposits
of Fixed Options. Deposits of Fixed Options and renewal deposits on its universal life insurance
contracts totaled $307.6 million in 2005 and $383.8 million in 2004, and are primarily deposits for
the Fixed Options. On an annualized basis, these deposits represent 22% in 2005 and 26% in 2004,
of the related reserve balances at the beginning of the respective periods. Net investment spread includes 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 $303.5 million in 2005, compared with $272.6
million in 2004. The difference between the Companys yield on average invested assets and the
rate paid on average interest-bearing liabilities was 1.87% in 2005
and 2.11% in 2004. Investment
income (and the related yields on average invested assets) totaled
$81.9 million
(5.53%) in 2005, compared with $90.8 million (5.78%) in 2004.
The decrease in the investment yield reflects the reinvesting in the historically low
prevailing interest rate environment that persisted for most of 2004. Expenses incurred to manage
the investment portfolio amounted to $0.9 million in 2005 and $1.1 million in 2004. These expenses
are included as a reduction of investment income in the consolidated statement of operations and
comprehensive income. Interest expense (and the related rate paid on average interest-bearing liabilities) totaled
$51.5 million (3.66%) in 2005 and $55.1 million (3.67%) in 2004. Interest-bearing liabilities
averaged $5.62 billion during 2005 and $6.01 billion during 2004. NET REALIZED INVESTMENT GAINS/LOSSES totaled $17.8 million of gains in 2005 and $15.2 million
of losses in 2004. The net realized gain in 2005 included a $3.9 million in net gain from the mark
to market of the S&P 500 put options and the GMAV and GMWB embedded derivatives, and impairment
writedowns of $0.7 million. The net realized loss in 2004
included a $4.2 million in net loss from the mark to market of
the S&P 500 put options and the GMAV and GMWB embedded
derivatives, and impairment writedowns of $1.1 million. Thus, net realized gains from sales and redemptions of investments
totaled $14.6 million in 2005, compared with net realized losses of $9.9 million in 2004. The Company sold or redeemed invested assets, principally bonds and notes, aggregating $528.5
million in 2005 and $840.4 million in 2004. 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 0.99% and 0.63% of average invested assets for 2005 and 2004,
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 16




---



##### Table of Contents



portfolio management is to maximize total returns on the investment portfolio, taking into
account credit, option, liquidity and interest-rate risk. Impairment writedowns include $0.7 million and $1.1 million of provisions principally applied
to bonds in 2005 and 2004, respectively. On an annualized basis, impairment writedowns represent
0.05% and 0.07% of average invested assets in the respective periods. For the twenty quarters
ended March 31, 2005, impairment writedowns as an annualized percentage of average invested assets
have ranged from 0.05% to 1.95% and have averaged 0.69%. Such writedowns are based upon estimates
of the fair value of invested assets and recorded when declines in the value of such assets are
considered to be other than temporary. Actual realization will be dependent upon future events. VARIABLE ANNUITY POLICY FEES, NET OF REINSURANCE are generally based on the market value of
assets in the separate accounts supporting variable annuity
contracts. Such fees totaled $102.6 million in 2005 and $87.0 million in 2004 and are net of reinsurance premiums of $7.2 million and
$8.5 million, respectively. The increased fees in 2005 compared to 2004 primarily reflect the
improved equity market conditions in the latter part of 2004, and the resulting favorable impact on
market values of the assets in the separate accounts. On an annualized basis, variable annuity
policy fees represent 1.8% of average variable annuity assets in both periods of $22.87 billion and
$20.27 billion in 2005 and 2004, respectively. Variable annuity deposits, which exclude deposits
allocated to the Fixed Options, totaled $574.6 million in 2005 and $742.3 million in 2004. On an
annualized basis, these amounts represent 10% and 15% of variable annuity reserves at the beginning
of the respective periods. The decrease in variable annuity deposits in 2005 reflected lower
demand for variable annuity products due to the unfavorable equity market conditions in 2005.
Transfers from the Fixed Options 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 Options
(Variable Annuity Product Sales) amounted to $871.4 million and $1.11 billion in 2005 and 2004,
respectively. Such sales primarily reflect those of the Companys Polaris and Seasons families of
variable annuity products which are multi-manager variable annuities that offer investors a choice
of several variable funds as well as up to seven fixed funds, depending on the product. The
decrease in Variable Annuity Product Sales in 2005 reflects the generally unfavorable equity market
conditions in 2005. 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 $8.6 million in 2005 and
$9.2 million in 2004 and are net of reinsurance premiums of $8.4 million and $8.1 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 insurance 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% of average reserves for universal life insurance
contracts in both periods. With respect to all 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. SURRENDER CHARGES on variable annuity and universal life insurance contracts totaled $6.6
million in 2005 and $7.0 million in 2004. Surrender charge periods range up to nine years
primarily from the date a deposit is received. Surrender charges generally are assessed on
withdrawals at declining rates. 17




