##### 









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, DC 20549




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Form 10-Q



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|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|          
|           |  | For the quarterly period ended June 30,
    2003                                            
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to                                             

Commission File Number 1-16561

ANNUITY AND LIFE RE (HOLDINGS), LTD.

(Exact Name of Registrant as Specified in Its
Charter)


|                                                                   |  |                                      
|------------------------------------------------------------------ |  | -------------------------------------
|Bermuda                                                            |  | Not applicable                       
|(State or Other Jurisdiction of
    Incorporation or Organization) |  | (IRS Employer
    Identification No.)
|                                                                  
|Cumberland House,
    1 Victoria Street,
    Hamilton, Bermuda     |  | HM11                                 
|(Address of Principal Executive
    Offices)                       |  | (Zip Code)                           

441-296-7667

(Registrants Telephone Number, Including
Area Code)


Indicate by check mark whether the registrant:
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days. Yes þ No
o

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

The number of the registrants Common Shares
(par value $1.00 per share) outstanding as of July 5, 2003
was 26,579,228.



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##### 



INDEX TO FORM 10-Q

|           |  |                                                                                                                           |    |      |    | 
|---------- |  | ------------------------------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|           |  |                                                                                                                           |    | page
|           |  |                                                                                                                           |    |     
|           |  | PART I
    FINANCIAL INFORMATION                                                                                          |    |      |    | 
|          
|Item 1.    |  | Unaudited Consolidated Financial Statements                                                                               |    |      |    | 
|           |  | Consolidated Balance Sheets June 30, 2003
    and December 31, 2002                                                       |    |      | 1  | 
|           |  | Consolidated Statements of Operations Three
    Months and Six Months ended June 30, 2003 and June 30,
    2002           |    |      | 2  | 
|           |  | Consolidated Statements of Comprehensive (Loss)
    Three Months and Six Months ended June 30, 2003 and
    June 30, 2002 |    |      | 3  | 
|           |  | Consolidated Statements of Cash Flows Six Months
    ended June 30, 2003 and June 30, 2002                                |    |      | 4  | 
|           |  | Consolidated Statements of Changes in
    Stockholders Equity Six Months ended June 30, 2003
    and June 30, 2002       |    |      | 5  | 
|           |  | Notes to Unaudited Consolidated Financial
    Statements                                                                  |    |      | 6  | 
|Item 2.    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                                 |    |      | 16 | 
|          
|Item 3.    |  | Quantitative and Qualitative Disclosures About
    Market Risk                                                            |    |      | 35 | 
|          
|Item 4.    |  | Controls and Procedures                                                                                                   |    |      | 37 | 
|           |  | PART II
    OTHER INFORMATION                                                                                             |    |      |    | 
|Item 1.    |  | Legal Proceedings                                                                                                         |    |      | 38 | 
|Item 2.    |  | Change in Securities and Use of Proceeds                                                                                  |    |      | 38 | 
|Item 4.    |  | Submission of Matters to a Vote of Security
    Holders                                                                   |    |      | 39 | 
|Item 5.    |  | Other Information                                                                                                         |    |      | 40 | 
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                                                          |    |      | 41 | 
|Signatures |  |                                                                                                                           | 42 |     



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##### 



PART I

FINANCIAL INFORMATION



|        |                                                
|------- | -----------------------------------------------
|Item 1. | Unaudited Consolidated Financial
    Statements

ANNUITY AND LIFE RE (HOLDINGS), LTD.

CONSOLIDATED BALANCE SHEETS

|                                                                                                                                                            |                                            |                   |               |               |               |   |               |               |               | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----------------- | ------------- | ------------- | ------------- | - | ------------- | ------------- | ------------- | 
|                                                                                                                                                            |                                            | June 30,          |               | December 31, 
|                                                                                                                                                            |                                            | 2003              |               | 2002         
|                                                                                                                                                            |                                            |                   |               |              
|                                                                                                                                                            |                                            | (Unaudited)       |               |              
|                                                                                                                                                            |                                            |                  
|                                                                                                                                                            |                                            | (U.S. dollars)   
|Assets                                                                                                                                                      |                                            |                   |               |               |               |   |               |              
|Cash and cash equivalents                                                                                                                                   |                                            | $                 | 139,793,317   |               |               | $ | 152,930,908   |              
|Fixed maturity investments at fair value
    (amortized cost of $82,117,597 and $146,487,903 at June 30,
    2003 and December 31, 2002)                    |                                            |                   | 85,064,792    |               |               |   | 153,415,429   |              
|Funds withheld at interest                                                                                                                                  |                                            |                   | 845,456,798   |               |               |   | 1,427,093,380 |              
|Accrued investment income                                                                                                                                   |                                            |                   | 1,080,806     |               |               |   | 2,141,338     |              
|Receivable for reinsurance ceded                                                                                                                            |                                            |                   | 90,396,049    |               |               |   | 93,669,173    |              
|Other reinsurance receivables                                                                                                                               |                                            |                   | 6,947,154     |               |               |   | 25,025,453    |              
|Deferred policy acquisition costs                                                                                                                           |                                            |                   | 108,570,393   |               |               |   | 187,913,648   |              
|Other assets                                                                                                                                                |                                            |                   | 1,429,685     |               |               |   | 2,508,858     |              
|                                                                                                                                                            |                                            |                   |               |               |               |   |               |              
|                                                                                                                                                            | Total Assets                               |                   | $             | 1,278,738,994 |               |   | $             | 2,044,698,187 |              
|                                                                                                                                                            |                                            |                   |               |               |               |   |               |              
|Liabilities                                                                                                                                                 |                                            |                   |               |               |               |   |               |              
|Reserves for future policy benefits                                                                                                                         |                                            | $                 | 235,720,387   |               |               | $ | 269,619,809   |              
|Interest sensitive contracts liability                                                                                                                      |                                            |                   | 815,685,167   |               |               |   | 1,443,143,080 |              
|Other reinsurance liabilities                                                                                                                               |                                            |                   | 71,046,391    |               |               |   | 51,139,164    |              
|Accounts payable and accrued expenses                                                                                                                       |                                            |                   | 9,565,313     |               |               |   | 12,459,423    |              
|                                                                                                                                                            |                                            |                   |               |               |               |   |               |              
|                                                                                                                                                            |                                            | Total Liabilities |               | $             | 1,132,017,258 |   |               | $             | 1,776,361,476 | 
|                                                                                                                                                            |                                            |                   |               |               |               |   |               |              
|Stockholders Equity                                                                                                                                        |                                            |                   |               |               |               |   |               |              
|Preferred shares (par value $1.00; 50,000,000
    shares authorized; no shares outstanding)                                                                 |                                            | $                 |              |               |               | $ |              |              
|Common shares (par value $1.00; 100,000,000
    shares authorized; 26,579,228 and 26,106,328 shares outstanding
    at June 30, 2003 and December 31, 2002) |                                            |                   | 26,579,228    |               |               |   | 26,106,328    |              
|Additional paid-in capital                                                                                                                                  |                                            |                   | 334,887,270   |               |               |   | 335,334,932   |              
|Notes receivable from stock sales                                                                                                                           |                                            |                   |              |               |               |   | (1,626,493)   |              
|Unamortized stock grant compensation                                                                                                                        |                                            |                   | (2,318,844)   |               |               |   | (2,514,693)   |              
|Stock warrants                                                                                                                                              |                                            |                   | 1,250,000     |               |               |   |              |              
|Accumulated other comprehensive income                                                                                                                      |                                            |                   | 2,641,227     |               |               |   | 6,162,525     |              
|(Deficit)                                                                                                                                                   |                                            |                   | (216,317,145) |               |               |   | (95,125,888)  |              
|                                                                                                                                                            |                                            |                   |               |               |               |   |               |              
|                                                                                                                                                            | Total Stockholders Equity                 |                   | $             | 146,721,736   |               |   | $             | 268,336,711   |              
|                                                                                                                                                            |                                            |                   |               |               |               |   |               |              
|                                                                                                                                                            | Total Liabilities and Stockholders Equity |                   | $             | 1,278,738,994 |               |   | $             | 2,044,698,187 |              
|                                                                                                                                                            |                                            |                   |               |               |               |   |               |              

See accompanying Notes to Unaudited Consolidated
Financial Statements

1



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##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                          |         |                                 |             |                          |   |      |             |       |   |   |              |       |   |   |             |       |  
|--------------------------------------------------------- | ------- | ------------------------------- | ----------- | ------------------------ | - | ---- | ----------- | ----- | - | - | ------------ | ----- | - | - | ----------- | ----- | -
|                                                          |         |                                 |             |                         
|                                                          |         | For the Three Months Ended      |             | For the Six Months Ended
|                                                          |         | June 30,                        |             | June 30,                
|                                                          |         |                                 |             |                         
|                                                          |         | 2003                            |             | 2002                     |   | 2003 |             | 2002 
|                                                          |         |                                 |             |                          |   |      |             |      
|                                                          |         |                                
|                                                          |         | (Unaudited and in U.S. dollars)
|Revenues                                                  |         |                                 |             |                          |   |      |             |      
|Net premiums                                              |         | $                               | 58,563,721  |                          |   | $    | 92,065,743  |       |   | $ | 119,929,634  |       |   | $ | 170,072,634 |      
|Investment income, net of related expenses                |         |                                 | 5,734,738   |                          |   |      | 26,366,669  |       |   |   | 13,893,427   |       |   |   | 50,956,459  |      
|Net realized investment gains                             |         |                                 | 4,896,176   |                          |   |      | 1,837,672   |       |   |   | 6,560,044    |       |   |   | 1,515,964   |      
|Net change in fair value of embedded derivatives          |         |                                 | (1,717,537  | )                        |   |      | (6,566,805  | )     |   |   | 12,037,322   |       |   |   | (4,976,707  | )    
|Surrender fees and other revenues                         |         |                                 | 3,002,778   |                          |   |      | 6,161,207   |       |   |   | 4,393,025    |       |   |   | 10,057,332  |      
|                                                          |         |                                 |             |                          |   |      |             |       |   |   |              |       |   |   |             |      
|Total Revenues                                            |         | $                               | 70,479,876  |                          |   | $    | 119,864,486 |       |   | $ | 156,813,452  |       |   | $ | 227,625,682 |      
|                                                          |         |                                 |             |                          |   |      |             |       |   |   |              |       |   |   |             |      
|Benefits and Expenses                                     |         |                                 |             |                          |   |      |             |      
|Claim and policy benefits                                 |         | $                               | 84,425,206  |                          |   | $    | 74,443,139  |       |   | $ | 159,514,646  |       |   | $ | 133,258,745 |      
|Interest credited to interest sensitive products          |         |                                 | 4,217,542   |                          |   |      | 20,948,167  |       |   |   | 9,089,301    |       |   |   | 38,870,513  |      
|Policy acquisition costs and other insurance
    expenses |         |                                 | 44,631,210  |                          |   |      | 40,571,869  |       |   |   | 97,132,274   |       |   |   | 56,207,987  |      
|Collateral costs                                          |         |                                 |            |                          |   |      | 1,053,037   |       |   |   |             |       |   |   | 2,348,741   |      
|Operating expenses                                        |         |                                 | 5,922,358   |                          |   |      | 3,142,272   |       |   |   | 12,268,488   |       |   |   | 6,800,064   |      
|                                                          |         |                                 |             |                          |   |      |             |       |   |   |              |       |   |   |             |      
|Total Benefits and Expenses                               |         | $                               | 139,196,316 |                          |   | $    | 140,158,484 |       |   | $ | 278,004,709  |       |   | $ | 237,486,050 |      
|                                                          |         |                                 |             |                          |   |      |             |       |   |   |              |       |   |   |             |      
|Net (Loss)                                                |         | $                               | (68,716,440 | )                        |   | $    | (20,293,998 | )     |   | $ | (121,191,257 | )     |   | $ | (9,860,368  | )    
|                                                          |         |                                 |             |                          |   |      |             |       |   |   |              |       |   |   |             |      
|Net (loss) per common share                               |         |                                 |             |                          |   |      |             |      
|                                                          | Basic   |                                 | $           | (2.66                    | ) |      | $           | (0.79 | ) |   | $            | (4.69 | ) |   | $           | (0.38 | )
|                                                          | Diluted |                                 | $           | (2.66                    | ) |      | $           | (0.79 | ) |   | $            | (4.69 | ) |   | $           | (0.38 | )

See accompanying Notes to Unaudited Consolidated
Financial Statements

2



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##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.



CONSOLIDATED STATEMENTS OF COMPREHENSIVE
(LOSS)


|                                                                      |  |                                 |             |                          |  |      |             |      |  |   |              |   |  |   |            |  
|--------------------------------------------------------------------- |  | ------------------------------- | ----------- | ------------------------ |  | ---- | ----------- | ---- |  | - | ------------ | - |  | - | ---------- | -
|                                                                      |  |                                 |             |                         
|                                                                      |  | For the Three Months Ended      |             | For the Six Months Ended
|                                                                      |  | June 30,                        |             | June 30,                
|                                                                      |  |                                 |             |                         
|                                                                      |  | 2003                            |             | 2002                     |  | 2003 |             | 2002
|                                                                      |  |                                 |             |                          |  |      |             |     
|                                                                      |  |                                
|                                                                      |  | (Unaudited and in U.S. dollars)
|Net (loss) for the period                                             |  | $                               | (68,716,440 | )                        |  | $    | (20,293,998 | )    |  | $ | (121,191,257 | ) |  | $ | (9,860,368 | )
|Other comprehensive
    (loss) income:                                |  |                                 |             |                          |  |      |             |      |  |   |              |   |  |   |            |  
|Unrealized holding gains on securities arising
    during the period  |  |                                 | 2,130,876   |                          |  |      | 8,688,887   |      |  |   | 3,038,746    |   |  |   | 2,853,180  |  
|Less reclassification adjustment for realized
    gains in net (loss) |  |                                 | 4,896,176   |                          |  |      | 1,837,672   |      |  |   | 6,560,044    |   |  |   | 1,515,964  |  
|                                                                      |  |                                 |             |                          |  |      |             |      |  |   |              |   |  |   |            |  
|Other comprehensive (loss) income                                     |  | $                               | (2,765,300  | )                        |  | $    | 6,851,215   |      |  | $ | (3,521,298   | ) |  | $ | 1,337,216  |  
|                                                                      |  |                                 |             |                          |  |      |             |      |  |   |              |   |  |   |            |  
|Total Comprehensive (Loss)                                            |  | $                               | (71,481,740 | )                        |  | $    | (13,442,783 | )    |  | $ | (124,712,555 | ) |  | $ | (8,523,152 | )
|                                                                      |  |                                 |             |                          |  |      |             |      |  |   |              |   |  |   |            |  

See accompanying Notes to Unaudited Consolidated
Financial Statements

3



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##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.



CONSOLIDATED STATEMENTS OF CASH
FLOWS


|                                                                                         |                                                      |                                 |              |             |   |   |              |             |  
|---------------------------------------------------------------------------------------- | ---------------------------------------------------- | ------------------------------- | ------------ | ----------- | - | - | ------------ | ----------- | -
|                                                                                         |                                                      |                                
|                                                                                         |                                                      | For the Six Months Ended       
|                                                                                         |                                                      | June 30,                       
|                                                                                         |                                                      |                                
|                                                                                         |                                                      | 2003                            |              | 2002       
|                                                                                         |                                                      |                                 |              |            
|                                                                                         |                                                      |                                
|                                                                                         |                                                      | (Unaudited and in U.S. dollars)
|Cash flows from operating activities                                                     |                                                      |                                 |              |             |   |   |              |            
|Net (loss)                                                                               |                                                      | $                               | (121,191,257 | )           |   | $ | (9,860,368   | )          
|Adjustments to reconcile net (loss) to cash
    (used) provided by operating activities: |                                                      |                                 |              |             |   |   |              |            
|Net realized investment (gains)                                                          |                                                      |                                 | (6,560,044   | )           |   |   | (1,515,964   | )          
|Net change in fair value of embedded derivatives                                         |                                                      |                                 | (12,037,322  | )           |   |   | 4,976,707    |            
|Amortization of stock grant compensation                                                 |                                                      |                                 | 225,016      |             |   |   | 360,896      |            
|Stock warrants expense                                                                   |                                                      |                                 | 1,250,000    |             |   |   |             |            
|Changes in:                                                                              |                                                      |                                 |              |             |   |   |              |            
|Accrued investment income                                                                |                                                      |                                 | 1,060,532    |             |   |   | (602,536     | )          
|Deferred policy acquisition costs                                                        |                                                      |                                 | 79,343,255   |             |   |   | (2,232,078   | )          
|Other reinsurance receivables                                                            |                                                      |                                 | 21,351,424   |             |   |   | 11,296,348   |            
|Other assets                                                                             |                                                      |                                 | 1,079,173    |             |   |   | (1,770,523   | )          
|Reserves for future policy benefits                                                      |                                                      |                                 | (33,899,422  | )           |   |   | 32,829,600   |            
|Interest sensitive contracts, net of funds
    withheld                                  |                                                      |                                 | (33,784,009  | )           |   |   | (15,565,503  | )          
|Other reinsurance liabilities                                                            |                                                      |                                 | 19,907,227   |             |   |   | 282,534      |            
|Accounts payable                                                                         |                                                      |                                 | (2,894,110   | )           |   |   | 196,432      |            
|                                                                                         |                                                      |                                 |              |             |   |   |              |            
|                                                                                         | Net cash (used) provided by operating
    activities |                                 | $            | (86,149,537 | ) |   | $            | 18,395,545  |  
|                                                                                         |                                                      |                                 |              |             |   |   |              |            
|Cash flows from investing activities                                                     |                                                      |                                 |              |             |   |   |              |            
|Proceeds from sales of fixed maturity investments                                        |                                                      | $                               | 322,639,650  |             |   | $ | 287,775,849  |            
|Purchase of fixed maturity investments                                                   |                                                      |                                 | (251,254,197 | )           |   |   | (356,676,834 | )          
|                                                                                         |                                                      |                                 |              |             |   |   |              |            
|                                                                                         | Net cash provided (used) by investing
    activities |                                 | $            | 71,385,453  |   |   | $            | (68,900,985 | )
|                                                                                         |                                                      |                                 |              |             |   |   |              |            
|Cash flows from financing activities                                                     |                                                      |                                 |              |             |   |   |              |            
|Interest accrued on notes receivable                                                     |                                                      | $                               | (43,998      | )           |   | $ | (48,334      | )          
|Interest collected on notes receivable                                                   |                                                      |                                 | 420,491      |             |   |   | 38,620       |            
|Repayments (issuances) of notes receivable                                               |                                                      |                                 | 1,250,000    |             |   |   | (250,000     | )          
|Dividends paid to stockholders                                                           |                                                      |                                 |             |             |   |   | (2,576,588   | )          
|Increase in deposit liability                                                            |                                                      |                                 |             |             |   |   | 10,000,000   |            
|                                                                                         |                                                      |                                 |              |             |   |   |              |            
|                                                                                         | Net cash provided by financing activities            |                                 | $            | 1,626,493   |   |   | $            | 7,163,698   |  
|                                                                                         |                                                      |                                 |              |             |   |   |              |            
|Decrease in cash and cash equivalents                                                    |                                                      | $                               | (13,137,591  | )           |   | $ | (43,341,742  | )          
|Cash and cash equivalents, beginning of period                                           |                                                      |                                 | 152,930,908  |             |   |   | 104,793,019  |            
|                                                                                         |                                                      |                                 |              |             |   |   |              |            
|Cash and cash equivalents, end of period                                                 |                                                      | $                               | 139,793,317  |             |   | $ | 61,451,277   |            
|                                                                                         |                                                      |                                 |              |             |   |   |              |            

See accompanying Notes to Unaudited Consolidated
Financial Statements

4



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##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.

CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY

|                                            |  |                                 |              |      |  |   |             |  
|------------------------------------------- |  | ------------------------------- | ------------ | ---- |  | - | ----------- | -
|                                            |  |                                
|                                            |  | For the Six Months Ended       
|                                            |  | June 30,                       
|                                            |  |                                
|                                            |  | 2003                            |              | 2002
|                                            |  |                                 |              |     
|                                            |  |                                
|                                            |  | (Unaudited and in U.S. dollars)
|Preferred shares par value $1.00            |  |                                 |              |      |  |   |             |  
|Balance at beginning and end of period      |  | $                               |             |      |  | $ |            |  
|                                            |  |                                 |              |      |  |   |             |  
|Common shares par value $1.00               |  |                                 |              |      |  |   |             |  
|Balance at beginning of period              |  | $                               | 26,106,328   |      |  | $ | 25,705,328  |  
|Issuance of shares                          |  |                                 | 575,000      |      |  |   | 133,500     |  
|(Cancellation) of shares                    |  |                                 | (102,100     | )    |  |   |            |  
|                                            |  |                                 |              |      |  |   |             |  
|Balance at end of period                    |  | $                               | 26,579,228   |      |  | $ | 25,838,828  |  
|                                            |  |                                 |              |      |  |   |             |  
|Additional paid-in capital                  |  |                                 |              |      |  |   |             |  
|Balance at beginning of period              |  | $                               | 335,334,932  |      |  | $ | 332,447,062 |  
|Issuance of shares                          |  |                                 | 325,000      |      |  |   | 2,031,870   |  
|(Cancellation) of shares                    |  |                                 | (772,662     | )    |  |   |            |  
|                                            |  |                                 |              |      |  |   |             |  
|Balance at end of period                    |  | $                               | 334,887,270  |      |  | $ | 334,478,932 |  
|                                            |  |                                 |              |      |  |   |             |  
|Notes receivable from stock sales           |  |                                 |              |      |  |   |             |  
|Balance at beginning of period              |  | $                               | (1,626,493   | )    |  | $ | (1,317,259  | )
|Repayments (issuances)                      |  |                                 | 1,250,000    |      |  |   | (250,000    | )
|Interest collected on notes receivable      |  |                                 | 420,491      |      |  |   | 38,620      |  
|Accrued interest during period              |  |                                 | (43,998      | )    |  |   | (48,334     | )
|                                            |  |                                 |              |      |  |   |             |  
|Balance at end of period                    |  | $                               |             |      |  | $ | (1,576,973  | )
|                                            |  |                                 |              |      |  |   |             |  
|Unamortized stock grant compensation        |  |                                 |              |      |  |   |             |  
|Balance at beginning of period              |  | $                               | (2,514,693   | )    |  | $ |            |  
|(Issuance) of stock grants                  |  |                                 | (900,000     | )    |  |   | (2,165,370  | )
|Cancellation of stock grants                |  |                                 | 870,832      |      |  |   |            |  
|Amortization of stock grants                |  |                                 | 225,017      |      |  |   | 360,896     |  
|                                            |  |                                 |              |      |  |   |             |  
|Balance at end of period                    |  | $                               | (2,318,844   | )    |  | $ | (1,804,474  | )
|                                            |  |                                 |              |      |  |   |             |  
|Stock warrants outstanding                  |  |                                 |              |      |  |   |             |  
|Balance at beginning of period              |  | $                               |             |      |  | $ |            |  
|Issuance of warrants                        |  |                                 | 1,250,000    |      |  |   |            |  
|                                            |  |                                 |              |      |  |   |             |  
|Balance at end of period                    |  | $                               | 1,250,000    |      |  | $ |            |  
|                                            |  |                                 |              |      |  |   |             |  
|Accumulated other comprehensive
    income  |  |                                 |              |      |  |   |             |  
|Balance at beginning of period              |  | $                               | 6,162,525    |      |  | $ | 6,418,469   |  
|Net unrealized (losses) gains on securities |  |                                 | (3,521,298   | )    |  |   | 1,337,216   |  
|                                            |  |                                 |              |      |  |   |             |  
|Balance at end of period                    |  | $                               | 2,641,227    |      |  | $ | 7,755,685   |  
|                                            |  |                                 |              |      |  |   |             |  
|(Deficit) Retained earnings                 |  |                                 |              |      |  |   |             |  
|Balance at beginning of period              |  | $                               | (95,125,888  | )    |  | $ | 38,935,242  |  
|Net (loss)                                  |  |                                 | (121,191,257 | )    |  |   | (9,860,368  | )
|Stockholder dividends                       |  |                                 |             |      |  |   | (2,576,588  | )
|                                            |  |                                 |              |      |  |   |             |  
|Balance at end of period                    |  | $                               | (216,317,145 | )    |  | $ | 26,498,286  |  
|                                            |  |                                 |              |      |  |   |             |  
|Total Stockholders Equity                  |  | $                               | 146,721,736  |      |  | $ | 391,190,284 |  
|                                            |  |                                 |              |      |  |   |             |  

See accompanying Notes to Unaudited Consolidated
Financial Statements

5



---



##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS


1.     Organization

Annuity and Life Re (Holdings), Ltd.
(Holdings) was incorporated on December 2, 1997
under the laws of Bermuda. Holdings provides annuity and life
reinsurance to insurers and reinsurers through its wholly-owned
subsidiaries: Annuity and Life Reassurance, Ltd., which is
licensed under the laws of Bermuda as a long term insurer; and
Annuity and Life Re America, Inc., an insurance holding
company based in the United States, and Annuity and Life
Reassurance America, Inc., a life insurance company domiciled in
the United States. Holdings, Annuity and Life Reassurance,
Annuity and Life Re America and Annuity and Life
Reassurance America are collectively referred to herein as the
Company. The Company completed an initial public
offering of its equity securities and commenced operations on
April 17, 1998.

2.     Going Concern
Basis of Presentation

The accompanying unaudited consolidated financial
statements of the Company have been prepared in accordance with
accounting principles generally accepted in the United States of
America (U.S. GAAP) for interim financial
information and in accordance with Regulation S-X.
Accordingly, they do not include all of the information and
footnotes required by U.S. GAAP for complete financial
statements. These consolidated financial statements should be
read in conjunction with the audited consolidated financial
statements and notes thereto contained in the Companys
Form 10-K for the fiscal year ended December 31, 2002.
In the opinion of management, all adjustments considered
necessary for a fair presentation have been included in these
financial statements.

The accompanying unaudited consolidated financial
statements of the Company have been prepared on a going concern
basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business.
However, the Company incurred a significant operating loss in
2002 and the first six months of 2003. Further, the financial
strength ratings of the Companys operating subsidiaries
were downgraded in 2002 and 2003 by A.M. Best,
Standard & Poors, and Fitch Ratings to C+, BB-,
and C, respectively. The A.M. Best and Standard &
Poors ratings were subsequently withdrawn at the
Companys request.

In addition, the Company is required to post
collateral for the statutory reserves ceded to it by U.S. based
insurers and reinsurers. The Company did not have sufficient
available cash and investments at June 30, 2003 to satisfy
the collateral requirements asserted by its cedents under
certain of its reinsurance treaties. Two of the Companys
cedents have asserted that the Company must satisfy additional
collateral requirements of approximately $78 million in
excess of amounts the Company currently has posted. The Company
has not agreed with the assertion by one of these cedents that
the Company must post approximately $59 million of
additional collateral. As a result of the Companys
inability to satisfy its obligations, certain parties have
claimed that the Company is in breach of its agreements. As a
consequence, such parties have sought and others may seek
remedies for such claimed breaches by the Company, and the
Company may be required to enter into arbitration or litigation
proceedings with those parties. If the Company does not prevail
in any such arbitration or litigation proceeding, it would have
a material adverse effect on the Companys financial
condition and the Company may be required to liquidate its
operations.

As of June 30, 2003, the Company had
$29,810,000 of outstanding unsecured letters of credit issued on
its behalf by Citibank. In October 2002, Citibank agreed to
extend the Companys unsecured letter of credit facility
into 2003 in exchange for the Companys agreement to secure
or eliminate the letter of credit facility by June 30,
2003. The Company was unable to secure or eliminate the letter
of credit facility by that date. Although the Company is seeking
to reduce the amount of outstanding letters of credit issued on
its behalf by Citibank, primarily through recaptures and
terminations of reinsurance agreements, the Company expects that
there will be letters of credit outstanding that will expire on
December 31, 2003. At that time, Citibank may not renew the
letters of credit. If Citibank does not renew the letters of
credit, the Companys cedents will be

6



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##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

entitled to draw on the letters of credit and the
Company would be obligated to repay Citibank for any amounts
drawn.

Under Bermuda law, a single creditor could make a
statutory demand upon the Company for satisfaction of
obligations owed to that creditor. If the statutory demand is
held to be valid, and the Company is unable to satisfy its
obligations to that creditor, the creditor may institute
proceedings seeking the liquidation of the Company. As of the
date of this report, the Company has been served with two
statutory demands under Bermuda law and has satisfied or
otherwise eliminated its obligations to the parties making those
demands. If a creditor of the Company successfully pursues this
statutory process and the Company is unable to discharge its
obligations, liquidation proceedings could be commenced against
the Company.

On November 20, 2002, the State of
Connecticut Insurance Department and the Companys United
States domiciled operating subsidiary entered into a letter
agreement acknowledging that the Connecticut Insurance
Department is monitoring the financial condition of the
Companys United States domiciled operating subsidiary. The
letter agreement requires that certain financial transactions
entered into by the subsidiary, including the disposal of
assets, payment of dividends and settlement of inter-company
balances with the Companys Bermuda operating subsidiary,
be pre-approved by the insurance department. In addition, the
Connecticut Insurance Department has requested weekly updates
from senior management of the U.S. operating subsidiary on
the status of the Company and any changes in the status of the
U.S. operating subsidiary. The letter agreement continues
to be effective until March 1, 2004.

The Company continues to consider its strategic
alternatives, including the possibility of raising new capital,
but has not been able to successfully raise new capital to date.
The Company has ceased to write new reinsurance agreements and
has notified its existing clients that it will not be accepting
any new business under existing treaties on their current terms.
The Company does not anticipate writing new reinsurance
agreements in the foreseeable future. These aforementioned
factors raise substantial doubt about the Companys ability
to continue as a going concern.

The Companys plans involve attempting to
meet or reduce its collateral requirements by continuing to
negotiate the recapture, retrocession, novation or sale of
certain of its reinsurance agreements. During the first six
months of 2003, these types of transactions resulted in
significant losses for the Company. The Company expects to incur
additional charges in connection with similar transactions in
the third quarter of 2003; however, the magnitude of charges
associated with these types of transactions should be
significantly less than previous quarters. In January 2003, the
Company instituted substantial premium rate increases on all of
its non-guaranteed premium yearly renewable term contracts. All
of the Companys cedents subject to the rate increase,
except The Metropolitan Life Insurance Companies
(MetLife) and one other cedent who has accepted the
rate increase, have elected to recapture their reinsurance
agreements. MetLife has made the rate increase a subject of
arbitration with the Company, and has indicated that its
election to recapture is dependent upon the arbitration
panels conclusion about the validity of the rate increase.

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

7



---



##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

3.     (Loss) Per
Share

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

|                                                         |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |            |  
|-------------------------------------------------------- |  | ------------------ | ----------- | ---------------- |  | ---- | ----------- | ---- |  | - | ------------ | - |  | - | ---------- | -
|                                                         |  |                    |             |                 
|                                                         |  | Three Months Ended |             | Six Months Ended
|                                                         |  | June 30,           |             | June 30,        
|                                                         |  |                    |             |                 
|                                                         |  | 2003               |             | 2002             |  | 2003 |             | 2002
|                                                         |  |                    |             |                  |  |      |             |     
|Net (loss) available to common shareholders              |  | $                  | (68,716,440 | )                |  | $    | (20,293,998 | )    |  | $ | (121,191,257 | ) |  | $ | (9,860,368 | )
|                                                         |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |            |  
|Basic:                                                   |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |            |  
|Weighted average number of common shares
    outstanding |  |                    | 25,841,057  |                  |  |      | 25,722,016  |      |  |   | 25,816,982   |   |  |   | 25,716,453 |  
|Net (loss) per share                                     |  | $                  | (2.66       | )                |  | $    | (0.79       | )    |  | $ | (4.69        | ) |  | $ | (0.38      | )
|                                                         |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |            |  
|Diluted:                                                 |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |            |  
|Weighted average number of common shares
    outstanding |  |                    | 25,841,057  |                  |  |      | 25,722,016  |      |  |   | 25,816,982   |   |  |   | 25,716,453 |  
|Net (loss) per share                                     |  | $                  | (2.66       | )                |  | $    | (0.79       | )    |  | $ | (4.69        | ) |  | $ | (0.38      | )
|                                                         |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |            |  



|   |                  
|-- | -----------------
|4. | Business Segments

The Company separately tracks financial results
of the Companys life and annuity operations in segments.
Each segment is defined by a dominant risk characteristic
inherent in all products in that segment. The life segment
consists of all products where the dominant risk characteristic
is mortality risk. The annuity segment comprises all products
where the dominant risk characteristic is investment risk,
including those products that provide minimum guarantees on
variable annuity products. In addition, certain of the
Companys modified coinsurance and coinsurance funds
withheld annuity reinsurance agreements have features that
constitute embedded derivatives that require bifurcation and
separate accounting under FAS 133  Accounting
for Derivative Instruments and Hedging Activities. The change in
the fair value of these embedded derivatives is included in the
annuity segment. Both the life and annuity segments have
specific assets, liabilities, stockholders equity,
revenue, benefits and expenses that apply only to them. The
corporate segment contains all stockholders equity not
otherwise deployed to the life or annuity segment. In addition,
the corporate segment includes all capital gains and losses from
sales of securities in the Companys portfolio and
investment income on undeployed invested assets. Operating
expenses are allocated to the segments proportionately based
upon the amount of stockholders equity deployed to the
segment, except for capital raising costs, which are charged
directly to the corporate segment. Capital raising costs
incurred in 2002 have been reallocated to the corporate segment
to maintain comparability with the presentation for 2003. The
Company believes that investors will better understand the
Companys profitability, risk profile, and capital
deployment through this segment reporting method. There are no
intersegment transactions. The following table displays several
key measurements for each of the Companys business
segments:

|                                 |  |             |             |             |  |           |             |              |  |   |            |  |  |   |               |  
|-------------------------------- |  | ----------- | ----------- | ----------- |  | --------- | ----------- | ------------ |  | - | ---------- |  |  | - | ------------- | -
|                                 |  | Life        |             | Annuity     |  |           |             |             
|Three Months Ended June 30, 2003 |  | Reinsurance |             | Reinsurance |  | Corporate |             | Consolidated
|                                 |  |             |             |             |  |           |             |             
|Revenues                         |  | $           | 57,507,429  |             |  | $         | 7,766,799   |              |  | $ | 5,205,648  |  |  | $ | 70,479,876    |  
|Benefits and Expenses            |  |             | 96,845,758  |             |  |           | 40,830,738  |              |  |   | 1,519,821  |  |  |   | 139,196,316   |  
|                                 |  |             |             |             |  |           |             |              |  |   |            |  |  |   |               |  
|Segment (Loss) Income            |  | $           | (39,338,329 | )           |  | $         | (33,063,939 | )            |  | $ | 3,685,827  |  |  | $ | (68,716,440   | )
|                                 |  |             |             |             |  |           |             |              |  |   |            |  |  |   |               |  
|Total Assets                     |  | $           | 396,766,778 |             |  | $         | 849,885,167 |              |  | $ | 32,087,049 |  |  | $ | 1,278,738,994 |  
|                                 |  |             |             |             |  |           |             |              |  |   |            |  |  |   |               |  

8



---



##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                 |  |             |             |             |  |           |               |              |  |   |             |  |  |   |               |  
|-------------------------------- |  | ----------- | ----------- | ----------- |  | --------- | ------------- | ------------ |  | - | ----------- |  |  | - | ------------- | -
|                                 |  | Life        |             | Annuity     |  |           |               |             
|Three Months Ended June 30, 2002 |  | Reinsurance |             | Reinsurance |  | Corporate |               | Consolidated
|                                 |  |             |             |             |  |           |               |             
|Revenues                         |  | $           | 94,465,177  |             |  | $         | 21,395,350    |              |  | $ | 4,003,959   |  |  | $ | 119,864,486   |  
|Benefits and Expenses            |  |             | 88,013,741  |             |  |           | 51,185,729    |              |  |   | 959,014     |  |  |   | 140,158,484   |  
|                                 |  |             |             |             |  |           |               |              |  |   |             |  |  |   |               |  
|Segment Income (Loss)            |  | $           | 6,451,436   |             |  | $         | (29,790,379   | )            |  | $ | 3,044,945   |  |  | $ | (20,293,998   | )
|                                 |  |             |             |             |  |           |               |              |  |   |             |  |  |   |               |  
|Total Assets                     |  | $           | 605,018,193 |             |  | $         | 1,553,294,479 |              |  | $ | 137,994,918 |  |  | $ | 2,296,307,590 |  
|                                 |  |             |             |             |  |           |               |              |  |   |             |  |  |   |               |  

|                               |  |             |             |             |  |           |             |              |  |   |            |  |  |   |               |  
|------------------------------ |  | ----------- | ----------- | ----------- |  | --------- | ----------- | ------------ |  | - | ---------- |  |  | - | ------------- | -
|                               |  | Life        |             | Annuity     |  |           |             |             
|Six Months Ended June 30, 2003 |  | Reinsurance |             | Reinsurance |  | Corporate |             | Consolidated
|                               |  |             |             |             |  |           |             |             
|Revenues                       |  | $           | 117,677,416 |             |  | $         | 31,869,930  |              |  | $ | 7,266,106  |  |  | $ | 156,813,452   |  
|Benefits and Expenses          |  |             | 202,161,913 |             |  |           | 72,804,345  |              |  |   | 3,038,452  |  |  |   | 278,004,709   |  
|                               |  |             |             |             |  |           |             |              |  |   |            |  |  |   |               |  
|Segment (Loss) Income          |  | $           | (84,484,497 | )           |  | $         | (40,934,415 | )            |  | $ | 4,227,655  |  |  | $ | (121,191,257  | )
|                               |  |             |             |             |  |           |             |              |  |   |            |  |  |   |               |  
|Total Assets                   |  | $           | 396,766,778 |             |  | $         | 849,885,167 |              |  | $ | 32,087,049 |  |  | $ | 1,278,738,994 |  
|                               |  |             |             |             |  |           |             |              |  |   |            |  |  |   |               |  

|                               |  |             |             |             |  |           |               |              |  |   |             |  |  |   |               |  
|------------------------------ |  | ----------- | ----------- | ----------- |  | --------- | ------------- | ------------ |  | - | ----------- |  |  | - | ------------- | -
|                               |  | Life        |             | Annuity     |  |           |               |             
|Six Months Ended June 30, 2002 |  | Reinsurance |             | Reinsurance |  | Corporate |               | Consolidated
|                               |  |             |             |             |  |           |               |             
|Revenues                       |  | $           | 173,611,221 |             |  | $         | 48,311,104    |              |  | $ | 5,703,357   |  |  | $ | 227,625,682   |  
|Benefits and Expenses          |  |             | 159,970,569 |             |  |           | 75,183,152    |              |  |   | 2,332,329   |  |  |   | 237,486,050   |  
|                               |  |             |             |             |  |           |               |              |  |   |             |  |  |   |               |  
|Segment Income (Loss)          |  | $           | 13,640,652  |             |  | $         | (26,872,048   | )            |  | $ | 3,371,028   |  |  | $ | (9,860,368    | )
|                               |  |             |             |             |  |           |               |              |  |   |             |  |  |   |               |  
|Total Assets                   |  | $           | 605,018,193 |             |  | $         | 1,553,294,479 |              |  | $ | 137,994,918 |  |  | $ | 2,296,307,590 |  
|                               |  |             |             |             |  |           |               |              |  |   |             |  |  |   |               |  



|   |                     
|-- | --------------------
|5. | Accounting Standards

In December 2002, the FASB issued Statement
Number 148  Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment
of FASB Statement Number 123. This statement provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. On January 1, 2003, the Company voluntarily
adopted the fair value based method of accounting for
stock-based employee compensation under the prospective method
described in FASB Statement Number 148. Under this method, the
Company applies fair value accounting to all grants of employee
stock options subsequent to December 31, 2002. Previously,
the Company had applied the intrinsic value method when
accounting for its stock-based compensation and continues to
apply the intrinsic value method to stock-based compensation
issued prior to January 1, 2003. FASB Statement Number 148
also amends the disclosure requirements of FASB Statement
Number 123 to require more prominent disclosures in both
annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect
of the method used on reported results. The following table
provides the required disclosure for grants made prior to the
Companys adoption of the prospective method described in
FASB Statement Number 148.

