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SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 
 FORM 10-K
 
 FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13
OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One)þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2004
 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For 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
(State or Other Jurisdiction
of Incorporation or Organization)
    
    66-0619270
(I.R.S. Employer
Identification No.)CUMBERLAND HOUSE, 1 VICTORIA STREET,
HAMILTON, BERMUDA
(Address of Principal Executive Offices)
    
    HM 11
(Zip Code)
 Registrants telephone number, including area code (441) 296-7667
Securities registered pursuant to Section 12(b) of the
Act:

None Securities registered
pursuant to Section 12(g) of the Act:

Common Shares, $1.00 par value

(Title of Class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange
Act Rule 12b-2). Yes þ No o As of June 30, 2004, the aggregate market value of Common Shares, $1.00 par value, held by
non-affiliates was $11,934,034. As of March 1, 2005, 26,338,528 Common Shares, $1.00 par value, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE None




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TABLE OF CONTENTS PagePART IItem 1.
    
    Business
    
    
    1Item 2.
    
    Properties
    
    
    23Item 3.
    
    Legal Proceedings
    
    
    24Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    24PART IIItem 5.
    
    Market for Registrants Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
    
    
    25Item 6.
    
    Selected Financial Data
    
    
    26Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    27Item 7A.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    57Item 8.
    
    Financial Statements and Supplementary Data
    
    
    62Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    92Item 9A.
    
    Controls and Procedures
    
    
    92Item 9B.
    
    Other Information
    
    
    92PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    92Item 11.
    
    Executive Compensation
    
    
    92Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    92Item 13.
    
    Certain Relationships and Related Transactions
    
    
    92Item 14.
    
    Principal Accountant Fees and Services
    
    
    92PART IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    
    93LETTER OF INTENT, TRANSAMERICA OCCIDENTIAL LIFE INSURANCE COMPANYCONSENT OF MARCUM & KLIEGMAN LLP (INDEPENDENT ACCOUNTANTS)CONSENT OF KPMG (INDEPENDENT ACCOUNTANTS)CERTIFICATION OF THE COMPANY'S CHIEF EXECUTIVE OFFICERCERTIFICATION OF THE COMPANY'S CHIEF FINANCIAL OFFICERSECTION 1350 CERTIFICATION OF THE COMPANY'S CEOSECTION 1350 CERTIFICATION OF THE COMPANY'S CFO




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PART I 
 Item 1.Business. Overview 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. Our company has encountered significant difficulties during the last four years. In addition
to reporting significant operating losses for those years, we have reduced our operations
significantly through the novation, termination and recapture of many of our life and annuity
reinsurance agreements. We plan to continue to receive premiums and pay claims under our remaining
reinsurance treaties; however, we are not currently underwriting any new treaties or accepting any
new business from our existing treaties. On October 26, 2004, Connecticut General Life Insurance Company (CIGNA) agreed to recapture
its guaranteed minimum death benefit and guaranteed minimum income benefit agreement with us
effective as of July 1, 2004. We agreed with CIGNA to a mutual release of all past, present and
future claims under the agreement, including all obligations for claims and premiums that had
accrued under the agreement since July 1, 2004. We also agreed with CIGNA to a mutual release of
all claims under the letter of credit that we had posted as collateral under the agreement, and
that CIGNA would retain the $11.0 million it previously drew under the letter of credit. In
addition, on October 26, 2004, we issued CIGNA a warrant dated as of September 30, 2004 to acquire
one million of our common shares at an exercise price of $1.00 per share. The warrant expires on
September 30, 2014. Following the termination of our agreement with CIGNA, we no longer have any
exposure to guaranteed minimum death benefits or guaranteed minimum income benefits. We recorded a
charge of approximately $2.4 million in the third quarter of 2004 as a result of the settlement
with CIGNA. On December 31, 2004, we entered into a binding letter of intent with Transamerica Occidental
Life Insurance Company (Transamerica) that provided for the novation of our life reinsurance
agreements with Scottish Re Limited (Scottish Re) and with Fidelity and Guaranty Life Insurance
Company (F&G) to Transamerica as of December 31, 2004. The letter of intent also provided that,
upon consummation of the novation of the life reinsurance agreements, Transamerica would terminate
its annuity reinsurance agreement with us and recapture all business ceded under the agreement
effective as of December 1, 2004. Our annuity reinsurance agreement with Transamerica has generated
substantial losses since 2001 and has required us to make significant cash payments to
Transamerica. Terminating or restructuring this agreement has been a key strategic objective, as
well as a critical step to pursuing any strategic alternatives. Pursuant to our letter of intent with Transamerica, on January 31, 2005, we executed
definitive documents and novated our life reinsurance agreements with Scottish Re and F&G to
Transamerica as of December 31, 2004. In consideration of these novations, we paid Transamerica
$18.5 million, representing a transfer of reserves related to the life reinsurance agreements that
were novated. Also, on January 31, 2005, we executed an amendment to our annuity reinsurance
agreement with Transamerica pursuant to which our agreement with Transamerica was terminated, and
Transamerica recaptured all business ceded under the agreement effective as of December 1, 2004. In
consideration of the recapture, we paid Transamerica all amounts owed under the annuity reinsurance
agreement through November 30, 2004, which was approximately $7.1 million, along with a termination
premium of $14.0 million.




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In connection with the novations of the life reinsurance agreements, approximately $28.9
million of collateral held in a trust established with respect to our life reinsurance agreement
with Scottish Re was transferred to Transamerica. In addition, $23.8 million of the letters of
credit we posted on behalf of our life reinsurance agreement with F&G were cancelled and the
collateral securing those letters of credit was released to us. Approximately $39.6 million was
paid to Transamerica in connection with the novation and recapture transactions from this
collateral, including $18.5 million as consideration for the novations, a $14.0 termination premium
and approximately $7.1 million for amounts due to Transamerica on December 1, 2004. Following those
payments, approximately $13.1 million of cash and securities previously posted as collateral was
released to us. We recorded a loss of approximately $60.6 million during the fourth quarter of 2004
relating to these novation and recapture transactions. On
March 30, 2005, we received a demand letter from Transamerica
stating that $7.0 million was owed to Transamerica as an
adjustment to the F&G policy benefit reserves. If we and
Transamerica are unable to resolve this issue through continued
discussions, we would seek adjudication of the dispute in accordance
with the provisions of the Master Agreement, which calls for the
matter to be submitted to a Fellow of the Society of Actuaries whose
determination shall be final, binding and conclusive. While there can
be no assurances, we believe that Transamerica is not entitled to
this $7.0 million. Presently, we are unable to determine the
amounts, if any, that may be due to or from Transamerica resulting
from adjustments to the policy benefit reserves. Our remaining life reinsurance agreements are the reinsurance of ordinary life insurance,
primarily for mortality risk. Profitability of our life reinsurance line depends in large part on
the volume and amount of death claims incurred. While death claims are reasonably predictable over
a long time horizon, they are less predictable over shorter periods and are subject to fluctuation
from quarter to quarter and year to year, particularly given the relatively small size of our in
force business as a result of recaptures and terminations in previous periods. Significant
fluctuations from period to period could adversely affect the results of our operations. Similarly,
claims experience that exceeds what we anticipated at the time we enter into reinsurance agreements
can also adversely affect the results of our operations, as occurred in 2003 and 2002. At December
31, 2004 and December 31, 2003, the total face amount of our life insurance in force was
approximately $2.3 billion and $17.5 billion, respectively. Our remaining annuity reinsurance agreement reinsures general account fixed deferred
annuities. Profitability of this agreement is primarily dependent on earning a spread between the
interest rate earned on the assets under management and the interest rate credited to the
policyholder. This agreement is market and interest rate sensitive. Fluctuations in the general
level of interest rates and fixed income markets from period to period may cause fluctuations in
the profitability of this agreement. At December 31, 2004 and December 31, 2003, our liability for
annuity reinsurance agreements amounted to approximately $58 million and $671 million,
respectively. Because our financial results are heavily dependent on three life reinsurance agreements and
one remaining annuity reinsurance agreement, large fluctuations in actual experience under any one
of these agreements could cause volatility in our overall financial results. While we believe we have sufficient operating liquidity to sustain our operations for at least
the next twelve months, we continue to explore strategic alternatives to attempt to maximize
shareholder value. These alternatives include, but are not limited to, a merger, sale, joint
venture, sale of assets, including our remaining reinsurance agreements, or other comparable
transaction. We do not know the terms upon which these transactions might be available, if at all.
For a more detailed discussion of certain factors that could materially and adversely affect our
financial condition and results of operations, please see Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations Forward-Looking Statements. The Reinsurance Business The business of reinsurance generally consists of reinsurers, such as our company, entering
into contractual arrangements (known as treaties) with primary insurers (known as ceding companies)
whereby the reinsurer agrees to indemnify the ceding company for all or a portion of the risks
associated with an underlying insurance policy in exchange for a reinsurance premium payable to the
reinsurer. Reinsurers also may enter into retrocessional reinsurance arrangements with other
reinsurers, which operate in a manner similar to the underlying reinsurance arrangement described
above. Under retrocessional - 2 -




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reinsurance arrangements, the reinsurer cedes a portion of the risk associated with an
underlying reinsurance contract to other reinsurers (known as retrocessionaires). Reinsurance agreements may be written on an automatic treaty basis or facultative basis. An
automatic treaty provides for a ceding company to cede contractually agreed-upon risks on
identified types of business that meet established criteria to a reinsurer and binds that reinsurer
to accept such risks without obtaining further approval from that reinsurer. Facultative
reinsurance is the reinsurance of individual risks, which allows a reinsurer the opportunity to
analyze and separately underwrite a risk before agreeing to accept the risk. Both automatic treaty
and facultative reinsurance may be written on either a quota share basis, where a percentage of
each risk in the reinsured class of risk is assumed by the reinsurer from the ceding company, or on
an excess of retention basis, where the amount of risk in excess of the ceding companys retention
is reinsured. Under either basis, premiums are paid to the reinsurer in proportion to the risk
assumed by the reinsurer. The treaties that we have written that are still in force are generally in the form of yearly
renewable term, coinsurance, modified coinsurance or coinsurance funds withheld. Under yearly
renewable term, we share only in the mortality risk for which we receive a premium. In coinsurance,
modified coinsurance and coinsurance funds withheld arrangements, we generally share
proportionately in all or a portion of the risks inherent in the underlying policies, including
mortality, persistency and fluctuations in investment results. Under such agreements, we agree to
indemnify the primary insurer for all or a portion of the risks associated with the underlying
insurance policies in exchange for a proportionate share of premiums. Coinsurance differs from
modified coinsurance and coinsurance funds withheld with respect to ownership of the assets
supporting the reserves. Under our coinsurance arrangements, ownership of these assets is
transferred to us, whereas in modified coinsurance and coinsurance funds withheld arrangements, the
ceding company retains ownership of these assets, but we share in the investment income and risk
associated with the assets. Certain of our remaining reinsurance treaties provide for recapture rights, permitting the
ceding company to reassume all or a portion of the risk ceded to us after an agreed-upon period of
time (generally 10 years for our life reinsurance treaties), subject to certain other conditions.
Some of our reinsurance treaties allow the ceding company to recapture the ceded risk if we fail to
maintain a specified rating or if other financial conditions relating to us are not satisfied.
Because our financial ratings were downgraded in 2003 and subsequently withdrawn by the various
rating agencies, we have had certain treaties recaptured as a result. During the last three years,
we have also sought to negotiate the termination and recapture of certain unprofitable treaties and
to reduce or eliminate the collateral requirements associated with those treaties. Recapture of
business previously ceded does not affect earned premiums paid to us prior to the recapture of such
business and may involve the payment to us of a recapture fee. Nevertheless, we may be obligated to
return unearned premiums, or pay other penalties, and we may also have to liquidate assets in order
to return the assets supporting the reserve liabilities. In addition, we would no longer be
entitled to receive the premiums paid by the policyholders underlying the recaptured business and
would likely be required to accelerate the amortization of any unamortized deferred acquisition
costs associated with business that is recaptured, which was the case with certain treaties
recaptured during the last three years. These recaptures have had an adverse impact on our reported
results of operations. While some of our ceding companies may have these contractual rights, we are
not currently aware of any that intend to exercise their right to recapture. Risks Reinsured We have historically written reinsurance predominantly on a direct basis with primary life
insurance companies and other reinsurers. Our remaining reinsurance treaties are generally for
traditional life reinsurance and annuity reinsurance, which expose us to the following categories
of risks: (i) mortality, (ii) investment, (iii) persistency (or lapse) and (iv) expense. Mortality risk is the risk that death claims differ from what we expect. With respect to our
life segment, a greater frequency or higher average size of death claims than we expected could
cause us to pay greater death benefits, adversely affecting the profitability of our reinsurance
agreements. Even if the total - 3 -