---



##### Table of Contents



GENERAL
AND ADMINISTRATIVE EXPENSES totaled $24.3 million in 2005 and $27.3 million in 2004.
The decrease in 2005 results from higher information technology costs and payroll related expenses
in 2004. General and administrative expenses remain closely controlled through a company-wide cost
containment program and continue to represent less than 1% of average total assets. AMORTIZATION
OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES totaled $44.3 million
in 2005, compared with $22.1 million in 2004. The increase in the amortization reflects higher
variable annuity policy fee income, higher net realized investment gains and lower expenses. ANNUAL
COMMISSIONS totaled $18.4 million in 2005, compared with $15.0 million in 2004. Annual
commissions generally represent 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. The increase in
annual commissions primarily reflects higher trail commissions. CLAIMS ON UNIVERSAL LIFE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled $5.4 million in
2005, compared with $4.8 million in 2004 and are net of reinsurance recoveries of $6.9 million in
2005 and $9.3 million in 2004. The change in such claims resulted principally from changes in
mortality experience and the reinsurance recoveries thereon. GUARANTEED BENEFITS, NET OF REINSURANCE RECOVERIES on variable annuity contracts totaled $11.2
million in 2005, compared with $17.8 million in 2004 and are net of reinsurance recoveries of $0.4
million and $2.1 million, respectively. These guaranteed benefits consist primarily of guaranteed
minimum death benefits as well as immaterial amounts of earnings enhancement benefits and
guaranteed minimum income benefits. These guarantees are described in more detail in the following
paragraphs. The decrease during 2005 reflects the generally improved equity market conditions in
the latter part of 2004. Downturns in the equity markets could increase these expenses. Guaranteed minimum death benefits (GMDB) features are issued on a majority of the Companys
variable annuity products. GMDB feature provide that, upon the death of a contract holder, the
contract holders beneficiary will receive the greater of the contract holders account value or a
guaranteed minimum death benefit that varies by product and election by the contract holder. The
Company bears the risk that death claims following a decline in the debt and equity markets may
exceed contract holder account balances and that the fees collected under the contract are
insufficient to cover the costs of the benefit to be provided. Earnings enhancement benefit (EEB) is a feature the Company offers on certain variable
annuity products. For contract holders who elect the feature, the EEB provides an additional death
benefit amount equal to a fixed percentage of earnings in the contract, subject to certain
maximums. The Company bears the risk that account values following favorable performance of the
financial markets will result in greater EEB death claims and that the fees collected under the
contract are insufficient to cover the costs of the benefit to be provided. Guaranteed minimum income benefit (GMIB) is a feature the Company offers on certain variable
annuity products. This feature provides a minimum fixed annuity payment guarantee for those
contract holders who choose to receive fixed lifetime annuity payments after a seven, nine, or
ten-year waiting period in their deferred annuity contracts. The Company bears the risk that the
performance of the financial markets will not be sufficient for accumulated contract holder 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. As there is a waiting period to annuitize using
the GMIB, there are no policies eligible to receive this benefit at March 31, 2005. The Company
has eliminated offering a GMIB feature that guarantees a return in excess of the amount to be
annuitized in order to mitigate its exposure. Guaranteed minimum account value (GMAV) is a feature the Company offers on certain variable
annuity products. If available and elected by the contract holder at the time of contract
issuance, this feature guarantees that the account value under the contract will at least equal the
amount of the deposits invested during the first ninety 18




