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SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark One)  OR /  / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 Commission File No. 33-47472 AIG SUNAMERICA LIFE ASSURANCE COMPANY Incorporated in Arizona
    
    86-0198983
IRS Employer
Identification No.
 1 SunAmerica Center, Los Angeles, California 90067-6022
Registrants telephone number, including area code: (310) 772-6000 INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS Yes /X/ No /  / INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED BY RULE 12b-2 OF THE SECURITIES EXCHANGE ACT OF 1934).
Yes /  / No /X/ THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANTS COMMON STOCK ON
AUGUST 13, 2004 WAS AS FOLLOWS: Common Stock (par value $1,000 per share)
    
    3,511 shares outstanding
 REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND
(b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q WITH THE REDUCED
DISCLOSURE FORMAT.




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AIG SUNAMERICA LIFE ASSURANCE COMPANY INDEX PageNumber(s)Part I - Financial InformationConsolidated Balance Sheet (Unaudited) - June 30, 2004 and December 31, 2003
    
    2 - 3Consolidated Statement of Income and Comprehensive Income (Unaudited) - Three Months and Six Months Ended June 30, 2004 and 2003
    
    4 - 5Consolidated Statement of Cash Flows (Unaudited) - Six Months Ended June 30, 2004 and 2003
    
    6 - 7Notes to Consolidated Financial Statements (Unaudited)
    
    8 - 17Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    18 - 36Quantitative and Qualitative Disclosures About Market Risk
    
    37Disclosure Controls and Procedures
    
    37Part II - Other Information
    
    38Exhibits and Reports on 8-K
    
    40Exhibit 31.1Exhibit 31.2Exhibit 32




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AIG SUNAMERICA LIFE ASSURANCE COMPANY 
   June 30,
    
    December 31,2004
    
    2003(in thousands)ASSETSInvestments and cash:Cash and short-term investments
    
    $
    142,180
    
    
    $
    133,105Bonds, notes and redeemable preferred stocks
available for sale, at fair value (amortized
cost: June 30, 2004, $5,246,857; December 31,
2003, $5,351,183)
    
    
    5,314,581
    
    
    
    5,505,800Mortgage loans
    
    
    701,808
    
    
    
    716,846Policy loans
    
    
    191,903
    
    
    
    200,232Mutual funds
    
    
    11,465
    
    
    
    21,159Common stocks available for sale, at fair value
(cost: June 30, 2004, $5,125; December 31,
2003, $635)
    
    
    5,143
    
    
    
    727Real estate
    
    
    22,166
    
    
    
    22,166Securities lending collateral
    
    
    1,122,766
    
    
    
    514,145Other invested assets
    
    
    20,359
    
    
    
    10,453Total investments and cash
    
    
    7,532,371
    
    
    
    7,124,633Variable annuity assets held in separate accounts
    
    
    20,638,516
    
    
    
    19,178,796Accrued investment income
    
    
    75,947
    
    
    
    74,647Deferred acquisition costs
    
    
    1,316,696
    
    
    
    1,264,321Other deferred expenses
    
    
    258,634
    
    
    
    241,007Income taxes currently receivable from Parent
    
    
    19,321
    
    
    
    13,856Due from affiliates
    
    
    827
    
    
    
    Goodwill
    
    
    14,038
    
    
    
    14,038Other assets
    
    
    69,856
    
    
    
    59,166TOTAL ASSETS
    
    $
    29,926,206
    
    
    $
    27,970,464
 See accompanying notes to consolidated financial statements. 2




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AIG SUNAMERICA LIFE ASSURANCE COMPANY 
 June 30,
    
    December 31,2004
    
    2003(in thousands)LIABILITIES AND SHAREHOLDERS EQUITYReserves, payables and accrued liabilities:Reserves for fixed annuity contracts
    
    $
    4,233,103
    
    
    $
    4,274,329Reserves for universal life insurance contracts
    
    
    1,565,171
    
    
    
    1,609,233Reserves for guaranteed investment contracts
    
    
    214,032
    
    
    
    218,032Reserve for guaranteed benefits
    
    
    73,890
    
    
    
    12,022Securities lending payable
    
    
    1,122,766
    
    
    
    514,145Due to affiliates
    
    
    
    
    
    
    19,289Payable to brokers
    
    
    3,516
    
    
    
    1,140Other liabilities
    
    
    209,443
    
    
    
    248,258Total reserves, payables and accrued liabilities
    
    
    7,421,921
    
    
    
    6,896,448Variable annuity liabilities related to separate accounts
    
    
    20,638,516
    
    
    
    19,178,796Subordinated notes payable to affiliates
    
    
    41,498
    
    
    
    41,520Deferred income taxes
    
    
    301,497
    
    
    
    291,152Total liabilities
    
    
    28,403,432
    
    
    
    26,407,916Shareholders equity:Common stock
    
    
    3,511
    
    
    
    3,511Additional paid-in capital
    
    
    1,224,885
    
    
    
    1,224,885Retained earnings
    
    
    265,949
    
    
    
    261,542Accumulated other comprehensive income
    
    
    28,429
    
    
    
    72,610Total shareholders equity
    
    
    1,522,774
    
    
    
    1,562,548TOTAL LIABILITIES AND SHAREHOLDERS
EQUITY
    
    $
    29,926,206
    
    
    $
    27,970,464
 See accompanying notes to consolidated financial statements. 3




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AIG SUNAMERICA LIFE ASSURANCE COMPANY 
    Three months
    
    Six months2004
    
    2003
    
    2004
    
    2003(in thousands)REVENUESFee income:Variable annuity policy fees,
net of reinsurance
    
    $
    90,350
    
    
    $
    66,945
    
    
    $
    178,560
    
    
    $
    128,979Asset management fees
    
    
    22,619
    
    
    
    15,496
    
    
    
    43,521
    
    
    
    28,789Universal life insurance policy fees,
net of reinsurance
    
    
    8,515
    
    
    
    9,378
    
    
    
    17,707
    
    
    
    18,348Surrender charges
    
    
    6,492
    
    
    
    6,784
    
    
    
    13,491
    
    
    
    14,354Other fees
    
    
    3,571
    
    
    
    3,515
    
    
    
    7,192
    
    
    
    6,852Total fee income
    
    
    131,547
    
    
    
    102,118
    
    
    
    260,471
    
    
    
    197,322Investment income
    
    
    97,921
    
    
    
    102,155
    
    
    
    185,091
    
    
    
    199,063Net realized investment gains (losses)
    
    
    1,667
    
    
    
    (5,358
    )
    
    
    (9,726
    )
    
    
    (8,630
    )Total revenues
    
    
    231,135
    
    
    
    198,915
    
    
    
    435,836
    
    
    
    387,755BENEFITS AND EXPENSESInterest expense:Fixed annuity contracts
    
    
    35,571
    
    
    
    39,328
    
    
    
    70,807
    
    
    
    78,093Universal life insurance contracts
    
    
    18,524
    
    
    
    18,737
    
    
    
    37,005
    
    
    
    37,839Guaranteed investment contracts
    
    
    1,379
    
    
    
    2,031
    
    
    
    2,714
    
    
    
    4,047Subordinated notes payable
    
    
    538
    
    
    
    660
    
    
    
    1,098
    
    
    
    1,502Total interest expense
    
    
    56,012
    
    
    
    60,756
    
    
    
    111,624
    
    
    
    121,481General and administrative expenses
    
    
    35,409
    
    
    
    28,345
    
    
    
    71,633
    
    
    
    58,332Amortization of deferred acquisition
costs and other deferred expenses
    
    
    53,297
    
    
    
    45,567
    
    
    
    84,739
    
    
    
    89,529Annual commissions
    
    
    15,117
    
    
    
    15,995
    
    
    
    30,131
    
    
    
    30,173Claims on universal life contracts,
net of reinsurance recoveries
    
    
    5,099
    
    
    
    5,720
    
    
    
    9,922
    
    
    
    11,233Guaranteed benefits, net of
reinsurance
    
    
    13,152
    
    
    
    14,483
    
    
    
    30,926
    
    
    
    36,459Total benefits and expenses
    
    
    178,086
    
    
    
    170,866
    
    
    
    338,975
    
    
    
    347,207PRETAX INCOME BEFORE
CUMULATIVE EFFECT OF 
ACCOUNTING CHANGE
    
    
    53,049
    
    
    
    28,049
    
    
    
    96,861
    
    
    
    40,548Income tax expense
    
    
    15,169
    
    
    
    7,445
    
    
    
    27,365
    
    
    
    9,326INCOME BEFORE CUMULATIVE EFFECT
OF ACCOUNTING CHANGE
    
    
    37,880
    
    
    
    20,604
    
    
    
    69,496
    
    
    
    31,222Cumulative effect of accounting change,
net of tax
    
    
    
    
    
    
    
    
    
    
    (62,589
    )
    
    
    NET INCOME
    
    $
    37,880
    
    
    $
    20,604
    
    
    $
    6,907
    
    
    $
    31,222
 See accompanying notes to consolidated financial statements. 4




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AIG SUNAMERICA LIFE ASSURANCE COMPANY    Three months
    
    Six months2004
    
    2003
    
    2004
    
    2003(in thousands)OTHER COMPREHENSIVE INCOME (LOSS),
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
    
    $
    (140,220
    )
    
    $
    78,406
    
    
    $
    (74,368
    )
    
    $
    96,926Less reclassification adjustment for net realized
(gains) losses included in net income
    
    
    (1,016
    )
    
    
    3,400
    
    
    
    6,398
    
    
    
    4,755Income tax (expense) benefit
    
    
    49,432
    
    
    
    (28,633
    )
    
    
    23,789
    
    
    
    (35,589
    )OTHER COMPREHENSIVE INCOME (LOSS)
    
    
    (91,804
    )
    
    
    53,173
    
    
    
    (44,181
    )
    
    
    66,092COMPREHENSIVE INCOME (LOSS)
    
    $
    (53,924
    )
    
    $
    73,777
    
    
    $
    (37,274
    )
    
    $
    97,314
 See accompanying notes to consolidated financial statements. 5




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AIG SUNAMERICA LIFE ASSURANCE COMPANY




2004
    
    2003(in thousands)CASH FLOW FROM OPERATING ACTIVITIES:Net income
    
    $
    6,907
    
    
    $
    31,222Adjustments to reconcile net income to net cash provided by operating
activities:Cumulative effect of accounting change, net of tax
    
    
    62,589
    
    
    
    Interest credited to:Fixed annuity contracts
    
    
    70,807
    
    
    
    78,093Universal life insurance contracts
    
    
    37,005
    
    
    
    37,839Guaranteed investment contracts
    
    
    2,714
    
    
    
    4,047Net realized investment losses
    
    
    9,726
    
    
    
    8,630Amortization of premium on securities
    
    
    2,449
    
    
    
    2,614Amortization of deferred acquisition costs and other deferred expenses
    
    
    84,739
    
    
    
    89,529Depreciation of fixed assets
    
    
    833
    
    
    
    235Acquisition costs deferred
    
    
    (135,410
    )
    
    
    (102,204
    )Other
expenses deferred
    
    
    (37,521
    )
    
    
    (31,816
    )Provision for deferred income taxes
    
    
    67,837
    
    
    
    42,360Change in:Accrued investment income
    
    
    (1,300
    )
    
    
    (9,430
    )Other assets
    
    
    (11,441
    )
    
    
    3,382Income taxes currently payable to Parent
    
    
    (5,465
    )
    
    
    (7,221
    )Due to affiliates
    
    
    (20,116
    )
    
    
    (28,884
    )Other liabilities
    
    
    (28,810
    )
    
    
    9,469Other, net
    
    
    8,038
    
    
    
    8,675NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    113,581
    
    
    
    150,982CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of:Bonds, notes and redeemable preferred stocks
    
    
    (1,028,304
    )
    
    
    (1,328,167
    )Mortgage loans
    
    
    (9,276
    )
    
    
    (29,883
    )Other investments, excluding short-term investments
    
    
    (16,212
    )
    
    
    (14,849
    )Sales of:Bonds, notes and redeemable preferred stocks
    
    
    680,095
    
    
    
    858,085Other investments, excluding short-term investments
    
    
    11,173
    
    
    
    67Redemptions and maturities of:Bonds, notes and redeemable preferred stocks
    
    
    439,785
    
    
    
    492,682Mortgage loans
    
    
    24,903
    
    
    
    14,560Other investments, excluding short-term investments
    
    
    8,523
    
    
    
    59,927NET CASH PROVIDED BY INVESTING ACTIVITIES
    
    $
    110,687
    
    
    $
    52,422


See accompanying notes to consolidated financial statements.