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death benefits paid over the life of our contracts do not exceed the expected amount,
unexpected timing of deaths can cause us to pay more death benefits in a given time period than
expected, adversely impacting profitability in that period. We try to address these risks by
considering each block of business based on an evaluation of the ceding companys underwriting
efficacy, history, management, target market, concentration of risk, products and underwriting
criteria relative to the industry. We historically targeted primarily first dollar quota share
pools of top producing direct writing companies under which we participated proportionately with
other reinsurers on all of the ceded risks, although not necessarily at the same pricing. We sought
to mitigate our risk of exposure to any one block of business or any one individual life by
typically requiring our ceding companies to retain at least 10% of every life insurance risk
reinsured. We further addressed the risk of any one large claim by generally limiting our own net
liability on any single-life risk to $1,000,000. We are subject to investment risk with respect to our own investments and with respect to the
assets held and managed by our ceding companies or others under our modified coinsurance and
coinsurance funds withheld arrangements. Our investments, which primarily consist of investment
grade fixed income securities, are subject to interest rate and credit risk. Significant changes in
interest rates expose us to the risk of earning less income during periods when interest rates are
falling, or realizing losses if we are forced to sell securities during periods when interest rates
are rising. We are also subject to prepayment risk on certain securities in our investment
portfolio, including mortgage-backed securities and collateralized mortgage obligations, which
generally prepay faster during periods of falling interest rates as the underlying mortgage loans
are repaid and refinanced by borrowers in order to take advantage of lower interest rates. During
periods when interest rates have risen or are rising, the rate of prepayments on these types of
securities will decelerate, effectively extending maturities and increasing the potential for
losses. As of December 31, 2004, our ceding companies had approximately $56.4 million in assets that
were held and managed by or for them under our modified coinsurance and coinsurance funds withheld
arrangements. The largest portion of the funds withheld by our ceding companies at December 31,
2004, which amounted to $51.3 million, was related to our remaining modified coinsurance annuity
reinsurance agreement. While we do not own the assets that are held under modified coinsurance or
coinsurance funds withheld arrangements, they are used to fund our obligations under our
reinsurance agreements. We record a receivable called Funds withheld at interest based on the
amounts due to us under these contracts and are exposed to the risks associated with the securities
in which the assets supporting the receivable are invested. We are also subject to investment risk based on the difference between investment returns
earned on the investments managed by us or our ceding companies and the credited interest rates
paid under policies reinsured by us. Both rising and declining interest rates can affect the income
we derive from these interest rate spreads. During periods in which prevailing market interest
rates are falling, any new investments made in fixed income securities to replace investments that
mature or are prepaid will likely bear lower interest rates, reducing our investment income. We may
not be able to fully offset the decline in our investment income with lower crediting rates on our
annuity reinsurance agreement or reinsurance agreements covering life insurance policies with cash
value components. During periods of rising interest rates, our ceding companies may need to
increase the crediting rates on the annuities or life insurance policies with cash value components
that we reinsure. We may not, however, be able to acquire investments with interest rates
sufficient to offset these increased crediting rates. Significant declines in the financial markets
generally also increase our investment risk, because the return we receive on our assets may not be
sufficient to fully offset the cost of benefits due under certain reinsured policies. We may use interest rate swaps and other financial instruments as tools to mitigate the
effects of asset/liability mismatches or the effect of interest rate changes on our balance sheet.
In general, however, we do not hedge our investment risk. Persistency or lapse risk is the risk that policyholders maintain their policies for different
periods of time than expected. This includes policy surrenders and policy lapses. Surrenders are
the voluntary termination of a policy by the policyholder, while lapses are the termination of the
policy due to non-payment of premium. Surrender and lapse rates that are higher than what we
assumed when pricing a - 4 -




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contract can cause us to increase the rate of amortization of our deferred acquisition costs
for the annuity policies and certain types of life insurance that we reinsure, which would
adversely affect our results of operations. If the actual surrender and lapse rates remain too high
for too long and we conclude that the contract will be unprofitable over its expected lifetime, we
are then required to write down our deferred acquisition costs to their estimated recoverable cost,
as was the case in 2001 and 2002 with our annuity reinsurance agreement with Transamerica.
Surrenders also usually involve the return of the policys cash surrender value to the
policyholder, which reduces the asset base on which we earn investment income and, in some cases,
premiums. In addition, with respect to our Transamerica agreement, a surrendering policyholder was
entitled to a guaranteed minimum interest rate on his or her invested premiums, and we were
required to pay our proportionate share of any shortfall between that guaranteed amount and the
actual value of the policyholders account. As discussed later in this report, we have been
required to make significant minimum interest guarantee payments under this agreement, which has
been recaptured as of December 1, 2004. Certain of our life reinsurance products provide level premiums to us for a fixed period of
time, typically 10 to 20 years. The premiums we receive on these level premium contracts are
expected to exceed the death benefits payable to the underlying policyholders during the early
years of the contract. The death benefits we expect to pay under these contracts generally increase
over time, while the premiums we receive are expected to generally remain level or decrease over
time because of surrenders, lapses and deaths. Thus, the death benefits payable under the policy
ultimately exceed the premiums we receive in later years. With respect to these level premium
contracts, if the surrender and lapse rates of the policies are significantly lower than we assumed
when pricing the reinsurance contracts, the profitability of the contracts may be adversely
affected. Expense risk is the risk that our actual expenses will be higher than we anticipated, or that
our operations are less efficient than anticipated. Business Written The following table sets forth selected information for the indicated periods concerning our
insurance operations: Policy Revenues, Insurance In Force and Annuity Reinsurance Deposits Year Ended December 31,2004
    
    
    2003
    
    
    2002Policy RevenuesLife ReinsuranceFirst Year
    
    $
    
    
    
    $
    8,060,074
    
    
    $
    117,801,608Renewal
    
    
    46,995,273
    
    
    
    152,355,600
    
    
    
    215,379,401Annuity Reinsurance
    
    
    1,302,433
    
    
    
    6,557,166
    
    
    
    10,916,432Total
    
    $
    48,297,706
    
    
    $
    166,972,840
    
    
    $
    344,097,441Insurance in force at end
of year (in thousands)
    
    $
    2,344,200
    
    
    $
    17,510,100
    
    
    $
    117, 511,000Annuity Reinsurance Deposits
    
    $
    57,754,009
    
    
    $
    670,717,546
    
    
    $
    1,443,143,080
 We separately track the results of our life and annuity operations in segments. Please
refer to Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations  Segment Results and Note 15 to our consolidated financial statements for more detailed
information. Our life reinsurance segment is the reinsurance of ordinary life insurance, primarily for
mortality risks. Ordinary life reinsurance generally is the reinsurance of individual term life
insurance policies, whole life insurance policies and joint and survivor insurance policies on
yearly renewable term basis. In addition, we - 5 -




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reinsure the mortality risk portion of universal life insurance policies, variable universal
life insurance policies and variable life insurance policies. Our annuity reinsurance segment is the reinsurance of general account fixed deferred
annuities, which involve the tax-deferred accumulation of interest on premiums paid by the
policyholder (accumulation phase policies). In the past, our agreements included 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. All of the fixed annuities we currently reinsure are accumulation phase
policies. Underwriting We currently are not accepting any additional business under existing treaties or writing new
reinsurance treaties. Our remaining reinsurance agreements were written in accordance with
underwriting guidelines that we developed with the objective of controlling the risks of our
reinsurance policies as well as determining appropriate pricing levels. As our business and staff
grew, we incorporated peer review procedures to enhance our pricing and risk management controls.
If we resume writing new reinsurance agreements in the future, these guidelines may be amended in
response to market developments, changes in technology and other factors. In implementing our underwriting guidelines, we determined whether to assume any particular
reinsurance business by considering many factors, including the types of risks to be covered,
actuarial evaluations, historical performance data for the ceding company and the industry as a
whole, the ceding companys retention, the product to be reinsured, pricing assumptions,
underwriting standards, reputation and financial strength of the ceding company, the likelihood of
establishing a long term relationship with the cedent and the market share of the ceding company.
Pricing of our reinsurance products was based on actuarial and investment models which incorporated
a number of client specific factors including mortality, expenses, demographics, persistency and
investment returns, and macroeconomic factors, such as inflation, industry regulation, taxation and
capital requirements. The majority of our remaining life reinsurance agreements and our remaining annuity
reinsurance agreement were written on an automatic treaty quota share basis with a focus on large
blocks of business where the underlying policies met our underwriting criteria. We also have a
small number of facultative reinsurance arrangements with primary insurers with whom we had entered
into automatic treaty reinsurance business. We generally required ceding companies to retain at
least 10% of every life insurance risk reinsured, and we generally limited our own net liability on
any single-life risk to $1,000,000. The reinsurance agreements typically remain in force for the life of the underlying policies
reinsured. However, some agreements allow the ceding company to recapture (reassume) all or a
portion of the risk ceded to us subject to certain conditions. Recapture features were considered
when we underwrote the reinsurance agreements. Transamerica Agreement Prior to its recapture and termination effective December 1, 2004, our largest annuity
reinsurance agreement, which was effective as of September 30, 1998, was with Transamerica. The
agreement was a retrocessional reinsurance arrangement covering VisionMark fixed annuity products
issued by Indianapolis Life Insurance Company. - 6 -




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The following table sets forth certain financial information relating to our annuity
reinsurance agreement with Transamerica from its inception in 1998 through December 31, 2004: Interest Sensitive
    
    
    DeferredFor the Year Ended
    
    Funds Withheld
    
    
    Contracts
    
    
    Acquisition
    
    
    Contract IncomeDecember 31
    
    at Interest Asset
    
    
    Liability
    
    
    Cost Asset
    
    
    (Loss)1998
    
    $
    1,200,101,268
    
    
    $
    1,283,675,809
    
    
    $
    156,044,683
    
    
    $
    2,242,6001999
    
    
    1,514,093,530
    
    
    
    1,593,873,272
    
    
    
    201,473,796
    
    
    
    13,591,6002000
    
    
    1,242,788,747
    
    
    
    1,305,877,473
    
    
    
    159,438,128
    
    
    
    14,982,5402001
    
    
    962,303,099
    
    
    
    990,567,504
    
    
    
    84,754,222
    
    
    
    (52,045,952
    )2002
    
    
    733,689,256
    
    
    
    755,862,003
    
    
    
    50,020,388
    
    
    
    (26,802,520
    )2003
    
    
    603,880,707
    
    
    
    602,093,921
    
    
    
    32,903,594
    
    
    
    (3,067,220
    )2004
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    (59,974,455
    )
 The first column in the table is the amount of the Funds withheld at interest asset associated
with the Transamerica agreement that was included on our balance sheet at the end of each of the
periods indicated. The Funds withheld at interest asset is a receivable equal to our portion of
Transamericas statutory reserves related to the underlying policies. The second column sets forth
our Interest sensitive contracts liability included on our balance sheet at the end of each of the
periods indicated. This is our proportionate share of the liability to policyholders for their
account values. The third column sets forth the value of the deferred acquisition cost asset
related to the Transamerica agreement at the end of each period indicated. When we write a
reinsurance contract, a portion of our acquisition costs (primarily commissions) associated with
the new business is capitalized. The resulting deferred acquisition costs asset is recorded on our
balance sheet and amortized over future periods based on our estimates of expected gross profits
from the contract. The amounts deferred vary with the structure, size and type of contract written.
For our investment related products, we adjust our amortization when we revise our estimate of
expected gross profits. The effects of such adjustments are reflected in our earnings in the period
in which we revise our estimates of expected gross profits. The final column sets forth contract
income or loss for each of the periods indicated. The Funds withheld at interest asset associated with the Transamerica agreement was a
significant portion of our total assets since its inception, representing 70% of our total assets
at December 31, 1998 and 59% of our total assets at December 31, 2003. In similar fashion, the
Interest sensitive contract liability associated with the agreement has been a significant portion
of our total liabilities, representing 96% of our total liabilities at December 31, 1998 and 67% of
our total liabilities at December 31, 2003. The deferred acquisition costs associated with the
agreement declined from over 97% of our total deferred policy acquisition costs asset at December
31, 1998 and 1999 to 48% of our total deferred acquisition costs at December 31, 2003, primarily
because of the 2001 and 2002 write downs. On December 31, 2004, we entered into a binding letter of intent which provided that
Transamerica would terminate this annuity reinsurance agreement and recapture all business ceded
under the agreement effective as of December 1, 2004. Pursuant to the letter of intent with
Transamerica, on January 31, 2005, we executed definitive documents and completed the termination
and recapture of our annuity reinsurance agreement with Transamerica. As a result, at December 31,
2004, we no longer recorded any Funds withheld at interest asset, Interest sensitive contract
liability or deferred acquisition costs relating to the agreement, although we incurred substantial
charges in the fourth quarter of 2004 relating to the termination of the Transamerica agreement.
These charges were due to payments to Transamerica and the write off of deferred acquisition costs
and Funds withheld at interest assets in excess of reserves for Interest sensitive contract
liabilities. Please see Item 7. Managements Discussion and Analysis of Financial Condition and
Results of Operation. As a result of the changes to our remaining book of business, especially the termination of
our annuity reinsurance agreements with Ohio National in February 2003 and with Transamerica in
December 2004, we expect that the assets and liabilities associated with our remaining annuity
agreement with The Lafayette Life Insurance Company (Lafayette) will represent a significant
portion of our total assets and - 7 -




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liabilities in future periods. The amount of deferred acquisition costs we record as an asset
on our balance sheet related to our annuity agreement with Lafayette is based on a series of
assumptions related to the investment performance of the assets supporting our liabilities under
the contract, as well as future lapse rates for the underlying policies. These assumed lapse rates
include assumptions regarding future full surrenders, partial withdrawals, annuitizations and
policyholder deaths. While we believe the investment and lapse estimates to be reasonable, they are
estimates of future events and we cannot assure you that they will prove to be accurate. If such
assumptions turn out to be inaccurate, we could be required to write off some or all of the
deferred acquisition costs associated with the agreement, which would have an adverse impact on our
results of operations in future periods. Policy Benefit Liabilities and Interest Sensitive Contracts Liabilities Policy benefit liabilities and interest sensitive contracts liabilities comprise the majority
of our financial obligations. Policy benefit liabilities for our products other than annuities are
based upon our estimates of mortality, persistency, investment income and expenses, with allowances
for adverse deviation. The liabilities for policy benefits established by us with respect to
individual risks or classes of business may be greater or less than those established by our ceding
companies due to their use of different mortality and other assumptions. Policy benefit liabilities
include both mortality and morbidity claims in the process of settlement and an estimate of claims
that have been incurred by our ceding companies but not yet reported to us. Actual experience in a
particular period may be worse than assumed experience and, consequently, may adversely affect our
operating results for the period. Approximately $82.2 million of our policy benefit liabilities at December 31, 2004 represent
policy obligations we assumed as a result of the acquisition of our United States operating
subsidiary in June 2000. These policy obligations are 100% ceded to Reassure America Life Insurance
Company, a subsidiary of the seller, Swiss Re Life and Health, America. As the direct issuer of
those policies, Annuity and Life Reassurance America remains liable to policyholders in the event
the reinsurer is unable to pay its obligations to us under the reinsurance agreement. Reassure
America Life Insurance Companys financial strength is rated A+ (Superior) by A.M. Best as of
December 31, 2004. 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
contracts. Investments Invested Assets 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 and limit investment in fixed income securities that are non-rated or
below investment grade at the time of purchase to an aggregate of $3,000,000. In 2004, we invested
approximately $900,000 in securities that were non-rated at the time of their purchase. While any
investment carries some risk, the risks associated with non-rated or lower-rated securities
generally are greater than the risks associated with investment grade securities. 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 issuers;
however, the issuers capacity to meet its financial commitment on the security is still considered
to be strong. We currently do not invest in any fixed income securities in emerging markets. Prudential Investment Corporation serves as our advisor for our general investment portfolio.
Our investment management agreement with Prudential may be terminated by either party with 45 days
notice. Our Board of Directors periodically reviews the performance of Prudential and the fees
associated with this arrangement. - 8 -