---



##### Table of Contents



days of the contract, adjusted for any subsequent withdrawals, at the end of a ten-year
waiting period. The Company bears the risk that protracted under-performance of the financial
markets could result in GMAV benefits being higher than the underlying contract holder account
balance and that the fees collected under the contract are insufficient to cover the costs of the
benefit to be provided. The Company has 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. Guaranteed minimum withdrawal benefit (GMWB) is a feature the Company began offering on
certain variable annuity products in May of 2004. If available and elected by the contract holder
at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream,
regardless of market performance, equal to deposits invested during the first ninety days adjusted
for any subsequent withdrawals (Eligible Premium). These guaranteed annual withdrawals of up to
10% of Eligible Premium are available after either a three-year or a five-year waiting period, as
elected by the contract holder at the time of contract issuance, without reducing the future
amounts guaranteed. If no withdrawals have been made during the waiting period of three or five
years, the contract holder will realize an additional 10% or 20%, respectively, of Eligible Premium
after all other amounts guaranteed under this benefit have been paid. The Company bears the risk
that protracted under-performance of the financial markets could result in GMWB benefits being
higher than the underlying contract holder account balance and that the fees collected under the
contract are insufficient to cover the costs of the benefit to be provided. The Company has
purchased put options on the S&P 500 index to partially offset this risk. Changes in the market
value of both the GMWB benefit and the put options are recorded in investment income in the
accompanying consolidated statement of operations and comprehensive income. Management expects most of the Companys near-term exposure to guaranteed benefits will relate
to death benefits. As sales of products with other guaranteed benefits increase, the Company
expects these other guarantees to have an increasing impact on operating results, under current
hedging strategies. ASSET MANAGEMENT OPERATIONS PRETAX
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $7.7 million in 2005,
compared to $9.0 million in 2004. ASSET MANAGEMENT FEES, which include investment advisory fees and certain 12b-1 distribution
fees, are based on the market value of assets managed by SAAMCo in its mutual funds and certain
variable annuity portfolios. Such fees totaled $20.7 million on average assets managed of $10.05
billion in 2005 and $22.1 million on average assets managed of $9.60 billion in 2004 The inverse
relationship existing between the change in fees and assets under management was primarily due to a
reduction in fees on variable annuity subaccounts. Mutual fund sales, excluding sales of money
market accounts and private accounts, totaled $417.0 million in 2005, compared to $698.4 million in
2004. Redemptions of mutual funds, excluding redemptions of money market accounts, amounted to
$518.6 million in 2005 and $362.9 million in 2004, which, annualized, represent 25.3% and 18.6%,
respectively, of average related mutual fund assets. This adverse change in both sales and
redemptions reflects the generally unfavorable equity market conditions during the first quarter of
2005. Additionally, approximately 30% of the change for first quarter 2005 compared to first
quarter 2004 was attributable to one mutual fund, principally due to the funds relative
performance within its peer group. GENERAL
AND ADMINISTRATIVE EXPENSES totaled $9.4 million in 2005 and $8.9 million in 2004.
General and administrative expenses remain closely controlled through a company-wide cost
containment program and continue to represent less than 1% of average total assets. AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES includes amortization
of distribution costs that totaled $7.7 million in 2005, compared with $7.4 million in 2004. CAPITAL RESOURCES AND LIQUIDITY SHAREHOLDERS EQUITY decreased to $1.74 billion at March 31, 2005 from $1.75 billion at
December 31, 2004 due to a $41.2 million decrease in accumulated other comprehensive income and a
$25.0 million dividend 19




---



##### Table of Contents



to the Parent, partially
offset by $47.7 million of net income and $2.6 million in
capital contribution for the quarter. The decrease in
accumulated other comprehensive income was related to the decline in value of the Companys
portfolio of bonds, notes and redeemable preferred stocks (the Bond Portfolio) as interest rates
have risen, partially offset by the related amortization of DAC and other deferred expenses and
income tax effects. INVESTMENTS AND CASH at March 31, 2005 totaled $7.01 billion, compared with $7.13 billion at
December 31, 2004. The Companys invested assets are managed by an affiliate. The following table
summarizes the Companys Bond Portfolio and other investments and cash at March 31, 2005 and
December 31, 2004: March 31, 2005
    
    
    December 31, 2004Fair
    
    
    Percent of
    
    
    Fair
    
    
    Percent ofValue
    
    
    Portfolio
    
    
    Value
    
    
    Portfolio(in thousands, except for percentages)Bond Portfolio:U.S. government securities
    
    $
    33,940
    
    
    
    0.5
    %
    
    $
    30,300
    
    
    
    0.4
    %Mortgage-backed securities
    
    
    993,442
    
    
    