9



---



##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                                                                                         |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |             |  
|------------------------------------------------------------------------------------------------------------------------ |  | ------------------ | ----------- | ---------------- |  | ---- | ----------- | ---- |  | - | ------------ | - |  | - | ----------- | -
|                                                                                                                         |  |                    |             |                 
|                                                                                                                         |  | Three Months Ended |             | Six Months Ended
|                                                                                                                         |  | June 30,           |             | June 30,        
|                                                                                                                         |  |                    |             |                 
|                                                                                                                         |  | 2003               |             | 2002             |  | 2003 |             | 2002
|                                                                                                                         |  |                    |             |                  |  |      |             |     
|Net (loss)  as reported                                                                                                 |  | $                  | (68,716,440 | )                |  | $    | (20,293,998 | )    |  | $ | (121,191,257 | ) |  | $ | (9,860,368  | )
|Pro forma effect on net (loss) of applying fair
    value accounting to pre January 1, 2003 option grants                |  |                    | (547,800    | )                |  |      | (862,121    | )    |  |   | (1,095,601   | ) |  |   | (1,724,242  | )
|                                                                                                                         |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |             |  
|Net (loss)  pro forma                                                                                                   |  | $                  | (69,269,240 | )                |  | $    | (21,156,119 | )    |  | $ | (120,159,065 | ) |  | $ | (11,584,610 | )
|                                                                                                                         |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |             |  
|(Loss) per share as reported:                                                                                            |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |             |  
|Basic                                                                                                                    |  | $                  | (2.66       | )                |  | $    | (0.79       | )    |  | $ | (4.69        | ) |  | $ | (0.38       | )
|Diluted                                                                                                                  |  | $                  | (2.66       | )                |  | $    | (0.79       | )    |  | $ | (4.69        | ) |  | $ | (0.38       | )
|Pro forma effect on net (loss) per share of
    applying fair value accounting to pre January 1, 2003
    option grants: |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |             |  
|Basic                                                                                                                    |  | $                  | (0.02       | )                |  | $    | (0.03       | )    |  | $ | (0.05        | ) |  | $ | (0.07       | )
|Diluted                                                                                                                  |  | $                  | (0.02       | )                |  | $    | (0.03       | )    |  | $ | (0.05        | ) |  | $ | (0.07       | )
|Pro forma (loss) per share:                                                                                              |  |                    |             |                  |  |      |             |      |  |   |              |   |  |   |             |  
|Basic                                                                                                                    |  | $                  | (2.68       | )                |  | $    | (0.82       | )    |  | $ | (4.74        | ) |  | $ | (0.45       | )
|Diluted                                                                                                                  |  | $                  | (2.68       | )                |  | $    | (0.82       | )    |  | $ | (4.74        | ) |  | $ | (0.45       | )



|   |                           
|-- | --------------------------
|6. | Related Party Transactions



| |            
| | -----------
| | XL Life Ltd

On December 31, 2002, the Company entered
into a transaction with XL Life Ltd (XL Life), a
subsidiary of XL Capital, pursuant to which the Company
transferred certain blocks of life reinsurance business to XL
Life. Under the agreement with XL Life, the Company novated five
blocks of life reinsurance business to XL Life, which in turn
entered into a 50% quota share reinsurance contract with the
Company with respect to four of those blocks of business. As a
result of the transaction, the Company incurred a loss of
approximately $26.5 million, primarily as a result of a
write down of deferred acquisition costs of $38.7 million
(which was partially offset by a net ceding commission to the
Company of $18.0 million), a write down of prepaid expenses
of $2.4 million and transaction costs of approximately
$3.2 million. The agreement also provides that XL Life will
receive an additional payment of $5 million if, during the
18 months following the agreement, the Company receives new
capital funding of at least $35 million and the
Companys stock trades at a price at or above $5.00 per
share for a period of 20 out of any 30 consecutive trading days.
The Company is in discussions with XL Life regarding certain
post closing adjustments called for by the master novation
agreement entered into in connection with the transaction. If
the Company cannot reach a satisfactory resolution with XL Life
regarding these adjustments, it may be required to enter into
arbitration proceedings with XL Life under the agreement. If the
Company is unable to prevail in such arbitration proceedings, it
may be required to make substantial cash adjustment payments to
XL Life under the agreement.

On August 5, 2003, XL Life served the
Company with notice of its intention to recapture the 50% quota
share reinsurance contract with the Company. As a result, the
Company will not be able to recover the deferred acquisition
costs carried for this contract from future expected income, and
has written down approximately $21 million of such deferred
acquisition costs in the three months ended June 30, 2003.

10



---



##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

XL Life has also indicated its desire to
terminate other agreements with the Company, including the
$10 million excess of loss reinsurance policy purchased by
the Company in the first quarter of 2002 and two annuity
reinsurance contracts between the Company and XL Life or its
affiliates. The excess of loss reinsurance policy was purchased
to protect against lifetime minimum interest guarantee
(LMIG) payments under the Companys annuity
reinsurance contract with Transamerica Occidental Life Insurance
Company (Transamerica), and full recovery under the
policy has been anticipated in establishing the Companys
deferred acquisition cost asset. The two annuity reinsurance
contracts represent approximately $96 million (including a
cumulative loss from embedded derivatives of approximately
$2.8 million) of the Companys Funds withheld at
interest and approximately $95 million of the
Companys Interest sensitive contract and other
liabilities. The Company is in discussions with XL Life
regarding these other relationships. The outcome of these
discussions cannot be determined at this time.



| |                             
| | ----------------------------
| | Transactions with management

During 1998, certain of the Companys
officers purchased 163,121 shares in the Company, and the
Company made loans to the officers to partially finance such
purchases. The loans accrued interest at 7% per annum and
certain unpaid loans became due and payable in April 2003. In
connection with the renegotiation or termination of certain
officers employment agreements, the Company has deemed the
outstanding loans of those officers to have been repaid in
exchange for the officers agreeing to forego certain bonus,
severance or other payments that are or may become payable to
them. During the six months ended June 30, 2003, loans of
$1,000,000 with accrued interest of $402,812 had been deemed
repaid in this manner.

7.     Restricted
Stock

In 2002, the Board of Directors adopted a
Restricted Stock Plan under which it may grant common shares to
key employees. The aggregate number of common shares that may be
granted under the Restricted Stock Plan is 1,200,000. The
Compensation Committee of the Board of Directors administers the
Restricted Stock Plan. During 2002, the Company made two awards
to employees. Under the first award to employees, the Company
issued 133,500 shares of restricted stock that vest on the third
anniversary of the grant date. Under the second award, certain
employees of the Company were irrevocably offered shares of
restricted stock, conditioned upon the execution of a retention
agreement with the Company. The Company issued an aggregate
267,500 shares to those employees who chose to execute retention
agreements and such shares vest in three equal annual
installments commencing on the first anniversary of the grant
date.

During the first quarter of 2003, the Company
issued 200,000 shares of restricted stock to the Companys
President and Chief Executive Officer. These shares vest in
three equal annual installments commencing on the first
anniversary of the grant date. In addition, during the second
quarter of 2003, the Company issued an additional 375,000 shares
of restricted stock in connection with retention grants to
employees. These shares also vest in three equal annual
installments commencing on the first anniversary of the grant
date. During the first six months of 2003, 102,100 shares of
restricted stock were cancelled as a result of certain employees
terminating their employment with the Company. The fair value,
as determined at the date of grant, of the restricted stock
awards that remain outstanding on June 30, 2003 was
$3,064,108 and is reflected in the Companys balance sheet
as common shares and additional paid-in capital. The fair value
of the outstanding restricted stock is being amortized on a
straight-line basis over the three-year vesting period. The
unamortized balance of outstanding restricted stock is reflected
in the balance sheet as a component of unamortized stock grant
compensation.

11



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##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

8.     Vulnerability
Due to Concentrations

The Company has entered into a significant
deferred annuity reinsurance contract with Transamerica and a
significant life reinsurance contract with MetLife. Due to the
size of these contracts, there is a material concentration of
net premiums, net investment income, interest credited to
interest sensitive products, funds withheld at interest,
deferred policy acquisition costs and interest sensitive
contract liabilities with one or both of the underlying parties
to these contracts.

At June 30, 2003 and December 31, 2002,
approximately $648 million and $734 million,
respectively, of the Companys funds withheld at interest
receivable and $650 million and $756 million,
respectively of the Companys interest sensitive contracts
liability related to its reinsurance contract with Transamerica,
which is a retrocessional reinsurance arrangement covering
policies issued by IL Annuity and Insurance Company.
Transamericas agreement with IL Annuity is also structured
on a modified coinsurance basis, so IL Annuity maintains
ownership and control of the assets supporting the
Companys obligations to Transamerica. At June 30,
2003, IL Annuitys financial strength rating was BB+ from
Standard & Poors. At June 30, 2003, Transamerica
had financial strength or claims paying ratings of A+, AA, Aa3
and AA+ (with a negative outlook) from A.M. Best, Standard &
Poors, Moodys Ratings and Fitch Ratings,
respectively.

During the six months ended June 30, 2003,
the Company recorded $10,057,000 of LMIG payments in connection
with the Transamerica annuity reinsurance contract, as compared
to payments of $13,322,000 for the six months ended
June 30, 2002. XL Life, subsidiary of XL Capital, has
agreed to provide protection for up to $10,000,000 against LMIG
payments on this contract paid after December 31, 2001 in
excess of a $33,000,000 deductible. During the second quarter of
2003, the cumulative LMIG payments made by the Company under the
Transamerica contract exceeded the deductible and, as a result,
the Company is currently due approximately $3,800,000 under the
excess of loss reinsurance policy purchased from XL Life.

During 2002, the Company recorded a write down of
deferred acquisition costs in connection with the Transamerica
contract of $27,474,000. This charge was the result of a high
level of surrenders of the underlying policies coupled with poor
investment performance on the premiums paid by the holders of
policies underlying the reinsurance contract. In writing down
the deferred acquisition costs to their estimated recoverable
amount, management estimated the future levels of surrenders of
the underlying policies together with the estimated future level
of investment return on the invested premiums. No additional
write downs of deferred acquisition costs were required in the
six months ended June 30, 2003. While management has
established its deferred acquisition cost asset at what it
believes to be an appropriate level based upon reasonable
assumptions about future investment performance and surrenders,
if actual experience varies significantly from the assumptions
used to establish our deferred acquisition cost asset,
additional write downs may be needed in the future.

For the three and six months ended June 30,
2003, the Company recorded losses of approximately $2,246,000
and $3,935,000, respectively, related to its life reinsurance
contract with MetLife. Premiums associated with this contract
for the three and six months ended June 30, 2003, were
approximately $9,918,000 and $19,898,000, respectively. In
January 2003, the Company provided written notice to MetLife of
a premium rate increase in connection with this contract,
effective March 5, 2003, which has become a subject of the
Companys arbitration with MetLife. As a result of
novations and recaptures of certain of the Companys life
reinsurance contracts during the year ended December 31,
2002 and the first six months of 2003, MetLife now represents a
larger percentage of the Companys premium, revenue and net
income, and the Company expects the relative significance of the
MetLife contract to increase as additional contracts are
recaptured or novated.

During the first quarter of 2003, The Ohio
National Life Insurance Company terminated its annuity
reinsurance agreement with the Company, resulting in a loss of
approximately $(4,655,000) (net of the unrealized gain
associated with the reversal of cumulative unrealized losses in
the embedded derivative

12



---



##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

associated with the agreement). At
December 31, 2002, this reinsurance agreement was the
Companys second largest annuity reinsurance agreement
representing approximately $366 million of the
Companys funds withheld at interest (net of the fair value
of the embedded derivatives associated with that agreement,
which was an unrealized loss of approximately $10 million)
and $376 million of the Companys interest sensitive
contracts liability.

On December 31, 2002, the Company entered
into a transaction with XL Life pursuant to which the Company
transferred certain blocks of life reinsurance business to XL
Life. Under the agreement with XL Life, the Company novated five
blocks of life reinsurance business to XL Life, which in turn
entered into a 50% quota share reinsurance contract with the
Company with respect to four of those blocks of business. On
August 5, 2003, XL Life served the Company with notice of
its intention to recapture the 50% quota share reinsurance
contract with the Company.

9.     Contingencies

As of June 30, 2003, the Company did not
have sufficient available cash and investments to post
collateral to satisfy its obligations under certain of its
reinsurance treaties. Two of the Companys cedents have
asserted that the Company must satisfy additional collateral
requirements of approximately $78,000,000 in excess of amounts
the Company currently has posted. At June 30, 2003,
$59,000,000 of the collateral requirements asserted by the
Companys cedents related to the Companys only
combined guaranteed minimum death benefit (GMDB) and
guaranteed minimum income benefit (GMIB) contract.
The Company has not agreed with the cedent under that contract
regarding the amount that is in fact required to be posted as
collateral. If the Company is ultimately unable to satisfy its
collateral obligations under this or other contracts, its
cedents may elect to pursue the remedies available to them under
their contracts, including arbitration against the Company.

While the Company plans to continue receiving
premiums and paying claims under its remaining reinsurance
treaties, the Company has ceased to write new reinsurance
agreements and has notified its existing clients that it will
not be accepting any new business under existing treaties on
their current terms. The Company does not anticipate writing new
reinsurance agreements in the foreseeable future. The
Companys plans involve attempting to meet or reduce its
collateral requirements by continuing to negotiate the
recapture, retrocession, novation or sale of certain of its
reinsurance agreements. During the first six months of 2003,
these types of transactions resulted in significant losses for
the Company. The Company expects to incur additional charges in
connection with similar transactions in the third quarter of
2003; however, the magnitude of charges associated with these
types of transactions should be significantly less than previous
quarters. In January 2003, the Company instituted substantial
premium rate increases on all of its non-guaranteed premium
yearly renewable term contracts. All of the Companys
cedents subject to the rate increase, except MetLife and one
other cedent who has accepted the rate increase, have elected to
recapture their reinsurance agreements. MetLife has made the
rate increase a subject of arbitration with the Company, and has
indicated that its election to recapture is dependent upon the
arbitration panels conclusion about the validity of the
rate increase. There can be no assurance that the Companys
plans will be successful in improving its operations and
liquidity, or that the Company can successfully implement its
plans. If the Companys plans are not successful or it is
unable to implement its plans, it will not be able to satisfy
its obligations in 2003.

In April 2003, Hartford Life Insurance Company
(Hartford Life), the cedent under the Companys
largest GMDB reinsurance contract, drew approximately
$18,000,000 of assets held in trust for its benefit and drew
approximately $24,500,000 of letters of credit that had been
issued by Citibank for Hartford Lifes benefit. As a result
of Hartford Lifes draw on the letters of credit, Citibank
applied approximately $20,105,000 in assets that had been posted
by the Company as security under its letter of credit facility
against amounts due to Citibank from the Company. Consequently,
approximately $4,395,000 related to the Companys letter of
credit facility became due upon demand by Citibank and was paid
by the Company on

13



---



##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

June 30, 2003. On July 17, 2003,
Hartford Life agreed to recapture its GMDB reinsurance contract
with the Company, effective June 30, 2003. As consideration
for the recapture, Hartford Life retained approximately
$31 million of the funds it had drawn from the trust
account and letters of credit and the Company issued warrants to
purchase an aggregate one million of the Companys common
shares to Hartford Life. The impact of the recapture in the
second quarter of 2003, net of reserves for GMDB that were no
longer needed and released, was a charge of approximately
$20 million. Under the terms of the recapture, the Company
has no further obligations to Hartford Life.

In April 2002, the Company served written notice
of arbitration on MetLife, the cedent under its largest life
reinsurance agreement, seeking equitable relief and monetary
damages based on MetLifes misrepresentation of and failure
to disclose material facts relating to the agreement. In January
2003, the Company also provided written notice to MetLife of a
premium rate increase, effective March 5, 2003, which also
has become a subject of this arbitration. An arbitration panel
is scheduled to hear these claims in December 2003.

As of June 30, 2003, the Company had
$29,810,000 of outstanding unsecured letters of credit issued on
its behalf by Citibank. In October 2002, Citibank agreed to
extend the Companys unsecured letter of credit facility
into 2003 in exchange for the Companys agreement to secure
or eliminate the letter of credit facility by June 30,
2003. The Company was unable to secure or eliminate the letter
of credit facility by that date. Although the Company is seeking
to reduce the amount of outstanding letters of credit issued on
its behalf by Citibank, primarily through recaptures and
terminations of reinsurance agreements, the Company expects that
there will be letters of credit outstanding that will expire on
December 31, 2003. At that time, Citibank may not renew the
letters of credit. If Citibank does not renew the letters of
credit, the Companys cedents will be entitled to draw on
the letters of credit and the Company would be obligated to
repay Citibank for any amounts drawn.

On November 20, 2002, the State of
Connecticut Insurance Department and the Companys United
States domiciled operating subsidiary entered into a letter
agreement acknowledging that the Connecticut Insurance
Department is monitoring the financial condition of the
Companys United States domiciled operating subsidiary. The
letter agreement requires that certain financial transactions
entered into by the subsidiary, including the disposal of
assets, payment of dividends and settlement of inter-company
balances with the Companys Bermuda operating subsidiary,
be pre-approved by the insurance department. In addition, the
Connecticut Insurance Department has requested weekly updates
from senior management of the U.S. operating subsidiary on
the status of the Company and any changes in the status of the
U.S. operating subsidiary. The letter agreement continues
to be effective until March 1, 2004.

On and since December 4, 2002, certain of
the Companys shareholders filed purported shareholder
class action lawsuits against the Company and certain of its
present and former officers and directors in the United States
District Court for the District of Connecticut seeking
unspecified monetary damages. The plaintiffs claim that the
defendants violated certain provisions of the United States
securities laws by making various alleged material misstatements
and omissions in public filings and press releases. No assurance
can be given that the Company will not be required to pay
monetary damages in connection with these lawsuits.

As discussed in Note 6 above, on
December 31, 2002, the Company entered into a transaction
with XL Life pursuant to which the Company transferred
certain blocks of life reinsurance business to XL Life.
Under the agreement with XL Life, the Company novated five
blocks of life reinsurance business to XL Life, which in
turn entered into a 50% quota share reinsurance contract with
the Company with respect to four of those blocks of business.
The Company is in discussions with XL Life regarding
certain post closing adjustments called for by the master
novation agreement entered into in connection with the
transaction. If the Company cannot reach a satisfactory
resolution with XL Life regarding these adjustments, it may be
required to enter into arbitration proceedings with XL Life
under the agreement. If the Company is unable to prevail in such
arbitration proceedings, it may be required to make substantial
cash adjustment payments to XL Life under the agreement. On
August 5, 2003, XL Life served the Company with notice
of its intention to

14



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##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

recapture the 50% quota share reinsurance
contract with the Company. As a result, the Company will not be
able to recover the deferred acquisition costs carried for this
contract from future expected income, and has written down
approximately $21 million of such deferred acquisition
costs in the three months ended June 30, 2003.