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At December 31, 2004, our invested assets, including cash and cash equivalents, had an
aggregate fair value of $138,428,894, including gross unrealized gains of $1,266,517. At December
31, 2004, our fixed-income portfolio was comprised of fixed income securities with a weighted
average credit quality rating of AA and a weighted average duration of 2.9 years. The effective
yield rate earned on our total invested assets was approximately 3.51% for the year ended December
31, 2004. The yield on our fixed income portfolio was 6.33% for the same period. The effective
yield rate equals net investment income divided by the average of our total adjusted invested
assets at the end of each calendar quarter in the year ended December 31, 2004. The effective
yield rate on our total invested assets is significantly lower than the yield on our fixed-income
portfolio because approximately 33% of the total portfolio was in cash and cash equivalents for the
majority of the year. At December 31, 2004, we continued to hold a large portion of our general
account assets in short duration investments because of the low interest rate environment and the
belief that interest rates may likely continue to rise. Our results of operations and our financial condition are significantly affected by the
performance of our investments and by changes in interest rates. During a period of declining
interest rates, if our investments are prematurely sold, called, prepaid or redeemed, we may be
unable to reinvest the proceeds in securities of equivalent risk with comparable rates of return.
During a period of rising interest rates, the fair value of our invested assets could decline. In
addition, rising interest rates could also cause disintermediation, which in turn could cause us to
sell investments at prices and times when the fair values of such investments are less than their
amortized cost. We believe that our traditional life insurance liabilities are not highly interest
rate sensitive and, therefore, the effects of fluctuating interest rates on these liabilities are
not significant. For interest sensitive liabilities, we are primarily dependent upon asset/
liability matching or other strategies to minimize the impact of changes in interest rates. If we
do not appropriately match the asset management strategy to our obligations, we could sustain
losses. We may use interest rate swaps and other financial instruments as tools to mitigate the
effects of asset/liability mismatches or the effect of interest rate changes on our balance sheet.
In general, however, we do not hedge our investment risk. Our results of operations are also
significantly affected by the performance of assets held and managed by our ceding companies or
others under modified coinsurance and coinsurance funds withheld arrangements, as discussed below
under Funds Withheld at Interest. Funds Withheld at Interest As of December 31, 2004, our ceding companies had approximately $56.4 million in assets that
were held and managed by or for them under our modified coinsurance and coinsurance funds withheld
arrangements. Approximately $51.3 million of the funds withheld at interest relates to our
modified coinsurance annuity reinsurance agreement with Lafayette, with the balance related to a
coinsurance funds withheld life reinsurance agreement. Our annuity reinsurance agreement with Lafayette covers general account fixed deferred annuity
policies and is structured as a modified coinsurance arrangement. In this type of arrangement, the
ceding company invests the premiums received from policyholders or engages an investment manager to
do so, credits interest to policyholders accounts, processes surrenders and engages in other
administrative activities. The ceding company is also required to carry reserves for these annuity
policies based upon certain statutory rules in the state in which the ceding company is domiciled.
The underlying investments purchased with the premiums received from policyholders support these
statutory reserves. When a ceding company enters into a reinsurance contract structured as a modified coinsurance
arrangement with us, a portion of the ceding companys liability to the policyholders is ceded to
us. The portion 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 that is equal to our fixed portion of the statutory reserves carried by the
ceding company. 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 statutory reserve. - 9 -




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At December 31, 2004, our Funds withheld at interest receivable related to our annuity
reinsurance agreement with Lafayette had a carrying value of approximately $51.3 million. At
December 31, 2004, the assets held and managed by Lafayette were invested in fixed income
securities having a weighted average credit quality of A- and a weighted average duration of 3.7
years. In addition, at December 31, 2004, no such assets were invested in below investment grade
securities. The average yield rate earned on the assets held and managed under our annuity
reinsurance agreements (which includes Transamerica through November 30, 2004) was approximately
2.88% for the year ended December 31, 2004. The average yield rate earned on the invested premiums
funding our annuity obligations to Transamerica was approximately 2.65% for the year ended December
31, 2004. The average yield rate earned on the invested premiums funding our annuity obligations
to Lafayette was approximately 4.79% for the year ended December 31, 2004. These average yield
rates are based upon cash settlements between us and our ceding companies under our annuity
reinsurance agreements and do not include unrealized gains or losses in the underlying investment
portfolio. For purposes of calculating the average yield rates earned on assets held and managed by
our ceding companies under our annuity reinsurance agreements, we only include net realized capital
gains and losses as reported to us through our settlements with these ceding companies. The performance of the assets held and managed by our ceding companies depends to a great
extent on the ability of the ceding company and its investment managers to make appropriate
investments consistent with their investment guidelines. If these assets do not achieve investment
returns sufficient to meet our obligations on the underlying policies, we could experience
unexpected losses, as has happened under our annuity reinsurance agreement with Transamerica, where
the minimum interest guarantees on the underlying policies exceeded the underlying policyholder
account values due to poor investment performance, and we were forced to fund our proportionate
share of the shortfall. Our policy has been to seek counterparties for our annuity reinsurance treaties that have
strong financial strength and credit ratings. Although such ratings are assigned by independent
ratings agencies and are generally regarded as reliable, there can be no assurance that they
accurately reflect the financial condition of any of our counterparties. At December 31, 2004,
Lafayette, the ceding company under our remaining annuity reinsurance agreement, had financial
strength or claims paying ratings of A from A.M. Best, Standard & Poors and Fitch Ratings. Embedded Derivatives We have concluded that there is an embedded derivative within the Funds withheld at interest
receivable related to our Lafayette annuity reinsurance agreement that requires bifurcation and
separate accounting under Statement of Financial Accounting Standards No. 133  Accounting for
Derivative Instruments and Hedging Activities. This embedded derivative is similar to a total
return swap arrangement on the underlying assets held by our ceding company under the agreement.
The fair value of the embedded derivative 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 agreement. The fair value of the
embedded derivative is influenced by changes in credit risk, changes in expected future cash flows
under the annuity reinsurance agreement and interest rates. The change in fair value of the
embedded derivative is recorded in our statement of operations as the net change in fair value of
embedded derivatives. The change in fair value of the embedded derivative also impacts the
emergence of expected gross profits for purposes of amortizing deferred acquisition costs
associated with the contract. Consequently, the application of this accounting policy has increased
the volatility of our results of operations. While we have made an estimate of the fair value of
the embedded derivative 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. Changes
in our assumptions could have a significant impact on the fair value of the embedded derivative and
our results of operations. - 10 -




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Competition The reinsurance industry is highly competitive. We have historically competed with
approximately 20 reinsurers, both domestic and foreign, of annuity or life insurance products in
our traditional target market of North America. Reinsurers in our market typically compete on the
basis of many factors, including premium charges, terms and conditions of reinsurance policies,
financial ratings, reputation, claims adjudication philosophy and general industry experience. In
the event we resume writing new business in the future, other reinsurance industry participants
will likely have stronger financial ratings, better operating histories and substantially greater
financial and management resources than our company. Financial Ratings 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, as last
reported. At the Companys request, all three financial ratings have been withdrawn. Although we
currently are not writing new reinsurance treaties, in the event that we are able to position
ourselves to write new business in the future, we cannot provide assurance that we will be able to
attract and retain new customers if we are not able to obtain adequate financial ratings as part of
a plan to write new business or products. Employees As of December 31, 2004, we had eight employees located in Bermuda and two employees located
in the United States. Investor Relations Information on Internet Website We maintain an Internet website at www.alre.bm, although the information contained on our
Internet website is not part of this report. We make our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed with or
furnished to the Securities and Exchange Commission (the SEC) pursuant to Section 13(a) or 15(d)
of the Securities Exchange Act of 1934, as amended, available free of charge on or through our
Internet website as soon as reasonably practicable after each is filed with or furnished to the
SEC. In addition, on our Internet website, you may view the following corporate governance
materials: the Companys Corporate Governance Guidelines, the Code of Business Conduct and Ethics,
and the Audit, Compensation and Corporate Governance Committee Charters. Note that our Code of
Business Conduct and Ethics contains a code of ethics, as defined under SEC regulations, applicable
to our Principal Executive Officer, Principal Financial Officer and Principal Accounting Officer.
We will voluntarily provide electronic or paper copies of our SEC reports (other than exhibits) and
our corporate governance materials free of charge upon request to Investor Relations, Annuity and
Life Re (Holdings), Ltd., P.O. Box HM 98, Hamilton, HM AX, Bermuda, telephone number (441)
296-7667. In addition to posting our corporate governance materials on our Internet website, we intend
to satisfy Item 5.05 of Form 8-K, regarding amendments to and waivers under our Code of Business
Conduct and Ethics applicable to our Principal Executive Officer, Principal Financial Officer and
Principal Accounting Officer, by providing the relevant information on our Internet website within
five days of the amendment or waiver and by keeping the information posted for at least 12 months
thereafter. In addition, any waivers granted to directors and executive officers under, and any
amendments to, the Code of Business Conduct and Ethics will be promptly disclosed on our Internet
website. If we do not post on our website any such waiver or amendment, we will file a Form 8-K to
disclose that waiver or amendment, as applicable. - 11 -




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Regulation Bermuda As a holding company, Annuity and Life Re (Holdings) is not subject to Bermuda insurance
regulations. Annuity and Life Reassurance Ltd., our Bermuda operating subsidiary, is licensed as a
long-term insurer under the Bermuda Insurance Act of 1978, as amended, and related regulations
(collectively, the Insurance Act). The Insurance Act, which regulates the insurance business of
Annuity and Life Reassurance, provides that no person shall carry on an insurance business in
Bermuda unless registered as an insurer under the Insurance Act by the Bermuda Monetary Authority
(the Authority). The registration of an applicant as an insurer is subject to its complying with
the terms of its registration and such other conditions as the Authority may impose at any time. The Insurance Act imposes on Bermuda insurance companies solvency and liquidity standards and
auditing and reporting requirements and grants to the Authority powers to supervise, investigate
and intervene in the affairs of insurance companies. Further deterioration of our financial
condition will likely expose our operations in Bermuda to an increased level of regulatory scrutiny
and could possibly lead to the Authority petitioning for the winding up of our company. Some of the
significant aspects of the Bermuda insurance regulatory framework are set forth below. Classification of Insurers.The Insurance Act distinguishes between insurers carrying on
long-term business and insurers carrying on general business. Because Annuity and Life Reassurance
has been incorporated to provide reinsurance of annuity and life insurance related risks, it is
registered as a long-term insurer. Cancellation of Insurers Registration.An insurers registration may be cancelled by the
Authority on certain grounds specified in the Insurance Act. These grounds include failure of the
insurer to comply with its obligations under the Insurance Act or with a condition imposed on its
registrations or, if in the opinion of the Authority, the insurer has not been carrying on business
in accordance with sound insurance principles. Independent Approved Auditor.Every registered insurer must appoint an independent auditor who
will annually audit and report on the Statutory Financial Statements and the Statutory Financial
Return of the insurer, which are required to be filed annually with the Authority in Bermuda. The
independent auditor of the insurer must be approved by the Authority and may be the same person or
firm that audits the insurers financial statements and reports for presentation to its
shareholders. Annuity and Life Reassurance Ltd.s independent auditor for its Statutory Financial
Statements is Arthur Morris, Christensen & Co. LLP. Approved Actuary.Annuity and Life Reassurance Ltd., as a registered long-term insurer, is
required to submit an annual actuarys certificate when filing its Statutory Financial Return. The
actuarys certificate must state whether or not, in the opinion of the insurers approved actuary,
the aggregate amount of the liabilities of the insurer in relation to long-term business as at the
end of the relevant year exceeded the aggregate amount of those liabilities as shown in the
insurers statutory balance sheet. The approved actuary, who will normally be a qualified life
actuary, must be approved by the Authority. Annuity and Life Reassurance Ltd.s approved actuary is
William H. Mawdsley, who is Chief Actuary of the Company. Statutory Financial Statements.An insurer must prepare annual Statutory Financial Statements.
The Insurance Act prescribes rules for the preparation and substance of these Statutory Financial
Statements (which include, in statutory form, a balance sheet, income statement, a statement of
capital and surplus and notes thereto). The insurer is required to give detailed information and
analyses regarding premiums, claims, reinsurance and investments. An insurer is required to submit
the annual Statutory Financial Statements as part of the annual Statutory Financial Return. Minimum Solvency Margin.Under the Insurance Act, Annuity and Life Reassurance Ltd. must
ensure that the value of its long-term business assets exceeds the amount of its long-term business
liabilities by at least $250,000. Further, Annuity and Life Reassurance is prohibited from
declaring or paying any - 12 -