    14.2
    
    
    
    956,567
    
    
    
    13.4Securities of public utilities
    
    
    294,787
    
    
    
    4.2
    
    
    
    332,038
    
    
    
    4.7Corporate bonds and notes
    
    
    2,733,878
    
    
    
    39.0
    
    
    
    2,902,829
    
    
    
    40.8Other debt securities
    
    
    856,678
    
    
    
    12.2
    
    
    
    917,743
    
    
    
    12.9Total Bond Portfolio
    
    
    4,912,725
    
    
    
    70.1
    
    
    
    5,139,477
    
    
    
    72.2Mortgage loans
    
    
    638,870
    
    
    
    9.1
    
    
    
    624,179
    
    
    
    8.7Common stocks
    
    
    27,513
    
    
    
    0.4
    
    
    
    26,452
    
    
    
    0.4Cash and short-term investments
    
    
    363,187
    
    
    
    5.2
    
    
    
    201,117
    
    
    
    2.8Securities lending collateral
    
    
    825,030
    
    
    
    11.8
    
    
    
    883,792
    
    
    
    12.4Other invested assets
    
    
    239,686
    
    
    
    3.4
    
    
    
    250,969
    
    
    
    3.5Total investments and cash
    
    $
    7,007,011
    
    
    
    100.0
    %
    
    $
    7,125,986
    
    
    
    100.0
    %
 The Companys general investment philosophy is to hold fixed-rate assets for long-term
investment. 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 70% of the Companys total investment portfolio at March
31, 2005, had an aggregate fair value that was $66.6 million greater than its amortized cost at
March 31, 2005, compared with $151.7 million at December 31, 2004. At March 31, 2005, the Bond Portfolio had an aggregate fair value of $4.91 billion and an
aggregate amortized cost of $4.85 billion. At March 31, 2005, the Bond Portfolio included $4.35
billion of bonds rated by Standard & Poors (S&P), Moodys Investors Service (Moodys) or Fitch
(Fitch) and $561.7 million of bonds rated by the National Association of Insurance Commissioners
(NAIC) or the Company pursuant to statutory ratings guidelines established by the NAIC. At March
31, 2005, approximately $4.55 billion of the Bond Portfolio was investment grade, including $1.03
billion of mortgage-backed securities (MBS) and U.S. government/agency securities. At March 31, 2005, the Bond Portfolio included $358.4 million of bonds that were not
investment grade. These non-investment-grade bonds accounted for approximately 1% of the Companys
total assets and approximately 5% 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 20




---



##### Table of Contents



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, 2005, the Companys non-investment-grade bond portfolio consisted of 153 issues with no single
issuer representing more than 10% of the total non-investment-grade portfolio. These
non-investment-grade securities are comprised of bonds spanning 10 industries with 19%, 17%, 13%
and 13% concentrated in telecommunications, utilities, transportation and financial services
industries, respectively. No other industry concentration constituted more than 10% of these
assets. The table below summarizes the Companys rated bonds by rating classification as of March 31, 2005. RATED BONDS BY RATING CLASSIFICATION
(Dollars in millions) Issues not rated by
S&P/Moodys/Issues
rated by S&P/Moodys/Fitch
    
    
    Fitch, by NAIC category
    
    
    TotalNAIC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Percent ofS&P/Moodys/Fitch
    
    
    
    
    
    Estimated fair
    
    
    category
    
    
    Amortized
    
    
    Estimated fair
    
    
    
    
    
    
    Estimated fair
    
    
    total investedCategory (1)
    
    Amortized Cost
    
    
    value
    
    
    (2)
    
    
    Cost
    
    
    value
    
    
    Amortized Cost
    
    
    value
    
    
    assetsAAA+ to A-
(Aaa to A3)
[AAA to A-]
    
    $
    2,938
    
    
    $
    2,963
    
    
    
    1
    
    
    $
    245
    
    
    $
    246
    
    
    $
    3,183
    
    
    $
    3,209
    
    
    
    45.80
    %BBB+ to BBB-
(Baa to Baa3)
[BBB+ to BBB-]
    
    
    1,089
    
    
    
    1,102
    
    
    
    2
    
    
    
    240
    
    
    
    243
    
    
    
    1,329
    
    
    
    1,345
    
    
    
    19.20
    %BB+ to BB-
(Bal to Ba3)
[BB+ to BB-]
    