XL Life has also indicated its desire to
terminate other agreements with the Company, including the
$10 million excess of loss reinsurance policy purchased by
the Company in the first quarter of 2002 and two annuity
reinsurance contracts between the Company and XL Life or its
affiliates. The excess of loss reinsurance policy was purchased
to protect against LMIG payments under the Companys
annuity reinsurance contract with Transamerica, and full
recovery under the policy has been anticipated in establishing
the Companys deferred acquisition cost asset. The two
annuity reinsurance contracts represent approximately
$96 million (including a cumulative loss from embedded
derivatives of approximately $2.8 million) of the
Companys Funds withheld at interest and approximately
$95 million of the Companys Interest sensitive
contract and other liabilities. The Company is in discussions
with XL Life regarding these other relationships. The
outcome of these discussions cannot be determined at this time.

On April 8, 2003, the Company received
notice from the New York Stock Exchange that it did not satisfy
the NYSEs continued listing standards as of that date
because the average closing price of the Companys common
shares had been below $1.00 for a 30 consecutive trading day
period. If the Company cannot achieve (i) a $1.00 average
share price for the 30 consecutive trading days prior to
October 7, 2003, the expiration of the six month period
following the date of the receipt of this notification, and
(ii) a $1.00 share price on October 7, 2003, then the
NYSE will commence suspension and delisting procedures with
respect to the Companys common shares. In addition, the
NYSE informed the Company that it is considering whether it
continues to meet certain of the NYSEs qualitative
continued listing standards due to concerns over the
Companys financial condition.

10.     Stock
Warrants

On June 30, 2003, the Company issued
warrants to purchase an aggregate one million common shares of
the Company at an exercise price of $1.25 per share to Hartford
Life, the cedent under the Companys largest GMDB
reinsurance contract. The warrants were issued in connection
with the recapture of the GMDB contract and expire on
June 30, 2013. At June 30, 2003, the fair value of
warrants, using a Black-Scholes pricing model, was estimated at
$1,250,000, which has been included in the charge associated
with the recapture. The expense of issuing these warrants is
reflected as a component of Claim and policy benefits expense in
the Companys Consolidated Statements of Operations and as
Stock warrants in the Companys Consolidated Balance Sheet.

15



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##### 



ANNUITY AND LIFE RE (HOLDINGS), LTD.


NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

General

Annuity and Life Re (Holdings), Ltd. was
incorporated on December 2, 1997 under the laws of Bermuda.
We provide annuity and life reinsurance to select insurers and
reinsurers through our wholly-owned subsidiaries: Annuity and
Life Reassurance, Ltd., which is licensed under the insurance
laws of Bermuda as a long term insurer; and Annuity and Life Re
America, Inc., an insurance holding company based in the United
States, and its subsidiary, Annuity and Life Reassurance
America, Inc., a life insurance company authorized to conduct
business in over 40 states of the United States and the District
of Columbia. We acquired Annuity and Life Reassurance America on
June 1, 2000. For more information regarding the business
and operations of our company and its subsidiaries, please see
our Annual Report on Form 10-K for the year ended
December 31, 2002, as amended.

As discussed in greater detail elsewhere in this
report, our company continued to encounter significant
difficulties during the six month period ended June 30,
2003. In addition to reporting a significant operating loss for
the first six months of 2003, we did not have sufficient
available cash and investments at June 30, 2003 to satisfy
all the collateral requirements asserted by our cedents under
certain of our reinsurance treaties. Two of our cedents have
asserted that we must satisfy additional collateral requirements
of approximately $78,000,000 in excess of amounts we currently
have posted. We have not agreed with the assertion by one of
these cedents that we must post approximately $59,000,000 of
additional collateral. As a result of our inability to satisfy
our obligations, certain parties have claimed that we are in
breach of our agreements. As a consequence, such parties have
sought and others may seek remedies for such claimed breaches by
us, and we may be required to enter into arbitration or
litigation proceedings with those parties. If we do not prevail
in any such arbitration or litigation proceeding, it would have
a material adverse effect on our financial condition and we may
be required to liquidate our operations.

As of June 30, 2003, we had $29,810,000 of
outstanding unsecured letters of credit issued on our behalf by
Citibank. In October 2002, Citibank agreed to extend our
unsecured letter of credit facility into 2003 in exchange for
our agreement to secure or eliminate the letter of credit
facility by June 30, 2003. We were unable to secure or
eliminate the letter of credit facility by that date. Although
we are seeking to reduce the amount of outstanding letters of
credit issued on our behalf by Citibank, primarily through
recaptures and terminations of reinsurance agreements, we expect
that there will be letters of credit outstanding that will
expire on December 31, 2003. At that time, Citibank may not
renew the letters of credit. If Citibank does not renew the
letters of credit, our cedents will be entitled to draw on the
letters of credit and we would be obligated to repay Citibank
for any amounts drawn.

As discussed in Note 6 to our unaudited
consolidated financial statements included elsewhere in this
report, on December 31, 2002, we entered into a transaction
with XL Life Ltd (XL Life) pursuant to
which we transferred certain blocks of life reinsurance business
to XL Life. Under the agreement with XL Life, we
novated five blocks of life reinsurance business to
XL Life, which in turn entered into a 50% quota share
reinsurance contract with us with respect to four of those
blocks of business. We are in discussions with XL Life
regarding certain post closing adjustments called for by the
master novation agreement entered into in connection with the
transaction. If we cannot reach a satisfactory resolution with
XL Life regarding these adjustments, we may be required to
enter into arbitration proceedings with XL Life under the
agreement. If we are unable to prevail in such arbitration
proceedings, we may be required to make substantial cash
adjustment payments to XL Life under the agreement.

On August 5, 2003, XL Life served us
with notice of its intention to recapture the 50% quota share
reinsurance contract with us. As a result, we will not be able
to recover the deferred acquisition costs carried for this
contract from future expected income and have written down
approximately $21 million of such deferred acquisition
costs in the three months ended June 30, 2003.

XL Life has also indicated its desire to
terminate other agreements with us, including the
$10 million excess of loss reinsurance policy purchased by
us in the first quarter of 2002 and two annuity reinsurance
contracts between our company and XL Life or its
affiliates. The excess of loss reinsurance policy was

16



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##### 



purchased to protect against lifetime minimum
interest guarantee (LMIG) payments under our annuity
reinsurance contract with Transamerica Occidental Life Insurance
Company (Transamerica), and full recovery under the
policy has been anticipated in establishing our deferred
acquisition cost asset. The two annuity reinsurance contracts
represent approximately $96 million (including a cumulative
loss from embedded derivatives of approximately
$2.8 million) of our Funds withheld at interest and
approximately $95 million of our Interest sensitive
contract and other liabilities. We are in discussions with
XL Life regarding these other relationships. The outcome of
these discussions cannot be determined at this time.


While we plan to continue receiving premiums and
paying claims under our remaining reinsurance treaties, we have
ceased to write new reinsurance agreements and have notified our
existing clients that we will not be accepting any new business
under existing treaties on their current terms. We do not
anticipate writing new reinsurance agreements in the foreseeable
future. Our plans involve attempting to meet or reduce our
collateral requirements by continuing to negotiate the
recapture, retrocession, novation or sale of certain of our
reinsurance agreements. During the first six months of 2003,
these types of transactions resulted in significant losses for
us. We expect to incur additional charges in connection with
similar transactions in the third quarter of 2003; however, the
magnitude of charges associated with these types of transactions
should be significantly less than previous quarters. In January
2003, we instituted substantial premium rate increases on all of
our non-guaranteed premium yearly renewable term contracts. All
of our cedents subject to the rate increase, except The
Metropolitan Life Insurance Companies (MetLife) and
one other cedent who has accepted the rate increase, have
elected to recapture their reinsurance agreements. MetLife has
made the rate increase a subject of arbitration with us, and has
indicated that its election to recapture is dependent upon the
arbitration panels conclusion about the validity of the
rate increase. There can be no assurance that our plans will be
successful in improving our operations and liquidity, or that we
can successfully implement our plans. If our plans are not
successful or we are unable to implement our plans, we will not
be able to satisfy our obligations in 2003.

Critical Accounting Policies

Our consolidated financial statements are
prepared in accordance with accounting principles generally
accepted in the United States of America, which require our
management to make estimates and assumptions that affect the
amounts of our assets, liabilities, stockholders equity
and net income. We believe that the following critical
accounting policies, as well as those set forth in our
Form 10-K for the year ended December 31, 2002, as
amended, detail the more significant estimates and assumptions
used in the preparation of our consolidated financial statements.

Deferred Policy Acquisition Costs.The costs of acquiring new business,
principally allowances, which vary with and are primarily
related to the production of new business, are deferred. For
traditional life and annuity policies with life contingencies,
deferred policy acquisition costs are charged to expense using
assumptions consistent with those used in computing policy
reserves. Assumptions as to anticipated premiums are estimated
at the date of the policy issuance, or the effective date of the
most recent premium rate increase, and are consistently applied
during the life of the contracts. Deviations from estimated
experience are reflected in earnings in the period such
deviations occur. For these contracts, the amortization periods
are generally the estimated life of the policies. As discussed
elsewhere in this report, we are attempting to improve our
liquidity by novating and recapturing certain of our reinsurance
agreements. If we cannot novate or recapture these reinsurance
agreements on favorable terms, we will incur additional deferred
acquisition cost write downs.

In preparing our financial statements, we make
assumptions about our proportionate share of future investment
income that will be earned from the investment of premiums
received from underlying policyholders by our ceding companies
and about future rates of lapse of policies underlying our
annuity reinsurance contracts when estimating gross profits
arising from such contracts. These assumptions have a direct
impact on the amount of expected future LMIG payments and our
estimated expected gross profits on these annuity reinsurance
contracts and, therefore, on the recoverability of the deferred
acquisition costs carried on our balance sheet for these
contracts. While these estimates are based upon historical
results and information provided to us by our cedents, actual
results could differ (and, in the past, have differed)
materially from our estimates for a variety of reasons,
including the failure of our ceding companies to report timely
information

17



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##### 



regarding material developments under our
reinsurance agreements. Such differences could be material to
our future results. If our assumptions for investment returns
prove to be inaccurate, or if lapse rates exceed our
assumptions, we may be required to make additional LMIG payments
and record additional charges, which would adversely impact our
earnings.


Embedded Derivatives.We have concluded that there are
embedded derivatives within the Funds withheld at interest
receivable related to certain of our annuity reinsurance
contracts written on a modified coinsurance or coinsurance funds
withheld basis that require bifurcation and separate accounting
under Statement of Financial Accounting Standards
No. 133  Accounting for Derivative Instruments
and Hedging Activities. These embedded derivatives are similar
to a total return swap arrangement on the underlying assets held
by our ceding companies. The net fair value of these embedded
derivatives is classified as part of our Funds withheld asset on
our balance sheet. We have developed a cash flow model with the
assistance of outside advisors to arrive at an estimate of the
fair value of this total return swap that uses various
assumptions regarding future cash flows under the affected
annuity reinsurance contracts. The fair value of the embedded
derivative is influenced by changes in credit risk, changes in
expected future cash flows under the annuity contracts and
interest rates. The change in fair value of these embedded
derivatives is recorded in our statement of operations as Net
change in fair value of embedded derivatives, which is a
non-cash item. The change in fair value of these embedded
derivatives also impacts the emergence of expected gross profits
for purposes of amortizing deferred acquisition costs associated
with these contracts. The application of this accounting policy
has increased the volatility of our reported earnings. While we
have made an estimate of the fair value of these embedded
derivatives using a model that we believe to be appropriate and
based upon reasonable assumptions, the assumptions used are
subjective and may require adjustment in the future. In
addition, as industry standards for estimating the fair value of
embedded derivatives develop, it is possible that we may modify
our methodology. Changes in our assumptions and industry
standards could have a significant impact on the fair value of
the embedded derivatives and our reported earnings. We do not
bifurcate and separately account for the embedded derivatives
contained in certain of our contracts, including our
Transamerica annuity reinsurance agreement and our guaranteed
minimum income benefit (GMIB) reinsurance agreement,
because we acquired those agreements prior to the transition
date elected by us under FAS 133, as amended by
FAS 137. Because of the nature of the assets underlying our
Transamerica contract, which were roughly 63% convertible bonds
at June 30, 2003, the bifurcation and separate accounting
for the embedded derivatives contained in that contract would
add significant volatility to our reported results. If we
bifurcated and separately accounted for the embedded derivative
contained in our GMIB reinsurance agreement, it also would add
volatility to our reported results.

Recognition of Revenues and Expenses.Reinsurance premium revenues from life
products with mortality risk are recognized when due from the
policyholders. For those policies with premium paying periods
that are significantly shorter than the total period over which
benefits are expected to be provided, profits are deferred and
recognized as income in a constant relationship to the insurance
in force or, for annuities, in relation to the amount of
expected future benefit payments. Premiums from universal life
and investment-type contracts are recorded on our balance sheet
as interest sensitive contracts liability. Revenues from these
investment-type contracts consist of income earned on the assets
and amounts assessed during the period against
policyholders account balances for mortality charges,
policy administration charges and surrender charges. Items that
are charged to expense represent interest credited to
policyholder accounts and other benefits in excess of related
policyholders account balances, including LMIG payments.
Such LMIG payments are recognized when paid upon the surrender
of the underlying policy and are not charged to the
policyholders account balances. We make estimates at the
end of each reporting period regarding premiums and benefits for
cedents who do not report such information in a timely manner.
These estimates can have a significant effect on the amounts we
report in our financial statements.

Reserves for Policy Benefits, Including Claims
Incurred but not Reported (IBNR) and Interest Sensitive
Contracts Liability.The development
of reserves for policy benefits and for claims incurred but not
reported for our life reinsurance contracts requires us to make
estimates and assumptions regarding mortality, lapse,
persistency, expense and investment experience. Such estimates
are primarily based on historical experience and information
provided by ceding companies. Actual results could differ
materially from those estimates.

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We monitor actual experience, and where
circumstances warrant, will revise our assumptions and the
related reserve estimates.


We reinsure certain minimum guarantees associated
with variable annuity contracts. These have historically
included guaranteed minimum death benefits (GMDB),
GMIB, and enhanced earnings benefits (EEB). Our
accounting policy is designed to establish reserves for expected
claim payments based upon the long-term view of expected losses
over the life of the underlying policies, based upon the
original pricing assumptions. Our reserving policy allows us to
increase reserves if reported claim amounts or claims volume
exceed what was anticipated in pricing.

Policy benefit liabilities for annuities are
reflected on our balance sheet as Interest sensitive
contracts liability and are reported at the accumulated
policyholder balance of these accounts.

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

Operating Results

Net (Loss).For the
three months ended June 30, 2003, we had a net loss of
$(68,716,440), or $(2.66) per basic and fully diluted common
share, as compared with a net loss of $(20,293,998), or $(0.79)
per basic and fully diluted common share, for the three months
ended June 30, 2002. For the six months ended June 30,
2003, we had a net loss of $(121,191,257), or $(4.69) per basic
and fully diluted common share, as compared to net loss of
$(9,860,368), or $(0.38) per basic and fully diluted common
share, for the six months ended June 30, 2002. The loss in
the second quarter of 2003 was primarily the result of losses
associated with recaptures and terminations of life and annuity
reinsurance agreements and adverse claims experience under our
life and annuity reinsurance agreements.

During the three months ended June 30, 2003,
we negotiated the recapture and termination of certain of our
life and annuity reinsurance agreements. On July 17, 2003,
Hartford Life recaptured our largest GMDB contract effective
June 30, 2003. The impact of the recapture of the Hartford
Life contract in the second quarter, net of reserves for
guaranteed minimum death benefits that were no longer needed and
released, was a charge of approximately $20,400,000. In
addition, on August 5, 2003, XL Life served us with notice
of its intention to recapture its 50% quota share reinsurance
contract with us. As a result, we will not be able to recover
the deferred acquisition costs carried for this contract from
future expected income, and have written down approximately
$21,000,000 of such deferred acquisition costs in the three
months ended June 30, 2003. As a result of these and all
other recaptures and terminations, we incurred charges of
approximately $55 million and $94 million for the
three and six months ended June 30, 2003, respectively.
These charges resulted from the write down of deferred
acquisition costs and cash payments made to cedents net of
reserve releases associated with the recaptures. We also
incurred aggregate losses of approximately $8,500,000 and
$21,000,000, respectively, for the three and six month periods
ended June 30, 2003 on certain of our life, annuity and
GMDB contracts that were recaptured or terminated during the
first six months of 2003. Reduced investment income and
increased operating expenses also contributed to our net loss
for the three and six month periods ended June 30, 2003.

Net Premiums.Net
premium revenue for the three and six month periods ended
June 30, 2003 was $58,563,721 and $119,929,634,
respectively, a decrease of 36% and 30%, respectively, from net
premium revenue of $92,065,743 and $170,072,634, respectively,
for the three and six month periods ended June 30, 2002.
Substantially all premium revenue was derived from traditional
ordinary life reinsurance. The decline in premium revenue
reflects the significant reduction of business in force
resulting from the novation and recapture of life reinsurance
agreements in the fourth quarter of 2002 and the first six
months of 2003. At June 30, 2003, the total face amount of
life reinsurance in force had decreased to approximately
$60 billion, as compared with approximately
$137 billion at June 30, 2002. Of the $60 billion
life reinsurance in force at June 30, 2003, approximately
$17 billion related to those blocks of business covered by
our 50% quota share reinsurance agreement with XL Life, which
has served us with notice of its intent to recapture that
agreement. As we continue to novate, terminate and negotiate the
recapture of other reinsurance contracts, we expect our

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reinsurance in force and net premium revenue to
continue to decline. In addition, we have stopped writing new
reinsurance agreements and have notified our existing clients
that we will not be accepting any new business under existing
treaties on their current terms, which we expect will also
adversely impact our net premium revenue going forward.


Net Investment
Income.Total net investment income
for the three and six month periods ended June 30, 2003 was
$5,734,738 and $13,893,427, respectively, as compared with
$26,366,669 and $50,956,459, respectively, for the three and six
month period ended June 30, 2002. Net investment income is
comprised of income earned on our general account assets and
income earned on assets held and managed by our reinsurance
cedents under modified coinsurance contracts, which we refer to
as Funds withheld. Both sources of investment income declined
from the comparable prior periods.

Net investment income earned on general account
assets for the three and six month periods ended June 30,
2003 was approximately $1,527,000 and $3,409,000, respectively,
as compared to $7,192,000 and $13,235,000, respectively, for the
three and six month periods ended June 30, 2002. The
decrease in net investment income for the three and six months
periods ended June 30, 2003 was primarily the result of our
return of approximately $147,000,000 of invested assets related
to the termination of a reinsurance agreement that provided cash
deposits to us that were used to secure collateral obligations
of our U.S. based cedents, as well as lower investment
returns resulting from the shift in our general account assets
towards a greater cash position. Because the amount of our cash
and invested assets has decreased significantly due to our
operating losses as well as the recapture and termination of
certain of our reinsurance agreements, our net investment income
is expected to be lower in future periods, absent a significant
increase in yield rates.

The average annualized yield rate earned on our
invested assets (excluding the Funds withheld) for the three and
six months ended June 30, 2003 was approximately 2.87% and
2.46%, respectively, as compared with approximately 6.46% and
6.01%, respectively, for the three and six months ended
June 30, 2002. The decline in yield rates primarily
reflects our decision to invest funds supporting our letters of
credit in cash equivalents in an effort to maximize our
collateral funding ability and to minimize the impact of
changing interest rates on our collateral obligations.