6



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AIG SUNAMERICA LIFE ASSURANCE COMPANY    2004
    
    2003(in thousands)CASH FLOW FROM FINANCING ACTIVITIES:Deposits received on:Fixed annuity contracts
    
    $
    787,396
    
    
    $
    803,595Universal life insurance contracts
    
    
    21,825
    
    
    
    22,573Net exchanges from the fixed accounts of variable
annuity contracts
    
    
    (654,495
    )
    
    
    (405,412
    )Withdrawal payments on:Fixed annuity contracts
    
    
    (200,687
    )
    
    
    (242,148
    )Universal life insurance contracts
    
    
    (38,517
    )
    
    
    (33,365
    )Guaranteed investment contracts
    
    
    (6,120
    )
    
    
    (6,240
    )Claims and annuity payments on:Fixed annuity contracts
    
    
    (55,694
    )
    
    
    (55,667
    )Universal life insurance contracts
    
    
    (61,663
    )
    
    
    (62,153
    )Net payment related to a modified coinsurance transaction
    
    
    (4,738
    )
    
    
    (11,347
    )Dividend paid to Parent
    
    
    (2,500
    )
    
    
    (10,187
    )NET CASH USED IN FINANCING ACTIVITIES
    
    
    (215,193
    )
    
    
    (351
    )NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS
    
    
    9,075
    
    
    
    203,053CASH AND SHORT-TERM INVESTMENTS
AT BEGINNING OF PERIOD
    
    
    133,105
    
    
    
    116,882CASH AND SHORT-TERM INVESTMENTS
AT END OF PERIOD
    
    $
    142,180
    
    
    $
    319,935SUPPLEMENTAL CASH FLOW INFORMATION:Interest paid on indebtedness
    
    $
    1,098
    
    
    $
    1,502Income taxes paid to Parent
    
    $
    47,424
    
    
    $
    51,087
 See accompanying notes to consolidated financial statements. 7




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AIG SUNAMERICA LIFE ASSURANCE COMPANY 
    1.
    
    BASIS OF PRESENTATIONAIG SunAmerica Life Assurance Company (formerly Anchor National Life Insurance
Company) (the Company) is a direct wholly owned subsidiary of SunAmerica Life
Insurance Company (the Parent), which is a wholly owned subsidiary of AIG
Retirement Services, Inc. (AIGRS) (formerly AIG SunAmerica Inc.), a wholly
owned subsidiary of American International Group, Inc. (AIG). AIG is a
holding company which through its subsidiaries is engaged in a broad range of
insurance and insurance-related activities, financial services, retirement
services and asset management. The Company is an Arizona-domiciled life
insurance company principally engaged in the business of writing variable
annuities directed to the market for tax-deferred, long-term savings products.
It also administers closed blocks of fixed annuities, universal life policies
and guaranteed investment contracts (GICs).The Company changed its name to AIG SunAmerica Life Assurance Company on
January 24, 2002. The Company continued to do business as Anchor National Life
Insurance Company until February 28, 2003, at which time it began doing
business under its new name.Effective January 1, 2004, the Parent contributed to the Company 100% of the
outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset
Management Corp. (SAAMCo) (formerly SunAmerica Asset Management Corp.) which
in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services,
Inc. (SACS) (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica
Fund Services, Inc. (SFS) (formerly SunAmerica Fund Services, Inc.).
Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary
of the Company. This contribution increased the Companys shareholders equity
by $99,131,000. Included in the contribution of SAAMCo to the Company were tax
benefits of $24,624,000 derived from losses incurred by SA Affordable Housing,
L.L.C. through December 31, 2003, when it was no longer a subsidiary of SAAMCo.
Assets, liabilities and shareholders equity at December 31, 2003 were
restated to include $174,756,000, $75,625,000 and $99,131,000, respectively, of
SAAMCo balances. Similarly, the results of operations and cash flows for the
six months ended June 30, 2003 have been restated for the addition to pretax
income of $2,216,000 to reflect the SAAMCo activity. Pretax income from the
SAAMCos and its subsidiaries asset management operations totaled $7,686,000
for the second quarter of 2004 and $15,489,000 for the six months ended June
30, 2004.SAAMCo and its wholly owned distributor, SACS, and its wholly owned servicing
administrator, SFS, are included in asset management segment (see Note 5).
These companies earn fee income by distributing and managing a diversified
family of mutual funds, managing certain subaccounts within the Companys
variable annuity products and providing professional management of individual,
corporate and pension plan portfolios.In the opinion of the Company, the accompanying unaudited consolidated
financial statements contain all adjustments necessary, consisting of normal
recurring items, to present fairly the Companys consolidated financial
position as of June 30, 2004 and December 31, 2003, the results of its
consolidated operations for the three months and six months ended June 30, 2004
and 2003 and its consolidated cash flows for the six months ended June 30, 2004
and 2003. The results of operations for the three months and six months ended
June 30, 2004 are not necessarily indicative of the results to be expected for
the full year. The accompanying unaudited consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements for the year ended December 31, 2003, contained in the Companys
2003 Annual Report on Form 10-K. Certain prior period amounts have been
reclassified to conform to the current periods presentation.2.
    
    RECENTLY ISSUED ACCOUNTING STANDARDSIn July 2003, the American Institute of Certified Public Accountants issued
Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises
for Certain Nontraditional Long-Duration Contracts and for Separate Accounts
(SOP 03-1). This statement was effective as of January 1, 2004, and requires
the Company to recognize a liability for guaranteed minimum death benefits and
other living benefits related to its variable annuities 8




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  2.
    
    RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)and modifies certain disclosures and financial statement presentations for
these products. In addition, SOP 03-1 addresses the presentation and reporting
of separate accounts and the capitalization and amortization of sales
inducements. The Company reported for the first quarter of 2004 a one-time
cumulative accounting charge upon adoption of $62,589,000 ($96,291,000 pre-tax)
to reflect the liability and the related impact of deferred acquisition costs
(DAC) and reinsurance as of January 1, 2004.The Company issues variable annuities for which the investment risk is
generally borne by the contract holder, except with respect to amounts invested
in the fixed-rate account options. For many of the Companys variable
annuities, the Company offers contractual guarantees in the event of death, at
specified dates during the accumulation period, upon certain withdrawals or at
annuitization. Such benefits are referred to as guaranteed minimum death
benefits (GMDB), guaranteed minimum account value benefits (GMAV),
guaranteed minimum withdrawal benefits (GMWB) and guaranteed minimum income
benefits (GMIB), respectively. The Company also issues certain variable
annuity products that offer an optional earnings enhancement benefit (EEB)
feature.The assets supporting the variable portion of variable annuities are carried at
fair value and reported as summary total variable annuity assets held in
separate accounts with an equivalent summary total reported for liabilities.
Amounts assessed against the contract holders for mortality, administrative,
other services and certain features are included in variable annuity policy
fees, net of reinsurance, in the consolidated statement of income and
comprehensive income. Changes in liabilities for minimum guarantees are
included in guaranteed benefits, net of reinsurance, in the consolidated
statement of income and comprehensive income. Separate account net investment
income, net investment gains and losses and the related liability charges are
offset within the same line item in the consolidated statement of income and
comprehensive income.The Company offers GMDB options that guarantee for virtually all contract
holders, upon the death, the contract holders beneficiary will receive the
greater of (1) the contract holders account value, or (2) a guaranteed minimum
death benefit that varies by product and election by policy owner. The EEB
provides an additional death benefit amount equal to a fixed percentage of
earnings in the contract, subject to certain maximums. The GMDB liability is
determined each period end by estimating the expected value of death benefits
in excess of the projected account balance and recognizing the excess ratably
over the accumulation period based on total expected assessments. The Company
regularly evaluates estimates used and adjusts the additional liability
balance, with a related charge or credit to benefit expense, if actual
experience or other evidence suggests that earlier assumptions should be
revised. As of June 30, 2004, approximately 30% of in-force contracts with
GMDB (calculated based on account value) have been reinsured.If elected by the contract holder at the time of contract issuance, GMAV
guarantees that the account value under the contract will at least equal the
amount of initial principal invested during the first 90 days, adjusted for
withdrawals, at the end of a ten-year waiting period. The Company purchases
put options on the S&P 500 index to partially offset this risk. GMAVs are
considered to be derivatives under Financial Accounting Standards Board
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (FAS 133), and are recognized at fair value in the
consolidated balance sheet through investment income in the consolidated
statement of income and comprehensive income.The GMWB option provides a guaranteed annual withdrawal stream, regardless of
market performance, equal to premiums invested during the first ninety days
after issue adjusted for subsequent withdrawals (Eligible Premium). These
annual withdrawals are available after either a three-year waiting period or a
five-year waiting period and limited to 10% of Eligible Premiums annually
without reducing the amount guaranteed. Additional incentives are earned by
the contract holder if no withdrawals are taken prior to the end of the waiting
period. The GMWB is considered to be a derivative under FAS 133 and is
recognized 9




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  2.
    
    RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)at fair value in the consolidated balance sheet through investment income in
the consolidated statement of income and comprehensive income. In June 2004,
variable annuity deposits with the GMWB option were immaterial.If elected by the contract holder, GMIB provides a minimum fixed annuity
payment guarantee after a seven, nine or ten-year waiting period. As there is
a waiting period to annuitize using the GMIB, as of June 30, 2004, there are no
policies eligible to receive this benefit. The GMIB liability is determined
each period end by estimating the expected value of the annuitization benefits
in excess of the projected account balance at the date of annuitization and
recognizing the excess ratably over the accumulation period based on total
expected assessments. The Company regularly evaluates estimates used and
adjusts the additional liability balance, with a related charge or credit to
benefit expense, if actual experience or other evidence suggests that earlier
assumptions should be revised. As of June 30, 2004, virtually all of the
Companys GMIB exposure was effectively transferred to several large insurance
companies via reinsurance agreements. However, the Company does not have
reinsurance coverage on contracts to be sold after July 2004.Details concerning the Companys guaranteed benefit exposures as of June 30,
2004 are as follows: Highest SpecifiedReturn of Net
    
    Anniversary AccountDeposits
    
    Value MinusPlus a
    
    Withdrawals PostMinimum Return
    
    Anniversary(dollars in thousands)In the event of death (GMDB and EEB):Account value
    
    $
    12,343,952
    
    
    $
    11,715,093Net amount at risk (a)
    
    
    1,118,520
    
    
    
    1,412,543Average attained age of contract holders
    
    
    65
    
    
    
    64Range of guaranteed minimum return rates
    
    
    0%-5
    %
    
    
    0
    %At annuitization (GMIB):Account value
    
    $
    6,342,023Net amount at risk (a)
    
    
    3,997Weighted average period remaining until
expected annuitization
    
    4.1 YearsRange of guaranteed minimum return rates
    
    
    0%-6.5
    %Accumulation at specified date (GMAV):Account value
    
    $
    1,165,910Net amount at risk (a)
    
    
    703Weighted average period remaining until
expected payout
    
    9.2 YearsRange of guaranteed minimum return rates
    
    
    0
    %
  (a)
    
    Net amount at risk represents the guaranteed benefit exposure in excess of the current account value, net
of reinsurance, if all contract holders died, in the case of GMDB, annuitized, in the case of GMIB, or reached
the specified date, in the case of GMAV, at the same balance sheet date. 10




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2.
    
    RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)The following summarizes the reserve for guaranteed benefits, net of
reinsurance, on variable contracts reflected in the general account: (in thousands)Balance at January 1, 2004 (b)
    
    $
    65,423Guaranteed benefits incurred, net of reinsurance
    
    
    30,926Guaranteed benefits paid, net of reinsurance
    
    
    (22,459
    )Balance at June 30, 2004
    
    $
    73,890
  (b)Includes amounts from the one-time cumulative accounting change resulting from
the adoption of SOP 03-1.  The following assumptions and methodology were used to determine the reserve
for guaranteed benefits at June 30, 2004:  
    
    Data used was 5,000 stochastically generated investment performance scenarios.
    
    Mean investment performance assumption was 10%.
    
    Volatility assumption was 16%.
    
    Mortality was assumed to be 64 percent of the 75-80 ALB table.
    
    Lapse rates vary by contract type and duration and range from 1% to 30%.
    
    The discount rate was approximately 8%.  The Company currently offers enhanced crediting rates or bonus payments to
contract holders on certain of its products. These sales inducements are
deferred and amortized over the life of the policy using the same methodology
and assumptions used to amortize DAC. The Company previously deferred these
sales inducements as part of DAC and reported the amortization of such amounts
as part of DAC amortization. Upon implementation of SOP 03-1, the Company
reclassified sales inducements of $160.0 million from DAC to other deferred
expenses, which is reported on the consolidated balance sheet. For the six
months ended June 30, 2004, sales inducements of $20.7 million was deferred.
Amortization of the deferred sales inducements is reported as part of
amortization of deferred acquisition costs and other deferred expenses on the
consolidated statement of income and comprehensive income. For the six months
ended June 30, 2004, amortization of sales inducements was $4.5 million. Prior
period consolidated balance sheet and consolidated statement of income and
comprehensive income presentation has been reclassified to conform to the new
presentation.3.
    
    CONTINGENT LIABILITIESThe Company has entered into seven agreements in which it has provided
liquidity support for certain short-term securities of municipalities and
non-profit organizations by agreeing to purchase such securities in the event
there is no other buyer in the short-term marketplace. In return the Company
receives a fee. In addition, the Company guarantees the payment of these
securities upon redemption. The maximum liability under these guarantees at
June 30, 2004 is $480,490,000. In August 2004, these commitments decreased by
$287,890,000 due to early redemption. The remaining commitments have
contractual maturity dates as follows: $21,930,000 in the remainder of 2004 and
$170,670,000 in 2005. Related to each of these agreements are participation
agreements with the Parent under which the Parent will share in $61,521,000 of
these liabilities in exchange for a proportionate percentage of the fees
received under these agreements. The Internal Revenue Service has completed
its examinations into the transactions 11




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AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  3.
    