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dividends during any financial year if it is in breach of its minimum solvency margin, or if
the declaration or payment of such dividends would cause it to fail to meet such margin. If Annuity
and Life Reassurance Ltd. fails to meet its minimum solvency margin on the last day of any year, it
will be prohibited, without the approval of the Authority, from declaring or paying any dividends
during the next financial year. Also, under the Insurance Act, Annuity and Life Reassurance is
prohibited, without the approval of the Authority, from reducing by 15% or more its total statutory
capital as set out in its previous years financial statements. Annual Statutory Financial Return.Annuity and Life Reassurance Ltd. is required to file with
the Authority in Bermuda a Statutory Financial Return no later than four months after its fiscal
year-end (unless specifically extended). The Statutory Financial Return includes, among other
matters, a report of the approved independent auditor on the Statutory Financial Statements of the
insurer, a solvency certificate, Statutory Financial Statements and a certificate of the approved
actuary. The solvency certificate must be signed by our Principal Representative and at least two
directors. The directors are required to certify whether the minimum margin of solvency has been
met and the independent auditor is required to state whether in his opinion it was reasonable for
the directors to so certify. Where an insurers accounts have been audited for any purpose other
than compliance with the Insurance Act, a statement to that effect must be filed with the Statutory
Financial Return. Supervision, Investigation and Intervention.The Authority may appoint an inspector with
extensive powers to investigate the affairs of an insurer if the Authority believes that an
investigation is required in the interest of the insurers policyholders or potential
policyholders. In order to verify or supplement information otherwise provided to the Authority,
the Authority may direct an insurer to produce documents or information relating to matters
connected with the insurers business. If it appears to the Authority that there is a risk of the insurer becoming insolvent, or that
it is in breach of the Insurance Act or any conditions imposed upon its registration, the Authority
may, among other things, direct the insurer (i) not to take on any new insurance business, (ii) not
to vary any insurance contract if the effect would be to increase the insurers liabilities, (iii)
not to make certain investments, (iv) to realize certain investments, (v) to maintain, or transfer
to the custody of a specified bank, certain assets, (vi) not to declare or pay any dividends or
other distributions or to restrict the making of such payments, and/or (vii) to limit its premium
income. Principal Representative.Under the Insurance Act, an insurer is required to maintain a
principal office in Bermuda and to appoint and maintain a principal representative in Bermuda. For
the purpose of the Insurance Act, the principal office of Annuity and Life Reassurance is at our
offices in Hamilton, Bermuda, and John F. Burke, our Chief Executive Officer and President, is the
principal representative of Annuity and Life Reassurance. Without a reason acceptable to the
Authority, an insurer may not terminate the appointment of its principal representative, and the
principal representative may not cease to act as such, unless 30 days notice in writing to the
Authority is given of the intention to do so. It is the duty of the principal representative,
within 30 days of reaching the view that there is a likelihood of the insurer becoming insolvent or
that a reportable event has, to the principal representatives knowledge, occurred or is believed
to have occurred, to make a report in writing to the Authority setting out all the particulars of
the case that are available to the principal representative. Examples of such a reportable event
include failure by the insurer to comply substantially with a condition imposed upon the insurer by
the Authority relating to a solvency margin or certain other ratios. Long-term Business Fund.An insurer carrying on long-term business is required to keep its
accounts in respect of its long-term business separate from any accounts kept in respect of any
other business. All receipts of Annuity and Life Reassurances long-term business form part of its
long-term business fund. No payment may be made directly or indirectly from an insurers long-term
business fund for any purpose other than a purpose related to the insurers long-term business,
unless such payment can be made out of any surplus (certified by the insurers approved actuary) to
be available for distribution otherwise than to policyholders. Annuity and Life Reassurance may not
declare or pay a dividend to any person other than a policyholder unless the value of the assets in
its long-term business fund (as certified by the insurers approved actuary) exceeds the
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approved actuary) by the amount of the dividend and at least the $250,000 minimum solvency
margin prescribed by the Insurance Act, and the amount of any such dividend may not exceed the
aggregate of that excess (excluding the said $250,000) and any other funds properly available for
payment of dividends, such as funds arising out of the business of the insurer other than long-term
business. Certain Bermuda Law Considerations.We have been designated as non-resident for exchange
control purposes by the Authority whose permission for the issue and transfer of our common shares
has been obtained, as discussed below. This designation allows us to engage in transactions, or to
pay dividends to non-residents of Bermuda who are holders of our common shares, in currencies other
than the Bermuda Dollar. We have the consent from the Authority under the Exchange Control Act 1972 and regulations
thereunder allowing for the transfer of our common shares between persons regarded as non-resident
in Bermuda for exchange control purposes and our issuance of common shares to such persons,
provided that the shares remain listed on an appointed stock exchange or are trading on the OTC
Bulletin Board or in the Pink Sheets. In addition, issues and transfers of the common shares to any person regarded as resident in
Bermuda for exchange control purposes require specific prior approval under the Exchange Control
Act 1972. The common shares of Annuity and Life Reassurance Ltd. cannot be transferred without the
consent of the Authority. As exempted companies, Annuity and Life Re (Holdings) and Annuity and Life Reassurance Ltd.
are exempt from Bermuda laws restricting the percentage of share capital that may be held by
non-Bermudians, but as exempted companies they may not participate in certain business
transactions, including (i) the acquisition or holding of land in Bermuda (except that required for
our business and held by way of lease or tenancy for terms of not more than 21 years) without the
express authorization of the Bermuda legislature, (ii) the taking of mortgages on land in Bermuda
to secure an amount in excess of $50,000 without the consent of the Bermuda Minister of Finance,
(iii) the acquisition of any bonds or debentures secured by any land in Bermuda, other than certain
types of Bermuda government securities, or (iv) the carrying on of business of any kind in Bermuda,
including insuring domestic risks, except in furtherance of their business carried on outside
Bermuda, and, in the case of Annuity and Life Reassurance, reinsuring any long-term business risks
undertaken by any company incorporated in Bermuda and permitted to engage in the insurance and
reinsurance business, or under a license granted by the Bermuda Minister of Finance. United States General.Our Bermuda operating subsidiary, Annuity and Life Reassurance, is not licensed or
admitted as an insurer in any state of the United States and is not directly subject to regulation
in any state of the United States. The insurance laws of each state in the United States regulate
the sale of insurance and reinsurance within their jurisdiction by reinsurers, such as Annuity and
Life Reassurance, which are not licensed or admitted to do business within such jurisdiction.
Annuity and Life Reassurance conducts its business through its Bermuda office. Annuity and Life
Reassurance does not maintain an office, and its personnel do not solicit, advertise, settle claims
or conduct other activities that may constitute the transaction of the business of insurance, in
any jurisdiction in which it is not licensed or otherwise authorized to engage in such activities. Our United States operating subsidiary, Annuity and Life Reassurance America is licensed and
authorized to conduct life insurance business in over 40 states of the United States and the
District of Columbia. The insurance laws and regulations, as well as the supervisory authority that
may be exercised by the various insurance departments in the United States, vary by jurisdiction,
but generally grant broad powers to supervisory agencies or regulators to examine and supervise
insurance companies and insurance holding companies with respect to the conduct of their insurance
business. These laws and regulations generally require insurance companies to meet certain solvency
standards, asset tests, standards of business conduct, guarantee fund assessments and to file
certain reports with regulatory authorities, including - 14 -




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information concerning their capital structure, ownership and financial condition. The
insurance laws of Connecticut have the most significant impact on Annuity and Life Reassurance
America because that is its state of domicile. Annuity and Life Re America (our wholly-owned U.S. holding company) is domiciled in Delaware
and regulated as a Delaware corporation. The Delaware insurance holding company system laws and
regulations generally do not apply to Annuity and Life Re America because it is not an insurer and
because Annuity and Life Reassurance America is not required to file registration statements with
the Delaware Insurance Commissioner under applicable provisions of such laws and regulations. The
books and records of Annuity and Life Re America may be subject to inspection by the Connecticut
insurance regulators because Annuity and Life Re America is an affiliate of Annuity and Life
Reassurance America, which is subject to Connecticuts laws governing insurance company systems. The Connecticut insurance laws (applicable to Annuity and Life Reassurance America) require
that transactions between or among Annuity and Life Reassurance America and any of its affiliates,
including the payment of ordinary dividends to shareholders, shall be subject to the following
requirements: (i) the terms shall be fair and reasonable; (ii) charges or fees for services
performed shall be reasonable; (iii) expenses incurred and payment received shall be allocated to
Annuity and Life Reassurance America in conformity with customary insurance accounting practices
consistently applied; (iv) the books, accounts and records of each party shall be so maintained as
to clearly and accurately disclose the precise nature and details of the transactions, including
such accounting information as is necessary to support the reasonableness of the charges or fees to
the respective parties; and (v) Annuity and Life Reassurance Americas surplus with respect to
policyholders shall be reasonable in relation to its outstanding liabilities and adequate to meet
its financial needs. In addition, certain transactions, such as the payment of dividends, between
or among Annuity and Life Reassurance America may not be entered into until notice of such
transactions has been provided to the Connecticut Insurance Commissioner, and the Commissioner
either approves the transaction or a thirty-day waiting period has passed during which the
Commissioner has not disapproved the transaction. Current Connecticut law permits the payment of ordinary shareholder dividends or
distributions, the fair market value of which, together with that of other dividends or
distributions made during the preceding twelve months, does not exceed the greater of (i) 10% of
Annuity and Life Reassurance Americas statutory surplus as regards policyholders as of the
immediately preceding December 31, or (ii) statutory net gain from operations for the immediately
preceding calendar year, excluding pro rata distributions of any class of Annuity and Life
Reassurance Americas own securities. Any proposed dividend in excess of this amount is considered
an extraordinary dividend and may not be paid until it has been approved, or a thirty-day waiting
period has passed during which the Connecticut Insurance Commissioner has not disapproved the
dividend. In addition, except as otherwise provided by law, no dividend or other distribution
exceeding an amount equal to Annuity and Life Reassurance Americas earned surplus may be paid
without the prior approval of the Connecticut Insurance Commissioner. If the Connecticut Insurance Commissioner determines that Annuity and Life Reassurance America
paid or is about to pay a dividend, or committed or is about to commit another act, in violation of
the Connecticut insurance laws referenced above, the Commissioner may, among other things, apply
for an order enjoining Annuity and Life Reassurance America from violating or continuing such
violation of the insurance laws. The Connecticut Insurance Commissioner has the authority to apply
for an order authorizing him to rehabilitate an insurer if the Connecticut Insurance Commissioner
determines that such insurer is in such condition that the further transaction of business would be
hazardous, financially, to its policyholders, creditors or the public. If the Connecticut Insurance
Commissioner finds, among other things, that further attempts to rehabilitate the insurer are
futile, he may request a petition for an order of liquidation from a Connecticut court. Under Connecticut insurance regulations, the Connecticut Insurance Commissioner is required to
perform regular financial examinations of insurance companies under its jurisdiction at least every
three to five years. We have been notified that in April 2005, the Commissioner plans to examine
the Statutory Financial Statements of Annuity and Life Reassurance America for the three year
period ended December - 15 -




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##### Table of Contents



31, 2004. In August 2002, the Commissioner completed an examination of Annuity and Life
Reassurance America that covered the period of time since we purchased Capitol Bankers Life
Insurance Company in May 2000, which was renamed by Annuity and Life Reassurance America upon its
acquisition, through December 31, 2001. Credit for Reinsurance.In addition to the regulatory requirements imposed by the
jurisdictions in which a reinsurer is licensed, a reinsurers business operations are affected by
regulatory requirements in other jurisdictions governing credit for reinsurance which are imposed
on its ceding companies. In general, a ceding company which obtains reinsurance from a reinsurer
that is licensed, accredited or approved by the insurance regulator of the ceding companys
domiciliary jurisdiction is permitted to reflect in its statutory financial statements a credit in
an aggregate amount equal to the liability for policy reserves, claims and other amounts ceded to
such reinsurer. Many jurisdictions permit ceding companies to take credit on their statutory
financial statements for reinsurance obtained from unlicensed or non-admitted reinsurers only if
adequate security is posted. Because our operating subsidiary Annuity and Life Reassurance is not
licensed, accredited or approved in any jurisdiction except Bermuda, its reinsurance contracts
typically require it to post a letter of credit or other security. At December 31, 2004, we had satisfied the collateral requirements of all of our ceding
companies. Although our liquidity position has improved following the novation and recapture
transactions we completed with Transamerica, a large portion of our cash and investments is held by
our United States operating subsidiary or is posted as collateral under our remaining life
reinsurance agreements and is unavailable to fund our operations or those of our Bermuda operating
subsidiary. 
 Item 2.Properties. We conduct our operations from leased office space located at Cumberland House, 1 Victoria
Street, Hamilton, HM 11, Bermuda. Annuity and Life Re America conducts its operations from leased
space located at 280 Trumbull Street, Hartford, Connecticut, USA. We believe our space is adequate
to meet our current and future needs. 
 Item 3.Legal Proceedings. On and since December 4, 2002, certain of our shareholders, seeking to act as class
representatives, filed 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. On October 1, 2003, we
answered the amended and consolidated complaint and denied liability on the claims the plaintiffs
had asserted. In January 2004, the court ordered that a related action that the plaintiffs filed
against the KPMG LLP (United States) and KPMG in Bermuda be consolidated with the action against
us. In February 2004, the court denied certain individual defendants motions to dismiss the
action. In March 2004, the court denied motions to dismiss filed by certain other individual
defendants and XL Capital Ltd. Also in March 2004, KPMG LLP (United States) and KPMG in Bermuda
filed motions to dismiss the action. The court has not yet ruled on KPMG LLPs (United States) and
KPMG in Bermudas respective motions to dismiss. On July 20, 2004, we announced that we had reached an agreement in principle with the
plaintiffs, subject to full documentation by the parties to the settlement, notice to the class,
court approval and other steps required to consummate a class action settlement, to settle the
lawsuit. In August 2004, the parties to the settlement executed and filed a Stipulation setting
forth their settlement agreement, and sought court approval. The parties to the settlement are the
plaintiffs and the class (which consists, subject to certain exclusions, of persons who purchased
our common shares between March 15, 2000 and November 19, 2002), our company, all individual
defendants and XL Capital Ltd. The settlement is without any admission of liability or wrongdoing.
We, along with our directors and officers liability carrier and XL Capital Ltd, agreed to pay an
aggregate of $16.5 million. Our share of the settlement was $2.5 million in cash, which we - 16 -




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##### Table of Contents



paid into escrow in August 2004, and an additional $2.5 million to be paid in cash or in
common shares (subject to a cap of 19.9% of the Companys outstanding shares) at our election. On
January 10, 2005, we elected to pay the remaining $2.5 million in cash, which we paid into escrow
on that date. In October 2004, the court ordered that notice of the settlement be given to class members,
set deadlines for class members to exclude themselves from the class or file objections to the
settlement, and scheduled a Settlement Fairness Hearing for January 2005. Following the Settlement
Fairness Hearing, the District Court entered an order and final judgment approving the settlement
in January 2005. Robert P. Johnson, one of our current directors, has filed a proof of claim to
participate in the settlement based on his transactions in our common shares during the class
period and prior to joining our board of directors. On October 8, 2003, we were served with a statutory demand for $640,000 from Imagine Group
Holdings Limited (Imagine), a Bermuda based reinsurance company, which was subsequently
withdrawn. Imagine has since instituted a civil proceeding in the Bermuda Supreme Court against us,
alleging that we are obligated to reimburse it for $640,000 of expenses incurred by Imagine in
connection with a proposed December 2002 capital raising transaction that was not consummated. On
March 11, 2004, we filed an amended defense with the court to which Imagine responded on April 26,
2004. We do not believe that Imagine is entitled to reimbursement of these expenses under the
applicable agreement and intend to defend ourselves against Imagine Res claims. There are no other material arbitration or other legal proceedings currently in process in
which we are involved. 
 Item 4.Submission of Matters to a Vote of Security Holders. During the fourth quarter of 2004, no matters were submitted to our security holders for a
vote. - 17 -