Net investment income earned on Funds withheld
for the three and six month periods ended June 30, 2003 was
approximately $4,207,000 and $10,484,000, respectively, as
compared to approximately $19,175,000 and $37,722,000,
respectively, for the three and six month periods ended
June 30, 2002. The decrease in investment income on our
Funds withheld for the three and six month periods ended
June 30, 2003 is primarily due to a significant reduction
in Funds withheld as a result of terminations of several large
annuity reinsurance contracts, continued lapses and their
related invested asset withdrawals and lower investment returns.

The average annualized yield rates earned on
Funds withheld were approximately 1.65% and 2.13%, respectively,
for the three and six months ended June 30, 2003, as
compared with 5.36% and 5.38%, respectively, for the three and
six months ended June 30, 2002.

Net Realized Investment Gains.Net realized investment gains for the
three and six month periods ended June 30, 2003 were
$4,896,176 and $6,560,044, respectively, as compared with net
realized investment gains of $1,837,672 and $1,515,964,
respectively, for the three and six month periods ended
June 30, 2002. The increase in net realized investment
gains was the result of the strong credit quality of our
investment portfolio and the low interest rate environment.
Realized gains and losses will fluctuate from period to period
based on the market value of our invested assets, and we make
decisions concerning the sales of our invested assets based on a
variety of market, business and other factors.

Net Change in the Fair Value of Embedded
Derivatives.For the three and six
month periods ended June 30, 2003, the net change in fair
value of our embedded derivatives was an unrealized loss of
$(1,717,537) and unrealized gain of $12,037,322, respectively.
For the three and six month periods ended June 30, 2002,
the net change in fair value of our embedded derivatives was an
unrealized loss of $(6,566,805) and $(4,976,707), respectively.
The unrealized loss in our embedded derivatives during the three
month period ended June 30, 2003 largely reflects losses
related to the termination of one of our annuity reinsurance
agreements in the

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second quarter of 2003, partially offset by gains
due to credit spreads tightening in the sectors in which the
underlying investments are held. The primary reason for the
unrealized gain in our embedded derivative for the six month
period ended June 30, 2003 was the termination of our Ohio
National annuity reinsurance agreement in the first quarter of
2003. Widening credit spreads and bond defaults in the portfolio
of assets supporting this agreement had caused unrealized losses
in our embedded derivatives in prior periods, which were
reversed upon termination of the reinsurance agreement.


Surrender Fees and Other Revenue.Surrender fees and other revenue for
the three and six month periods ended June 30, 2003 were
$3,002,778 and $4,393,025, respectively, as compared with
$6,161,207 and $10,057,332, respectively, for the three and six
month periods ended June 30, 2002. This income is primarily
derived from surrender fees related to our fixed annuity
contract with Transamerica. The decrease in revenue for the
three and six month periods ended June 30, 2003 is mainly
due to a reduction in surrender fees under that contract
resulting from a lower absolute level of withdrawals during
those periods as compared with the three and six month periods
ended June 30, 2002.

Claims and Policy Benefits.Claims and policy benefits for the
three month periods ended June 30, 2003 and 2002 were
$84,425,206 and $74,443,139, or 144% and 81% of net premiums,
respectively. For the six months ended June 30, 2003 and
2002, claims and policy benefits were $159,514,646 and
$133,258,745, or 133% and 78% of net premiums, respectively. The
increase for the three month and six month periods ended
June 30, 2003 was primarily due to recaptures and
terminations of life and annuity reinsurance contracts and
reported claims under our life and annuity reinsurance contracts
that exceeded of our expectations. Recaptures and terminations
of life and annuity reinsurance contracts accounted for
$21 million and $31 million of claims and policy
benefits for the three and six month periods ended June 30,
2003, respectively. Approximately $8.5 million of our loss
for the three months ended June 30, 2003 was from contracts
that were recaptured in the quarter.

We continue to monitor and analyze our experience
under our remaining agreements. We cannot assure you that claims
experience under our remaining contracts will improve. If claim
experience continues at the levels observed during the fourth
quarter of 2002 and the first six months of 2003, or increases
from those levels, our operating results would be materially and
adversely affected. The novation, termination and recapture of
additional reinsurance agreements will reduce claims and policy
benefits at an aggregate level in future periods, and may affect
the level of claims and policy benefits as a percentage of
premiums. We decreased our reserves for expected claim payments
associated with our GMDB and EEB contracts by approximately
$10,850,000, largely as a result of the recapture of our GMDB
contract with Hartford Life, bringing our total carried reserves
for all minimum guarantees associated with variable annuity
contracts (including guaranteed minimum income benefits) to
$9,400,000 at June 30, 2003. We have one remaining combined
GMDB and GMIB contract.

During July 2003, we updated our analysis of
reported claims performed in the first quarter of 2003. Our
updated analysis includes claims paid and reported to us through
June 30, 2003, and indicates that our carried reserve for
incurred but not reported (IBNR) claims as of
December 31, 2002 was approximately $5,000,000 less than we
currently believe was needed. This adverse development has been
reflected in claims and policy benefits during the first six
months of 2003. In determining the amount of IBNR required at
June 30, 2003, we considered the full trending of claims
reported through June 30, 2003 on December 31, 2002
reserves. Due primarily to our reduced life reinsurance in force
at June 30, 2003 resulting from recaptures of life
reinsurance agreements, we have decreased our level of IBNR
reserves at June 30, 2003 by $2,560,000.

We are currently seeking relief from MetLife, our
largest cedent of life insurance, with respect to a reinsurance
contract that has generated mortality experience beyond our
initial pricing parameters and is producing losses. If we are
unable to rescind or recapture this agreement, we may incur
additional losses in future periods. This life reinsurance
agreement is currently in arbitration with respect to
representations made to us at the time we underwrote the
agreement and with respect to a rate increase we instituted in
the first quarter of 2003. In April 2003, MetLife informed us
that if the arbitration panel scheduled to hear these

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claims in December 2003 finds the rate increase
to be valid, MetLife will recapture the reinsurance agreement
effective as of March 5, 2003, the effective date of the
increase.


Interest Credited to Interest Sensitive
Contracts Liabilities.Interest
credited to Interest sensitive contract liabilities, which are
liabilities we assume under certain annuity reinsurance
agreements, was $4,217,542 and $9,089,301, respectively, for the
three and six month periods ended June 30, 2003, as
compared with $20,948,167 and $38,870,513, respectively, for the
three and six month periods ended June 30, 2002. Included
in Interest credited to interest sensitive contracts liabilities
for the three and six month periods ended June 30, 2003 are
LMIG payments of approximately $4,571,000 and $10,057,000,
respectively, as compared to LMIG payments of approximately
$8,129,000 and $13,322,000, respectively, for the comparable
prior periods in 2002. The decline in Interest credited to
interest sensitive contracts liabilities for the three and six
month periods ended June 30, 2003 was primarily the result of
terminations of annuity reinsurance contracts, particularly our
contract with Ohio National, which was our second largest
annuity contract at the time of its recapture, and a smaller
base of policyholders account values on our annuity reinsurance
contract with Transamerica. We terminated our reinsurance
agreement with Ohio National on February 14, 2003 and
another large annuity reinsurance contract on April 1, 2003.

Policy Acquisition and Other Insurance
Expenses.Policy acquisition and other
insurance expenses, consisting primarily of allowances and
amortization and write downs of deferred policy acquisition
costs, for the three and six month periods ended June 30,
2003 were $44,631,210 and $97,132,274, respectively, as compared
with $40,571,869 and $56,207,987, respectively, for the
comparable prior periods in 2002. The increase for the three and
six month periods ended June 30, 2003 is primarily due to
the net write down of deferred acquisition costs associated with
the recapture and termination of contracts of approximately
$30,980,000 and $74,210,000, respectively, for the three and six
month periods ended June 30, 2003. During the three and six
month periods ending June 30, 2002, we wrote down
$24,796,000 of deferred acquisition costs associated with our
Transamerica annuity reinsurance contract. There were no write
downs of deferred acquisition costs associated with the
Transamerica contract during the three and six month periods
ended June 30, 2003.

Operating Expenses.Operating expenses for the three month period ended
June 30, 2003 were $5,922,358 or 8.2% of total revenue
(excluding the net change in fair value of embedded
derivatives), as compared with $3,142,272 or 2.6% of total
revenue (excluding the net change in fair value of embedded
derivatives) for three month period ended June 30, 2002.
Operating expenses for the six month period ended June 30,
2003 were $12,268,488 or 8.5% of total revenue (excluding the
net change in fair value of embedded derivatives), as compared
to $6,800,064 or 3% of total revenue (excluding the net change
in fair value of embedded derivatives) for the comparable prior
period in 2002. The increase in expense for the three and six
month periods of 2003 reflect the write off of approximately
$2,100,000 of goodwill associated with our United States
operating subsidiary, costs associated with renegotiating
employment arrangements and other employee compensation,
increased costs of insurance for directors and officers
liability coverage and increased legal and audit fees.

Segment Results

We separately track financial results of our life
and annuity operations in segments. Each segment is defined by a
dominant risk characteristic inherent in products in that
segment. The life segment consists of all products where the
dominant risk characteristic is mortality risk. The annuity
segment comprises all products where the dominant risk
characteristic is investment risk. In addition, certain of our
remaining modified coinsurance and coinsurance funds withheld
annuity reinsurance agreements have features that constitute
embedded derivatives that require bifurcation and separate
accounting under FAS 133  Accounting for
Derivative Instruments and Hedging Activities. The change in the
fair value of these embedded derivatives is included in the
annuity segment. Both the life and annuity segments have
specific assets, liabilities, stockholders equity,
revenue, benefits and expenses that apply only to them. The
corporate segment contains all stockholders equity not
otherwise deployed to the life or annuity segment. In addition,
the corporate segment includes all capital gains and losses from
sales of securities in our portfolio and investment income on
undeployed invested assets. Operating expenses are generally
allocated to the segments proportionately based

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upon the amount of stockholders equity
deployed to the segment, except for capital raising costs, which
are charged directly to the corporate segment. Segment results
are reported in Note 4 to our unaudited consolidated
financial statements included elsewhere in this report.


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

Life segment loss for the three month period
ended June 30, 2003 was $(39,338,329), as compared with
segment income of $6,451,436 for the comparable prior period of
2002. Segment loss for the six months ended June 30, 2003
was $(84,484,497) compared to segment income of $13,640,652 for
the six months ended June 30, 2002. Segment loss in the
three and six months ended June 30, 2003 reflects the costs
of recaptures of life reinsurance agreements of approximately
$28,310,000 and $62,410,000, respectively. These charges reflect
the write down of deferred acquisition costs and cash payments
made to cedents net of reserve releases associated with the
recaptures, and include the write off of approximately
$21,000,000 of deferred acquisition costs resulting from our
receipt of XL Lifes notice of its intent to recapture the
50% quota share contract it entered into with us as part of our
December 31, 2002 transaction. Similar charges of
approximately $34,090,000 were recorded in the first quarter of
2003 in connection with recaptures of life reinsurance
agreements that took place in that quarter. We did not incur any
recapture costs during the three and six months ended
June 30, 2002. Our results for the three and six month
periods ending June 30, 2003 were also adversely affected
by reported claims from deaths prior to 2003 exceeding our
estimated reserves at December 31, 2002 by approximately
$5,000,000.

Segment revenues for the three month period ended
June 30, 2003 declined 39% to $57,507,429 from $94,465,177
in the second quarter of 2002. Segment revenues for the six
month period ended June 30, 2003 declined 32% to
$117,677,416 from $173,611,221 for the first six months of 2002.
These declines reflect our reduced levels of life reinsurance in
force as a result of novations and recaptures of life
reinsurance agreements during the fourth quarter of 2002 and the
first six months of 2003. We anticipate further declines in
segment revenue in the third quarter of 2003 as the result of
these novations and recaptures. In addition, net investment
income attributable to the life segment for the first six months
of 2003 decreased approximately $6,000,000, as compared with the
first six months of 2002, reflecting a reduction in invested
assets in the segment and lower asset yields.

Segment policy benefits and expenses increased
10% to $96,845,758 for the three month period ended
June 30, 2003, as compared with $88,013,741 for the three
month period ended June 30, 2002, reflecting costs of
recaptures during the period. Segment policy benefits and
expenses for the six month period ended June 30, 2003 were
$202,161,913 compared to $159,970,569 for the comparable prior
period. The net cost of recaptures during the three and six
month periods ended June 30, 2003 was $28,310,000 and
$62,410,000, respectively. For the second quarter these costs
are comprised of write downs of deferred acquisition costs of
approximately $28,520,000, including the write off of
approximately $21,000,000 of deferred acquisition costs
associated with XL Lifes recapture of the 50% quota share
contract it entered into with us as part of the December 31,
2002 transaction and the return of unearned premium reserves to
our cedents of $9,020,000, both offset by policy benefit reserve
reductions of $9,230,000. The increase in policy benefits and
expenses was also due to reported claims for deaths prior to
2003 that exceeded our expectations at December 31, 2002 by
approximately $5,000,000. If claim experience continues at the
levels observed during the fourth quarter of 2002 and the first
six months of 2003, or increases from those levels, our
operating results would be materially and adversely affected.
The novation, termination and recapture of additional
reinsurance agreements will reduce claims and policy benefits at
an aggregate level in future periods, and may affect the level
of claims and policy benefits as a percentage of premiums.

During July 2003, we updated our analysis of
reported claims performed in the first quarter of 2003. Our
updated analysis indicates that our carried reserve for IBNR
claims as of December 31, 2002 was approximately $5,000,000
less than we currently believe was needed. This adverse
development has been

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reflected in claims and policy benefits during
the first six months of 2003. In determining the amount of IBNR
required at June 30, 2003, we considered the full trending
of claims reported through June 30, 2003 on
December 31, 2002 reserves. Due primarily to our reduced
life reinsurance in force at June 30, 2003 resulting from
recaptures of life reinsurance agreements, we have decreased our
level of IBNR reserves at June 30, 2003 by $2,560,000.


Annuity Segment.Our
annuity reinsurance segment is the reinsurance of general
account fixed deferred annuities, general account payout annuity
obligations and certain risks arising from variable annuities.
With respect to the general account fixed annuities we reinsure,
our agreements generally relate to individual general account
single premium deferred annuity policies, which either involve
the tax-deferred accumulation of interest on a single premium
paid by the policyholder (accumulation phase policies) or are
annuities that pay fixed amounts periodically to policyholders
over a fixed period of time or their lives (payout phase
policies). Accumulation phase policies are subject primarily to
investment risk and persistency (lapse) risk, while payout
phase policies are primarily subject to investment risk and
mortality (longevity) risk. We have also historically
reinsured certain guarantees associated with variable annuity
contracts, including GMDB, EEB and GMIB. As of June 30,
2003, our only remaining EEB contract had been recaptured.

Our annuity segment contains the majority of our
assets. While we would expect it be a small contributor to our
net income, it contains significant volatility from two sources.
First, under FAS 133  Accounting for Derivative
Instruments and Hedging Activities we must value embedded
derivatives in certain of our annuity reinsurance agreements.
This unrealized change in the value of the derivative is
reported in our income statement each quarter. The change in the
value of the derivative can be large, and is driven by financial
market conditions, most notably credit risk related changes.
Second, our Transamerica annuity reinsurance contract has
exhibited volatility due to write downs of our deferred
acquisition cost balance which are based upon managements
estimates of future investment performance and lapse experience.
Our annuity reinsurance contract with Transamerica, which
represented 80% of our annuity segment assets at June 30,
2003, is not expected to generate significant income going
forward.

Segment loss was $(33,063,939) for the three
month period ended June 30, 2003, as compared with a loss
of $(29,790,379) for the three month period ended June 30,
2002. The loss for the three months ended June 30, 2003
includes a $20,400,000 charge related to the recapture of our
largest GMDB reinsurance contract, approximately $2,900,000 of
operating loss during the second quarter on that contract, an
approximate $4,100,000 loss related to the termination of
another annuity reinsurance agreement, approximately $2,400,000
of operating loss from a third annuity reinsurance contract, and
embedded derivative losses of approximately $1,700,000. For the
first six months of 2003, segment loss was $(40,934,415)
compared to $(26,872,048) for the first half of 2002. This
reflects the second quarter activity previously mentioned and a
$(4,875,000) first quarter loss related to the termination of
our annuity reinsurance agreement with Ohio National (net of the
unrealized gain associated with the reversal of cumulative
unrealized losses in the embedded derivative associated with
this agreement). We also incurred a loss of approximately
$(1,000,000) in the first quarter of 2003 on one of our annuity
reinsurance agreements as the result of an experience refund
adjustment reflecting a change in mortality assumptions by the
cedent under the contract. The three and six months ended
June  30, 2002 includes the $24,796,000 write off of
deferred acquisition costs associated with our annuity
reinsurance contract with Transamerica.

Under FAS 133, we are required to bifurcate and
separately account for embedded derivatives contained in certain
of our annuity reinsurance agreements. The change in the fair
value of the embedded derivatives is influenced by changes in
credit risk, changes in expected future cash flows under the
annuity reinsurance contracts and interest rate changes. For the
three and six month periods ended June 30, 2003, the net
change in fair value of our embedded derivatives was an
unrealized loss of $(1,717,537) and an unrealized gain of
$12,037,322, respectively. For the three and six month periods
ended June 30, 2002, the net change in fair value of our
embedded derivatives was an unrealized loss of $(6,566,805) and
$(4,976,707), respectively. The unrealized loss in our embedded
derivatives during the three month period ended June 30,
2003 largely reflects losses related to the termination of one
of our annuity reinsurance agreements in the second quarter of
2003, partially offset by gains due to credit spreads tightening
in the sectors in which the underlying investments are

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held. The primary reason for the unrealized gain
in our embedded derivative for the six month period ended
June 30, 2003 was the termination of our Ohio National
annuity reinsurance agreement in the first quarter of 2003.
Widening credit spreads and bond defaults in the portfolio of
assets supporting this agreement had caused unrealized losses in
our embedded derivatives in prior periods, which were reversed
upon the termination of the Ohio National agreement.


As a result of the recapture of our GMDB contract
with Hartford Life, we decreased our reserves for expected claim
payments associated with our GMDB and EEB contracts by
approximately $10,850,000, bringing our total carried reserves
for all minimum guarantees associated with variable annuity
contracts (including guaranteed minimum income benefits) to
$9,400,000 at June 30, 2003. We have one remaining combined
GMDB and GMIB contract.

Total revenue for our annuity segment declined
64% to $7,766,799 for the three month period ended June 30,
2003, as compared with $21,395,350 for the three month period
ended June 30, 2002. Total revenue for our annuity segment
declined 34% to $31,869,930 for the six month period ended
June 30, 2003, as compared with $48,311,104 for the six
month period ended June 30, 2002. The decreases are
primarily related to lower investment income of approximately
$10,500,000 for the three and six month periods ending
June 30, 2003. This reduction is due to a lower base of
invested assets as a result of annuity contract terminations
during the six months ended June 30, 2003, most notably our
annuity reinsurance contract with Ohio National, a decline in
net investment income due to reduced assets under management
resulting from policy lapses, and lower yields on the remaining
assets, including realized losses. Surrender fees from our
Transamerica annuity reinsurance contract also decreased by
approximately $2,300,000 and $3,700,000 for the three and six
months ended June 30, 2003 compared with the comparable
prior periods of 2002. The declines in segment revenue were
partially offset by increases in net change in the fair value of
embedded derivatives of $4,849,268 and $17,014,029 for the three
and six month periods ended June 30, 2003, as compared with
the comparable prior periods of 2002.

Policy benefits and expenses for the annuity
segment, which include interest credited to policyholders,
segment specific expenses, and allocated expenses, declined 20%
to $40,830,738 for the three month period ended June 30,
2003, as compared with $51,185,729 for the three month period
ended June 30, 2002. These expenses declined 3% to
$72,804,345 for the six months ended June 30, 2003, as compared
with $75,183,152 for the six months ended June 30, 2002.
The three and six months ended June 30, 2003 include a
charge of $20,400,000 for the recapture of our largest GMDB
contract during the second quarter and LMIG payments of
approximately $4,571,000 and $10,057,000, respectively, during
the first and second quarters. The three and six month periods
ended June 30, 2002 includes a write off of $24,796,000 of
deferred acquisition costs associated with our annuity
reinsurance contract with Transamerica and LMIG payments of
$8,129,000 and $13,322,000, respectively, during the first and
second quarters.