    CONTINGENT LIABILITIES (Continued)underlying these commitments, including the Companys role in the transactions.
The examination did not result in a material loss to the Company.At June 30, 2004, the Company has commitments to purchase a total of
approximately $28,000,000 of asset backed securities in the ordinary course of
business. The expiration dates of these commitments are as follows:
$19,000,000 in 2004 and $9,000,000 in 2006.Various lawsuits against the Company have arisen in the ordinary course of
business. Contingent liabilities arising from litigation, income taxes and
regulatory and other matters are not considered material in relation to the
financial position, results of operations or cash flows of the Company.On April 5, 2004, a purported class action captioned Nitika Mehta, as Trustee
of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case
04L0199, was filed in the Circuit Court, Twentieth Judicial District in St.
Clair County, Illinois. The lawsuit alleges certain improprieties in
conjunction with alleged market timing activities. The probability of any
particular outcome cannot be reasonably estimated at this time.4.
    
    RELATED-PARTY MATTERSSubordinated notes (including accrued interest of $538,000) payable to
affiliates totaled $41,498,000 at interest rates ranging from 4.00% to 9.5% at
June 30, 2004, and require principal payments of $3,000,000 in 2004, $7,560,000
in 2005 and $30,400,000 in 2008.On October 31, 2003, the Company entered into an existing credit agreement
under which the Company agreed to make loans to AIG in an aggregate amount of
$60,000,000. This commitment expires on October 30, 2004. There was no
outstanding balance under this agreement at June 30, 2004.On February 1, 2004, SAAMCo entered into an administrative services agreement
with its affiliate, First SunAmerica Life Insurance Company (FSA), whereby
SAAMCo will pay to FSA a fee based on a percentage of all assets invested
through FSAs variable annuity products in exchange for services performed.
SAAMCo is the investment advisor for certain trusts that serve as investment
options for FSAs variable annuity products. Amounts paid or accrued to FSA
under this agreement totaled $0.9 million in 2004 and are included in asset
management fees in the statement of income and comprehensive income. A fee of
$0.8 million was paid under a different agreement in 2003.The Companys insurance policy obligations are guaranteed by American Home
Assurance Company (American Home), a subsidiary of AIG, and a member of an
AIG intercompany pool. This guarantee is unconditional and irrevocable, and
the Companys policyholders have the right to enforce the guarantee directly
against American Home.The Company has a support agreement in effect between the Company and AIG (the
Support Agreement), pursuant to which AIG has agreed that AIG will cause the
Company to maintain a policyholders surplus of not less than $1,000,000 or
such greater amount as shall be sufficient to enable the Company to perform its
obligations under any policy issued by it. The Support Agreement also provides
that if the Company needs funds not otherwise available to it to make timely
payment of its obligations under policies issued by it, AIG will provide such
funds at the request of the Company. The Support Agreement is not a direct or
indirect guarantee by AIG to any person of any obligations of the Company. AIG
may terminate the Support Agreement with respect to outstanding obligations of
the Company only under circumstances where the Company attains, without the
benefit of the Support Agreement, a financial strength rating equivalent to
that held by the Company with the benefit of the Support Agreement.
Policyholders have the right to cause the Company to enforce its rights against
AIG and, if the Company fails or refuses to take timely action to enforce the
Support Agreement or if the Company defaults in any 12




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##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  4.
    
    RELATED-PARTY MATTERS (Continued)claim or payment owed to such policyholder when due, have the right to enforce
the Support Agreement directly against AIG.American Home does not publish financial statements prepared on the basis of
U.S. generally accepted accounting principles, although it files statutory
annual and quarterly reports with the New York State Insurance Department,
where such reports are available to the public. AIG is a reporting company
under the Securities Exchange Act of 1934, and files annual reports on Form
10-K and quarterly reports on Form 10-Q, which are available from the
Securities and Exchange Commission.5.
    
    SEGMENT INFORMATIONAs of January 1, 2004, the Company began conducting its business through two
business segments, annuity operations and asset management operations. Prior
to January 1, 2004, the Company conducted its business through one segment:
annuity operations. Annuity operations consists of the sale and administration
of deposit-type insurance contracts, including fixed and variable annuities,
universal life insurance contracts and GICs. Asset management operations,
which includes the distribution and management of mutual funds, is conducted by
SAAMCo and its subsidiary and distributor, SACS, and its subsidiary and
servicing administrator, SFS. Following is selected information pertaining to
the Companys business segments. 13




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##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  5.
    
    SEGMENT INFORMATION (Continued) AssetManagementAnnuity Operations
    
    Operations
    
    TotalTHREE MONTHS ENDED JUNE 30, 2004
    
    
    
    
    
    (in thousands)REVENUES:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    


Fee income:Variable annuity policy fees, net of
reinsurance
    
    $
    90,350
    
    
    $
    
    
    
    $
    90,350Asset management fees
    
    
    
    
    
    
    22,619
    
    
    
    22,619Universal life insurance fees, net of
reinsurance
    
    
    8,515
    
    
    
    
    
    
    
    8,515Surrender charges
    
    
    6,492
    
    
    
    
    
    
    
    6,492Other fees
    
    
    
    
    
    
    3,571
    
    
    
    3,571Total fee income
    
    
    105,357
    
    
    
    26,190
    
    
    
    131,547Investment income
    
    
    97,783
    
    
    
    138
    
    
    
    97,921Net realized investment gains
    
    
    1,667
    
    
    
    
    
    
    
    1,667Total revenues
    
    
    204,807
    
    
    
    26,328
    
    
    
    231,135BENEFITS AND EXPENSES:Interest expense
    
    
    55,474
    
    
    
    538
    
    
    
    56,012General and administrative expenses
    
    
    25,273
    
    
    
    10,136
    
    
    
    35,409Amortization of deferred acquisition
costs and other deferred expenses
    
    
    45,329
    
    
    
    7,968
    
    
    
    53,297Annual commissions
    
    
    15,117
    
    
    
    
    
    
    
    15,117Claims on universal life contracts,
net of reinsurance recoveries
    
    
    5,099
    
    
    
    
    
    
    
    5,099Guaranteed benefits, net of reinsurance
    
    
    13,152
    
    
    
    
    
    
    
    13,152Total benefits and expenses
    
    
    159,444
    
    
    
    18,642
    
    
    
    178,086Pretax income before cumulative effect
of accounting change
    
    $
    45,363
    
    
    $
    7,686
    
    
    $
    53,049Total assets
    
    $
    29,740,719
    
    
    $
    185,487
    
    
    $
    29,926,206Expenditures for long-lived assets
    
    $
    
    
    
    $
    37
    
    
    $
    
 14




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##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  5.
    
    SEGMENT INFORMATION (Continued) AssetManagementAnnuity Operations
    
    Operations
    
    TotalTHREE MONTHS ENDED JUNE 30, 2003
    
    
    
    
    
    (in thousands)REVENUES:Fee income:Variable annuity policy fees, net of
reinsurance
    
    $
    66,945
    
    
    $
    
    
    
    $
    66,945Asset management fees
    
    
    
    
    
    
    15,496
    
    
    
    15,496Universal life insurance fees, net of
reinsurance
    
    
    9,378
    
    
    
    
    
    
    
    9,378Surrender charges
    
    
    6,784
    
    
    
    
    
    
    
    6,784Other fees
    
    
    
    
    
    
    3,515
    
    
    
    3,515Total fee income
    
    
    83,107
    
    
    
    19,011
    
    
    
    102,118Investment income
    
    
    100,040
    
    
    
    2,115
    
    
    
    102,155Net realized investment losses
    
    
    (5,358
    )
    
    
    
    
    
    
    (5,358
    )Total revenues
    
    
    177,789
    
    
    
    21,126
    
    
    
    198,915BENEFITS AND EXPENSES:Interest expense
    
    
    60,096
    
    
    
    660
    
    
    
    60,756General and administrative expenses
    
    
    19,030
    
    
    
    9,315
    
    
    
    28,345Amortization of deferred acquisition
costs and other deferred expenses
    
    
    40,256
    
    
    
    5,311
    
    
    
    45,567Annual commissions
    
    
    15,995
    
    
    
    
    
    
    
    15,995Claims on universal life contracts,
net of reinsurance recoveries
    
    
    5,720
    
    
    
    
    
    
    
    5,720Guaranteed benefits, net of reinsurance
    
    
    14,483
    
    
    
    
    
    
    
    14,483Total benefits and expenses
    
    
    155,580
    
    
    
    15,286
    
    
    
    170,866Pretax income before cumulative effect
of accounting change
    
    $
    22,209
    
    
    $
    5,840
    
    
    $
    28,049Total assets
    
    $
    25,456,775
    
    
    $
    222,207
    
    
    $
    25,678,982Expenditures for long-lived assets
    
    $
    
    
    
    $
    565
    
    
    $
    
 15




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##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  5.
    
    SEGMENT INFORMATION (Continued) AssetManagementAnnuity Operations
    
    Operations
    
    TotalSIX MONTHS ENDED JUNE 30, 2004
    
    
    
    
    
    (in thousands)REVENUES:Fee income:Variable annuity policy fees, net of
reinsurance
    
    $
    178,560
    
    
    $
    
    
    
    $
    178,560Asset management fees
    
    
    
    
    
    
    43,521
    
    
    
    43,521Universal life insurance fees, net of
reinsurance
    
    
    17,707
    
    
    
    
    
    
    
    17,707Surrender charges
    
    
    13,491
    
    
    
    
    
    
    
    13,491Other fees
    
    
    
    
    
    
    7,192
    
    
    
    7,192Total fee income
    
    
    209,758
    
    
    
    50,713
    
    
    
    260,471Investment income
    
    
    184,776
    
    
    
    315
    
    
    
    185,091Net realized investment losses
    
    
    (9,726
    )
    
    
    
    
    
    
    (9,726
    )Total revenues
    
    
    384,808
    
    
    
    51,028
    
    
    
    435,836BENEFITS AND EXPENSES:Interest expense
    
    
    110,526
    
    
    
    1,098
    
    
    
    111,624General and administrative expenses
    
    
    52,601
    
    
    
    19,032
    
    
    
    71,633Amortization of deferred acquisition
costs and other deferred expenses
    
    
    69,330
    
    
    
    15,409
    
    
    
    84,739Annual commissions
    
    
    30,131
    
    
    
    
    
    
    
    30,131Claims on universal life contracts,
net of reinsurance recoveries
    
    
    9,922
    
    
    
    
    
    
    
    9,922Guaranteed benefits, net of reinsurance
    
    
    30,926
    
    
    
    
    
    
    
    30,926Total benefits and expenses
    
    
    303,436
    
    
    
    35,539
    
    
    
    338,975Pretax income before cumulative effect
of accounting change
    
    $
    81,372
    
    
    $
    15,489
    
    
    $
    96,861Total assets
    
    $
    29,740,719
    
    
    $
    185,487
    
    
    $
    29,926,206Expenditures for long-lived assets
    
    $
    
    
    
    $
    83
    
    
    $
    
 16




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##### Table of Contents



AIG SUNAMERICA LIFE ASSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)  5.
    