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##### Table of Contents



PART II 
  Item 5.
    Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Market Information Our common shares were traded on the New York Stock Exchange under the ticker symbol ANR
until the New York Stock Exchange suspended trading in our common shares prior to the market
opening on Friday, July 30, 2004. On August 17, 2004, our common shares began trading on the OTC
Bulletin Board under the ticker symbol ANNRF.OB. Based upon publicly available information on
trading in our shares, the high and low sales or bid prices per share of our common shares for each
calendar quarter for the years 2004 and 2003 were as follows: 2004
    
    
    2003Period
    
    High
    
    
    Low
    
    
    High
    
    
    LowJanuary 1  March 31
    
    $
    1.57
    
    
    $
    1.07
    
    
    $
    5.19
    
    
    $
    0.42April 1  June 30
    
    
    1.11
    
    
    
    0.82
    
    
    
    1.67
    
    
    
    0.55July 1  September 30
    
    
    0.81
    
    
    
    0.32
    

    
    
    1.39
    
    
    
    0.90October 1  December 31
    
    
    0.48
    
    
    
    0.27
    
    
    
    1.80
    
    
    
    1.06
 As of March 1, 2005, there were approximately 3,000 record holders of our outstanding common
shares, excluding participants in securities position listings. At March 1, 2005, the closing price
of our stock was $1.19 per common share. Dividends We did not pay any cash dividends on our common shares during 2003 or 2004. 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 and since December 31, 2002, we have not declared a dividend to
shareholders and we do not expect to declare or pay dividends to shareholders in the near future.
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 results of operations 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. For a discussion of other factors affecting our ability to pay dividends, see Item 1.
Business  Regulation, Item 7. Managements Discussion and Analysis of Financial Condition and
Results of Operations  Liquidity and Capital Resources and Note 17 to our Consolidated Financial
Statements included elsewhere in this report. Currently, there is no Bermuda withholding tax on
dividends paid by us to shareholders. - 18 -




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##### Table of Contents



Item 6.Selected Financial Data. Historical The following table sets forth selected financial data and other operating information. The
selected financial data has been derived from our consolidated financial statements and should be
read in conjunction with our consolidated financial statements and accompanying notes and Item 7.
Managements Discussion and Analysis of Financial Condition and Results of Operations included in
this report. For the Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Income Statement DataRevenuesNet premiums
    
    $
    48,297,706
    
    
    $
    166,972,840
    
    
    $
    344,097,441
    
    
    $
    251,793,237
    
    
    $
    168,404,022Investment income, net of related
expenses
    
    
    21,697,563
    
    
    
    29,042,223
    
    
    
    102,138,985
    
    
    
    91,128,696
    
    
    
    136,648,327Net realized investment gains (losses)
    
    
    439,536
    
    
    
    6,406,587
    
    
    
    19,749,266
    
    
    
    1,230,038
    
    
    
    (4,817,121
    )Net change in fair value of embedded
derivatives
    
    
    2,181,070
    
    
    
    16,692,688
    
    
    
    (25,846,110
    )
    
    
    5,029,027
    
    
    
    Surrender fees and other revenues
    
    
    4,475,691
    
    
    
    7,297,015
    
    
    
    16,156,437
    
    
    
    18,519,701
    
    
    
    6,915,870Total Revenues
    
    $
    77,091,566
    
    
    $
    226,411,353
    
    
    $
    456,296,019
    
    
    $
    367,700,699
    
    
    $
    307,151,098Benefits and ExpensesClaims and policy benefits
    
    $
    14,101,129
    
    
    $
    198,002,905
    
    
    $
    352,408,801
    
    
    $
    216,025,010
    
    
    $
    132,810,192Interest credited to interest
sensitive products
    
    
    5,399,460
    
    
    
    13,980,723
    
    
    
    71,370,616
    
    
    
    49,258,418
    
    
    
    65,842,303Policy acquisition costs and other
insurance expenses
    
    
    110,922,948
    
    
    
    128,549,288
    
    
    
    125,877,980
    
    
    
    126,580,549
    
    
    
    58,985,523Collateral costs

    
    
    
    
    
    
    
    
    
    
    12,948,115
    
    
    
    1,200,000
    
    
    
    Operating expenses
    
    
    14,628,524
    
    
    
    18,034,021
    
    
    
    22,577,792
    
    
    
    11,552,418
    
    
    
    10,411,344Total Benefits and Expenses
    
    $
    145,052,061
    
    
    $
    358,566,937
    
    
    $
    585,183,304
    
    
    $
    404,616,395
    
    
    $
    268,049,362(Loss) income before cumulative effect
of a change in accounting principle
    
    $
    (67,960,495
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )
    
    $
    (36,915,696
    )
    
    $
    39,101,736Cumulative effect of a change in
accounting principle
    
    
    (365,960
    )
    
    
    
    
    
    
    
    
    
    
    (3,665,735
    )
    
    
    Net (Loss) Income
    
    $
    (68,326,455
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )
    
    $
    (40,581,431
    )
    
    $
    39,101,736Basic (loss) income per common share
    
    $
    (2.64
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )
    
    $
    (1.59
    )
    
    $
    1.53Diluted (loss) income per common share
    
    $
    (2.64
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )
    
    $
    (1.59
    )
    
    $
    1.42Dividends per common share
    
    $
    0.00
    
    
    $
    0.00
    
    
    $
    0.20
    
    
    $
    0.20
    
    
    $
    0.16Weighted average shares outstanding
    
    
    25,856,995
    
    
    
    25,880,202
    
    
    
    25,738,724
    
    
    
    25,602,664
    
    
    
    25,499,999Balance Sheet Data (in thousands)Invested assets, including cash and cash
equivalents
    
    $
    138,429
    
    
    $
    197,881
    
    
    $
    306,346
    
    
    $
    423,780
    
    
    $
    321,819Funds withheld
    
    $
    56,415
    
    
    $
    667,825
    
    
    $
    1,427,093
    
    
    $
    1,489,689
    
    
    $
    1,530,110Total assets
    
    $
    289,405
    
    
    $
    1,029,882
    
    
    $
    2,044,698
    
    
    $
    2,310,773
    
    
    $
    2,226,602Stockholders equity
    
    $
    66,417
    
    
    $
    135,173
    
    
    $
    268,337
    
    
    $
    402,189
    
    
    $
    440,330Other Financial DataBook value per common share (1)
    
    $
    2.52
    
    
    $
    5.11
    
    
    $
    10.28
    
    
    $
    15.65
    
    
    $
    17.27Life insurance in force (in thousands)
    
    $
    2,344,200
    
    
    $
    17,510,000
    
    
    $
    117,511,000
    
    
    $
    117,400,000
    
    
    $
    77,019,000
   (1)
    
    Book value per share is computed by dividing stockholders equity at the end of the period by the number of common shares then outstanding. - 19 -




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##### Table of Contents



Pro Forma Effect of Novations, Recaptures and Terminations During 2004, we novated, negotiated the recapture of and terminated a significant amount of
our reinsurance business. In particular, as discussed elsewhere in this report, we negotiated the
termination and recapture of our annuity reinsurance agreement with Transamerica Occidental Life
Insurance Company (Transamerica), novated our life reinsurance agreements with Scottish Re
Limited (Scottish Re) and Fidelity and Guaranty Life Insurance Company (F&G) to Transamerica
and negotiated the recapture of our guaranteed minimum death benefit and guaranteed minimum income
benefit agreement with Connecticut General Life Insurance Company (CIGNA). Our audited
consolidated statement of operations for the year ended December 31, 2004 included in this report
reflects revenues and expenses from each novated, recaptured or terminated agreement from January
1, 2004 through the effective date of its novation, recapture or termination, as well as the cost
of its novation, recapture or termination. We expect that our statement of operations will be
substantially different in 2005 and subsequent years as a result of these transactions.
Accordingly, we have prepared a pro forma statement of operations to assist you in understanding
the operating results generated in 2004 by our remaining book of business. The pro forma statement of operations adjusts the reported GAAP statement of operations by
assuming that (1) all of the novation, recapture and termination transactions that had effective
dates in 2004 occurred on January 1, 2004 (which removes from reported net (loss) actual
performance for each agreement through its novation, recapture or termination date), and (2) there
was no gain or loss from the novation, recapture or termination transactions. No attempt has been
made to estimate the impact of the aforementioned adjustments on cash flow for the period or on net
investment income earned on the collateral underlying the novated life reinsurance agreements and
operating expenses. In addition, we have made no adjustment for $5,120,700 in settlement costs and
legal fees recorded as Operating expenses in 2004 in connection with the purported shareholder
class action lawsuit against our company and certain of our present and former directors and
officers. The court entered an order and final judgment approving the settlement of this suit in
January 2005. The full effect of the recapture and termination transactions is reflected in our
consolidated balance sheet as of December 31, 2004, and, consequently, no adjustments were required
to highlight the impact of these transactions on our consolidated balance sheet. The following pro forma figures are presented for informational purposes only and do not
purport to represent what our results of operations would actually have been had each of the
novation, recapture and termination transactions occurred on January 1, 2004 and should not be
considered indicative of our expected results of operations in 2005. For a discussion of certain
factors that could materially and adversely affect our operations, please see Item 7. Managements
Discussion and Analysis of Financial Conditions and Results of Operations Forward-Looking
Statements included in this report. - 20 -




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##### Table of Contents



Annuity and Life Re (Holdings), Ltd.
Pro Forma Consolidated Statement of Operation for the Year Ended December 31, 2004
(Unaudited and in U.S. Dollars) Transamerica
    
    
    
    
    
    
    Scottish Re/ F&GAnnuity
    
    
    
    
    
    
    Novations
    
    
    
    
    
    
    CIGNAReported
    
    
    Recapture
    
    
    
    
    
    
    to Transamerica
    
    
    
    
    
    
    Recapture
    
    
    
    
    
    
    Pro FormaRevenuesNet premiums
    
    $
    48,297,706
    
    
    $
    
    
    
    
    
    
    
    $
    (29,022,915
    )
    
    
    (F
    )
    
    $
    (1,302,433
    )
    
    
    (I
    )
    
    $
    17,972,358Investment income, net of
related expenses
    
    
    21,697,563
    
    
    
    (13,439,098
    )
    
    
    (A
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,258,465Net realized investment gains
    
    
    439,536
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    439,536Net change in fair value of
embedded derivatives
    
    
    2,181,070
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,181,070Surrender fees and other
revenues
    
    
    4,475,691
    
    
    
    (4,257,721
    )
    
    
    (B
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    217,970Total Revenues
    
    $
    77,091,566
    
    
    $
    (17,696,819
    )
    
    
    
    
    
    $
    (29,022,915
    )
    
    
    
    
    
    $
    (1,302,433
    )
    
    
    
    
    
    $
    29,069,399Benefits and ExpensesClaims and policy benefits
    
    $
    14,101,129
    
    
    $
    
    
    
    
    
    
    
    $
    2,330,468
    
    
    
    (G
    )
    
    $
    (2,637,020
    )
    
    
    (J
    )
    
    $
    13,794,577Interest credited to
interest sensitive products
    
    
    5,399,460
    
    
    
    (3,530,883
    )
    
    
    (C
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,868,577Policy acquisition costs and
other insurance expenses
    
    
    110,922,948
    
    
    
    (71,895,671
    )
    
    
    (D
    )
    
    
    (33,501,983
    )
    
    
    (H
    )
    
    
    (204,623
    )
    
    
    (K
    )
    
    
    5,320,671Operating expenses
    
    
    14,628,524
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,628,524Total Benefits and Expenses
    
    $
    145,052,061
    
    
    $
    (75,426,554
    )
    
    
    
    
    
    $
    (31,171,515
    )
    
    
    
    
    
    $
    (2,841,643
    )
    
    
    
    
    
    $
    35,612,349Loss before cumulative
effect of a change in
accounting principal
    
    $
    (67,960,495
    )
    
    $
    57,729,735
    
    
    
    
    
    
    $
    2,148,600
    
    
    
    
    
    
    $
    1,539,210
    
    
    
    
    
    
    $
    (6,542,950
    )Cumulative effect of a
change in accounting
principal
    
    
    (365,960
    )
    
    
    2,244,720
    
    
    
    (E
    )
    
    
    
    
    
    
    
    
    
    
    (1,878,760
    )
    
    
    (L
    )
    
    
    Net Loss
    
    $
    (68,326,455
    )
    
    $
    59,974,455
    
    
    
    
    
    
    $
    2,148,600
    
    
    
    
    
    
    $
    (339,550
    )
    
    
    
    
    
    $
    (6,542,950
    )Loss per common share before
cumulative effect of change
in accounting principal per
common share:Basic
    
    $
    (2.63
    )
    
    $
    2.24
    
    
    
    
    
    
    $
    0.08
    
    
    
    
    
    
    $
    0.06
    
    
    
    
    
    
    $
    (0.25
    )Diluted
    
    $
    (2.63
    )
    
    $
    2.24
    
    
    
    
    
    
    $
    0.08
    
    
    
    
    
    
    $
    0.06
    
    
    

    
    
    
    $
    (0.25
    )Cumulative effect of a
change in accounting
principal per common share:Basic
    
    $
    (0.01
    )
    
    $
    0.08
    
    
    
    
    
    
    $
    0.00
    
    
    
    
    
    
    $
    (0.07
    )
    
    
    
    
    
    $
    0.00Diluted
    
    $
    (0.01
    )
    
    $
    0.08
    
    
    
    
    
    
    $
    0.00
    
    
    
    
    
    
    $
    (0.07
    )
    
    
    
    
    
    $
    0.00Net loss per common share:Basic
    
    $
    (2.64
    )
    
    $
    2.32
    
    
    
    
    
    
    $
    0.08
    
    
    
    
    
    
    $
    (0.01
    )
    
    
    
    
    
    $
    (0.25
    )Diluted
    
    $
    (2.64
    )
    
    $
    2.32
    
    
    
    
    

    
    $
    0.08
    
    
    
    
    
    
    $
    (0.01
    )
    
    
    
    
    
    $
    (0.25
    )
   (A)
    