Corporate Segment.The corporate segment includes all of our capital gains and
losses, investment income on undeployed invested assets, capital
raising costs and a proportionate share of operating expenses
based upon how stockholders equity is deployed to the life
and annuity segments. As a result, the corporate segment, while
small relative to our total company, will likely have volatile
results. Segment income grew to $3,685,827 and $4,227,655 for
the three and six month periods ended June 30, 2003, as
compared with $3,044,945 and $3,371,028 for the three and six
month periods ended June 30, 2002. Revenues grew by 30% to
$5,205,648 for the three month period ended June 30, 2003,
as compared with $4,003,959 for the three month period ended
June 30, 2002, and grew by 27% to $7,266,106 for the six
month period ended June 30, 2003, as compared with
$5,703,357 for the six month period ended June 30, 2002.
These increases were the result the movement of
stockholders equity from the life and annuity segments
into the corporate segment as a result of novations, recaptures
and terminations of reinsurance contracts during 2002 and the
first six months of 2003. Net realized investment gains of
$4,896,176 and $6,560,044 in the three and six month periods
ended June 30, 2003, respectively, as compared to
$1,837,672 and $1,515,964 for the first three and six month
periods ended June 30, 2002 also contributed to both increases,
partially offset by a reduction in investment income allocated
to the segment.

25



---



##### 



Segment benefits and expenses increased slightly
to approximately $1.5 million and $3.0 million for the
three and six month periods ended June 30, 2003,
respectively, as compared with approximately $1 million and
$2.3 million, respectively, for the comparable prior
periods in 2002.

Financial Condition



| |            
| | -----------
| | Investments

At June 30, 2003 and December 31, 2002,
virtually all of our invested assets were posted as collateral
to secure our obligations under reinsurance agreements and
letter of credit facilities or were required to maintain the
statutory capital and surplus requirements of our U.S. operating
subsidiary. At June 30, 2003, our invested assets,
including cash and cash equivalents, had an aggregate fair value
of $224,858,109, including unrealized gains of $2,641,227, as
compared with an aggregate fair value of $306,346,337, including
unrealized gains of $6,162,525, at December 31, 2002. The
decline in our invested assets during the second quarter of 2003
was primarily the result of recaptures and terminations of
certain of our reinsurance agreements during the first six
months of 2003, as well as increased operating expenses during
that period. At June 30, 2003 and December 31, 2002,
the weighted average duration of the fixed income securities
included in our invested assets was 3.2 and 3.8 years,
respectively, and the weighted average investment quality rating
was AA+ and AA, respectively.

Our investments are governed by investment
guidelines established and approved by our Board of Directors.
Our investment objectives are to achieve above average
risk-adjusted total returns, maintain a high quality portfolio,
maximize current income, maintain an adequate level of liquidity
in our portfolio and match the cash flows of our investments to
our related insurance liabilities. Our investment guidelines
require our overall fixed income portfolio to maintain a minimum
weighted average credit quality of A. A fixed income
security rated A by Standard & Poors is
considered to be somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
higher rated issuer; however, the issuers capacity to meet
its financial commitment on the security is still considered to
be strong. As of July 31, 2002, our investment guidelines
were amended to prohibit us from investing in fixed income
securities that are rated below investment grade at the time of
purchase. We do not invest in any fixed income securities in
emerging markets or securities that are not rated by a major
rating agency.

At both June 30, 2003 and December 31,
2002, less than 1% of our fixed income securities consisted of
below investment grade securities. The fair value of such
investments varies depending on economic and market conditions,
the level of interest rates and the perceived creditworthiness
of the issuer. As noted above, our investment guidelines
prohibit the purchase of below investment grade securities, as
these investments are subject to a higher degree of credit risk
than investment grade securities. We monitor the
creditworthiness of the portfolio as a whole, and when the fair
market value of a security declines for reasons other than
changes in interest rates or other perceived temporary
conditions, the security is written down to its fair value.

At June 30, 2003, mortgage-backed securities
represented approximately 5% of our invested assets, including
cash and cash equivalents, as compared with approximately 10% at
December 31, 2002. Investors in these securities are
compensated primarily for reinvestment risk rather than credit
quality risk. Investments in mortgage-backed securities include
collateralized mortgage obligations (CMOs) and
mortgage-backed pass-through securities. Mortgage-backed
securities generally are collateralized by mortgages issued by
the Government National Mortgage Association (GNMA),
the Federal National Mortgage Association and the Federal Home
Loan Mortgage Corporation. Of these, only GNMA mortgages are
backed by the full faith and credit of the U.S. government.
Credit risk generally is not a consideration when investing in
agency mortgage backed securities. Our mortgage backed
securities portfolio had a weighted average investment quality
rating of AAA at both June 30, 2003 and
December 31, 2002.

At June 30, 2003, none of our
mortgage-backed investment portfolio consisted of securities
with planned repayment schedules, as compared with 7% at
December 31, 2002. These investments are designed to
amortize in a more predictable manner by shifting the primary
risk of prepayment of the underlying collateral to investors in
other tranches of the CMO.

26



---



##### 



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

Investment Results

|                                                             |  |                        |         |                     |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|------------------------------------------------------------ |  | ---------------------- | ------- | ------------------- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                             |  |                        |         |                    
|                                                             |  | Six Months Ended       |         | Twelve Months Ended
|                                                             |  | June 30,               |         | December 31,       
|                                                             |  |                        |         |                    
|                                                             |  | 2003                   |         | 2002                |  | 2002 |         | 2001 |  | 2000
|                                                             |  |                        |         |                     |  |      |         |      |  |     
|                                                             |  |                       
|                                                             |  | (Dollars in thousands)
|Total invested assets, including cash and
    equivalents(1) |  | $                      | 224,858 |                     |  | $    | 456,578 |      |  | $    | 306,346 |   |  | $ | 423,780 |   |  | $ | 321,819 |  
|Investment income, net of related expenses                   |  | $                      | 3,409   |                     |  | $    | 13,235  |      |  | $    | 25,931  |   |  | $ | 20,165  |   |  | $ | 20,126  |  
|Effective annualized yield rate(2)                           |  |                        | 2.46    | %                   |  |      | 5.57    | %    |  |      | 5.28    | % |  |   | 5.74    | % |  |   | 6.85    | %
|Realized investment gains (losses)                           |  | $                      | 6,560   |                     |  | $    | 1,516   |      |  | $    | 19,749  |   |  | $ | 1,230   |   |  | $ | (4,817  | )



---



|    |                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Fair value at end of the indicated period.                                                                                                                                                               
|   
|(2) | The effective yield rate equals (i) net
    investment income divided by (ii) the average of total
    adjusted invested assets at the end of each calendar quarter
    included in the indicated period.

The effective annualized yield rate on our
invested assets has declined significantly during the first six
months of 2003. This decline is the result of the shift in our
general account assets towards a greater cash position. We have
increased and are maintaining this greater cash position to
maximize the amount of collateral we can provide to our cedents
and letter of credit providers and to minimize market risk
related to our collateral requirements.



| |                           
| | --------------------------
| | Funds Withheld at Interest

At June 30, 2003, our Funds withheld
receivable was $845 million, as compared with
$1.4 billion at December 31, 2002. Historically, when
a ceding company enters into a reinsurance contract structured
as a modified coinsurance or coinsurance funds withheld
arrangement with us, a portion of the ceding companys
liability to the policyholders or, in the case of a
retrocessional arrangement, the primary insurer, is ceded to us.
Our remaining modified coinsurance and coinsurance funds
withheld arrangements are generally on a quota share basis, so
the portion that is ceded to us is a fixed percentage of the
liabilities arising from the underlying policies. Our share of
the ceding companys liability is included on our balance
sheet as Interest sensitive contracts liabilities.
However, unlike other reinsurance arrangements in which we
receive cash or investments as consideration for assuming a
portion of the ceding companys liability, under these
types of arrangements, we have established a receivable called
Funds withheld at interest. For annuity reinsurance
agreements, the Funds withheld at interest receivable is equal
to our fixed portion of the statutory reserves carried by the
ceding company. For life reinsurance agreements, the Funds
withheld at interest receivable is equal to the value of the
ceding companys GAAP reserves related to the policies
underlying our life reinsurance agreements, which includes
reserves for pending claims and reserves for incurred but not
reported claims. We are allocated our share of the investment
income and realized capital gains and losses that arise from the
securities in the investment portfolio underlying the Funds
withheld at interest under each type of agreement.

At June 30, 2003, our Funds withheld at
interest receivable related to our annuity reinsurance contracts
had a carrying value of approximately $820 million. Our
contract with Transamerica accounted for approximately 79% of
annuity related Funds withheld at interest receivable as
June 30, 2003, as compared to 51% at December 31,
2002. The increase in the proportion of our Funds withheld at
interest assets related to the Transamerica contract generally
reflects the decrease in our Funds withheld at interest asset
that resulted from the termination of our annuity reinsurance
agreement with Ohio National in February 2003. At June 30,
2003, the assets held and managed by our ceding companies under
our annuity reinsurance contracts were invested in convertible
bonds and fixed income securities having a weighted average
credit quality of A and a weighted average duration
of 4.97 years. In addition, at June 30, 2003,
approximately 6% of such assets were invested in below
investment grade securities, as compared with 4.2% of such
assets at December 31, 2002. At

27



---



##### 



December 31, 2002, these assets had a
weighted average credit quality of A and a weighted
average duration of 5.3 years.


The average annualized yield rate earned on the
assets held and managed by our ceding companies under our
annuity reinsurance contracts was approximately 1.65% and 2.13%
for the three and six month periods ended June 30, 2003, as
compared to 5.36% and 5.38% for the three and six month periods
ended June 30, 2002. The average annualized yield rate
earned on the assets funding our annuity obligations to
Transamerica was approximately 1.24% and 1.43% for the three and
six month periods ended June 30, 2003, as compared with
4.28% and 4.47% for the three and six month periods ended
June 30, 2002. For purposes of calculating the average
yield rate earned on assets held and managed by our ceding
companies, including Transamerica, we include net realized
capital gains and losses as reported to us by our ceding
companies.

At June 30, 2003, approximately
$25.3 million of our Funds withheld at interest receivable
was attributable to a 50% quota share reinsurance contract we
entered into with XL Life Ltd covering certain blocks of
life reinsurance business that we novated to XL Life on
December 31, 2002. As of June 30, 2003, the assets
related to these reinsurance contracts are investment grade
corporate and government securities with an average credit
quality of AA- and a weighted average duration of
5.8 years. On August 5, 2003 XL Life served
notice that it would recapture the 50% quota share reinsurance
contract.



| |             
| | ------------
| | Transamerica

Our annuity reinsurance contract with
Transamerica is our largest annuity reinsurance contract and, as
of June 30, 2003, approximately $648 million, or 77%,
of our Funds withheld at interest receivable; approximately
$650 million, or 80%, of our Interest sensitive contracts
liability; and approximately $45 million of the Deferred policy
acquisition costs assets on our balance sheet related to this
contract. As a result of the changes to our Company resulting
from the recapture, termination, and novations of numerous
blocks of business, including the termination of our annuity
reinsurance contract with Ohio National in February 2003, we
expect that the assets and liabilities associated with the
Transamerica contract will represent a significant portion of
our total assets and liabilities in future periods. We do not
expect the Transamerica contract to generate significant income
in future periods.

At June 30, 2003, the assets funding the
policyholder obligations under the Transamerica contract had an
average credit quality of A and an average duration
of 4.58 years, as compared with an average credit quality
of A- and an average duration of 4.2 years at
December 31, 2002. The contract is a retrocessional
arrangement covering VisionMark fixed annuity products issued by
IL Annuity and Insurance Company, the primary insurance company.
The assets underlying the Transamerica contract are managed by
AmerUS Capital Management, the investment manager appointed by
IL Annuity. At June 30, 2003 and December 31,
2002, AmerUS Capital Management had invested approximately 63%
of the premiums paid in connection with the underlying policies
in investment grade convertible bonds and had invested the
remaining premiums in investment grade bonds, high yield bonds
and mortgage-backed securities. The value of convertible bonds
is a function of their investment value (determined by comparing
their yield with the yields of other securities of comparable
maturity and quality that do not have a conversion privilege)
and their conversion value (at market value, if converted into
the underlying common stock). To the extent the market price of
the underlying common stock approaches or exceeds the conversion
price, the price of the convertible bonds will be increasingly
influenced by their conversion value. Consequently, the value of
convertible bonds may be influenced by changes in the equity
markets.

While convertible bonds would typically be
expected to produce lower investment income than other fixed
income securities, convertible bonds provide the potential for
higher total returns through the underlying equity component of
the bonds, which are passed on to VisionMark policyholders
through the total return adjustment upon surrender of the
policies. As with the holders of other single premium deferred
annuity policies, a VisionMark policyholder is guaranteed a
return of premiums paid plus a guaranteed minimum interest rate
of 3% to 3.5% per annum over the life of the policy. During the
six months ended June 30, 2003 and the year ended
December 31, 2002, we paid approximately $10,057,000 and
$26,700,000, respectively, under our annuity reinsurance
contract with Transamerica to cover our proportionate share of
the shortfall that

28



---



##### 



arose because the net investment returns on the
assets related to these policies substantially underperformed
the LMIG for surrendered policies.


According to data provided to us by Transamerica,
at June 30, 2003, the assets held by IL Annuity and managed
by AmerUS Capital were comprised of the following:

|                                            |                                                             |               |             |              |  |              |             |             |  |  |      |       |  
|------------------------------------------- | ----------------------------------------------------------- | ------------- | ----------- | ------------ |  | ------------ | ----------- | ----------- |  |  | ---- | ----- | -
|                                            |                                                             |               |             |              |  | % of Total  
|Type of Security                            |                                                             | Book Value(1) |             | Market Value |  | Market Value
|                                            |                                                             |               |             |              |  |             
|Investment grade convertible bonds          |                                                             | $             | 455,949,172 |              |  | $            | 449,219,666 |             |  |  | 63.2 | %    
|Investment grade U.S. corporate bonds       |                                                             |               | 130,993,912 |              |  |              | 139,664,607 |             |  |  | 19.6 | %    
|Below investment grade U.S. corporate bonds |                                                             |               | 38,354,642  |              |  |              | 40,410,242  |             |  |  | 5.7  | %    
|Mortgage-backed securities                  |                                                             |               | 30,758,742  |              |  |              | 31,834,698  |             |  |  | 4.5  | %    
|Short term securities                       |                                                             |               | 48,907,542  |              |  |              | 49,774,302  |             |  |  | 7.0  | %    
|                                            |                                                             |               |             |              |  |              |             |             |  |  |      |      
|                                            | Total invested assets                                       |               | $           | 704,964,010  |  |              | $           | 710,903,515 |  |  |      | 100.0 | %
|                                            |                                                             |               |             |              |  |              |             |             |  |  |      |      
|Accrued investment income                   |                                                             |               |             |              |  |              | 4,492,280   |             |  |  |      |      
|                                            |                                                             |               |             |              |  |              |             |             |  |  |      |      
|                                            | Total market value, including accrued investment
    income |               |             |              |  |              | $           | 715,395,795 |  |  |      |       |  
|                                            |                                                             |               |             |              |  |              |             |             |  |  |      |      



---



|    |                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Book values are those reported to us by the
    cedent for the underlying investments and do not represent the
    value of our Funds withheld at interest receivable.

According to data provided to us by Transamerica,
at June 30, 2003, the credit ratings of the assets
(excluding accrued investment income) held by IL Annuity and
managed by AmerUS Capital were approximately as follows:

|                          |                                                             |               |             |              |  |              |             |             |  |  |      |       |  
|------------------------- | ----------------------------------------------------------- | ------------- | ----------- | ------------ |  | ------------ | ----------- | ----------- |  |  | ---- | ----- | -
|                          |                                                             |               |             |              |  | % of Total  
|Ratings(1)                |                                                             | Book Value(2) |             | Market Value |  | Market Value
|                          |                                                             |               |             |              |  |             
|AAA                       |                                                             | $             | 171,308,887 |              |  | $            | 171,627,688 |             |  |  | 24.1 | %    
|AA                        |                                                             |               | 21,475,641  |              |  |              | 21,497,080  |             |  |  | 3.0  | %    
|A                         |                                                             |               | 205,689,315 |              |  |              | 209,188,365 |             |  |  | 29.5 | %    
|BBB                       |                                                             |               | 261,119,509 |              |  |              | 260,768,620 |             |  |  | 36.7 | %    
|BB and below              |                                                             |               | 45,370,658  |              |  |              | 47,821,762  |             |  |  | 6.7  | %    
|                          |                                                             |               |             |              |  |              |             |             |  |  |      |      
|                          | Total invested assets                                       |               | $           | 704,964,010  |  |              | $           | 710,903,515 |  |  |      | 100.0 | %
|                          |                                                             |               |             |              |  |              |             |             |  |  |      |      
|Accrued investment income |                                                             |               |             |              |  |              | 4,492,280   |             |  |  |      |      
|                          |                                                             |               |             |              |  |              |             |             |  |  |      |      
|                          | Total market value, including accrued investment
    income |               |             |              |  |              | $           | 715,395,795 |  |  |      |       |  
|                          |                                                             |               |             |              |  |              |             |             |  |  |      |      



---



|    |                                                                                                                                                                                  
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | As assigned by Standard & Poors,
    or, if unrated by Standard & Poors, based on an
    equivalent rating assigned by the National Association of
    Insurance Commissioners.
|   
|(2) | Book values are those reported to us by the
    cedent for the underlying investments and do not represent the
    value of our Funds withheld at interest receivable.           

29



---



##### 



According to data provided to us by Transamerica,
at June 30, 2003, the maturity distribution of the assets
held by IL Annuity and managed by AmerUS Capital was
approximately as follows:

|                       |                 |               |             |              |  |            |             |             |  |  |      |       |  
|---------------------- | --------------- | ------------- | ----------- | ------------ |  | ---------- | ----------- | ----------- |  |  | ---- | ----- | -
|                       |                 |               |             |              |  | % of Total
|Maturity               |                 | Book Value(1) |             | Market Value |  | Book Value
|                       |                 |               |             |              |  |           
|Within one year        |                 | $             | 59,009,794  |              |  | $          | 59,109,505  |             |  |  | 8.3  | %    
|From one to five years |                 |               | 180,045,321 |              |  |            | 182,876,013 |             |  |  | 25.7 | %    
|From six to ten years  |                 |               | 140,737,409 |              |  |            | 146,658,905 |             |  |  | 20.6 | %    
|More than ten years    |                 |               | 325,171,486 |              |  |            | 322,259,092 |             |  |  | 45.4 | %    
|                       |                 |               |             |              |  |            |             |             |  |  |      |      
|                       | Total all years |               | $           | 704,964,010  |  |            | $           | 710,903,515 |  |  |      | 100.0 | %
|                       |                 |               |             |              |  |            |             |             |  |  |      |      



---



|    |                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Book values are those reported to us by the
    cedent for the underlying investments and do not represent the
    value of our Funds withheld at interest receivable.

Other Annuity Reinsurance Contracts

At June 30, 2003, we had two other annuity
reinsurance contracts that guaranteed crediting rates that vary
in amount and duration. At June 30, 2003, the assets
funding the policyholder obligations under these contracts had
an average credit quality of A and an average
duration of approximately 6.47 years, as compared with an
average credit quality of A and an average duration
of approximately 7.04 years at December 31, 2002.