    
    145
    
    
    
    145
    
    
    
    3
    
    
    
    36
    
    
    
    38
    
    
    
    181
    
    
    
    183
    
    
    
    2.61
    %B+ to B-
(Bl to B3)
[B+ to B-]
    
    
    114
    
    
    
    123
    
    
    
    4
    
    
    
    2
    
    
    
    2
    
    
    
    116
    
    
    
    125
    
    
    
    1.78
    %CCC+ to CCC-
(Caal to Caa3)
[CCC+ to CCC-]
    
    
    13
    
    
    
    13
    
    
    
    5
    
    
    
    19
    
    
    
    27
    
    
    
    32
    
    
    
    40
    
    
    
    0.57
    %CC to D
(Ca to C)
[CC to D]
    
    
    2
    
    
    
    5
    
    
    
    6
    
    
    
    3
    
    
    
    6
    
    
    
    5
    
    
    
    11
    
    
    
    0.16
    %TOTAL RATED
ISSUES
    
    $
    4,301
    
    
    $
    4,351
    
    
    
    
    
    
    $
    545
    
    
    $
    562
    
    
    $
    4,846
    
    
    $
    4,913
 Footnotes to the table of Rated Bonds by Rating Classification  (1)
    S&P and Fitch rate debt securities in rating categories ranging from AAA (the highest) to D
(in payment default). A plus (+) or minus (-) indicates the debts relative standing within
the rating category. A security rated BBB- or higher is considered investment grade. Moodys
rates debt securities in rating categories ranging from Aaa (the highest) to C (extremely poor
prospects of ever attaining any real investment standing). The number 1, 2 or 3 (with 1 the
highest and 3 the lowest) indicates the debts relative standing within the rating category.
A security rated Baa3 or higher is considered investment grade. Issues are categorized based
on the highest of the S&P, Moodys and Fitch ratings if rated by multiple agencies.(2)
    Bonds and short-term promissory instruments are divided into six quality categories for NAIC
rating purposes, ranging from 1 (highest) to 5 (lowest) for non-defaulted bonds plus one
category 6, for bonds in or near default. These six categories correspond with the
S&P/Moodys/Fitch rating groups listed above, with categories 1 and 2 considered investment
grade. The NAIC categories include $54.6 million of assets that were rated by the Company
pursuant to applicable NAIC rating guidelines. 21




---



##### 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 $0.7
million and $1.1 million in 2005 and 2004, respectively. No individual impairment loss, net of DAC
and taxes, during the year exceeded 10% of the Companys net income for the quarter ended March 31,
2005. 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, 2005, the fair value of the Companys Bond Portfolio aggregated $4.91 billion.
Of this aggregate fair value, less than 0.01% 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 DAC and
other deferred expenses and decreases in income taxes. At
March 31, 2005, approximately $2.95 billion, at amortized cost, of the Bond Portfolio had a
fair value of $3.06 billion resulting in an aggregate unrealized
gain of $109.6 million. At March 31, 2005, approximately
$1.90 billion, at amortized cost, of the Bond Portfolio had a fair value of
$1.85 billion resulting in an aggregate unrealized loss of $43.0 million. No single issuer
accounted for more than 10% of unrealized losses. Approximately 38%, 11% and 11% of unrealized
losses were from the financial services, transportation and telecommunications industries,
respectively. No other industry accounted for more than 10% of unrealized losses. 22




---



##### Table of Contents



The amortized cost of the Bond Portfolio in an unrealized loss position at March 31, 2005, by
contractual maturity, is shown below. Amortized Cost(in thousands)Due in one year or less
    
    $
    33,160Due after one year through five years
    
    
    870,948Due after five years through ten years
    
    
    553,287Due after ten years
    
    
    440,216Total
    
    $
    1,897,611
 The aging of the Bond Portfolio in an unrealized loss position at March 31, 2005 is shown
below: (dollars inthousands)
    
    Less than or Equal to 20%
    
    
    Greater than 20% to 50%
    
    
    Greater than 50%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
    
    $
    1,227,283
    
    
    $
    (16,404
    )
    
    
    204
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    1,227,283
    
    
    $
    (16,404
    )
    
    
    2047-12
    
    
    333,344
    
    
    
    (9,740
    )
    
    
    56
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    333,344
    
    
    
    (9,740
    )
    
    
    56>12
    
    
    238,338
    
    
    