    To reflect reduced Net investment income as if the Transamerica annuity agreement did
not exist in 2004.(B)
    
    To reflect reduced Surrender fees and other revenues as if the Transamerica annuity
agreement did not exist in 2004.(C)
    
    To reflect reduced Interest credited to interest sensitive products as if the
Transamerica annuity agreement did not exist in 2004. Includes the release of interest sensitive contracts liability net of funds withheld at
interest and the termination premium of $14,000,000 paid to Transamerica in consideration
of the termination of this agreement as of December 1, 2004.(D)
    
    To reflect reduced Policy acquisition costs and other insurance expenses as if the
Transamerica annuity agreement did not exist in 2004. Includes the write down of deferred
acquisition costs of approximately $63,100,000 associated with the termination of this
agreement as of December 1, 2004.(E)
    
    To reflect the reversal of the application of SOP 03-1 to the Transamerica annuity
agreement as if that agreement did not exist in 2004. - 21 -




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##### Table of Contents



(F)
    
    To reflect reduced Premiums as if the Scottish Re and F&G life reinsurance agreements
novated to Transamerica did not exist in 2004.(G)
    
    To reflect reduced Claim and Policy Benefits as if the Scottish Re and F&G life
reinsurance agreements novated to Transamerica did not exist in 2004.(H)
    
    To reflect reduced Policy acquisition and other insurance expenses as if the Scottish
Re and F&G life reinsurance agreements novated to Transamerica did not exist in 2004.
Includes the write down of deferred acquisition costs of approximately $24,900,000
associated with the novation of these agreements as of December 31, 2004.(I)
    
    To reflect reduced Premiums as if the GMDB/GMIB agreement recaptured by CIGNA did not
exist in 2004.(J)
    
    To reflect reduced Claims and policy benefits as if the GMDB/GMIB agreement
recaptured by CIGNA did not exist in 2004.(K)
    
    To reflect reduced Policy acquisition costs and other insurance expenses as if the
GMDB/GMIB agreement recaptured by CIGNA did not exist in 2004.(L)
    
    To reflect the reversal of the application of SOP 03-1 to the GMDB/GMIB agreement
recaptured by CIGNA as if that agreement did not exist in 2004. - 22 -




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Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations. The following analysis of our consolidated financial condition and results of operations
should be read in conjunction with Item 6. Selected Financial Data and the consolidated financial
statements and accompanying notes included elsewhere in this report. Forward-Looking 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. We assume no obligation to update any forward-looking
statement to reflect actual results or changes in or additions to the factors affecting such
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, the
following:  
    While we believe we have sufficient operating liquidity to
sustain our operations through at least the next twelve months, we continue to
explore strategic alternatives to attempt to maximize shareholder
value. These alternatives include, but are not limited to, a merger,
sale, joint venture, sale of assets, including our remaining
reinsurance agreements, or other comparable transaction. We do not
know the terms upon which these transactions might be available, if at
all.
    As a Bermuda reinsurer, we are required to post collateral for the
statutory reserves ceded to us by U.S. based insurers and reinsurers.
Although our liquidity position has improved following the novation
and recapture transactions we completed with Transamerica Occidental
Life Insurance Company (Transamerica), a large portion of our cash
and investments is held by our U.S. operating subsidiary or is posted
as collateral under our remaining life reinsurance agreements and is
unavailable to fund our operations or those of our Bermuda operating
subsidiary.
    Under Bermuda law, a single creditor could make a statutory demand
upon us for satisfaction of obligations owed to that creditor. If the
statutory demand is held to be valid, and we are unable to satisfy our
obligations to that creditor, the creditor may institute proceedings
seeking the liquidation of our business.
    We have ceased to write new reinsurance agreements and are not
accepting new business on existing agreements. We do not anticipate
resuming writing new reinsurance agreements in the foreseeable future,
unless we are able to increase our cash and liquidity positions. As a
result, our cash flow and results of operations in the near future
will be based solely upon the performance of our remaining book of
business and the returns generated from our invested assets. Of our
remaining book of business, we have a few large reinsurance contracts
that represent a material concentration of our net premiums and
deferred policy acquisition costs. Our remaining annuity reinsurance
agreement represents the vast majority of our funds withheld at
interest asset and the entirety of our interest sensitive contract
liabilities. - 23 -




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
    Prior to requesting their withdrawal, the financial strength ratings
of both our operating subsidiaries had been downgraded to a level that
effectively precluded them from writing new business. We cannot assure
you that we will be able to obtain sufficient financial strength
ratings or increase our cash and liquidity positions to a level where
we can resume writing new business. If we are able to position
ourselves to write new business in the future, we cannot assure you
that we will be able to attract or retain customers.
    The New York Stock Exchange suspended trading in our common shares
prior to the market opening on Friday July 30, 2004. The NYSEs action
was taken because we had again fallen below the NYSEs continued
listing standards, as the average closing price of our common shares
had been less than $1.00 over a consecutive 30-trading-day period. On
August 17, 2004, our common shares began trading on the OTC Bulletin
Board under the ticker symbol ANNRF.OB. We cannot assure you that we
will be able to list our common shares for trading on any other
national exchange or automated quotation system, which will adversely
affect the public market for and liquidity of our common shares, and
may adversely affect any capital raising or other strategic
transactions we may choose to pursue in the future.
    In preparing our financial statements, we use estimates and
assumptions based upon the best information available and managements
best judgment at the time our financial statements are prepared. The
most significant estimates relate to policyholder benefit reserves for
the life and annuity business, the recoverability of deferred
acquisition costs and the fair value of the embedded derivatives
related to our remaining annuity reinsurance agreement. These
estimates require us to make assumptions about, among other things,
future mortality, persistency, lapses, expenses and investment
performance based upon historical results and information provided to
us by our ceding companies. While we believe these estimates to be
reasonable, we cannot assure you that they will be accurate. If these
estimates prove to be inaccurate, they could have a significant
adverse impact on our financial condition and results of operations.
    We are exposed to the risk that the level of death claims we receive
will exceed that which we assumed in pricing our reinsurance
contracts. In 2001, 2002 and 2003, we had substantial unexpected
adverse mortality experience compared to our original pricing
assumptions under many of our life reinsurance contracts. Mortality
experience that is less favorable than we assumed in pricing a
reinsurance agreement will negatively affect our results of
operations. Furthermore, even if the total benefits paid over the life
of a contract do not exceed the expected amount, unexpected increases
in the incidence of deaths or the size of individual claims can cause
us to pay more benefits in a given accounting period than expected,
adversely impacting the results of operations in any particular
quarter or year.
    Our continued operations are dependent on our ability, and the ability
of our ceding companies, to manage investment risks. Unexpected
volatility or illiquidity in the markets in which we directly or
indirectly hold positions could adversely affect our business. Our
investments and the assets held and managed by our ceding companies
may include a limited amount of investments in below investment grade
fixed income securities. While any investment carries some risk, the
risks associated with lower-rated securities generally are greater
than the risks associated with investment grade securities.
    As of the date of this report, approximately $56.4 million of the
assets supporting the policies we reinsure were held and managed by
our ceding companies or their investment managers under modified
coinsurance and coinsurance funds withheld arrangements. A significant
portion of our total investments is therefore dependent upon the
investment decisions of third parties over whom we have limited, if
any, control.
    Our ability to satisfy our obligations under our reinsurance contracts
is significantly affected by the performance of our investments and
the invested assets held and managed by our ceding companies. For
example, if the invested assets held and managed by the ceding company
under our annuity - 24 -




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reinsurance agreement with the Lafayette Life
Insurance Company (Lafayette) do not accumulate at rates sufficient
to allow us to meet our obligations, we could be forced to fund any
shortfalls in these policy benefits, which would adversely affect our
business.
    Significant changes in interest rates expose us to the risk of reduced
investment income when interest rates are falling and to greater
realized losses from the sale of securities when interest rates are
rising. In addition, changes in interest rates can negatively affect
the income we derive from the spreads between the interest rates
earned on investments and the credited interest rates paid on the
policies that we reinsure. If interest rates decline below current
levels, our investment yields may be insufficient to cover the
credited interest rates paid under the policies we reinsure, which
would adversely affect our business.
    Pursuant to SFAS No. 133  Accounting for Derivative Instruments and
Hedging Activities, our annuity reinsurance agreement with Lafayette
is deemed to host an embedded derivative that must be bifurcated and
accounted for separately. The change in the fair value of the embedded
derivative is primarily driven by credit risk related changes in the
market value of assets underlying the contract, changes in expected
future cash flows under the annuity reinsurance agreement and changes
in interest rates. The change in fair value is reported on our
statements of operations, thereby increasing the volatility of our
reported results of operations. If prevailing market conditions or
other factors adversely impact the value of the embedded derivative,
it could have a substantial effect on our results of operations.
    The annuity products reinsured under our annuity reinsurance agreement
with Lafayette allow policyholders to withdraw their funds under
certain circumstances. In addition, this annuity reinsurance agreement
and certain of our life reinsurance agreements provide recapture
rights that allow the ceding company to reassume all or a portion of
the risk formerly ceded to us. Because our financial strength ratings
have been withdrawn, certain of these agreements can be recaptured.
Although we attempt to manage our investment portfolio so that we have
sufficient liquidity to support anticipated withdrawals and
recaptures, we cannot assure you that we will be able to dispose of
assets on favorable terms in the future to support withdrawals and
recaptures.
    Terrorist attacks may negatively affect our results of operations in
that we may experience higher than expected death claims in a given
period, such as occurred in 2001 with the attack on the World Trade
Center. There can be no assurance that there will not be further
terrorist attacks against the United States or United States
businesses. In addition, the United States has entered into armed
conflicts, which could have a further impact on our business in ways
we cannot currently anticipate. Political and economic instability in
some regions of the world may also result and could negatively impact
our business.
    The loss of any member of our management team, particularly John F.
Burke, our Chief Executive Officer, John W. Lockwood, our Chief
Financial Officer, or William H. Mawdsley, our Chief Actuary, could
adversely affect our business.
    When we purchase reinsurance from another reinsurance company, known
as a retrocessionaire, to cover certain risks that we have ourselves
reinsured, we are subject to the risk that the retrocessionaire will
be unable to pay amounts due to us because of its own financial
troubles. The failure of a retrocessionaire to pay amounts due to us
will not absolve us of our responsibility to pay our customers for
risks that we have insured. Failure of our retrocessionaires to pay us
could have a material adverse effect on our business, results of
operations and financial condition. In particular, when we purchased
our United States operating subsidiary, Annuity and Life Reassurance
America, Inc., 100% of the risks related to the directly written life
and annuity policies existing at the date of our purchase transaction
were ceded to Reassure America Life Insurance Company, a subsidiary of
the seller, Swiss Re Life and Health, America. As the direct issuer
of those policies, Annuity and Life Reassurance America remains liable
to policyholders in the event the reinsurer is unable to pay its
obligations to us under the - 25 -




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reinsurance agreement. Reserves ceded
under this reinsurance agreement amounted to approximately $82.2
million and $88.2 million at December 31, 2004 and December 31, 2003,
respectively. Reassure America Life Insurance Companys financial
strength is rated A+ (Superior) by A.M. Best as of December 31, 2004.
    We are subject to the laws and regulations of the jurisdictions in
which we conduct business. These laws and regulations cover many
aspects of our business, including licensure, premium rates, marketing
practices and capital adequacy. Recently, the insurance and
reinsurance regulatory framework has become subject to increased
scrutiny in many jurisdictions and regulators have started to
reexamine existing laws and regulations. Changes in these laws and
regulations could have an adverse affect on our operations. Further
deterioration in our financial condition could expose our operations
in the United States and Bermuda to increased levels of regulatory
scrutiny and possibly to the winding up of our operations.
    As a holding company, we have no significant operations or assets
other than our ownership of the capital stock of our subsidiaries.
Dividends and other permitted payments from our subsidiaries are our
sole source of funds to pay expenses and dividends, and any
limitations imposed on our subsidiaries to make such payments to us
may cause us to have insufficient funds to operate our business and
satisfy our obligations.
    We, along with Annuity and Life Reassurance, are Bermuda corporations
that we believe are not subject to United States income tax because
neither engages in business in the United States. However, because
there is no definitive guidance as to what constitutes being engaged
in trade or business in the United States, there can be no assurance
that in the future the Internal Revenue Service may not contend that
we are engaged in trade or business in the United States. The
Internal Revenue Service is currently conducting an audit of our
United States subsidiaries and has requested certain information and
documents from us and our Bermuda operating subsidiary. While our
United States subsidiaries have complied with the IRS requests for
information, both we and our Bermuda operating subsidiary declined to
supply the IRS with certain information in response to its initial
requests for information on May 7, 2002 and July 1, 2002. We did
provide the IRS with certain publicly available information regarding
us and our Bermuda operating subsidiary in addition to minutes of the
Board of Directors meetings and committee meetings held from 1999
through to 2001. We have not received any additional requests for
information since July 1, 2002. If we were considered to be engaged in
business in the United States, we could be subject to United States
tax at regular corporate rates on our taxable income that is
effectively connected with their United States business plus an
additional 30% branch profits tax on such income remaining after the
regular tax. Such taxes would have a material adverse effect on our
results of operations and financial condition. General Our company has encountered significant difficulties during the last four years. In addition
to reporting significant operating losses for those years, we have reduced our operations
significantly through the novation, termination and recapture of many of our life and annuity
reinsurance agreements. We plan to continue to receive premiums and pay claims under our remaining
reinsurance treaties; however, we are not currently underwriting any new treaties or accepting any
new business from our existing treaties. On October 26, 2004, Connecticut General Life Insurance Company (CIGNA) agreed to recapture
its guaranteed minimum death benefit (GMDB) and guaranteed minimum income benefit (GMIB)
agreement with us. We agreed with CIGNA to a mutual release of all past, present and future claims
under the agreement, including all obligations for claims and premiums that had accrued under the
agreement since July 1, 2004. We also agreed with CIGNA to a mutual release of all claims under the
letter of credit that we had posted as collateral under the agreement, and that CIGNA would retain
the $11.0 million it previously drew under the letter of credit. In addition, on October 26, 2004,
we issued CIGNA a warrant dated as of September 30, 2004 to acquire one million of our common
shares at an exercise price of $1.00 - 26 -