According to information provided by the ceding
companies under these two annuity reinsurance contracts, at
June 30, 2003, the assets held and managed by those ceding
companies were comprised of as follows:

|                                    |                                                             |               |            |              |  |              |            |             |  |  |      |       |  
|----------------------------------- | ----------------------------------------------------------- | ------------- | ---------- | ------------ |  | ------------ | ---------- | ----------- |  |  | ---- | ----- | -
|                                    |                                                             |               |            |              |  | % of Total  
|Type of Security                    |                                                             | Book Value(1) |            | Market Value |  | Market Value
|                                    |                                                             |               |            |              |  |             
|Investment grade US corporate bonds |                                                             | $             | 74,175,750 |              |  | $            | 78,630,000 |             |  |  | 42.0 | %    
|Investment grade UK corporate bonds |                                                             |               | 84,834,955 |              |  |              | 92,167,324 |             |  |  | 49.3 | %    
|Government bonds                    |                                                             |               | 6,016,848  |              |  |              | 5,504,040  |             |  |  | 3.0  | %    
|Mortgage securities                 |                                                             |               | 4,966,500  |              |  |              | 5,796,000  |             |  |  | 3.0  | %    
|Below investment grade bonds        |                                                             |               | 5,843,450  |              |  |              | 5,043,111  |             |  |  | 2.7  | %    
|                                    |                                                             |               |            |              |  |              |            |             |  |  |      |      
|                                    | Total invested assets                                       |               | $          | 175,837,503  |  |              | $          | 187,140,475 |  |  |      | 100.0 | %
|                                    |                                                             |               |            |              |  |              |            |             |  |  |      |      
|Accrued investment income           |                                                             |               |            |              |  |              | 3,600,082  |             |  |  |      |      
|                                    |                                                             |               |            |              |  |              |            |             |  |  |      |      
|                                    | Total market value, including accrued investment
    income |               |            |              |  |              | $          | 190,740,557 |  |  |      |       |  
|                                    |                                                             |               |            |              |  |              |            |             |  |  |      |      



---



|    |                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Book values are those reported to us by the
    cedent for the underlying investments and do not represent the
    value of our Funds withheld at interest receivable.

30



---



##### 



According to information provided by the ceding
companies under these two annuity reinsurance contracts, at
June 30, 2003, the credit ratings of the assets (excluding
accrued investment income) held and managed by those ceding
companies were approximately as follows:

|                          |                                                             |               |            |              |  |              |            |             |  |  |      |       |  
|------------------------- | ----------------------------------------------------------- | ------------- | ---------- | ------------ |  | ------------ | ---------- | ----------- |  |  | ---- | ----- | -
|                          |                                                             |               |            |              |  | % of Total  
|Ratings(1)                |                                                             | Book Value(2) |            | Market Value |  | Market Value
|                          |                                                             |               |            |              |  |             
|AAA                       |                                                             | $             | 31,253,062 |              |  | $            | 33,968,312 |             |  |  | 18.2 | %    
|AA                        |                                                             |               | 20,209,536 |              |  |              | 21,825,974 |             |  |  | 11.7 | %    
|A                         |                                                             |               | 62,775,763 |              |  |              | 67,605,513 |             |  |  | 36.1 | %    
|BBB                       |                                                             |               | 54,243,693 |              |  |              | 57,332,564 |             |  |  | 30.6 | %    
|BB and below              |                                                             |               | 7,355,449  |              |  |              | 6,408,112  |             |  |  | 3.4  | %    
|                          |                                                             |               |            |              |  |              |            |             |  |  |      |      
|                          | Total invested assets                                       |               | $          | 175,837,503  |  |              | $          | 187,140,475 |  |  |      | 100.0 | %
|                          |                                                             |               |            |              |  |              |            |             |  |  |      |      
|Accrued investment income |                                                             |               |            |              |  |              | 3,600,082  |             |  |  |      |      
|                          |                                                             |               |            |              |  |              |            |             |  |  |      |      
|                          | Total market value, including accrued investment
    income |               |            |              |  |              | $          | 190,740,557 |  |  |      |       |  
|                          |                                                             |               |            |              |  |              |            |             |  |  |      |      



---



|    |                                                                                                                                                                                  
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | As assigned by Standard & Poors, or, if
    unrated by Standard & Poors, based on an equivalent
    rating assigned by the National Association of Insurance
    Commissioners.
|   
|(2) | Book values are those reported to us by the
    cedent for the underlying investments and do not represent the
    value of our Funds withheld at interest receivable.           

According to information provided by the ceding
companies under these two annuity reinsurance contracts, at
June 30, 2003, the maturity distribution of the assets held
and managed by those ceding companies was approximately as
follows:

|                       |                 |               |            |              |  |            |            |             |  |  |      |       |  
|---------------------- | --------------- | ------------- | ---------- | ------------ |  | ---------- | ---------- | ----------- |  |  | ---- | ----- | -
|                       |                 |               |            |              |  | % of Total
|Maturity               |                 | Book Value(1) |            | Market Value |  | Book Value
|                       |                 |               |            |              |  |           
|Within one year        |                 | $             | 16,811,366 |              |  | $          | 16,982,329 |             |  |  | 9.6  | %    
|From one to five years |                 |               | 34,021,304 |              |  |            | 36,566,412 |             |  |  | 19.3 | %    
|From six to ten years  |                 |               | 45,164,298 |              |  |            | 46,621,583 |             |  |  | 25.7 | %    
|More than ten years    |                 |               | 79,840,535 |              |  |            | 86,970,150 |             |  |  | 45.4 | %    
|                       |                 |               |            |              |  |            |            |             |  |  |      |      
|                       | Total all years |               | $          | 175,837,503  |  |            | $          | 187,140,475 |  |  |      | 100.0 | %
|                       |                 |               |            |              |  |            |            |             |  |  |      |      



---



|    |                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Book values are those reported to us by the
    cedent for the underlying investments and do not represent the
    value of our Funds withheld at interest receivable.

Liquidity and Capital Resources

Our liquidity and capital resources are a measure
of our overall financial strength and our ability to generate
cash flows from our operations to meet our operating and growth
needs. Our principal sources of funds are premiums received, net
investment income, proceeds from investments called, redeemed or
sold and cash and short term investments. The principal
obligations and uses of the funds are to post collateral for the
statutory reserves ceded to us by U.S. based insured and
reinsurers, the payment of policy benefits, acquisition and
operating expenses and the purchase of investments. Under the
terms of our reinsurance agreements, we are required to provide
letters of credit or fund trust accounts with liquid assets to
satisfy the collateral requirements of our cedents. At
June 30, 2003 and December 31, 2002, letters of credit
totaling $106,000,000 and $174,000,000, respectively, had been
issued in the ordinary course of our business by our bankers in
favor of certain ceding insurance companies (including our U.S.
operating subsidiary) to provide security and meet regulatory
requirements. At June 30, 2003 and December 31, 2002,
cash and investments of approximately $80,000,000 and
$115,000,000, respectively, were pledged as collateral for
letters of credit. At both June 30, 2003 and
December 31, 2002, cash and investments of $98,220,000 and
$125,085,000 respectively were held in

31



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trust for the benefit of certain ceding insurance
companies to provide security and to meet regulatory
requirements.


We have two reinsurance operating subsidiaries,
the largest of which is based in and operates out of Bermuda.
Our other reinsurance operating subsidiary is based in and
operates out of the United States. Our Bermuda operating
subsidiary reinsures a large portion of the reinsurance business
written by our U.S. operating subsidiary. The primary purpose of
this reinsurance is to provide reinsurance capacity to our U.S.
operating subsidiary so that it can compete in its market place.
Our Bermuda operating subsidiary has made capital infusions into
the U.S. operating subsidiary to allow the U.S. company to
maintain targeted statutory surplus levels and to provide cash
and securities as collateral for the reinsurance cessions the
U.S. operating subsidiary makes to the Bermuda operating
company. At June 30, 2003, approximately $51,000,000 of our
cash and cash equivalents and fixed income securities were held
by the U.S. operating subsidiary and were not available to us or
our Bermuda operating subsidiary to fund our liquidity or
collateral needs. In addition, our U.S. operating company has
entered into a letter agreement with the Connecticut Insurance
Department that, among other things, restricts the U.S.
operating company from paying dividends or settling
inter-company balances with us or our Bermuda operating company.

In March 2003, Hartford Life Insurance Company,
the cedent under our largest GMDB reinsurance contract, served
notice seeking to institute arbitration proceedings against us
alleging that we had failed to satisfy additional collateral
requirements under the contract of approximately $59,000,000 as
of December 31, 2002. We did not agree with the additional
collateral requirements asserted by Hartford Life and, as a
result, ceased making claim payments to Hartford Life under the
contract. In April 2003, Hartford Life drew approximately
$18,000,000 of assets held in trust for its benefit and drew
approximately $24,500,000 of letters of credit that had been
issued by Citibank for Hartford Lifes benefit. As a result
of Hartford Lifes draw on the letters of credit, Citibank
applied approximately $20,105,000 in assets that had been posted
by us as security under our letter of credit facility against
amounts due to Citibank from us. Consequently, approximately
$4,395,000 related to our letter of credit facility became due
upon demand by Citibank and was paid by us on June 30,
2003. On July 17, 2003, Hartford Life agreed to recapture
its GMDB reinsurance contract with us, effective June 30,
2003. As consideration for the recapture, Hartford Life retained
approximately $31 million of the funds it had drawn from
the trust account and letters of credit and we issued warrants
to purchase an aggregate one million of our common shares to
Hartford Life. The impact of the recapture in the second quarter
of 2003, net of reserves for GMDB that were no longer needed and
released, was a charge of approximately $20 million. Under
the terms of the recapture, the Company has no further
obligations to Hartford Life.

As discussed in Note 6 to our unaudited
consolidated financial statements included elsewhere in this
report, on December 31, 2002, we entered into a transaction
with XL Life pursuant to which we novated five blocks of life
reinsurance business to XL Life, which in turn entered into a
50% quota share reinsurance contract with us with respect to
four of those blocks of business. We are in discussions with XL
Life regarding certain post closing adjustments called for by
the master novation agreement entered into in connection with
the transaction. If we cannot reach a satisfactory resolution
with XL Life regarding these adjustments, we may be required to
enter into arbitration proceedings with XL Life under the
agreement. If we are unable to prevail in such arbitration
proceedings, we may be required to make substantial cash
adjustment payments to XL Life under the agreement.

On August 5, 2003, XL Life served us with
notice of its intention to recapture the 50% quota share
reinsurance contract with us. As a result we will not be able to
recover our deferred acquisition costs carried for this contract
from future expected income, and have written down approximately
$21 million of such deferred acquisition costs in the three
months ended June 30, 2003.

XL Life has also indicated its desire to
terminate other agreements with us including the
$10 million excess of loss reinsurance policy purchased by
us in the first quarter of 2002 and two annuity reinsurance
contracts between our company and XL Life or its
affiliates. The excess of loss reinsurance policy was purchased
to protect against LMIG payments under our annuity reinsurance
contract with Transamerica, and full recovery under the policy
has been anticipated in establishing our deferred acquisition
cost asset. The two

32



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annuity reinsurance contracts represent
approximately $96 million (including a cumulative loss from
embedded derivatives of approximately $2.8 million) of our
Funds withheld at interest and approximately $95 million of
our Interest sensitive contract and other liabilities. We are in
discussions with XL Life regarding these other relationships.
The outcome of these discussions cannot be determined at this
time.


We did not have sufficient available cash and
investments at June 30, 2003 to satisfy the collateral
requirements asserted by our cedents under certain of our
reinsurance treaties. Two of our cedents have asserted that we
must satisfy additional collateral requirements of approximately
$78,000,000 in excess of amounts we currently have posted. We
have not agreed with the assertion by one of these cedents that
we must post approximately $59,000,000 of additional collateral.
As a result of our inability to satisfy our obligations, certain
parties have claimed that we are in breach of our agreements. As
a consequence, such parties have sought and others may seek
remedies for such claimed breaches, and we may be required to
enter into arbitration or litigation proceedings with those
parties. If we do not prevail in any such arbitration or
litigation proceeding, it would have a material adverse effect
on our financial condition and we may be required to liquidate
our operations.

As of June 30, 2003, we had $29,810,000 of
outstanding unsecured letters of credit issued on our behalf by
Citibank. In October 2002, Citibank agreed to extend our
unsecured letter of credit facility into 2003 in exchange for
our agreement to secure or eliminate the letter of credit
facility by June 30, 2003. We were unable to secure or
eliminate the letter of credit facility by that date. Although
we are seeking to reduce the amount of outstanding letters of
credit issued on our behalf by Citibank, primarily through
recaptures and terminations of reinsurance agreements, we expect
that there will be letters of credit outstanding that will
expire on December 31, 2003. At that time, Citibank may not
renew the letters of credit. If Citibank does not renew the
letters of credit, our cedents will be entitled to draw on the
letters of credit and we would be obligated to repay Citibank
for any amounts drawn.

At June 30, 2003, our total capitalization,
which consists entirely of equity, was $146,721,736. On
March 1, 2002, we filed a shelf registration statement on
Form S-3 to register under the Securities Act of 1933 for
$200,000,000 of senior debt to be sold in one or more
transactions on a delayed basis. We subsequently determined that
we would not utilize the shelf registration and requested that
the Securities and Exchange Commission withdraw the registration
statement in March 2003.

For the six months ended June 30, 2003, we
utilized $86,149,537 of our cash and equivalents to fund our
operating activities, as compared with generating cash and
equivalents of $18,395,545 from our operating activities for the
six months ended June 30, 2002. The utilization of our cash
and equivalents during the first six months of 2003 primarily
reflects recaptures and terminations of certain of our
reinsurance agreements, as well as increased operating expenses
during that period.

While we plan to continue receiving premiums and
paying claims under our remaining reinsurance treaties, we have
ceased to write new reinsurance agreements and have notified our
existing clients that we will not be accepting any new business
under existing treaties on their current terms. We do not
anticipate writing new reinsurance agreements in the foreseeable
future. Our plans involve attempting to meet or reduce our
collateral requirements by continuing to negotiate the
recapture, retrocession, novation or sale of certain of our
reinsurance agreements. During the first six months of 2003,
these types of transactions resulted in significant losses for
us. We expect to incur additional charges in connection with
similar transactions in the third quarter of 2003; however, the
magnitude of charges associated with these types of transactions
should be significantly less than previous quarters. In January
2003, we instituted substantial premium rate increases on all of
our non-guaranteed premium yearly renewable term contracts. All
of our cedents subject to the rate increase, except MetLife and
one other cedent who has accepted the rate increase, have
elected to recapture their reinsurance agreements. MetLife has
made the rate increase a subject of arbitration with us, and has
indicated that its election to recapture is dependent upon the
arbitration panels conclusion about the validity of the
rate increase. There can be no assurance that our plans will be
successful in improving our operations and liquidity, or that we
can successfully implement its plans. If our plans are not
successful or we are unable to implement our plans we will not
be able to satisfy our obligations in 2003 and will likely be
required to liquidate our business if we cannot successfully
pursue any other strategic alternative. The report of our
independent

33



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auditors included in our Annual Report on
Form 10-K for the year ended December 31, 2002, as
amended, contains a paragraph expressing substantial doubt
regarding our ability to continue as a going concern.


Both we and our Bermuda operating subsidiary,
Annuity and Life Reassurance, are required to comply with the
provisions of the Bermuda Companies Act that regulate the
payment of dividends and the making of distributions from
contributed surplus. Neither we nor Annuity and Life Reassurance
may declare or pay a dividend, or make a distribution out of
contributed surplus, if there are reasonable grounds for
believing that: (i) the relevant company is, or would be
after the payment, unable to pay its liabilities as they become
due; or (ii) the realizable value of the relevant
companys assets would thereby be less than the aggregate
of its liabilities and its issued share capital and share
premium accounts. As of December 31, 2002, we could not
reasonably determine that we met these grounds. Accordingly, on
February 19, 2003, we announced that we would not declare
or pay a dividend on our common shares during the first quarter
of 2003. The declaration and payment of future dividends to
holders of our common shares will be at the discretion of our
Board of Directors and will depend upon our earnings and
financial condition, capital requirements of our subsidiaries,
the ability of our operating subsidiaries to pay dividends to
us, regulatory considerations and other factors the Board of
Directors deems relevant. We do not expect to declare or pay
dividends in the near future.

During 2001, our Board of Directors approved a
share repurchase program of up to $25,000,000 of our common
stock. While our Board has given us the flexibility to
repurchase our common stock in the future if market conditions
so dictate, at the present time we do not anticipate
repurchasing any common shares.

We have no material commitments for capital
expenditures as of June 30, 2003, but as noted above, we
have significant obligations that we will not be able to satisfy
unless we are able to negotiate the termination, recapture, or
novation of certain reinsurance agreements on favorable terms,
or raise capital. Since beginning our efforts to raise capital,
we have been unable to do so, and there can be no assurances
that our efforts to raise capital or pursue other strategic
alternatives will be successful.

Forward-Looking and Cautionary
Statements

This report, together with other statements and
information we may provide, contains forward-looking
statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These statements may include, but are not
limited to, projections of revenues, income or loss, capital
expenditures, plans for future operations and financing needs or
plans, as well as assumptions relating to the foregoing. The
words expect, project,
estimate, predict,
anticipate, believe and similar
expressions are intended to identify forward-looking statements,
although not all forward-looking statements include these
expressions. Forward-looking statements are inherently subject
to risks and uncertainties, some of which cannot be predicted or
quantified. Future events and actual results, performance and
achievements could differ materially from those set forth in,
contemplated by or underlying the forward-looking statements.
Factors that could materially and adversely affect our
operations and financial condition and/or cause our actual
results of operations or financial condition to differ from
those expressed or implied in our forward-looking statements
include, but are not necessarily limited to, our ability to meet
the obligations associated with our current business and to fund
our continuing operations; our ability to reduce or otherwise
satisfy our collateral obligations through novations, recaptures
or otherwise; the outcome of pending legal proceedings involving
us; our ability to obtain acceptable financial ratings; the
ability of our cedents to manage successfully assets they hold
on our behalf; our success in managing our investments; our
ability to maintain the listing of our common shares on the New
York Stock Exchange; changes in mortality, morbidity and claims
experience; our ability to make accurate estimates and
assumptions regarding future mortality, persistency, lapses,
expenses and investment performance based upon historical
results and information provided to us by our cedents; our
ability to underwrite business; unanticipated withdrawal or
surrender activity; changes in market conditions, including
changes in interest rate levels; the competitive environment;
the impact of recent and possible future terrorist attacks and
the U.S. governments response thereto; our ability to
attract and retain clients; the loss of a key executive;
regulatory changes (such as changes in U.S. tax law and
insurance regulation that directly affect the competitive
environment for our products); and a prolonged economic
downturn. Investors are also directed to consider the risks and
uncertainties discussed in other documents we have filed with
the Securities and Exchange Commission, and in particular, our
Annual Report on Form 10-K for the year ended
December 31, 2002, as amended. We do not undertake to
update any forward-looking statement that may be made from time
to time by or on our behalf.

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Item 3.     Quantitative
and Qualitative Disclosures about Market Risk

Market risk is the risk of loss arising from
adverse changes in market rates and prices, such as interest
rates, foreign currency exchange rates, and other relevant
market rate or price changes. The following is a discussion of
our primary market risk exposures and how those exposures are
currently managed as of June 30, 2003.

Our major market risk exposure is changing
interest rates, primarily in the United States. We have a
portfolio of fixed income investments and a change in interest
rates will affect the fair value of our investments and may
affect our operating results and financial condition. We seek to
manage interest rate risk with effective maturity structures and
with the application of duration management practices.