    SEGMENT INFORMATION (Continued) AssetManagementAnnuity Operations
    
    Operations
    
    TotalSIX MONTHS ENDED JUNE 30, 2003
    
    
    
    
    
    (in thousands)REVENUES:Fee income:Variable annuity policy fees, net of
reinsurance
    
    $
    128,979
    
    
    $
    
    
    
    $
    128,979Asset management fees
    
    
    
    
    
    
    28,789
    
    
    
    28,789Universal life insurance fees, net of
reinsurance
    
    
    18,348
    
    
    
    
    
    
    
    18,348Surrender charges
    
    
    14,354
    
    
    
    
    
    
    
    14,354Other fees
    
    
    
    
    
    
    6,852
    
    
    
    6,852Total fee income
    
    
    161,681
    
    
    
    35,641
    
    
    
    197,322Investment income
    
    
    196,825
    
    
    
    2,238
    
    
    
    199,063Net realized investment losses
    
    
    (8,630
    )
    
    
    
    
    
    
    (8,630
    )Total revenues
    
    
    349,876
    
    
    
    37,879
    
    
    
    387,755BENEFITS AND EXPENSES:Interest expense
    
    
    119,979
    
    
    
    1,502
    
    
    
    121,481General and administrative expenses
    
    
    40,289
    
    
    
    18,043
    
    
    
    58,332Amortization of deferred acquisition
costs and other deferred expenses
    
    
    79,077
    
    
    
    10,452
    
    
    
    89,529Annual commissions
    
    
    30,173
    
    
    
    
    
    
    
    30,173Claims on universal life contracts,
net of reinsurance recoveries
    
    
    11,233
    
    
    
    
    
    
    
    11,233Guaranteed benefits, net of reinsurance
    
    
    36,459
    
    
    
    
    
    
    
    36,459Total benefits and expenses
    
    
    317,210
    
    
    
    29,997
    
    
    
    347,207Pretax income before cumulative effect
of accounting change
    
    $
    32,666
    
    
    $
    7,882
    
    
    $
    40,548Total assets
    
    $
    25,456,775
    
    
    $
    222,207
    
    
    $
    25,678,982Expenditures for long-lived assets
    
    $
    
    
    
    $
    2,693
    
    
    $
    
 17




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AIG SUNAMERICA LIFE ASSURANCE COMPANY 
   Managements discussion and analysis of financial condition and results of
operations of AIG SunAmerica Life Assurance Company (formerly Anchor National
Life Insurance Company) (the Company) for the three months and six months
ended June 30, 2004 and June 30, 2003 follows. Certain prior period amounts
have been reclassified to conform to the current periods presentation. In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions readers regarding certain
forward-looking statements contained in this report and in any other statements
made by, or on behalf of, the Company, whether or not in future filings with
the Securities and Exchange Commission (the SEC). Forward-looking statements
are statements not based on historical information and which relate to future
operations, strategies, financial results, or other developments. Statements
using verbs such as expect, anticipate, believe or words of similar
import generally involve forward-looking statements. Without limiting the
foregoing, forward-looking statements include statements which represent the
Companys beliefs concerning future levels of sales and redemptions of the
Companys products, investment spreads and yields, or the earnings and
profitability of the Companys activities. Forward-looking statements are necessarily based on estimates and
assumptions that are inherently subject to significant business, economic and
competitive uncertainties and contingencies, many of which are beyond the
Companys control and many of which are subject to change. These uncertainties
and contingencies could cause actual results to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company. Whether or not actual results differ materially from forward-looking
statements may depend on numerous foreseeable and unforeseeable developments.
Some may be national in scope, such as general economic conditions, changes in
tax law and changes in interest rates. Some may be related to the insurance
industry generally, such as pricing, competition, regulatory developments and
industry consolidation. Others may relate to the Company specifically, such as
credit, volatility and other risks associated with the Companys investment
portfolio. Investors are also directed to consider other risks and
uncertainties discussed in documents filed by the Company with the SEC. The
Company disclaims any obligation to update forward-looking information. CRITICAL ACCOUNTING POLICIES The Company considers among its most critical accounting policies those
policies with respect to valuation of certain financial instruments,
amortization of deferred acquisition costs and 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 $67.8 million at June
30, 2004. In determining if and when a decline in fair value below amortized
cost is other than temporary, the Company evaluates at each reporting period
the market conditions, offering prices, trends of earnings, price multiples,
and other key measures for investments in debt and marketable equity
securities. In particular, for debt securities, the Company assesses the
probability that all amounts due are collectible according to the contractual
terms of the obligation. When such a decline in value is deemed to be other
than temporary, the Company recognizes an impairment loss in the current period
operating results to the extent of the decline (See also discussion within
Capital Resources and Liquidity herein). Securities in the Companys portfolio with a carrying value of
approximately $972.3 million at June 30, 2004 do not have readily determinable
market prices. For these securities, the Company estimates the fair value with
internally prepared valuations (including those based on estimates of future
profitability).Otherwise, the Company uses its most recent purchases and
sales of similar unquoted securities, independent broker quotes or comparison
to similar securities with quoted prices when possible to estimate the fair
value of those securities. All such securities are classified as available for
sale. The Companys ability to liquidate its positions in these securities
will be impacted to a significant degree by the lack of an actively traded
market, and the Company may not be able 18




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##### Table of Contents



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:
Approximately 82% of the amortization of deferred acquisition costs (DAC) and
other deferred expenses was attributed to policy acquisition costs deferred by
the annuity operations and 18% was attributed to the distribution costs
deferred by the asset management operations. For the annuity operations, the
Company amortizes deferred acquisition costs (DAC) based on a percentage of
expected gross profits (EGPs) over the life of the underlying policies over
the estimated lives of the fund deposits on a straight-line basis. EGPs are
computed based on assumptions related to the underlying policies written,
including their anticipated duration, the growth rate of the separate account
assets (with respect to variable annuities) or general account assets (with
respect to fixed annuities, fixed options of variable annuities and universal
life contracts) supporting the annuity obligations, costs of providing policy
guarantees and the level of expenses necessary to maintain the policies. The
Company adjusts amortization of DAC and other deferred expenses (a DAC
unlocking) when estimates of current or future gross profits to be realized
from its annuity policies are revised. Approximately 95% of the DAC balance
attributed to annuity operations at June 30, 2004 related to variable annuity
products and 5% related to fixed annuity and universal life products. DAC amortization on annuities is sensitive to surrender rates, claims
costs, and the actual and assumed future growth rate of the assets supporting
the Companys obligations under annuity policies. With respect to fixed
annuities, the growth rate depends on the yield on the general account assets
supporting those annuities. With respect to variable annuities, the growth
rate depends on the performance of the investment options available under the
annuity contract and the allocation of assets among these various investment
options. The assumption the Company uses for the long-term annual net growth of the
separate account assets in the determination of DAC amortization with respect
to its variable annuity policies is 10% (the long-term growth rate
assumption). The Company uses a reversion to the mean methodology that
allows it to maintain this 10% long-term growth rate assumption, while also
giving consideration to the effect of short-term swings in the equity markets.
For example, if performance was 15% during the first year following the
introduction of a product, the DAC model would assume that market returns for
the following five years (the short-term growth rate assumption) would be
approximately 9%, resulting in an average annual growth rate of 10% during the
life of the product. Similarly, following periods of below 10% performance,
the model will assume a short-term growth rate higher than 10%. A DAC
unlocking will occur if management deems the short-term growth rate assumption
(i.e., the growth rate required to revert to the mean 10% growth rate over a
five-year period) to be unreasonable. The use of a reversion to the mean
assumption is common within the industry; however, the parameters used in the
methodology are subject to judgment and vary within the industry. For the asset management operations, the Company defers distribution costs
that are directly related to the sale of mutual funds which 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 sensitive
to 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)
on January 1, 2004, the Company is required to recognize a liability for
guaranteed minimum death benefits (GMDB) and other guaranteed benefits. In
calculating the projected liability, five thousand stochastically generated
investment performance scenarios were developed with a mean investment
performance of 10%. Additional assumptions are made for mortality, lapse rates
of return and the volatility of equity markets. 19




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RESULTS OF OPERATIONS NET INCOME totaled $37.9 million in the second quarter of 2004, compared
with $20.6 million in the second quarter of 2003. For the six months ended
June 30, 2004, net income amounted to $6.9 million,
compared to $31.2 million
in 2003. CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflected the adoption
of SOP 03-1 on January 1, 2004. The Company recorded a loss of $62.6 million,
net of tax, which is recognized in the consolidated statement of income and
comprehensive income as a cumulative effect of accounting change for the six
months ended June 30, 2004. PRETAX
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $53.0
million in the second quarter of 2004, compared with $28.0 million in the
second quarter of 2003. For the six months, pretax income before cumulative
effect of accounting change totaled $96.9 million in 2004, compared to $40.5
million in 2003. The increase in both the second quarter and the six months of
2004 was primarily due to higher variable annuity and asset management fee
income partially offset by higher general and administrative expenses. INCOME TAX EXPENSE totaled $15.2 million in the second quarter of 2004,
$7.4 million in the second quarter of 2003, $27.4 million of tax
expense in the six months of 2004 and $9.3 million in the six
months of 2003, representing effective tax rates of 29%, 27%, 28% and
2.3%,
respectively. The increase in 2004 is due primarily to higher pretax income in 2004 without
corresponding increase in permanent tax differences. BUSINESS SEGMENTS Effective January 1, 2004, SunAmerica Life Insurance Company (the
Parent) contributed to the Company 100% of the outstanding capital stock of
its then wholly owned subsidiary, AIG SunAmerica Asset Management Corp.
(SAAMCo), which in turn has two wholly owned subsidiaries: AIG SunAmerica
Capital Services, Inc. (SACS) and AIG SunAmerica Fund Services, Inc. (SFS).
This contribution increased the Companys shareholders equity by
approximately $99.1 million (see Note 1 of Notes to Consolidated Financial
Statements). Effective January 1, 2004, the Companys earnings include the
asset management operations of SAAMCo, SACS and SFS. Prior year results have
been restated to account for this contribution as if it had occurred at the
beginning of the earliest period presented. 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
annuities and universal life insurance contracts. The Company focuses
primarily on the marketing of variable annuity products. The variable annuity
products offer investors a broad spectrum of fund alternatives, with a choice
of investment managers, as well as guaranteed fixed-rate account options. The
Company earns fee income on investments in the variable account options and net
investment spread on the fixed-rate account options. The asset management operations are conducted by the Companys registered
investment advisor subsidiary, SAAMCo, and its wholly owned distributor, SACS,
and its wholly owned servicing administrator, SFS. These companies earn fee
income by distributing and managing a diversified family of mutual funds,
managing certain subaccounts within the Companys variable annuity products and
providing professional management of individual, corporate and pension plan
portfolios. SAAMCo is the investment advisor for certain trusts that serve as
investment options for the Companys variable annuity products. 20




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##### Table of Contents



ANNUITY OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $45.4
million in the second quarter of 2004, compared with $22.2 million in the
second quarter of 2003. For the six months, pretax income before cumulative
effect of accounting change totaled $81.4 million in 2004, compared to $32.7
million in 2003. The increase in 2004 compared to 2003 was primarily due to
higher variable annuity policy fee income. NET INVESTMENT SPREAD, a non-GAAP measure, which represents investment
income earned on invested assets less interest credited to fixed annuity
contracts, universal life insurance contracts and guaranteed investment
contracts is a key measurement used by the Company in evaluating the
profitability of its business. Accordingly, the Company presents an analysis
of net investment spread because the Company has determined this measure to be
useful and meaningful. In evaluating its investment yield and net investment spread, the Company
calculates average invested assets using the amortized cost of bonds, notes and
redeemable preferred stocks. This basis does not include unrealized gains and
losses, which are reflected in the carrying value (i.e., fair value) of those
investments pursuant to Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities. In the
calculation of average invested assets, the Company excludes cash collateral
received from the securities lending program, which is offset by a securities
lending payable in the same amount. The Company participates in a securities
lending program with an affiliated agent, pursuant to which it lends its
securities and primarily takes cash as collateral with respect to the
securities lent. Participation in securities lending agreements provides
additional net investment income for the Company, resulting from investment
income earned on the collateral, less interest paid on the securities lending
agreements and the related management fees paid to an affiliate to administer
the program. 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
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(in thousands)Investment income
    
    $
    97,783
    
    
    $
    100,040
    
    
    $
    184,776
    
    
    $
    196,825Interest credited to fixed annuity contracts
    
    
    (35,571
    )
    
    
    (39,328
    )
    
    
    (70,807
    )
    
    
    (78,093
    )Interest credited to universal life insurance
contracts
    
    
    (18,524
    )
    
    
    (18,737
    )
    
    
    (37,005
    )
    
    
    (37,839
    )Interest credited to guaranteed investment
contracts
    
    
    (1,379
    )
    
    
    (2,031
    )
    
    
    (2,714
    )
    
    
    (4,047
    )Net investment spread
    
    
    42,309
    
    
    
    39,944
    
    
    
    74,250
    
    
    
    76,846Net realized investment gain (losses)
    
    
    1,667
    
    
    
    (5,358
    )
    
    
    (9,726
    )
    
    
    (8,630
    )Fee income, net of reinsurance
    
    
    105,357
    
    
    
    83,107
    
    
    
    209,758
    
    
    
    161,681General and administrative expenses
    
    
    (25,273
    )
    
    
    (19,030
    )
    
    
    (52,601
    )
    
    
    (40,289
    )Amortization
of deferred acquisition costs and other deferred expenses
    
    
    (45,329
    )
    
    
    (40,256
    )
    
    
    (69,330
    )
    
    
    (79,077
    )Annual commissions
    
    
    (15,117
    )
    
    
    (15,995
    )
    
    
    (30,131
    )
    
    
    (30,173
    )Claims on UL contracts, net of reinsurance
recoveries
    
    
    (5,099
    )
    
    
    (5,720
    )
    
    
    (9,922
    )
    
    
    (11,233
    )Guaranteed benefits, net of
reinsurance
    
    
    (13,152
    )
    
    
    (14,483
    )
    
    
    (30,926
    )
    
    
    (36,459
    )Pretax income before cumulative effect of
accounting change
    
    $
    45,363
    
    
    $
    22,209
    
    
    $
    81,372
    
    
    $
    32,666
 21




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Net investment spread totaled $42.3 million in the second quarter of 2004,
compared to $39.9 million in the second quarter of 2003. These amounts equal
2.70% on average invested assets (computed on a daily basis) of $6.26 billion
in the second quarter of 2004 and 2.37% on average invested assets of $6.75
billion in the second quarter of 2003. For the six months, net investment
spread totaled $74.3 million in 2004 and $76.8 million in 2003, representing
2.37% of average invested assets of $6.27 billion in 2004 and 2.28% of average
invested assets of $6.74 billion in 2003 on an annualized basis. The components of net investment spread were as follows: Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(in thousands)Net investment spread
    