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per share. The warrant expires on September 30, 2014. We recorded a charge of approximately
$2.4 million in the third quarter of 2004 as a result of the settlement with CIGNA. On December 31, 2004, we entered into a binding letter of intent with Transamerica that
provided for the novation of our life reinsurance agreements with Scottish Re Limited (Scottish
Re) and Fidelity and Guaranty Life Insurance Company (F&G) to Transamerica as of December 31,
2004. The letter of intent also provided that, upon consummation of the novation of the life
reinsurance agreements, Transamerica would terminate its annuity reinsurance agreement with us and
recapture all business ceded under the agreement effective as of December 1, 2004. Our annuity
reinsurance agreement with Transamerica has generated substantial losses since 2001 and has
required us to make significant cash payments to Transamerica. Terminating or restructuring this
agreement has been a key strategic objective, as well as a critical step to pursuing any strategic
alternatives. Pursuant to our letter of intent with Transamerica, on January 31, 2005, we executed
definitive documents and novated our life reinsurance agreements with Scottish Re and F&G to
Transamerica as of December 31, 2004. In consideration of these novations, we paid Transamerica
$18.5 million, representing a transfer of reserves related to the life reinsurance agreements that
were novated. Also, on January 31, 2005, we completed an amendment to our annuity reinsurance
agreement with Transamerica, pursuant to which our agreement with Transamerica was terminated, and
Transamerica recaptured all business ceded under the agreement effective as of December 1, 2004. In
consideration of the recapture, we paid Transamerica all amounts owed under the annuity reinsurance
agreement through November 30, 2004, which was approximately $7.1 million, along with a termination
premium of $14.0 million. In connection with the novations of the life reinsurance agreements, approximately $28.9
million of collateral held in a trust with respect to our life reinsurance agreement with Scottish
Re was transferred to Transamerica. In addition, $23.8 million of the letters of credit posted on
behalf of our life reinsurance agreement with F&G were cancelled and the collateral securing those
letters of credit was released to us. Approximately $39.6 million was paid to Transamerica in
connection with the novation and recapture transactions from this collateral, including $18.5
million as consideration for the novations, a $14.0 million termination premium and approximately
$7.1 million for amounts due to Transamerica as of December 1, 2004. Following those payments,
approximately $13.1 million of cash and securities previously posted as collateral was released to
us. We recorded a loss of approximately $60.6 million during the fourth quarter of 2004 relating to
these novation and recapture transactions. On March 30, 2005, we
received a demand letter from Transamerica stating that
$7.0 million was owed to Transamerica as an adjustment to the
F&G policy benefit reserves. If we and Transamerica are unable to
resolve this issue through continued discussions, we would seek
adjudication of the dispute in accordance with the provisions of the
Master Agreement, which calls for the matter to be submitted to a
Fellow of the Society of Actuaries whose determination shall be
final, binding and conclusive. While there can be no assurances, we
believe that Transamerica is not entitled to this $7.0 million.
Presently, we are unable to determine the amounts, if any, that may
be due to or from Transamerica resulting from adjustments to the
policy benefit reserves. Our remaining life reinsurance agreements are the reinsurance of ordinary life insurance,
primarily for mortality risk. Profitability of our life reinsurance line depends in large part on
the volume and amount of death claims incurred. While death claims are reasonably predictable over
a long time horizon, they are less predictable over shorter periods and are subject to fluctuation
from quarter to quarter and year to year, particularly given the relatively small size of our in
force business as a result of recaptures and terminations in previous periods. Significant
fluctuations from period to period could adversely affect the results of our operations. Similarly,
claims experience that exceeds what we anticipated at the time we entered into reinsurance
agreements can also adversely affect the results of our operations, as occurred in 2003 and 2002.
At December 31, 2004 and December 31, 2003, the total face amount of our life insurance in force
was approximately $2.3 billion and $17.5 billion, respectively. Our remaining annuity reinsurance agreement reinsures general account fixed deferred
annuities. Profitability of this agreement is primarily dependent on earning a spread between the
interest rate earned on the assets under management and the interest rate credited to the
policyholder. This agreement is market and interest rate sensitive. Fluctuations in the general
level of interest rates and fixed income markets from period to period may cause fluctuations in
the profitability of this agreement. At December 31, 2004 and - 27 -




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December 31, 2003, our liability for annuity reinsurance agreements amounted to approximately
$58 million and $671 million, respectively. Because our financial results are heavily dependent on three life reinsurance agreements and
one remaining annuity reinsurance agreement which contains an embedded derivative, large
fluctuations in any one of these contracts could cause volatility in our overall financial results. While we believe we have sufficient operating liquidity to sustain our operations through at
least the next twelve months, we continue to explore strategic alternatives to attempt to maximize
shareholder value. These alternatives include, but are not limited to, a merger, sale, joint
venture, sale of assets, including our remaining reinsurance agreements, or other comparable
transaction. We do not know the terms upon which these transactions might be available, if at all.
For a more detailed discussion of certain factors that could materially and adversely affect our
financial condition and results of operations, please see  Forward-Looking Statements. Critical Accounting Policies Annuity and Life Re (Holdings), Ltd. is a Bermuda holding company with operating subsidiaries
in Bermuda and the United States. We consolidate the operations of all of our subsidiaries in
accordance with accounting principles generally accepted in the United States. The preparation of
financial statements in conformity with generally accepted accounting principles requires the use
of estimates and assumptions developed by our management. Any adjustments to the reported amounts
of assets or liabilities resulting from changes in estimates are reflected in our results of
operations in the period the estimates are revised. Certain management estimates are based, in
part, on information provided by ceding companies. Our ceding companies periodically update, refine
and revise the reinsurance information they provide to us. This revised data is reflected in our
results of operations as changes in estimates. Set forth below is a summary of the accounting policies that management believes are critical
to the preparation of our consolidated financial statements. This summary should be read in
conjunction with the discussion of our accounting policies included in Note 4 to the consolidated
financial statements included elsewhere in this report. 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
results of operations in the period such deviations occur. For these contracts, the amortization
periods are generally the estimated life of the policies. We terminated or recaptured several of
our reinsurance agreements during 2003 and 2004, which caused us to incur significant deferred
acquisition cost write-downs. For example, we completed the termination and recapture of our
annuity reinsurance agreement with Transamerica effective as of December 1, 2004, which resulted in
a write off of deferred acquisition costs of approximately $63,100,000. We will consider other
transactions that are economically beneficial to us, which may require write downs of deferred
acquisition costs. 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. These assumptions have a direct impact on our
estimated expected gross profits on our 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
ceding companies, actual results could differ (and, in the past, have differed) materially from our
estimates for a variety of reasons, including the failure of our ceding companies to report timely
information regarding material developments under our reinsurance agreements. Such differences
could be material to our future results. If our assumptions for investment returns prove to - 28 -




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be inaccurate, or if lapse rates exceed our assumptions, we may be required to record
additional charges, which would adversely impact our results of operations. Consistent with our accounting policies, we review the key assumptions used in determining the
carrying value of our deferred acquisition cost associated with our annuity reinsurance agreement
each quarter. A change in these assumptions could result in additional charges that would adversely
impact future results of operations. If our assumptions for total returns prove to be inaccurate,
or if lapse rates exceed our assumptions, we may be required to record additional write downs of
deferred acquisition costs, which would adversely impact future results of operations. Assuming no
change in lapse assumptions, the net impact of a 100 basis point decrease in our total return
assumptions in all future years would have required an additional write down of deferred
acquisition costs of approximately $1,800,000 as of December 31, 2004. Embedded Derivatives.We have concluded that there is an embedded derivative within the Funds
withheld at interest receivable related to our annuity reinsurance agreement with Lafayette that
requires bifurcation and separate accounting under Statement of Financial Accounting Standards No.
133  Accounting for Derivative Instruments and Hedging Activities. This embedded derivative is
similar to a total return swap arrangement on the underlying assets held by Lafayette. The fair
value of the embedded derivative 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 agreement. The fair value of the embedded derivative is influenced by changes
in credit risk, changes in expected future cash flows under the agreement and interest rates. The
change in fair value of the embedded derivative 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 the embedded derivative also impacts the emergence of expected
gross profits for purposes of amortizing deferred acquisition costs associated with our annuity
reinsurance agreement with Lafayette. The application of this accounting policy has increased the
volatility of our reported results of operations. While we have made an estimate of the fair value
of the embedded derivative 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. Changes in our assumptions could have a significant impact on the fair value of the
embedded derivative and our reported results of operations. Recognition of Revenues and Expenses.Reinsurance premium revenues from life products with
mortality risk are recognized when due from the policyholders. 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. We make estimates at the end of each reporting period
regarding premiums and benefits for ceding companies 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 Liabilities.The development of reserves for policy benefits and for claims
incurred but not reported for our life reinsurance agreements 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, and in the past have differed, materially from those
estimates. We monitor actual experience, and where circumstances warrant, will revise our
assumptions and the related reserve estimates. Until the third quarter of 2004, we reinsured certain minimum guarantees associated with
variable annuity agreements through our combined GMDB/GMIB agreement with CIGNA. Our obligations
for the GMDB/GMIB agreement with CIGNA were reflected on our balance sheet as Reserves for future
policy benefits. This agreement was recaptured by CIGNA, and under the terms of the recapture, the
parties - 29 -




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agreed to a mutual release of all past, present and future claims under the GMDB/GMIB
agreement, including all obligations for claims and premiums that had accrued under the agreement
since July 1, 2004. Our obligations arising from our fixed annuity reinsurance agreements in 2004
came from our agreement with Transamerica and our agreement with Lafayette. Our obligations for
these fixed annuity agreements were reflected on our balance sheet as Interest sensitive contracts
liability. On December 31, 2004, we entered into a binding letter of intent with Transamerica
which provided that it would terminate its annuity reinsurance agreement with us and recapture all
business ceded under the agreement effective as of December 1, 2004. Pursuant to this letter of
intent, on January 31, 2005, we executed definitive documents and completed the termination and
recapture of our annuity reinsurance agreement with Transamerica. AICPA Statement of Position (SOP 03-1).In July 2003, the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants (AICPA) issued Statement of
Position 03-1 (SOP), Accounting and Reporting by Insurance Enterprises for Certain
Non-Traditional Long-Duration Contracts and for Separate Accounts, which provides guidance on
accounting and reporting by insurance enterprises for certain nontraditional long-duration
contracts and for separate accounts. The SOP is effective for financial statements for fiscal years
beginning after December 15, 2003. We adopted the SOP as of January 1, 2004. On January 1, 2004, we had a combined GMDB/GMIB agreement with CIGNA and an annuity
reinsurance agreement with Transamerica, both of which were affected by the adoption of this new
SOP. The agreement with CIGNA and the Transamerica agreement have both since been recaptured. The
SOP provides guidance for reserving for contracts with guaranteed minimum death and guaranteed
minimum income benefits. The SOP requires projections of a wide number of future economic scenarios
that impact the present value of premiums earned and claims paid. Based on these projections and
historical experience, a Benefit Ratio is determined. The reserve is then determined by applying
the Benefit Ratio to premiums received and then deducting claims paid, both with interest. The SOP
also provides guidance for reserving for annuity agreements with more than one potential account
balance. These types of exposures are reserved for based upon the highest contractually
determinable balance for each policyholder, without consideration of surrender fees. Upon adoption
of the SOP on January 1, 2004, we recorded a one-time transition adjustment to our carried reserves
for interest sensitive contracts liability and deferred acquisition costs asset for the
Transamerica annuity reinsurance agreement, and future policy benefits for the CIGNA contract. The
impact of our adoption of the SOP is discussed below in Operating Results. Stock-Based Compensation.On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004),
Share-Based Payment (SFAS No. 123R). SFAS No. 123R replaces SFAS No. 123 Accounting for
Stock-Based Compensation and supersedes APB opinion No. 25 Accounting for Stock Issued to
Employees. The statement requires all entities to recognize compensation expense in an amount
equal to the fair value of share-based payments granted to employees and is effective as of the
beginning of the first interim or annual reporting period that begins after June 15, 2005. We
already record compensation expense for awards of stock options and restricted stock to employees
based on the fair value of the awards, consequently this statement will not have a material impact
on our results of operations or financial condition. If actual events differ significantly from the underlying estimates and assumptions used by us
in the application of any of the aforementioned accounting policies, there could be a material
adverse effect on our results of operations and financial condition. Operating Results Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 Net Loss. For the year ended December 31, 2004, we had a net loss, after the cumulative effect
of a change in accounting principle, of $(68,326,455), or $(2.64) per basic and fully diluted
common share, as compared to net loss of $(132,155,584), or $(5.11) per basic and fully diluted
common share, for the year ended December 31, 2003. Our loss for the year ended December 31, 2004
was primarily the result of the novation and recapture transactions with Transamerica which
produced a loss of approximately - 30 -