    (10,234
    )
    
    
    27
    
    
    
    2,752
    
    
    
    (552
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    241,090
    
    
    
    (10,786
    )
    
    
    28Total
    
    $
    1,798,965
    
    
    $
    (36,378
    )
    
    
    287
    
    
    $
    2,752
    
    
    $
    (552
    )
    
    
    1
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    1,801,717
    
    
    $
    (36,930
    )
    
    
    288Below Investment
Grade Bonds0-6
    
    $
    52,623
    
    
    $
    (1,263
    )
    
    
    27
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    52,623
    
    
    $
    (1,263
    )
    
    
    277-12
    
    
    6,638
    
    
    
    (734
    )
    
    
    9
    
    
    
    161
    
    
    
    (50
    )
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,799
    
    
    
    (784
    )
    
    
    11>12
    
    
    32,397
    
    
    
    (3,118
    )
    
    
    8
    
    
    
    4,075
    
    
    
    (947
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36,472
    
    
    
    (4,065
    )
    
    
    9Total
    
    $
    91,658
    
    
    $
    (5,115
    )
    
    
    44
    
    
    $
    4,236
    
    
    $
    (997
    )
    
    
    3
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    95,894
    
    
    $
    (6,112
    )
    
    
    47Total Bonds0-6
    
    $
    1,279,906
    
    
    $
    (17,667
    )
    
    
    231
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    1,279,906
    
    
    $
    (17,667
    )
    
    

    2317-12
    
    
    339,982
    
    
    
    (10,474
    )
    
    
    65
    
    
    
    161
    
    
    
    (50
    )
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    340,143
    
    
    
    (10,524
    )
    
    
    67>12
    
    
    270,735
    
    
    
    (13,352
    )
    
    
    35
    
    
    
    6,827
    
    
    
    (1,499
    )
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    277,562
    
    
    
    (14,851
    )
    
    
    37Total
    
    $
    1,890,623
    
    
    $
    (41,493
    )
    
    
    331
    
    
    $
    6,988
    
    
    $
    (1,549
    )
    
    
    4
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    1,897,611
    
    
    $
    (43,042
    )
    
    
    335
 In 2005, the pretax realized losses incurred with respect to the sale of fixed-rate securities
in the Bond Portfolio was $3.2 million. The aggregate fair value of securities sold was $57.0
million, which was approximately 95% of amortized cost. The average period of time that securities
sold at a loss during 2005 were trading continuously at a price below amortized cost was
approximately 13 months. 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 and certain structured securities. The
aggregate fair value of these securities at March 31, 2005 was 23




---



##### Table of Contents



approximately $729.4 million. 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. 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
$226.6 million at March 31, 2005. Secured Loans are senior to subordinated debt and equity and are
secured by assets of the issuer. At March 31, 2005, Secured Loans consisted of $144.0 million of
privately traded securities and $82.6 million of publicly traded securities. These Secured Loans
are composed of loans to 51 borrowers spanning 9 industries, with 31%, 17%, 15%, and 14% from the
utilities, transportation, telecommunications and cyclical consumer products industries,
respectively. 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. MORTGAGE LOANS aggregated $638.9 million at March 31, 2005 and consisted of 101 commercial
first mortgage loans with an average loan balance of approximately $6.3 million, collateralized by
properties located in 30 states. Approximately 36% of this portfolio was office, 16% was
manufactured housing, 15% was multifamily residential, 11% was industrial, 11% was hotels, and 11%
was other types. At March 31, 2005, approximately 30%, 11% and 10% of this portfolio were secured
by properties located in California, Michigan and Massachusetts, respectively. No more than 10% of
this portfolio was secured by properties located in any other single state. At March 31, 2005, 14
mortgage loans have an outstanding balance of $10 million or more, which collectively aggregated
approximately 48% of this portfolio. At March 31, 2005, approximately 39% of the mortgage loan
portfolio consisted of loans with balloon payments due before April 1, 2008. During 2005 and 2004,
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 $825.0 million at March 31, 2005, compared with $883.8
million at December 31, 2004, and consisted of cash collateral invested in highly rated short-term
securities received in connection with the Companys securities lending program. The change in
securities lending collateral in 2005 results from change in demand for securities in the Companys
portfolio. 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 24