    $
    42,309
    
    
    $
    39,944
    
    
    $
    74,250
    
    
    $
    76,846Average invested assets
    
    
    6,259,041
    
    
    
    6,745,831
    
    
    
    6,269,022
    
    
    
    6,735,124Average interest-bearing liabilities
    
    
    5,987,837
    
    
    
    6,500,720
    
    
    
    5,997,113
    
    
    
    6,478,404Yield on average invested assets
    
    
    6.25
    %
    
    
    5.93
    %
    
    
    5.89
    %
    
    
    5.84
    %Rate paid on average interest-bearing liabilities
    
    
    3.71
    
    
    
    3.70
    
    
    
    3.69
    
    
    
    3.70Difference between yield and interest rate paid
    
    
    2.54
    %
    
    
    2.23
    %
    
    
    2.20
    %
    
    
    2.14
    %Net investment spread as a percentage of
average invested assets
    
    
    2.70
    %
    
    
    2.37
    %
    
    
    2.37
    %
    
    
    2.28
    %
 The decline in average invested assets resulted primarily from net
exchanges from fixed accounts into the separate accounts of variable annuity
contracts, partially offset by sales of the fixed account options of the
Companys variable annuity products (Fixed Annuity Deposits). Fixed Annuity
Deposits and renewal deposits on its universal life product totaled $425.4
million in the second quarter of 2004, $386.7 million in the second quarter of
2003, $809.2 million in the six months of 2004 and $826.2 million in the six
months of 2003, and are largely deposits for the fixed accounts of variable
annuities. On an annualized basis, these deposits represent 30%, 29%, 28% and
28%, respectively, of the related reserve balances at the beginning of the
respective periods. Net investment spreads include the effect of income earned or interest
paid on the difference between average invested assets and average
interest-bearing liabilities. Average invested assets exceeded average
interest-bearing liabilities by $271.2 million in the second quarter of 2004,
compared with $245.1 million in the second quarter of 2003. For the six
months, average invested assets exceeded average interest-bearing liabilities
by $271.9 million in 2004, compared with $256.7 million in 2003. The
difference between the Companys yield on average invested assets and the rate
paid on average interest-bearing liabilities was 2.54% in the second quarter of
2004, 2.23% in the second quarter of 2003, 2.20% in the six months of 2004 and
2.14% in the six months of 2003. Investment income (and the related yields on average invested assets)
totaled $97.8 million (6.25%) in the second quarter of 2004, $100.0 million
(5.93%) in the second quarter of 2003, $184.8 million (5.89%) in the six months
of 2004 and $196.8 million (5.84%) in the six months of 2003. The increase in
the investment yield primarily reflects $3.0 million in income from the mark to
market of the GMAV put options and embedded derivatives in the second quarter
of 2004, compared to a $2.8 million loss in the second quarter of 2003.
Excluding the impact of the put options, investment income would have been
$94.7 (6.06%) and $102.8 (6.10%) in the second quarters of 2004 and 2003,
respectively. For the six months, the increase in the investment yield
primarily reflects $1.2 million loss from the mark to market of the GMAV put
options and embedded derivatives in 2004, compared to $4.5 million in 2003.
Excluding the impact of the put options, investment income would have been
$185.9 (5.93%) and $201.3 (5.98%) in the six months of 2004 and 2003,
respectively. Expenses incurred to manage the investment portfolio amounted to
$0.6 million in the second quarter of 2004, $0.6 million in the second quarter
of 2003, $1.2 million in the six months of 2004 and $1.1 million in the six
months of 2003. These expenses are included as a reduction of investment
income in the consolidated statement of income and comprehensive income. 22




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Interest expense totaled $55.5 million in the second quarter of 2004 and
$60.1 million in the second quarter of 2003. For the six months, interest
expense aggregated $110.5 million in 2004, compared with $120.0 million in
2003. The average rate paid on all interest-bearing liabilities was 3.71% in
the second quarter of 2004, compared with 3.70% in the second quarter of 2003.
For the six months, the average rate paid on all interest-bearing liabilities
was 3.69% in 2004 and 3.70% in 2003. Interest-bearing liabilities averaged
$5.99 billion during the second quarter of 2004, $6.50 billion during the
second quarter of 2003, $6.00 billion during the six months of 2004 and $6.48
billion during the six months of 2003. NET REALIZED INVESTMENT GAINS (LOSSES) totaled $1.7 million of gains in
the second quarter of 2004, compared with net realized investment losses of
$5.4 million in the second quarter of 2003 and include impairment writedowns of
$1.5 million and $10.4 million, respectively. For the six months, net realized
investment losses totaled $9.7 million in 2004, compared with $8.6 million in
2003 and include impairment writedowns of $2.6 million and $15.5 million,
respectively. Thus, net realized gains from sales and redemptions of
investments totaled $3.2 million in the second quarter of 2004 and $5.0 million
in the second quarter of 2003. For the six months, net realized losses from
sales and redemptions of investments totaled $7.1 million in 2004, compared to
net realized gains of $6.9 million in 2003. The Company sold or redeemed invested assets, principally bonds and notes,
aggregating $335.3 million in the second quarter of 2004, $517.6 million in the
second quarter of 2003, $1.18 billion in the six months of 2004 and $1.35
billion in the six months of 2003. Sales of investments result from the active
management of the Companys investment portfolio. Because redemptions of
investments are generally involuntary and sales of investments are made in both
rising and falling interest rate environments, net gains and losses from sales
and redemptions of investments fluctuate from period to period, and represent
0.20%, 0.30%, 0.23% and 0.21% of average invested assets in the second quarter
of 2004, the second quarter of 2003, the six months of 2004 and the six months
of 2003, respectively. Active portfolio management involves the ongoing
evaluation of asset sectors, individual securities within the investment
portfolio and the reallocation of investments from sectors that are perceived
to be relatively overvalued to sectors that are perceived to be relatively
undervalued. The intent of the Companys active portfolio management is to
maximize total returns on the investment portfolio, taking into account credit,
option, liquidity and interest-rate risk. Impairment writedowns include $1.5 million, $10.4 million, $2.6 million
and $15.5 million of provisions principally applied to bonds in the second
quarter of 2004, the second quarter of 2003, the six months of 2004 and the six
months of 2003, respectively. On an annualized basis, impairment writedowns
represent 0.09%, 0.62%, 0.08% and 0.46% of average invested assets in the
respective periods. For the twenty quarters ended June 30, 2004, impairment
writedowns as an annualized percentage of average invested assets have ranged
from 0.07% to 1.95% and have averaged 0.67%. 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 based on the market
value of assets in separate accounts supporting variable annuity contracts.
Such fees totaled $90.4 million in the second quarter of 2004 and $66.9 million
in the second quarter of 2003 and are net of reinsurance premiums of $6.4
million and $7.7 million, respectively. For the six months, variable annuity
policy fees totaled $178.6 million in 2004 and $129.0 million in 2003 and are
net of reinsurance premiums of $14.9 million and $14.1 million, respectively.
The increased fees in 2004 as compared to 2003 primarily reflect the improving
equity market conditions since the first quarter of 2003, 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%, 1.7%, 1.8%
and 1.7% of average variable annuity assets in the second quarters and six
months of 2004 and 2003, respectively. Variable annuity assets averaged $20.13
billion, $15.67 billion, $19.98 billion and $15.08 billion during the
respective periods. Variable annuity deposits, which exclude deposits
allocated to the fixed accounts of variable annuity products, totaled $757.6
million in the second quarter of 2004 and $394.3 million in the second quarter
of 2003. For the six months, variable annuity deposits totaled $1.50 billion
in 2004, compared with $722.7 million in 2003. On an annualized basis, these
amounts represent 15%, 11%, 16% and 10% of variable annuity reserves at the
beginning of the respective periods. The increase in variable annuity deposits
in 2004 reflected increased demand for variable annuity products due to the
improved equity market conditions in 2004 and the latter part of 2003.
Transfers from the fixed accounts of the Companys variable annuity products to
the separate accounts are not classified as variable annuity deposits. 23




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Accordingly, changes in variable annuity deposits are not necessarily
indicative of the ultimate allocation by customers among fixed and variable
account options of the Companys variable annuity products. Sales of variable annuity products (which include deposits allocated to
the fixed accounts) (Variable Annuity Product Sales) amounted to $1.17
billion, $769.6 million, $2.29 billion and $1.52 billion in the second quarters
and the six months of 2004 and 2003, respectively. Such sales primarily
reflect those of the Companys Polaris and Seasons families of variable annuity
products. The Companys variable annuity products are primarily multi-manager
variable annuities that offer investors a choice of several variable funds as
well as a number of guaranteed fixed-rate funds. Investors can select from a
choice of several variable funds and up to 7 guaranteed fixed-rate funds,
depending on the product. The increase in Variable Annuity Product Sales for
the six months reflects the improving equity market conditions since the first
quarter of 2003. The Company has encountered increased competition in the variable annuity
marketplace during recent years and anticipates that the market will remain
highly competitive for the foreseeable future. Also, from time to time,
Federal initiatives are proposed that could affect the taxation of annuities
(see Regulation). UNIVERSAL LIFE INSURANCE POLICY FEES, NET OF REINSURANCE amounted to $8.5
million in the second quarter of 2004 and $9.4 million in the second quarter of
2003 and are net of reinsurance premiums of $8.4 million and $7.8 million,
respectively. For the six months, universal life insurance policy fees totaled
$17.7 million in 2004 and $18.3 million in 2003 and are net of reinsurance
premiums of $16.5 million and $16.3 million, respectively. Universal life
insurance policy fees consist of mortality charges, up-front fees earned on
deposits received and administrative fees, net of reinsurance premiums. The
administrative fees are assessed based on the number of policies in force as of
the end of each month. The Company acquired its universal life contracts as
part of the acquisition of business from MBL Life Assurance Corporation on
December 31, 1998 and does not actively market such contracts. Such fees
annualized represent 2.2%, 2.3%, 2.3% and 2.3% of average reserves for
universal life insurance contracts in the respective periods. SURRENDER CHARGES on variable annuity and universal life contracts totaled
$6.5 million in the second quarter of 2004 and $6.8 million in the second
quarter of 2003. For the six months, such surrender charges totaled $13.5
million in 2004 and $14.4 million in 2003. Surrender charge periods range from
zero to nine years from the date a deposit is received. Surrender charges
generally are assessed on withdrawals at declining rates during the first seven
or nine years following receipt of the deposit. GENERAL AND ADMINISTRATIVE EXPENSES totaled $25.3 million in the second
quarter of 2004 and $19.0 million in the second quarter of 2003. For the six
months, general and administrative expenses totaled $52.6 million in 2004 and
$40.3 million in 2003. The increase in 2004 results from higher information
technology costs and payroll related expenses. General and administrative
expenses remain closely controlled through a company-wide cost containment
program and continue to represent less than 1% of average total assets. AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES
totaled $45.3 million in the second quarter of 2004, compared to $40.3 million
in the second quarter of 2003. For the six months, such amortization totaled
$69.3 million in 2004 and $79.1 million in 2003. Prior year included
accelerated amortization due to higher than anticipated surrenders on certain
products with features which have been discontinued. ANNUAL COMMISSIONS totaled $15.1 million in the second quarter of 2004,
compared with $16.0 million in the second quarter of 2003. For the six months,
annual commissions totaled $30.1 million in 2004 and $30.2 million in 2003.
Annual commissions represent renewal commissions paid quarterly in arrears to
maintain the persistency of certain of the Companys variable annuity
contracts. Substantially all of the Companys currently available variable
annuity products allow for an annual commission payment option in return for a
lower immediate commission. The vast majority of the Companys average
balances of its variable annuity products are currently subject to such annual
commissions. CLAIMS ON UNIVERSAL LIFE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled
$5.1 million in the second quarter of 2004, compared to $5.7 million in the
second quarter of 2003 (net of reinsurance recoveries of $13.4 million in the
second quarter of 2004 and $7.0 million in the second quarter of 2003). For
the 24