We have no equity securities in our general
account. We have significant market risk, including equity risk,
from our largest annuity reinsurance contract and our GMDB/ GMIB
contract. We do not currently use derivative financial
instruments such as futures and options to manage risk in our
general account or assumed through our reinsurance agreements,
although we may do so in the future. We manage other risks,
including credit and liquidity, in the normal course of
business. In managing credit risk, we establish overall quality
and rating guidelines and place limits on credit exposure by
issuer and industry to achieve appropriate diversification in
the portfolio. We do not have a trading portfolio and are not
exposed to market risk from trading activities.

Our primary market risk exposures as of
June 30, 2003 have changed since the year ended
December 31, 2002 as a result of a decrease in the amount
of our invested assets and funds withheld. In addition, the
recapture of our GMBD reinsurance contract with Hartford Life
has changed our market risk exposures.

The table below presents as of June 30, 2003
the amortized cost amounts and related weighted average interest
rates by years of maturity for our investment portfolio.
Mortgage-backed securities are included in the table by
anticipated year of maturity.

|                 |  |                        |         |                  |  |                |      |                  |  |   |        |  |  |  |      |  
|---------------- |  | ---------------------- | ------- | ---------------- |  | -------------- | ---- | ---------------- |  | - | ------ |  |  |  | ---- | -
|                 |  | Cash and Cash          |         | Weighted Average |  | Fixed Maturity |      | Weighted Average
|Year of Maturity |  | Equivalents            |         | Interest Rate    |  | Investments    |      | Interest Rate   
|                 |  |                        |         |                  |  |                |      |                 
|                 |  |                       
|                 |  | (Dollars in thousands)
|2003             |  | $                      | 139,793 |                  |  |                | 0.87 | %                |  | $ | 3,344  |  |  |  | 6.54 | %
|2004             |  |                        |         |                  |  |                |      |                  |  |   | 6,026  |  |  |  | 3.59 | %
|2005             |  |                        |         |                  |  |                |      |                  |  |   | 9,019  |  |  |  | 4.51 | %
|2006             |  |                        |         |                  |  |                |      |                  |  |   | 12,859 |  |  |  | 5.55 | %
|2007             |  |                        |         |                  |  |                |      |                  |  |   | 8,519  |  |  |  | 5.61 | %
|Thereafter       |  |                        |         |                  |  |                |      |                  |  |   | 42,351 |  |  |  | 5.11 | %
|                 |  |                        |         |                  |  |                |      |                  |  |   |        |  |  |  |      |  
|Total            |  | $                      | 139,793 |                  |  |                | 0.87 | %                |  | $ | 82,118 |  |  |  |      |  
|                 |  |                        |         |                  |  |                |      |                  |  |   |        |  |  |  |      |  
|Fair Value       |  | $                      | 139,793 |                  |  |                |      |                  |  | $ | 85,065 |  |  |  |      |  
|                 |  |                        |         |                  |  |                |      |                  |  |   |        |  |  |  |      |  

Sensitivity analysis and duration modeling are
used to estimate changes in fair values of fixed income
investments and the potential effects on operating earnings and
cash flows resulting from possible near term changes in interest
rates. The term near term means a period of time
going forward up to one year from the date of our consolidated
financial statements. Durations of fixed income investments are
adjusted for call, put and reset features. Portfolio durations
are calculated on a market value weighted basis, including
accrued investment income. Our duration model uses a 100 basis
point change in interest rates to measure the hypothetical
change in fair value of financial instruments included in the
model. The duration model produces a loss in fair value of the
fixed income investments of approximately $2,800,000 based on a
100 basis point increase in interest rates as of
June 30, 2003. Conversely, gains of similar amounts are
produced by the model with a 100 basis point decrease in
interest rates. Actual results may differ from the hypothetical
change in fair values assumed in this disclosure, especially
since the analysis does not and cannot reflect the results of
any actions that would be taken by us to mitigate losses or to
optimize gains in fair values.

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Certain of our modified coinsurance and
coinsurance funds withheld annuity reinsurance agreements have
features that constitute embedded derivatives that require
bifurcation and separate accounting under
FAS 133  Accounting for Derivative Instruments
and Hedging Activities. We have identified an embedded
derivative, similar to a total return swap arrangement, within
our funds withheld at interest receivable asset that we record
in connection with these agreements. The valuation of these
embedded derivatives requires complex cash flow modeling and
assumptions, most notably with respect to expected future cash
flows. The net fair value of these derivatives is classified on
our balance sheet as a component of our Funds withheld asset.
Changes in the fair value of these derivatives are reported in
net income as Net change in fair value of embedded derivatives.
While we believe these estimates of future cash flows and other
assumptions in our models are reasonable when made, the
assumptions used are subjective and may require adjustment in
the future. In addition, as industry standards for estimating
the fair value of embedded derivatives develop, we may modify
our methodology.

The methodology we use to determine the fair
value of the embedded derivatives in our annuity reinsurance
agreements that require bifurcation and separate accounting
under FAS 133 is to determine the fair value of the host
contract (notional asset) based upon expected future cash flows
under the annuity contracts. The fair value of the embedded
derivative is calculated as being the market value of the actual
assets less the fair value of the notional asset. The change in
fair value of the embedded derivative is influenced by changes
in credit risk, changes in expected future cash flows under the
annuity contracts and interest rate changes. This methodology,
which applies to all of our fixed annuity reinsurance contracts
other than Transamerica, results in a valuation of the embedded
derivative reflecting the market risk inherent in the underlying
contracts.

As of June 30, 2003, after giving effect to
the termination or recapture of certain annuity reinsurance
agreements that were in effect on December 31, 2002, the
net impact on our embedded derivatives of a 20 basis point
increase or decrease in credit spreads is a loss or gain on the
embedded derivative of approximately $52,000, respectively. Also
as of June 30, 2003 and after giving effect to the
termination or recapture of certain annuity reinsurance
agreements, the net impact on our embedded derivatives of a 50
basis point increase or decrease in interest rates as a result
of duration mismatching is a gain or loss on the embedded
derivative of approximately $770,000, respectively. The duration
of the actual assets is approximately 7.17 years and the
duration of the notional asset is approximately 7.62 years.

The table below shows the change in our embedded
derivatives by quarter for 2002 and 2003, including only those
embedded derivatives relating to contracts in force at
June 30, 2003:

|                    |  |                    |            |                     |  |   |             |  
|------------------- |  | ------------------ | ---------- | ------------------- |  | - | ----------- | -
|                    |  | Change in Embedded |            | Embedded Derivative
|                    |  | Derivative Value   |            | at Fair Value      
|                    |  |                    |            |                    
|First Quarter 2002  |  | $                  | 843,491    |                     |  | $ | (2,831,908  | )
|Second Quarter 2002 |  | $                  | (4,447,113 | )                   |  | $ | (7,279,021  | )
|Third Quarter 2002  |  | $                  | (5,832,309 | )                   |  | $ | (3,111,330  | )
|Fourth Quarter 2002 |  | $                  | (672,539   | )                   |  | $ | (13,783,869 | )
|First Quarter 2003  |  | $                  | 2,155,984  |                     |  | $ | (11,627,885 | )
|Second Quarter 2003 |  | $                  | (817,612   | )                   |  | $ | (12,445,497 | )

Our accounting policy for guaranteed minimum
death benefit, guaranteed minimum income benefit and enhanced
earnings benefit contracts is discussed in Note 3 to our
consolidated financial statements included in our Annual Report
on Form 10-K for the fiscal year ended December 31, 2002.
As of December 31, 2002, we had established reserves of
approximately $18,500,000 related to these types of minimum
guarantees associated with variable annuity products. As a
result of the recapture of our largest guaranteed minimum death
benefit contract as of June 30, 2003, our exposure to
guaranteed minimum death benefits has declined from
$1,231 million to less than $170 million. Our exposure
for guaranteed minimum income benefits has not materially
changed since December 31, 2002. Our reserve as of
June 30, 2003 is $9,400,000. These reserves are calculated
on the basis of actuarial assumptions related to projected
benefits and related contract charges over the lives of the
contracts. Our reserve methodology for these variable annuity
minimum guarantee

36



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##### 



products is not directly market sensitive,
although we do make assumptions about the state of the financial
markets when we establish our reserves for these exposures.
After giving effect to the recapture of our largest guaranteed
minimum death benefit contract, we estimate no significant
impact on our reserve for guaranteed minimum death benefits and
guaranteed minimum income benefits based on our preliminary
review of the Statement of Position 03-1 Accounting
and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate
Accounts.


We refer you to Part II, Item 7A,
Quantitative and Qualitative Disclosures About Market
Risk of our Annual Report on Form 10-K for the year
ended December 31, 2002 for additional information
regarding our exposure to market risk.

The statements above are forward-looking
statements within the meaning of the Private Securities
Litigation Reform Act. See Forward-Looking and Cautionary
Statements.

Item 4.     Controls
and Procedures

As of the end of the period covered by this
Form 10-Q, the Companys management, including its
Chief Executive Officer/ Chief Financial Officer, conducted an
evaluation of the effectiveness of the Companys disclosure
controls and procedures. Based on that evaluation, the Chief
Executive Officer/ Chief Financial Officer concluded that the
Companys disclosure controls and procedures were
effective. There have been no changes in the Companys
internal controls over financial reporting during the period
ended June 30, 2003 that have materially affected, or are
reasonably likely to materially affect, the Companys
internal controls over financial reporting.

37



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PART II

OTHER INFORMATION

Item 1.     Legal
Proceedings

On April 23, 2002, we served written notice
of arbitration on The Metropolitan Life Insurance Companies
(MetLife), the cedent under our largest life
reinsurance agreement, seeking equitable relief and monetary
damages based on MetLifes misrepresentation of and failure
to disclose material facts known to it relating to the
agreement. On January 30, 2003, we also provided written
notice to MetLife of a premium rate increase, effective
March 5, 2003, which also has become a subject of this
arbitration. In April 2003, MetLife informed us that, if the
arbitration panel finds the premium rate increase valid, MetLife
would recapture the reinsurance agreement as of March 5,
2003. An arbitration panel is scheduled to hear these claims in
December 2003.

On and since December 4, 2002, certain of
our shareholders have filed purported shareholder class action
lawsuits against us and certain of our present and former
officers and directors in the United States District Court for
the District of Connecticut seeking unspecified monetary
damages. The plaintiffs claim that the defendants violated
certain provisions of the United States securities laws by
making various alleged material misstatements and omissions in
public filings and press releases. The plaintiffs filed a single
consolidated amended complaint in July 2003, adding as
defendants XL Capital Ltd and two additional directors. The
Companys response is currently due in September 2003.

On March 18, 2003, Hartford Life Insurance
Company, the cedent under our largest guaranteed minimum death
benefit reinsurance contract, served notice seeking to institute
arbitration proceedings against us alleging that we have failed
to satisfy additional collateral requirements under the contract
of approximately $59.0 million. On July 17, 2003,
Hartford Life agreed to recapture its guaranteed minimum death
benefits reinsurance contract with us. As consideration for the
recapture, Hartford Life retained approximately $31 million
of the funds it had drawn from a trust account and letters of
credit that had been posted as collateral under the contract,
and we issued warrants to purchase an aggregate one million of
our common shares to Hartford Life. Under the terms of the
recapture, we have no further obligations to Hartford Life.

There are no other arbitration or other legal
proceedings currently in process.

Item 2.     Changes
in Securities and Use of Proceeds

On June 25, 2003, our Board approved the
issuance of 575,000 shares of restricted stock to various
employees in connection with retention arrangements. Issuance of
the restricted stock required no investment decision on the part
of each recipient. If the grant were deemed to be a sale of
securities under the Securities Act of 1933 (the 1933
Act), we believe such sale would be exempt from the 1933
Act pursuant to Section 4(2) thereof or Regulation S
thereunder.

On July 17, 2003, we issued warrants to
purchase an aggregate one million of our common shares at an
exercise price of $1.25 per share to Hartford Life, the ceding
company under our largest guaranteed minimum death benefit
reinsurance contract. The warrants were issued in connection
with the recapture of the contract and expire on June 30,
2013. The issuance of the warrants was exempt from the
registration requirements of the 1933 Act pursuant to
Section 4(2) thereof.

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Item 4. Submission of Matters to
a Vote of Security Holders

The Annual Meeting of Shareholders of the Company
was held on June 3, 2003. The following matters were voted
upon at the Annual Meeting, and received the votes set forth
below:

(a) All of the following persons were
elected to serve as directors and received the number of votes
set forth opposite their respective name:

|                   |  |     |            |          |  |  |         | 
|------------------ |  | --- | ---------- | -------- |  |  | ------- | 
|                   |  | FOR |            | WITHHELD
|                   |  |     |            |         
|John F. Burke      |  |     | 19,070,559 |          |  |  | 97,061  | 
|Albert R. Dowden   |  |     | 19,056,275 |          |  |  | 111,345 | 
|Robert P. Johnson  |  |     | 19,056,875 |          |  |  | 110,745 | 
|Henry C.V. Keeling |  |     | 19,056,275 |          |  |  | 111,345 | 
|Robert M. Lichten  |  |     | 19,056,875 |          |  |  | 110,745 | 
|Jeffrey D. Watkins |  |     | 19,056,275 |          |  |  | 111,345 | 

(b) A proposal to ratify the appointment of
KPMG as independent accountants for the Company for the 2003
fiscal year was approved and received 17,248,722 votes FOR and
22,684 votes AGAINST, with 1,896,214 abstentions and broker
non-votes.

39



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##### 



Item 5.     Other
Information

Effective as of June 30, 2003, our largest
guaranteed minimum death benefit reinsurance contract was
recaptured by Hartford Life, the ceding company under that
contract. As discussed elsewhere in this report, in connection
with securing the recapture of the contract, we issued warrants
to acquire up to one million of our common shares to Hartford
Life.

On August 5, 2003, XL Life served us
with notice of its intention to recapture a 50% quota share
reinsurance contract entered into with us on December 31,
2002. We will not be able to recover the deferred acquisition
costs carried for this contract from future expected income, and
have written down approximately $21 million of such
deferred acquisition costs in the three months ended
June 30, 2003.

XL Life has also indicated its desire to
terminate other agreements with us, including a $10 million
excess of loss reinsurance policy purchased by us in the first
quarter of 2002 and two annuity reinsurance contracts between
our company and XL Life or its affiliates. The excess of
loss reinsurance policy was purchased to protect against
lifetime minimum interest guarantee payments under our annuity
reinsurance contract with Transamerica Occidental Life Insurance
Company. We are in discussions with XL Life regarding these
other relationships. The outcome of these discussions cannot be
determined at this time.

During 1998, certain of our officers purchased
163,121 of our common shares, and we made loans to the officers
to partially finance such purchases. The loans accrued interest
at 7% per annum and certain unpaid loans became due and payable
in April 2003. In connection with the renegotiation or
termination of certain officers employment agreements, we
have deemed the outstanding loans of those officers to have been
repaid in exchange for the officers agreeing to forego certain
bonus, severance or other payments that are or may become
payable to them. During the six months ended June 30, 2003,
loans of $1,000,000 with accrued interest of $402,812 had been
deemed repaid in this manner.

On April 8, 2003, we received notice from
the New York Stock Exchange that we did not satisfy the
NYSEs continued listing standards as of that date because
the average closing price of our common shares had been below
$1.00 for a 30 consecutive trading day period. If we cannot
achieve (i) a $1.00 average share price for the 30
consecutive trading days prior to October 7, 2003, the
expiration of the six month period following the date of the
receipt of this notification, and (ii) a $1.00 share price
on October 7, 2003, then the NYSE will commence suspension
and delisting procedures with respect to our common shares. In
addition, the NYSE informed us that it is considering whether we
continue to meet certain of the NYSEs qualitative
continued listing standards due to concerns over our financial
condition.

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Item 6.     Exhibits
and Reports on Form 8-K

(a) Exhibits 

|     |  |                                                                                                                                                                                                                                                                         
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4    |  | Form of Warrant issued to Hartford Life and
    Annuity Insurance Company and Hartford Life Insurance Company.                                                                                                                                                          
|10.1 |  | Amended and Restated Employment Agreement, dated
    as of July 28, 2003, by and between Annuity and Life Re
    (Holdings), Ltd., Annuity and Life Reassurance, Ltd. and John F.
    Burke.                                                                            
|10.2 |  | Employment Agreement, dated as of June 10,
    2003, among Annuity and Life Re (Holdings), Ltd., Annuity and
    Life Reassurance, Ltd. and Robert Reale.                                                                                                               
|10.3 |  | Recapture Agreement and General Release of
    Guaranteed Minimum Death Benefit Reinsurance Agreements, dated
    as of June 30, 2003, among Hartford Life and Annuity
    Insurance Company, Hartford Life Insurance Company and Annuity
    and Life Reassurance, Ltd.
|31   |  | Rule 13a-14(a)/15d-14(a) Certification of
    the Companys Chief Executive Officer and Chief Financial
    Officer.                                                                                                                                                    
|32   |  | Section 1350 Certification of the
    Companys Chief Executive Officer and Chief Financial
    Officer.                                                                                                                                                                

(b) Reports on Form 8-K 

Current Report on Form 8-K (Items 7 and
12) dated and filed on April 3, 2003, regarding the
Companys release of its financial results for the three
and twelve month periods ended December 31, 2002.

Amended Current Report on Form 8-K
(Item 7) dated February 14, 2003 and filed on
April 16, 2003, providing unaudited pro forma condensed
consolidated financial statements for the year ended
December 31, 2002, reflecting the termination of the
Companys annuity reinsurance agreement with The Ohio
National Life Insurance Company and the transfer of certain
blocks of life reinsurance business to XL Life Ltd, as well
as other terminations and recaptures of reinsurance contracts
during 2002 and through March 31, 2003.

Current Report on Form 8-K (Items 7 and
12) dated May 15, 2003 and filed on May 16, 2003,
regarding the Companys release of its financial results
for the three month period ended March 31, 2003.

Current Report on Form 8-K (Items 7 and
12) dated and filed on August 7, 2003, reporting several
recent developments that had occurred with respect to the
Company, including the recapture of the Companys largest
guaranteed minimum death benefit reinsurance contract and the
announcement that XL Life Ltd had served notice that it
intended to recapture four life reinsurance contracts ceded to
the Company on a 50% quota share basis.

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ANNUITY AND LIFE RE (HOLDINGS), LTD.



SIGNATURES


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



| |                                     
| | ------------------------------------
| | ANNUITY AND LIFE RE (HOLDINGS), LTD.
|
| | /s/ JOHN F. BURKE                   
| |                                     
| | Name: John F. Burke                 

| |        |                            
| | ------ | ---------------------------
| | Title: | Chief Executive Officer and

| |                        
| | -----------------------
| | Chief Financial Officer

Date: August 14, 2003

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##### 



EXHIBIT INDEX

|     |  |                                                                                                                                                                                                                                                                         
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4    |  | Form of Warrant issued to Hartford Life and
    Annuity Insurance Company and Hartford Life Insurance Company.                                                                                                                                                          
|10.1 |  | Amended and Restated Employment Agreement, dated
    as of July 28, 2003, by and between Annuity and Life Re
    (Holdings), Ltd., Annuity and Life Reassurance, Ltd. and John F.
    Burke.                                                                            
|10.2 |  | Employment Agreement, dated as of June 10,
    2003, among Annuity and Life Re (Holdings), Ltd., Annuity and
    Life Reassurance, Ltd. and Robert Reale.                                                                                                               
|10.3 |  | Recapture Agreement and General Release of
    Guaranteed Minimum Death Benefit Reinsurance Agreements, dated
    as of June 30, 2003, among Hartford Life and Annuity
    Insurance Company, Hartford Life Insurance Company and Annuity
    and Life Reassurance, Ltd.
|31   |  | Rule 13a-14(a)/15d-14(a) Certification of
    the Companys Chief Executive Officer and Chief Financial
    Officer.                                                                                                                                                    
|32   |  | Section 1350 Certification of the
    Companys Chief Executive Officer and Chief Financial
    Officer.