---



##### Table of Contents



least two nationally recognized statistical rating organizations (NRSRO), with no less than
a S&P rating of A or equivalent by any other NRSRO. 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
incentives, surrender charges and/or other restrictions in order to encourage persistency.
Approximately 77% of the Companys reserves for Fixed-Rate Products had surrender penalties or
other restrictions at March 31, 2005. 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, 2005, these assets had an aggregate fair value of $6.10 billion with an
option-adjusted duration of 3.3 years. The Companys fixed-rate liabilities include Fixed Options,
as well as universal life insurance, fixed annuity and GIC contracts. At March 31, 2005, these
liabilities had an aggregate fair value (determined by discounting future contractual cash flows by
related market rates of interest) of $5.31 billion with an option-adjusted duration of 3.7 years.
The Companys potential exposure due to a relative 10% increase in prevailing interest rates from
its March 31, 2005 levels is a loss of approximately $1.6 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 years 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. A significant portion of the Companys fixed annuity contracts and the Fixed Options has
reached or is near the minimum contractual guaranteed rate (generally 3%). 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 2005 and 2004 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 25




---



##### Table of Contents



by the average ten-year U.S. Treasury bond rate, are presented in the following table: Three monthsended March 31,
    
    
    Years ended December, 312005
    
    
    2004
    
    
    2003
    
    
    2002Average 10-year U.S. Treasury bond rate:
    
    
    4.29
    %
    
    
    4.26
    %
    
    
    4.01
    %
    
    
    4.61
    %AIG SunAmerica Life Assurance Company:Average yield on Bond Portfolio
    
    
    5.62
    
    
    
    5.66
    
    
    
    5.75
    
    
    
    6.23Rate paid on average interest-bearing liabilities
    
    
    3.66
    
    
    
    3.71
    
    
    
    3.71
    
    
    
    3.93
 Since the Companys investing strategy is to hold fixed-rate assets for long-term investment,
the Companys average yield tends to trail movements in the average U.S. treasury yield. For
further discussion on average yield on the bond portfolio and the rate paid on average
interest-bearing liabilities, see discussion on Investment Spread. 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 exchange interest rate payments of differing character (for example, variable-rate
payments exchanged for fixed-rate payments) with a counterparty, based on an underlying principal
balance (notional principal) to hedge against interest rate changes. The Company seeks to provide liquidity by investing in
MBS. MBS are generally investment-grade securities collateralized by large pools of mortgage
loans. MBS 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 Swap Agreements is counterparty risk. The Company believes,
however, that the counterparties to its 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 MBS 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. 26




---



##### Table of Contents



The carrying values of investments that are determined to have declines in value that are
other than temporary are reduced to net realizable value and, in the case of bonds, no further
accruals of interest are made. The provisions for impairment on mortgage loans are based on losses
expected by management to be realized on transfers of mortgage loans to real estate, on the
disposition and settlement of mortgage loans and on mortgage loans that management believes may not
be collectible in full. Accrual of interest is suspended when principal and interest payments on
mortgage loans are past due more than 90 days. Impairment losses on securitized assets are
recognized if the fair value of the security is less than its book value, and the net present value
of expected future cash flows is less than the net present value of expected future cash flows at
the most recent (prior) estimation date. DEFAULTED INVESTMENTS, comprising all investments that are in default as to the payment of
principal or interest, totaled $40.6 million of bonds at March 31, 2005, and constituted
approximately 0.6% of total invested assets. At December 31, 2004, defaulted investments totaled
$40.1 million of bonds, which constituted approximately 0.6% 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, reverse repurchase agreement capacity on
invested assets and, if required, proceeds from invested asset sales. The Companys liquidity is
primarily derived from operating cash flows from annuity operations. At March 31, 2005,
approximately $3.06 billion of the Bond Portfolio had an
aggregate unrealized gain of $109.6
million, while approximately $1.85 billion of the Bond Portfolio had an aggregate unrealized loss
of $43.0 million. In addition, the Companys investment portfolio currently provides approximately
$42.8 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 Fixed-Rate Products 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,
thereby avoiding the sale of fixed-rate assets in an unfavorable bond market. In a declining interest rate environment, the Companys cost of funds would decrease over
time, reflecting lower interest crediting rates on its Fixed-Rate Products. 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 six agreements outstanding in which it has provided liquidity support for
certain short-term securities of municipalities and non-profit organizations by agreeing to
purchase such securities in the event there is no other buyer in the short-term marketplace. In
return the Company receives a fee. In addition, the Company guarantees the payment of these
securities upon redemption. The maximum liability under these guarantees at March 31, 2005 is
$195.4 million. The expiration dates of these commitments are as follows: $81.0 million in 2005
and $114.4 million in 2006. Related to each of these agreements are participation agreements with
the Parent, under which the Parent will share in $62.6 million of these liabilities in exchange for
a proportionate percentage of the fees received under these agreements. 27