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##### Table of Contents



six months, such claims totaled $9.9 million in 2004 and $11.2 million in
2003 (net of reinsurance recoveries of $22.6 million in 2004 and $17.8 million
in 2003). The change in such claims resulted principally from changes in the
mortality experience. GUARANTEED BENEFITS, NET OF REINSURANCE RECOVERIES (Net GMDB) on
variable annuity contracts totaled $13.2 million in the second quarter of 2004,
compared with $14.5 million in the second quarter of 2003 (net of reinsurance
recoveries of $0.2 million in 2004 and $2.8 million in 2003). For the six
months, Net GMDB amounted to $30.9 million in 2004 and $36.5 million in 2003
(net of reinsurance recoveries of $2.4 million in 2004 and $5.7 million in
2003). Net GMDB consists primarily of guaranteed minimum death benefits as
well as immaterial amounts of earnings enhancement benefits and guaranteed
minimum income benefits. These guarantees are described in more detail in the
following paragraphs. The decrease in Net GMDB in 2004 reflects the upturn in
the equity markets in 2004 and 2003. Downturns in the equity markets could
increase these expenses. A majority of the Companys variable annuity products are issued with a
death benefit feature which provides that, upon the death of a contract holder,
the contract holders beneficiary will receive the greater of (1) the contract
holders account value, or (2) a guaranteed minimum death benefit that varies
by product and election by policyholder. The Company bears the risk that death claims following a decline
in the 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. At June 30, 2004, approximately 30% of in-force
contracts with GMDB (calculated based on account value) have been reinsured.
In 2004, a substantial majority of contracts sold have reinsurance coverage.
However, the Company does not currently have reinsurance coverage on the
majority of the contracts to be sold after December 2004. Reinsurance coverage
is subject to limitations such as caps and deductibles. On January 1, 2004,
the Company recorded a reserve for GMDB (see Note 2 of Notes to Consolidated
Financial Statements) pursuant to adoption of a new accounting standard, SOP
03-1. EARNINGS ENHANCEMENT BENEFIT (EEB): The Company issues certain variable
annuity products that offer an optional EEB feature. For contract holders who
elect the feature, the EEB provides an additional death benefit amount equal to
a fixed percentage of earnings in the contract, subject to certain maximums.
The Company bears the risk that account values following favorable performance
of the financial markets will result in greater EEB death claims and that the
fees collected under the contract are insufficient to cover the costs of the
benefit to be provided. At June 30, 2004, approximately 8% (calculated based
on current account value) of in-force contracts include EEB coverage, and 88%
of the contracts with EEB are reinsured. GUARANTEED MINIMUM INCOME BENEFIT (GMIB): The Company issues certain
variable annuity products that contain or offer a GMIB feature. This feature
provides a minimum annuity payment guarantee for those contract holders who
choose to receive fixed lifetime annuity payments after a seven, nine, or
ten-year waiting period in their deferred annuity contracts. The Company bears
the risk that the performance of the financial markets will not be sufficient
for accumulated policyholder account balances to support GMIB benefits and that
the fees collected under the contract are insufficient to cover the costs of
the benefit to be provided. Substantially all of the Companys products
containing the GMIB feature have been reinsured. However, the Company does not
have reinsurance coverage on contracts to be sold after July 2004. As there is
a waiting period to annuitize using the GMIB, as of June 30, 2004, there are no
policies eligible to receive this benefit. GUARANTEED MINIMUM ACCOUNT VALUE (GMAV): In the third quarter of 2002,
the Company began issuing certain variable annuity products that offer an
optional GMAV. If elected by the policyholder at the time of contract
issuance during the first 90 days, this feature guarantees that the account value under the contract
will at least equal the amount of the initial principal invested, adjusted for
withdrawals, at the end of a ten-year waiting period. The Company bears the
risk that protracted under-performance of the financial markets could result in
GMAV benefits being higher than the underlying 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 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 income and comprehensive income. GUARANTEED MINIMUM WITHDRAWAL BENEFIT (GMWB): In May of 2004, the
Company began issuing certain variable annuity products that offer an optional
GMWB. This feature provides a guaranteed annual withdrawal stream, regardless
of market performance, equal to premiums invested during the first ninety days after issue 25




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##### Table of Contents



adjusted for subsequent withdrawals (Eligible Premium). These annual
withdrawals are available after either a three-year waiting period or a
five-year waiting period and limited to 10% of Eligible Premium before the
amount guaranteed is reduced. Additional incentives are earned by the contract
holder if no withdrawals are taken prior to the end of the waiting period. In
2004, variable annuity deposits with GMWB were immaterial. With respect to its reinsurance agreements, the Company could become
liable for all obligations of the reinsured policies if the reinsurers were to
become unable to meet the obligations assumed under the respective reinsurance
agreements. The Company monitors its credit exposure with respect to these
agreements. Due to the high credit ratings and periodic monitoring of these
ratings of the reinsurers, such risks are considered to be minimal. ASSET MANAGEMENT OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $7.7
million in the second quarter of 2004 compared to a $5.8 million in the second
quarter of 2003. For the six months, pretax income before cumulative effect of
accounting change amounted to $15.5 million in 2004 and $7.9 million in 2003.
The increases in the quarter and six months of 2004 from 2003 resulted from
increased asset management fees, partially offset by increased
amortization of DAC and other deferred expenses. ASSET MANAGEMENT FEES, which include investment advisory fees and 12b-1
distribution fees, are based on the market value of assets managed in mutual
funds by SAAMCo. Such fees totaled $22.6 million on average assets managed of
$9.64 billion in the second quarter of 2004 and $15.5 million on average assets
managed of $7.84 billion in the second quarter of 2003. For the six months,
asset management fees amounted to $43.5 million on average assets managed of
$9.62 billion in 2004 and $28.8 million on average assets managed of $7.61
billion in 2003. Asset management fees are not necessarily proportionate to
average assets managed, principally due to changes in product mix. Mutual fund
sales, excluding sales of money market accounts and private accounts, totaled
$538.1 million in the second quarter of 2004, compared to $561.1 million in the
second quarter of 2003. For the six months, mutual fund sales amounted to
$1.24 billion in 2004 and $1.00 billion in 2003. Redemptions of mutual funds,
excluding redemptions of money market accounts, amounted to $379.1 million in
the second quarter of 2004, $350.3 million in the second quarter of 2003,
$742.1 million in the six months of 2004 and $773.2 million in the six months
of 2003, which, annualized, represent 19%, 23%, 19% and 27%, respectively, of
average related mutual fund assets. The increase in sales in 2004 principally
reflects increasing demand for equity products, due to the improving stock
market conditions over the past year. GENERAL AND ADMINISTRATIVE EXPENSES totaled $10.1 million in the second
quarter of 2004, $9.3 million in the second quarter of 2003, $19.0 million in
the six months of 2004 and $18.0 million in the six months of 2003. The
increase in expenses in 2004 is attributable to higher marketing and advertising costs. AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES
totaled $8.0 million in the second quarter of 2004, compared with $5.3 million
in the second quarter of 2003. For the six months, such amortization totaled
$15.4 million in 2004 and $10.5 million in 2003. The increase in amortization
was primarily due to additional mutual fund sales since the second quarter of
2003 and amortization of the deferred commissions thereon. 26




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##### Table of Contents



CAPITAL RESOURCES AND LIQUIDITY SHAREHOLDERS EQUITY decreased to $1.52 billion at June 30, 2004 from
$1.56 billion at December 31, 2003. The decrease reflected a $44.2 million
decrease in unrealized gains, net of the effect of taxes and DAC, and a $2.5
million dividend to the Parent partially offset by $6.9 million of net income. INVESTMENTS AND CASH at June 30, 2004 totaled $7.53 billion, compared with
$7.12 billion at December 31, 2003. The Companys invested assets are managed
by an affiliate of AIG. The following table summarizes the Companys portfolio
of bonds, notes and redeemable preferred stocks (the Bond Portfolio) and
other investments and cash at June 30, 2004 and December 31, 2003: June 30, 2004
    
    December 31, 2003Fair
    
    Percent of
    
    Fair
    
    Percent ofValue
    
    Portfolio
    
    Value
    
    PortfolioBond Portfolio:
    
    
    
    
    
    (in thousands, except for percentages)U.S. government securities
    
    $
    29,933
    
    
    
    0.4
    %
    
    $
    24,292
    
    
    
    0.3
    %Mortgage-backed securities
    
    
    1,054,405
    
    
    
    14.0
    
    
    
    1,191,817
    
    
    
    16.7Securities of public utilities
    
    
    320,498
    
    
    
    4.3
    
    
    
    365,150
    
    
    
    5.1Corporate bonds and notes
    
    
    2,855,942
    
    
    
    37.9
    
    
    
    2,697,142
    
    
    
    37.9Redeemable preferred stocks
    
    
    21,400
    
    
    
    0.3
    
    
    
    22,175
    
    
    
    0.3Other debt securities
    
    
    1,032,403
    
    
    
    13.7
    
    
    
    1,205,224
    
    
    
    16.9Total Bond Portfolio
    
    
    5,314,581
    
    
    
    70.6
    
    
    
    5,505,800
    
    
    
    77.2Mortgage loans
    
    
    701,808
    
    
    
    9.3
    
    
    
    716,846
    
    
    
    10.1Common stocks
    
    
    5,143
    
    
    
    0.1
    
    
    
    727
    
    
    
    0.0Cash and short-term investments
    
    
    142,180
    
    
    
    1.9
    
    
    
    133,105
    
    
    
    1.9Securities lending collateral
    
    
    1,122,766
    
    
    
    14.9
    
    
    
    514,145
    
    
    
    7.2Other
    
    
    245,893
    
    
    
    3.2
    
    
    
    254,010
    
    
    
    3.6Total investments and cash
    
    $
    7,532,371
    
    
    
    100.0
    %
    
    $
    7,124,633
    
    
    
    100.0
    %
 The Companys general investment philosophy is to hold fixed-rate assets
for long-term investment. Thus, it does not have a trading portfolio.
However, the Company has determined that all of the Bond Portfolio is available
to be sold in response to changes in market interest rates, changes in relative
value of asset sectors and individual securities, changes in prepayment risk,
changes in the credit quality outlook for certain securities, the Companys
need for liquidity and other similar factors. THE BOND PORTFOLIO, which constituted 71% of the Companys total
investment portfolio at June 30, 2004, had an aggregate fair value that was
$67.7 million greater than its amortized cost at June 30, 2004, compared with
$154.6 million at December 31, 2003. The decrease in net unrealized gains on
the Bond Portfolio during 2004 principally reflects the rise in prevailing
interest rates during the second quarter of 2004 and the corresponding effect
on the fair value of the Bond Portfolio at June 30, 2004. At June 30, 2004, the Bond Portfolio had an aggregate fair value of $5.31
billion and an aggregate amortized cost of $5.25 billion. At June 30, 2004,
the Bond Portfolio (excluding $21.4 million of redeemable preferred stocks)
included $5.19 billion of bonds rated by Standard & Poors (S&P), Moodys
Investors Service (Moodys), Fitch (Fitch) or the National Association of
Insurance Commissioners (NAIC), and $107.4 million of bonds rated by the
Company pursuant to statutory ratings guidelines established by the NAIC. At
June 30, 2004, approximately $4.93 billion of the Bond Portfolio was investment
grade, including $1.08 billion of mortgage-backed securities (MBS) and U.S.
government/agency securities. 27




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##### Table of Contents



At June 30, 2004, the Bond Portfolio included $367.0 million of bonds that
were not investment grade. These non-investment-grade bonds accounted for
approximately 1.2% of the Companys total assets and approximately 4.9% of its
invested assets. Non-investment-grade securities generally provide higher
yields and involve greater risks than investment-grade securities because their
issuers typically are more highly leveraged and more vulnerable to adverse
economic conditions than investment-grade issuers. In addition, the trading
market for these securities is usually more limited than for investment-grade
securities. An economic downturn could produce higher than average issuer
defaults on the non-investment-grade securities, which could cause the
Companys investment returns and net income to decline. At June 30, 2004, the
Companys non-investment-grade bond portfolio consisted of 167 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 11 industries with 21% of these assets concentrated in financial
institutions, 19% concentrated in utilities and 16% concentrated in
telecommunications. No other industry concentration constituted more than 10%
of these assets. The table on the following page summarizes the Companys rated bonds by
rating classification as of June 30, 2004. 28




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##### Table of Contents



RATED BONDS BY RATING CLASSIFICATION
(Dollars in thousands) Issues not rated by S&P/Moodys/Issues rated by S&P/Moodys/Fitch
    
    Fitch, by NAIC category
    
    TotalPercentEstimated
    
    NAIC
    
    
    
    
    
    Estimated
    
    
    
    
    
    Estimated
    
    of totalS&P/Moodys/Fitch
    
    Amortized
    
    fair
    
    category
    
    Amortized
    
    fair
    
    Amortized
    
    fair
    
    investedCategory (1)
    
    cost
    
    value
    
    (2)
    
    cost
    
    value
    
    cost
    
    value
    
    assetsAAA+ to A-
(Aaa to A3)
[AAA to A-]
    
    $
    2,949,718
    
    
    $
    2,992,884
    
    
    
    1
    
    
    $
    407,658
    
    
    $
    412,618
    
    
    $
    3,357,376
    
    
    $
    3,405,502
    
    
    
    47.31
    %BBB+ to BBB-
(Baa1 to Baa3)
[BBB+ to BBB-]
    
    
    1,227,247
    
    
    
    1,248,445
    
    
    
    2
    
    
    
    270,729
    
    
    
    272,230
    
    
    
    1,497,976
    
    
    
    1,520,675
    
    
    
    21.12
    %BB+ to BB-
(Ba1 to Ba3)
[BB+ to BB-]
    
    
    133,404
    
    
    
    133,210
    
    
    
    3
    
    
    
    28,450
    
    
    
    29,423
    
    
    
    161,854
    
    
    
    162,633
    
    
    
    2.26
    %B+ to B-
(B1 to B3)
[B+ to B-]
    
    
    151,136
    
    
    
    140,414
    
    
    
    4
    
    
    
    16,967
    
    
    
    19,996
    
    
    
    168,103
    
    
    
    160,410
    
    
    
    2.23
    %CCC+ to CCC-
(Caa1 to Caa3)
[CCC+ to CCC-]
    
    
    17,918
    
    
    
    19,562
    
    
    
    5
    
    
    
    6,238
    
    
    
    5,638
    
    
    
    24,156
    
    
    
    25,200
    
    
    
    0.35
    %CC to D
(Ca to C)
[CC to D]
    
    
    2,933
    
    
    
    4,659
    
    
    
    6
    
    
    
    14,318
    
    
    
    14,102
    
    
    
    17,251
    
    
    
    18,761
    
    
    
    0.26
    %TOTAL RATED
ISSUES
    
    $
    4,482,356
    
    
    $
    4,539,174
    
    
    
    
    
    
    $
    744,360
    
    
    $
    754,007
    
    
    $
    5,226,716
    
    
    $
    5,293,181
 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 $107.4 million of assets that were
rated by the Company pursuant to applicable NAIC rating guidelines. 29




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##### Table of Contents



The valuation of invested assets involves obtaining a fair value for each
security. The source for the fair value is generally from market exchanges,
with the exception of non-traded securities. Another aspect of valuation pertains to impairment. As a matter of
policy, the determination that a security has incurred an other-than-temporary
decline in value and the amount of any loss recognition requires the judgment
of the Companys management and a continual review of its investments. In
general, a security is considered a candidate for impairment if it meets any of
the following criteria:  
    
    Trading at a significant discount to par, amortized cost (if lower)
or cost for an extended period of time;
    
    The occurrence of a discrete credit event resulting in: (i) the
issuer defaulting on a material outstanding obligation; (ii) the issuer
seeking protection from creditors under the bankruptcy laws or similar
laws intended for the court supervised reorganization of insolvent
enterprises; or (iii) the issuer proposing a voluntary reorganization
pursuant to which creditors are asked to exchange their claims for cash
or securities having a fair value substantially lower than the par
value of their claims; or
    
    In the opinion of the Companys management, it is unlikely the
Company will realize a full recovery on its investment, irrespective of
the occurrence of one of the foregoing events. Once a security has been identified as potentially impaired, the amount of
such impairment is determined by reference to that securitys contemporaneous
market price. The Company has the ability to hold any security to its stated maturity.
Therefore, the decision to sell reflects the judgment of the Companys
management that the security sold is unlikely to provide, on a relative value
basis, as attractive a return in the future as alternative securities entailing
comparable risks. With respect to distressed securities, the sale decision
reflects managements judgment that the risk-discounted anticipated ultimate
recovery is less than the value achieved on sale. As a result of these policies, the Company recorded pretax impairment
writedowns of $2.6 million and $15.5 million in the six months of 2004 and
2003, respectively. One impairment loss amounted to 20% of net income for the six months ended June 30, 2004. No other individual impairment loss exceeded 10% of the
Companys net income for the six months ended June 30, 2004. Excluding the impairments noted above, the changes in fair value for the
Companys Bond Portfolio, which constitutes the vast majority of the Companys
investments, were recorded as a component of other comprehensive income in
shareholders equity as unrealized gains or losses. At June 30, 2004, the fair value of the Companys Bond Portfolio
aggregated $5.31 billion. Of this aggregate fair value, approximately 0.6%
represented securities trading at or below 75% of amortized cost. The impact
of unrealized losses on net income will be further mitigated upon realization,
because realization will result in current decreases in the amortization of
certain deferred acquisition costs and decreases in income taxes. At June 30, 2004, approximately $3.48 billion, at amortized cost, of the
Bond Portfolio had a fair value of $3.61 billion resulting in an aggregate
unrealized gain of $135.5 million. At June 30, 2004, approximately $1.77
billion, at amortized cost, of the Bond Portfolio had a fair value of $1.70
billion resulting in an aggregate unrealized loss of $67.8 million. One issuer
accounted for 15% of unrealized losses. No other single issuer accounted for
more than 10% of unrealized losses. Approximately 29%, 29% and 11% of
unrealized losses were from the transportation, financial and
noncyclical consumer industries, respectively. No other industry accounted for
more than 10% of unrealized losses. 30




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##### Table of Contents



The amortized cost of the Bond Portfolio in an unrealized loss position at
June 30, 2004, by contractual maturity, is shown below. AmortizedCost(in thousands)Due in one year or less
    
    $
    25,663Due after one year through five years
    
    
    545,701Due after five years through ten years
    
    
    648,597Due after ten years
    
    
    550,103Total
    
    $
    1,770,064
 The aging of the Bond Portfolio in an unrealized loss position at June 30,
2004 is shown below: Less than or Equal to 20%
    
    Greater than 20% to 50%
    
    Greater than 50%(dollars in thousands)
    
    of Amortized Cost
    
    of Amortized Cost
    
    of Amortized Cost
    

TotalAmortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    UnrealizedMonths
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    ItemsInvestment Grade Bonds0-6
    
    $
    1,079,373
    
    
    $
    (22,096
    )
    
    
    150
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    


    
    
    $
    1,079,373
    
    
    $
    (22,096
    )
    
    
    1507-12
    
    
    444,065
    
    
    
    (15,006
    )
    
    
    90
    
    
    
    22,715
    
    
    
    (5,900
    )
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    
    

    
    
    466,780
    
    
    
    (20,906
    )
    
    
    93>12
    
    
    33,640
    
    
    
    (782
    )
    
    
    11
    
    
    
    19,465
    
    
    
    (4,359
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53,105
    
    
    
    (5,141
    )
    
    
    12Total
    
    $
    1,557,078
    
    
    $
    (37,884
    )
    
    
    251
    
    
    $
    42,180
    
    
    $
    (10,259
    )
    
    
    4
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    1,599,258
    
    
    $
    (48,143
    )
    
    
    255Below Investment Grade
Bonds0-6
    
    $
    80,035
    
    
    $
    (2,079
    )
    
    
    53
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    

    
    $
    80,035
    
    
    $
    (2,079
    )
    
    
    537-12
    
    
    48,611
    
    
    
    (2,911
    )
    
    
    9
    
    
    
    39,890
    
    
    
    (14,127
    )
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    88,501
    
    
    
    (17,038
    )
    
    
    15>12
    
    
    1,671
    
    
    
    (108
    )
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    599
    
    
    
    (469
    )
    
    
    1
    
    
    
    2,270
    
    
    
    (577
    )
    
    
    3Total
    
    $
    130,317
    
    
    $
    (5,098
    )
    
    
    64
    
    
    $
    39,890
    
    
    $
    (14,127
    )
    
    
    6
    
    
    $
    599
    
    
    $
    (469
    )
    
    
    1
    
    
    $
    170,806
    
    
    $
    (19,694
    )
    
    
    71Total Bonds0-6
    
    $
    1,159,408
    
    
    $
    (24,175
    )
    
    
    203
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    
    



    
    $
    1,159,408
    
    
    $
    (24,175
    )
    
    
    2037-12
    
    
    492,676
    
    
    
    (17,917
    )
    
    
    99
    
    
    
    62,605
    
    
    
    (20,027
    )
    
    
    9
    
    
    
    
    
    
    
    
    
    
    
    
    


    
    555,281
    
    
    
    (37,944
    )
    
    
    108>12
    
    
    35,311
    
    
    
    (890
    )
    
    
    13
    
    
    
    19,465
    
    
    
    (4,359
    )
    
    
    1
    
    
    
    599
    
    
    
    (469
    )
    
    
    1
    


    
    55,375
    
    
    
    (5,718
    )
    
    
    15Total
    
    $
    1,687,395
    
    
    $
    (42,982
    )
    
    
    315
    
    
    $
    82,070
    
    
    $
    (24,386
    )
    
    
    10
    
    
    $
    599
    
    
    $
    (469
    )
    
    
    1
    


    $
    1,770,064
    
    
    $
    (67,837
    )
    
    
    326
 In 2004, the pretax realized losses incurred with respect to the sale of
fixed securities in the Bond Portfolio were $7.2 million. The aggregate fair
value of securities sold was $100.9 million, which was approximately 89.5% of
amortized cost. The average period of time that securities sold at a loss
during 2004 were trading continuously at a price below amortized cost was
approximately 16 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
June 30, 2004 was approximately $972.3 million. The methodology used to estimate fair value of non-traded fixed income
investments is by reference to traded securities with similar attributes and
using a matrix pricing methodology. This technique takes into account such
factors as the industry, the securitys rating and tenor, its coupon rate, its
position in the capital structure of the issuer and other relevant factors.
The change in fair value is recognized as a component of other comprehensive
income. 31




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##### Table of Contents



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 $289.3 million at June 30, 2004. Secured Loans are senior to
subordinated debt and equity and are secured by assets of the issuer. At June
30, 2004, Secured Loans consisted of $191.5 million of privately traded
securities and $97.8 million of publicly traded securities. These Secured
Loans are composed of loans to 59 borrowers spanning 10 industries, with 23% of
these assets concentrated in utilities, 17% concentrated in communications, 15%
concentrated in transportation, 11% concentrated in cyclical consumer products
and 10% concentrated in noncyclical consumer products. No other industry
constituted more than 10% of these assets. While the trading market for the Companys privately traded Secured Loans
is more limited than for publicly traded issues, participation in these
transactions has enabled the Company to improve its investment yield. As a
result of restrictive financial covenants, these Secured Loans involve greater
risk of technical default than do publicly traded investment-grade securities.
However, management believes that the risk of loss upon default for these
Secured Loans is mitigated by such financial covenants and the collateral
values underlying the Secured Loans. The Companys Secured Loans are rated by
S&P, Moodys, Fitch, the NAIC or by the Company, pursuant to comparable
statutory ratings guidelines established by the NAIC. MORTGAGE LOANS aggregated $701.8 million at June 30, 2004 and consisted of
103 commercial first mortgage loans with an average loan balance of
approximately $6.8 million, collateralized by properties located in 31 states.
Approximately 34% of this portfolio was office, 18% was multifamily
residential, 15% was manufactured housing, 12% was industrial, 11% was hotels,
and 10% was other types. At June 30, 2004, approximately 26%, 11%, 10% and 10%
of this portfolio were secured by properties located in California, New York,
Massachusetts and Michigan, respectively. No more than 10% of this portfolio
was secured by properties located in any other single
state. At June 30, 2004, 16 mortgage loans have an outstanding balance of
$10 million or more, which collectively aggregated approximately 51% of this
portfolio. At June 30, 2004, approximately 36% of the mortgage loan portfolio
consisted of loans with balloon payments due before July 1, 2007. During 2004
and 2003, loans delinquent by more than 90 days, foreclosed loans and
structured loans have not been significant in relation to the total mortgage
loan portfolio. Substantially all of the mortgage loan portfolio has been originated by
the Company under its underwriting standards. Commercial mortgage loans on
properties such as offices, hotels and shopping centers generally represent a
higher level of risk than do mortgage loans secured by multifamily residences.
This greater risk is due to several factors, including the larger size of such
loans and the more immediate effects of general economic conditions on these
commercial property types. However, due to the Companys underwriting
standards, the Company believes that it has prudently managed the risk
attributable to its mortgage loan portfolio while maintaining attractive
yields. SECURITIES LENDING COLLATERAL totaled $1.12 billion at June 30, 2004,
compared to $514.1 million at December 31, 2003, and consisted of cash
collateral invested in highly rated short-term securities received in
connection with the Companys securities lending program. Although the cash
collateral is currently invested in highly rated short-term securities, the
applicable collateral agreements permit the cash collateral to be invested in
highly liquid short and long-term investment portfolios. At least 75% of the
portfolios short-term investments must have external issue ratings of A-1/P-1,
one of the highest ratings for short-term credit quality. Long-term
investments include corporate notes with maturities of five years or less and a
credit rating by at least two nationally recognized statistical rating
organizations (NRSRO), with no less than a S&P rating of A or equivalent by
any other NRSRO. 32