---



##### Table of Contents



At
March 31, 2005, the Company held reserves for GICs with maturity
dates as follows: $187.0 million in 2005 and $29.1 million in 2024. RECENTLY ISSUED ACCOUNTING STANDARDS In July 2003, the American Institute of Certified Public Accountants issued SOP 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 GMDB and certain living benefits
related to its variable annuity contracts, account for enhanced crediting rates or bonus payments
to contract holders and modifies certain disclosures and financial statement presentations for
these products. In addition, SOP 03-1 addresses the presentation and reporting of separate
accounts and the capitalization and amortization of certain other expenses. The Company reported
for the first quarter of 2004 a one-time cumulative accounting charge upon adoption of $62,589,000
($96,291,000 pre-tax) to reflect the liability and the related impact of DAC as of January 1, 2004. 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
contract, deposits of securities for the benefit of contract holders, 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 contract holders 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, 2005. The federal government does not directly regulate the business of insurance, however, the
Company, its subsidiaries and its products are governed by federal agencies, including the
Securities and Exchange Commission (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
the Employee Retirement Income Security Act 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), suitability, revenue sharing arrangements and greater transparency 28




---



##### Table of Contents



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. 
 Item 3. 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 27 to 28 herein. 
 Item 4. Controls and
Procedures The Companys disclosure controls and procedures are designed to provide reasonable assurance
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 (SEC). Disclosure controls and procedures include controls and
procedures reasonably 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
were effective as of the end of the period covered by this report to provide reasonable assurance
that the information required to be disclosed in the reports the Company files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time periods specified in
the rules and forms of the SEC. In addition, there has been no change in the Companys internal
control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that
occurred during the first fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 29




---



##### Table of Contents



PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings Various lawsuits against the Company and its subsidiaries have arisen in the ordinary course
of business. Contingent liabilities arising from litigation, income taxes and regulatory and other
matters are not considered material in relation to the consolidated financial position, results of
operations or cash flows of the Company. A purported class action captioned Nitika Mehta, as Trustee of the N.D.
Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case
04L0199, was filed on April 5, 2004 in the Circuit Court, Twentieth
Judicial District in St. Clair County, Illinois. The action has been transferred to and is currently pending in the
United States District Court for the District of Maryland, Case No. 04-md-15863, as part of a Multi-District
Litigation proceeding. 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. See
also Managements Discussion and Analysis of Financial Condition
and Results of Operations  Recent Developments for a discussion of circumstances affecting
AIG that could impact the Company. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The
Company had no unregistered sales of equity securities. 
 Item 3. Defaults Upon Senior Securities The
Company had no defaults upon senior securities. 
 Item 4. Submissions of Matters to a Vote of Security Holders No matters were submitted during the quarter ending March 31, 2005 to a vote of security
holders, through the solicitation of proxies or otherwise. 
 Item 5. Other Information The
Company did not file timely with the SEC its Form 10-K for the
fiscal year December 31, 2004. Pursuant to a Form 12b-25
filed with the SEC on March 31, 2005, the Companys filing
deadline for its Form 10-K was extended to April 15, 2005.
The Company filed its Form 10-K with the SEC on April 18,
2005. 
 Item 6. Exhibits See accompanying Exhibit Index. 30




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AIG SUNAMERICA LIFE ASSURANCE COMPANY
Registrant/s/ N. SCOTT GILLISDate: May 13, 2005
    N. Scott GillisSenior Vice President,
Chief Financial Officer
and Director Date: May 13, 2005
    /s/ STEWART POLAKOVStewart PolakovSenior Vice President and Controller
(Principal Accounting Officer) 31




---



##### Table of Contents



Exhibit Index Exhibit31.1
    
    Rule 13a-14(a)/15d-14(a) Certifications31.2
    
    Rule 13a-14(a)/15d-14(a) Certifications32
    
    Section 1350 Certifications
 32