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ASSET-LIABILITY MATCHING is utilized by the Company in an effort to
minimize the risks of interest rate fluctuations and disintermediation (i.e.
the risk of being forced to sell investments during unfavorable market
conditions). The Company believes that its fixed-rate liabilities should be
backed by a portfolio principally composed of fixed-rate investments that
generate predictable rates of return. The Company does not have a specific
target rate of return. Instead, its rates of return vary over time depending
on the current interest rate environment, the slope of the yield curve, the
spread at which fixed-rate investments are priced over the yield curve, default
rates and general economic conditions. Its portfolio strategy is constructed
with a view to achieve adequate risk-adjusted returns consistent with its
investment objectives of effective asset-liability matching, liquidity and
safety. The Companys fixed-rate products incorporate surrender charges or
other restrictions in order to encourage persistency. Approximately 78% of the
Companys fixed annuity, universal life and GIC reserves had surrender
penalties or other restrictions at June 30, 2004. As part of its asset-liability matching discipline, the Company conducts
detailed computer simulations that model its fixed-rate assets and liabilities
under commonly used interest rate scenarios. With the results of these
computer simulations, the Company can measure the potential gain or loss in
fair value of its interest-rate sensitive instruments and seek to protect its
economic value and achieve a predictable spread between what it earns on its
invested assets and what it pays on its liabilities by designing its fixed-rate
products and conducting its investment operations to closely match the duration
and cash flows of the fixed-rate assets to that of its fixed-rate liabilities.
The fixed-rate assets in the Companys asset-liability modeling include: cash
and short-term investments; bonds, notes and redeemable preferred stocks;
mortgage loans; policy loans; and investments in limited partnerships that
invest primarily in fixed-rate securities. At June 30, 2004, these assets had
an aggregate fair value of $6.39 billion with an option-adjusted duration of
3.3 years. The Companys fixed-rate liabilities include fixed options of
variable annuities, as well as universal life, fixed annuity and GIC contracts.
At June 30, 2004, these liabilities had an aggregate fair value (determined by
discounting future contractual cash flows by related market rates of interest)
of $5.98 billion with an option-adjusted duration of 3.5 years. The Companys
potential exposure due to a relative 10% increase in prevailing interest rates
from its June 30, 2004 levels is a loss of approximately $0.8 million,
representing an increase in fair value of its fixed-rate liabilities that is
not offset by an increase in fair value of its fixed-rate assets. Because the
Company actively manages its assets and liabilities and has strategies in place
to minimize its exposure to loss as interest rate changes occur, it expects
that actual losses would be less than the estimated potential loss. 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 (including
the fixed option of variable contracts) have reached or are near the minimum
contractual guaranteed rate (generally 3% or 4%). Continual declines in
interest rates could cause the spread between the yield on the portfolio and
the interest rate credited to policyholders to deteriorate. The Company has had the ability, limited by minimum interest rate
guarantees, to respond to the generally declining interest rate environment in
the last five years by lowering crediting rates in response to lower investment
returns. See the earlier discussion under Managements Discussion and
Analysis of Financial Condition and Results of Operations for additional
information on the calculation of investment yield and net investment spread
used by the Companys management as a key component in evaluating the
profitability of its annuity business. The trends experienced during the six
months ended June 30, 2004 and the three years ended December 31, 2003 in the
Companys yield on average invested assets and rate of interest credited on
average interest-bearing liabilities, compared to the market trend in long-term
interest rates as illustrated by the average ten-year U.S. Treasury bond rate,
are presented in the following table: 33




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Six months endedJune 30,
    
    Years ended December, 312004
    
    2003
    
    2002
    
    2001Average 10-year U.S. Treasury bond rate:
    
    
    4.29
    %
    
    
    4.01
    %
    
    
    4.61
    %
    
    
    5.02
    %AIG SunAmerica Life Assurance Company:Average yield on Bond Portfolio
    
    
    5.79
    
    
    
    5.75
    
    
    
    6.23
    
    
    
    6.82Rate paid on average interest-bearing liabilities
    
    
    3.69
    
    
    
    3.71
    
    
    
    3.93
    
    
    
    4.58
 As a component of its asset-liability management strategy, the Company may
utilize interest rate swap agreements (Swap Agreements) to match assets more
closely to liabilities. Swap Agreements are agreements to exchange with a
counterparty interest rate payments of differing character (for example,
variable-rate payments exchanged for fixed-rate payments) based on an
underlying principal balance (notional principal) to hedge against interest
rate changes. The Company seeks to enhance its spread income with dollar roll repurchase
agreements (Dollar Roll Repos). Dollar Roll Repos involve a sale of MBS by
the Company and an agreement to repurchase substantially similar MBS at a later
date at an agreed upon price. The Company also seeks to provide liquidity by
investing in 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 Dollar Roll Repos
and Swap Agreements is counterparty risk. The Company believes, however, that
the counterparties to its Dollar Roll Repos and Swap Agreements are financially
responsible and that the counterparty risk associated with those transactions
is minimal. It is the Companys policy that these agreements are entered into
with counterparties who have a debt rating of A/A2 or better from both S&P and
Moodys. The Company continually monitors its credit exposure with respect to
these agreements. In addition to counterparty risk, Swap Agreements also have
interest rate risk. However, the Companys Swap Agreements are intended to
hedge variable-rate assets or liabilities. The primary risk associated with
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. 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 34




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if the fair value of the
security is less than its book value, and the net present value of expected
future cash flows is less than the net present value of expected future cash
flows at the most recent (prior) estimation date. DEFAULTED INVESTMENTS, comprising all investments that are in default as
to the payment of principal or interest, totaled $38.0 million of bonds at June
30, 2004, which constituted approximately 0.5% of total invested assets. At
December 31, 2003, defaulted investments totaled $49.6 million, which
constituted approximately 0.7% of total invested assets. SOURCES OF LIQUIDITY are readily available to the Company in the form of
the Companys existing portfolio of cash and short-term investments, repo
capacity on invested assets and, if required, proceeds from invested asset
sales. The Companys liquidity is primarily derived from operating cash flows
from annuity operations. At June 30, 2004, approximately $3.61 billion of the
Bond Portfolio had an aggregate unrealized gain of $135.5 million, while
approximately $1.70 billion of the Bond Portfolio had an aggregate unrealized
loss of $67.8 million. In addition, the Companys investment portfolio
currently provides approximately $46.6 million of monthly cash flow from
scheduled principal and interest payments. Historically, cash flows from
operations and from the sale of the Companys annuity products have been more
than sufficient in amount to satisfy the Companys liquidity needs. Management is aware that prevailing market interest rates may shift
significantly and has strategies in place to manage either an increase or
decrease in prevailing rates. In a rising interest rate environment, the
Companys average cost of funds would increase over time as it prices its new
and renewing annuities to maintain a generally competitive market rate.
Management would seek to place new funds in investments that were matched in
duration to, and higher yielding than, the liabilities assumed. The Company
believes that liquidity to fund withdrawals would be available through incoming
cash flow, the sale of short-term or floating-rate instruments or repos on the
Companys substantial MBS segment of the Bond Portfolio, thereby avoiding the
sale of fixed-rate assets in an unfavorable bond market. In a declining rate environment, the Companys cost of funds would
decrease over time, reflecting lower interest crediting rates on its fixed
annuities. Should increased liquidity be required for withdrawals, the Company
believes that a significant portion of its investments could be sold without
adverse consequences in light of the general strengthening that would be
expected in the bond market. If a substantial portion of the Companys Bond Portfolio diminished
significantly in value and/or defaulted, the Company would need to liquidate
other portions of its investment portfolio and/or arrange financing. Such
events that may cause such a liquidity strain could be the result of economic
collapse or terrorist acts. Management believes that the Companys liquid assets and its net cash
provided by operations will enable the Company to meet any foreseeable cash
requirements for at least the next twelve months. GUARANTEES AND OTHER COMMITMENTS The Company has entered into seven agreements in which it has provided
liquidity support for certain short-term securities of municipalities and
non-profit organizations by agreeing to purchase such securities in the event
there is no other buyer in the short-term marketplace. In return the Company
receives a fee. In addition, the Company guarantees the payment of these
securities upon redemption. The maximum liability under these guarantees at
June 30, 2004 is $480.5 million. In August 2004, these commitments decreased
by $287.9 due to early redemption. The remaining commitments have contractual
maturity dates as follows: $21.9 million in the remainder of 2004 and $170.7
million in 2005. Related to each of these agreements are participation
agreements with the Parent, under which the Parent will share in $61.5 million
of these liabilities in exchange for a proportionate percentage of the fees
received under these agreements. The Internal Revenue Service has completed
examinations into the transactions underlying these commitments, including the
Companys role in the transactions. The examination did not result in a
material loss to the Company. At June 30, 2004, the Company held reserves for GICs with maturity dates
as follows: $185.6 million in 2005 and $28.4 million in 2006 and thereafter. 35




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RECENTLY ISSUED ACCOUNTING STANDARDS In July 2003, the American Institute of Certified Public Accountants
issued Statement of Position 03-1, Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts (SOP 03-1). (For further discussion see Note 2 of Notes to
Consolidated Financial Statements.) REGULATION The Company, in common with other insurers, is subject to regulation and
supervision by the states and jurisdictions in which it does business. Within
the United States, the method of such regulation varies but generally has its
source in statutes that delegate regulatory and supervisory powers to an
insurance official. The regulation and supervision relate primarily to
approval of policy forms and rates, the standards of solvency that must be met
and maintained, including risk based capital measurements, the licensing of
insurers and their agents, the nature of and limitations on investments,
restrictions on the size of risks which may be insured under a single policy,
deposits of securities for the benefit of policyholders, methods of accounting,
periodic examinations of the affairs of insurance companies, the form and
content of reports of financial condition required to be filed, and reserves
for unearned premiums, losses and other purposes. In general, such regulation
is for the protection of policyholders rather than security holders. Risk-based capital (RBC) standards are designed to measure the adequacy
of an insurers statutory capital and surplus in relation to the risks inherent
in its business. The standards are intended to help identify inadequately
capitalized companies and require specific regulatory actions in the event an
insurers RBC is deficient. The RBC formula develops a risk-adjusted target
level of adjusted statutory capital and surplus by applying certain factors to
various asset, premium and reserve items. Higher factors are applied to more
risky items and lower factors are applied to less risky items. Thus, the
target level of statutory surplus varies not only as a result of the insurers
size, but also on the risk profile of the insurers operations. The RBC Model
Law provides four incremental levels of regulatory attention for insurers whose
surplus is below the calculated RBC target. These levels of attention range in
severity from requiring the insurer to submit a plan for corrective action to
actually placing the insurer under regulatory control. The statutory capital
and surplus of the Company exceeded its RBC requirements as of June 30, 2004. The federal government does not directly regulate the business of
insurance, however, the Company and its products are governed by federal
agencies, including the SEC, the Internal Revenue Service and the
self-regulatory organization, the National Association of Securities Dealers,
Inc. (NASD). Federal legislation and administrative policies in several
areas, including financial services regulation, pension regulation and federal
taxation, can significantly and adversely affect the insurance industry. The
federal government has from time to time considered legislation relating to the
deferral of taxation on the accretion of value within certain annuities and
life insurance products, changes in ERISA regulations, the alteration of the
federal income tax structure and the availability of Section 401(k) and
individual retirement accounts. Although the ultimate effect of any such
changes, if implemented, is uncertain, both the persistency of our existing
products and our ability to sell products may be materially impacted in the
future. Recently there has been a significant increase in federal and state
regulatory activity relating to financial services companies, particularly
mutual fund companies and life insurers issuing variable annuity products.
These inquiries have focused on a number of issues including, among other
items, after-hours trading, short-term trading (sometimes referred to as market
timing), revenue sharing arrangements and greater transparency regarding
compensation arrangements. There are several rule proposals pending at the
SEC, the NASD and on a federal level, which, if passed, could have an impact on
the business of the Company and/or its subsidiaries. 36




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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 33 to 34
herein. 
 DISCLOSURE CONTROLS & PROCEDURES The Companys disclosure controls and procedures are designed to ensure
that information required to be disclosed in the reports that the Company files
or submits under the Securities Exchange Act of 1934, as amended (Exchange
Act), is recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange Commission.
Disclosure controls and procedures include controls and procedures designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the Companys management, including the Companys Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure. The Companys management, with the participation of the
Companys Chief Executive Officer and Chief Financial Officer, have evaluated
the effectiveness of the Companys disclosure controls and procedures as of the
end of the period covered by this report. Based on that evaluation, the
Companys Chief Executive Officer and Chief Financial Officer concluded that
the disclosure controls and procedures provide reasonable assurance of
effectiveness as of the end of the period covered by this report. In addition,
there has been no change in the Companys internal control over financial
reporting that occurred during the fiscal quarter covered by this report that
has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. 37




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PART II - OTHER INFORMATION Item 1. Legal
Proceedings Various lawsuits against the Company have arisen in the ordinary course of
business. Contingent liabilities arising from litigation, income taxes and
regulatory and other matters are not considered material in relation to the
financial position, results of operations or cash flows of the Company. On April 5, 2004, a purported class action captioned Nitika Mehta, as Trustee
of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case
04L0199, was filed in the Circuit Court, Twentieth Judicial District in St.
Clair County, Illinois. The lawsuit alleges certain improprieties in
conjunction with alleged market timing activities. The probability of any
particular outcome cannot be reasonably estimated at this time. Item 2. Changes in
Securities and Use of Proceeds Not applicable. Item 3. Defaults Upon Senior Securities Not applicable. Item 4. Submissions of Matters to a Vote of Security Holders Not applicable. Item 5. Other Information Not applicable. Item 6. Exhibits and Reports on Form 8-K EXHIBITS None. 
 REPORTS FOR FORM 8-K There were no current reports on Form 8-K filed during the three months ended
June 30, 2004. 38




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SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. AIG SUNAMERICA LIFE ASSURANCE COMPANY 
RegistrantDate: August 13, 2004
    /s/ N. SCOTT GILLISN. Scott GillisSenior Vice President,
Chief Financial Officer
and Director Date: August 13, 2004
    /s/ STEWART POLAKOVStewart PolakovSenior Vice President and Controller
(Principal Accounting Officer) 39




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Exhibit Index Exhibit  31.1
    
    Rule 13a-14(a)/15d-14(a) Certifications31.2
    
    Rule 13a-14(a)/15d-14(a) Certifications32
    
    Section 1350 Certifications 40