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$60,627,000. Also contributing to our net loss was a $5,000,000 accrual for the settlement of the
shareholder lawsuit and a charge in the third quarter of 2004 of approximately $2,421,000
associated with the recapture of our GMDB/ GMIB agreement with CIGNA. On October 26, 2004, CIGNA agreed to recapture its GMDB/GMIB agreement with us. We agreed with
CIGNA to a mutual release of all past, present and future claims under the agreement, including all
obligations for claims and premiums that had accrued under the agreement since July 1, 2004. We
also agreed with CIGNA to a mutual release of all claims under the letter of credit that we had
posted as collateral under the agreement, and that CIGNA would retain the $11,000,000 it previously
drew under the letter of credit. In addition, on October 26, 2004, we issued CIGNA a warrant dated
as of September 30, 2004 to acquire one million of our common shares at an exercise price of $1.00
per share. The warrant expires on September 30, 2014. The impact of the recapture, net of reserves
released for GMDB and GMIB risks, was a charge of approximately $2,421,000. Following the recapture
of our agreement with CIGNA, we no longer have any exposure to GMDB or GMIB. On December 31, 2004, we entered into a binding letter of intent with Transamerica that
provided for the novation of our life reinsurance agreements with Scottish Re and F&G to
Transamerica as of December 31, 2004. The letter of intent also provided that, upon consummation of
the novation of the life reinsurance agreements, Transamerica would terminate its annuity
reinsurance agreement with us and recapture all business ceded under the agreement effective as of
December 1, 2004. Pursuant to the letter of intent with Transamerica, on January 31, 2005, we
executed definitive documents and novated our life reinsurance agreements with Scottish Re and F&G
to Transamerica as of December 31, 2004. In consideration of these novations, we paid Transamerica
$18,500,000, representing a transfer of reserves related to the life reinsurance agreements that
were novated. Also, on January 31, 2005, we completed an amendment to our annuity reinsurance
agreement with Transamerica, pursuant to which our agreement with Transamerica was terminated, and
Transamerica recaptured all business ceded under the agreement effective as of December 1, 2004. In
consideration of the recapture, we paid Transamerica all amounts owed under the annuity reinsurance
agreement through November 30, 2004, which was approximately $7,100,000, along with a termination
premium of $14,000,000. We have recorded substantial charges in the fourth quarter of 2004 relating to the
transactions with Transamerica described above. These charges are due to payments to Transamerica
and the write off of deferred acquisition costs and funds withheld at interest assets in excess of
reserves for interest sensitive contract liabilities and life reinsurance reserves related to the
contracts that were novated and terminated. We have incurred a loss of approximately $60,627,000
relating to these novation and recapture transactions. This includes the write off of deferred
acquisition costs of approximately $63,100,000 for the recapture of our agreement with
Transamerica, approximately $13,300,000 for the novation of our life reinsurance agreement with
Scottish Re, and approximately $11,600,000 for the novation of our life reinsurance agreement with
F&G. This loss also includes the termination premium paid to Transamerica of $14,000,000 as well
as the payment of $18,500,000 to Transamerica, which represented a transfer of reserves related to
the agreements that were novated. These charges were partially offset by the release of reserves
for the life reinsurance agreements that were novated of approximately $36,900,000 and reserves for
interest sensitive contract liabilities under the annuity reinsurance agreement in excess funds
withheld at interest assets of approximately $23,000,000. For the year ended December 31, 2004, our loss before cumulative effect of a change in
accounting principle was $(67,960,495). The cumulative effect of a change in accounting principle
due to the adoption of Statement of Position (SOP) 03-1 was a net loss of $(365,960) for the year
ended December 31, 2004. Upon the adoption of the SOP on January 1, 2004, the amount of Reserves
for future policy benefits relating to our GMDB/GMIB agreement with CIGNA was reduced by
$1,878,760, favorably impacting our reported results of operations during the year ended December
31, 2004. The impact of the adoption of the SOP on our accounting for the Transamerica annuity
reinsurance agreement was a net charge of $2,244,720 as a result of an increase in interest
sensitive contracts liability of $38,398,730, partially offset by an increase in deferred policy
acquisition costs of $36,154,010. - 31 -




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The net loss of $(132,155,584) for during the year ended December 31, 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 reinsurance agreements. During the year
ended December 31, 2003, we recorded charges in connection with the recapture and termination of a
number of our life and annuity reinsurance agreements, including those with the Ohio National Life
Insurance Company, Hartford Life, and XL Life Ltd. As a result of these and all other recaptures
and terminations, we incurred charges of approximately $90,830,000 for the year ended December 31,
2003. These charges reflect the effect of a $9,000,000 benefit resulting from the comprehensive
settlement with XL Life Ltd in the third quarter of 2003. Reduced investment gains and significant
operating expenses due to litigation costs and employee retention and severance costs also
contributed to our net loss for the year ended December 31, 2003. Net Premiums. Net premium revenue for the year ended December 31, 2004 was $48,297,706, a
decrease of 71% from net premium revenue of $166,972,840 for the year ended December 31, 2003.
Substantially all premium revenue in both years was derived from traditional ordinary life
reinsurance agreements. The decline in premium revenue reflects the significant reduction of
business in force resulting from the recapture and termination of life reinsurance agreements
during 2003. At December 31, 2003, the total face amount of life insurance in force was
approximately $17.5 billion, as compared with approximately $117.5 billion at December 31, 2002.
At December 31, 2004, the total face amount of life insurance in force had decreased to
approximately $2.3 billion reflecting the novation of our life reinsurance agreements with Scottish
Re and F&G to Transamerica effective as of December 31, 2004. Our now largest life reinsurance
agreement represented approximately $0.3 billion of life insurance in force at December 31, 2004
and approximately $11.3 million of premium revenue for the year ended December 31, 2004. We have
stopped writing new reinsurance agreements and are not accepting any new business under existing
treaties. The novations and terminations of life reinsurance agreements on December 31, 2004 will
further reduce net premiums in future periods. Approximately $30.3 million of net premium revenue
for 2004 was generated from reinsurance agreements that have been novated and terminated. Net Investment Income. Total net investment income for the year ended December 31, 2004 was
$21,697,563, as compared with $29,042,223 for the year ended December 31, 2003. Net investment
income is comprised of income earned on our general account assets and income earned on assets held
and managed by our reinsurance ceding companies under modified coinsurance contracts, which we
refer to as Funds withheld. Net investment income earned on our general account assets for the year ended December 31,
2004 was approximately $5,335,000, as compared to $6,936,000, respectively, for the year ended
December 31, 2003. The average annualized yield rate earned on our general account assets for the
year ended December 31, 2004 was 3.51%, as compared with 2.53% for the year ended December 31,
2003. The increase in the effective yield rate was largely due to moving a greater portion of our
invested assets from cash and cash equivalents to longer duration investments during the second
quarter of 2004, but the impact was offset by the lower level of invested assets in the year ended
December 31, 2004 as compared to 2003. We held a larger cash position in 2003 in an effort to
maximize our collateral funding ability and to minimize the impact of changing interest rates on
our collateral obligations. Because the amount of our cash and invested assets has decreased
significantly due to payments associated with the novation of certain life reinsurance agreements
to Transamerica on December 31, 2004, we expect our net investment income earned on our general
account assets for 2005 to be substantially less than 2004. Net investment income earned on Funds withheld for the year ended December 31, 2004 was
approximately $16,362,000, as compared to approximately $22,106,000 for the year ended December 31,
2003. The decrease in investment income on our Funds withheld during the year ended December 31,
2004 was primarily due to a decreased asset base underlying our annuity reinsurance agreements,
which was largely the result of four such annuity agreements being recaptured in 2003, as well as
realized capital losses on the Funds withheld assets. The average annualized yield rates earned on
Funds withheld were approximately 2.88% for the year ended December 31, 2004, as compared with
2.68% for the year ended December 31, 2003. For purposes of calculating the average yield rates
earned on our Funds withheld at interest, we include our share of the investment income and net
realized capital gains and losses as reported - 32 -




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to us through our settlements with our ceding companies. Because the amount of invested assets
underlying our Funds withheld at interest receivable has decreased significantly due to the
recapture and termination of our reinsurance agreement with Transamerica, we expect our net
investment income earned on Funds withheld for 2005 to be substantially less than 2004.
Approximately $13.4 million of net investment income earned on Funds withheld was generated on
account of our annuity reinsurance agreement with Transamerica in 2004. Net Realized Investment Gains. Net realized investment gains for the year ended December 31,
2004 were $439,536, as compared with net realized investment gains of $6,406,587 for the year ended
December 31, 2003. The relatively high level of net realized investment gains for the year ended
December 31, 2003 reflected the significant sales from our investment portfolio in 2003 in
connection with the termination and recapture of a number of our reinsurance agreements and to meet
the collateral requirements of certain of our ceding companies. Although we have begun to move a
greater portion of our invested assets into longer duration investments, we plan to continue to
hold a relatively large portion of our assets in short duration investments until interest rates
rise or we conclude they are not going to rise in the foreseeable future. However, we will adjust
our investment strategy based on developments in the markets and our business and those adjustments
may result in realized gains or losses being recognized. We make decisions concerning the sales of
invested assets based on a variety of market, business and other factors. Net Change in the Fair Value of Embedded Derivatives. Under SFAS No. 133, we have been
required to bifurcate and separately account for the embedded derivatives contained in certain of
our annuity reinsurance agreements, and unrealized changes in the fair value of those embedded
derivatives are reflected in our results of operations. Since the end of the third quarter of 2003,
only our annuity reinsurance agreement with Lafayette contained embedded derivatives that we were
required to bifurcate and separately account for. For the year ended December 31, 2004, the net
change in fair value of our embedded derivatives was an unrealized gain of $2,181,070, as compared
to an unrealized gain of $16,692,688 for the year ended December 31, 2003. The primary reason for
the net change in fair value of our embedded derivatives for the year ended December 31, 2003 was
the termination of certain of our annuity reinsurance agreements, including the termination of an
annuity reinsurance agreement with an affiliate of XL Life as part of our comprehensive settlement
with XL Life, and the termination of our agreement with Ohio National. Widening credit spreads and
bond defaults in the portfolio of assets supporting these agreements had caused unrealized losses
in our embedded derivatives in prior periods, which were reversed upon termination of the
reinsurance agreements. Surrender Fees and Other Revenue. Surrender fees and other revenue for the year ended December
31, 2004 were $4,475,691 as compared with $7,297,015 for the year ended December 31, 2003. This
income was primarily derived from surrender fees related to our fixed annuity agreement with
Transamerica. The decrease in revenue is mainly due to a smaller policyholder base resulting in a
lower absolute level of withdrawals. Lower surrender fee rates charged to the policyholders upon
surrendering their policies also contributed to the decrease in surrender fees. In light of the
termination and recapture of our annuity reinsurance agreement with Transamerica, effective as of
December 1, 2004, we do not expect to report significant surrender fee revenue in future periods. Claims and Policy Benefits. Claims and policy benefits include both life and variable annuity
benefits, including GMDB, GMIB and, during the first half of 2003, enhanced earnings benefits
(EEB). Claims and policy benefits for the year ended December 31, 2004 were $14,101,129 or 29% of
net premiums, as compared with $198,002,905, or 119% of net premiums for the year ended December
31, 2003. The decrease in Claims and policy benefits is partially due to the release of
approximately $36,855,000 of life reinsurance reserves related to the agreements with Scottish Re
and F&G that were terminated and novated to Transamerica in excess of the $18,500,000 we agreed to
pay for the transfer of reserves related to the those agreements, and the $11,000,000 release of
reserves due to the recapture of our GMDB/GMIB agreement with CIGNA in 2004. The absolute decline
in claims and policy benefits in 2004 was also the result of the significant reduction of life
insurance in force from approximately $117.5 billion at December 31, 2002 to approximately $2.3
billion at December 31, 2004. This included the termination of our GMDB agreement with Hartford
Life in 2003 and the recapture and termination of other life and annuity - 33 -




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reinsurance agreements in 2003, including the comprehensive settlement with XL Life, as well
as the novation of our life reinsurance agreements with Scottish Re and F&G to Transamerica as of
December 31, 2004. While the recaptures of life reinsurance agreements have reduced claims and
policy benefits in 2004, they may increase volatility in the level of claims and policy benefits as
a percentage of premiums in the future. Interest Credited to Interest Sensitive Products. Interest credited to interest sensitive
products, which are liabilities we assume under certain annuity reinsurance agreements, was
$5,399,460 for the year ended December 31, 2004, as compared with $13,980,723 for the year ended
December 31, 2003. Included in Interest credited to interest sensitive products for the year ended
December 31, 2004 are lifetime minimum interest guarantee (LMIG) payments of approximately
$9,990,000, as compared to LMIG payments of approximately $16,120,000 for the year ended December
31, 2003. The reduction in LMIG payments in 2004 was primarily due to improving lapse experience
and total returns on our annuity reinsurance agreement with Transamerica during 2003 and the first
quarter of 2004. The decrease in Interest credited to interest sensitive products is also due to
the release of reserves for interest sensitive contract liabilities in excess of the write-off of
funds withheld at interest and the termination premium related to our Transamerica agreement, which
was terminated effective as of December 1, 2004. Policy Acquisition Costs and Other Insurance Expenses. Policy acquisition costs and other
insurance expenses, consisting primarily of allowances and amortization and write downs of deferred
policy acquisition costs, for the year ended December 31, 2004 were $110,922,948, as compared with
$128,549,288 for the year ended December 31, 2003. The expense for the year ended December 31, 2004
was primarily comprised of approximately $88,000,000 for the write-downs of deferred acquisition
costs associated with the recaptures and terminations of life and annuity reinsurance agreements
during 2004. Of these write-downs, approximately $63,100,000 related to the recapture of our
annuity reinsurance agreement with Transamerica and approximately $24,900,000 related to our life
reinsurance agreements with Scottish Re and F&G that were novated to Transamerica as of December
31, 2004. Policy acquisition costs and other insurance expenses for the year December 31, 2003
included the net write down of deferred acquisition costs associated with the recapture and
termination of life and annuity reinsurance agreements of approximately $85,931,000. Operating Expenses. Operating expenses for the year ended December 31, 2004 were $14,628,524
or 19.5% of total revenue (excluding the net change in fair value of embedded derivatives), as
compared to $18,034,021 or 8.6% of total revenue (excluding the net change in fair value of
embedded derivatives) for the year ended December 31, 2003. This proportionate increase in expenses
for the year ended December 31, 2004 reflects the accrual of $5,000,000 for the anticipated
settlement of the purported shareholder class action lawsuit, as well as increased professional and
consulting fees partially offset by reduced employee compensation costs. Costs associated with
capital raising efforts and the pursuit of other strategic alternatives of approximately $914,000
also contributed to the proportionate increase in operating expenses for the period. Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Net Loss.For the year ended December 31, 2003, we had a consolidated net loss of
$(132,155,584), or $(5.11) per primary and fully diluted common share, as compared to a net loss of
$(128,887,285), or $(5.01) per primary and fully diluted common share for the year ended December
31, 2002. The loss for 2003 was primarily the result of losses associated with recaptures and
terminations of life and annuity reinsurance agreements, as well as adverse claims experience under
our life reinsurance agreements. Reduced investment gains and significant operating expenses due
to litigation costs and employee retention and severance costs also contributed to our net loss for
the year ended December 31, 2003. During the year ended December 31, 2003, we negotiated the recapture and termination of most
of our life and annuity reinsurance agreements. As a result, we incurred charges from the write
down of deferred acquisition costs and cash payments made to ceding companies in excess of reserve
releases associated with the recaptured agreements aggregating to approximately $90,830,000. These
charges include costs of - 34 -




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approximately $20,400,000 associated with Hartford Lifes recapture of our then largest GMDB
agreement, the net costs of approximately $11,680,000 due to the recapture of our 50% quota share
reinsurance agreement with XL Life, a net charge of $5,020,000 related to the termination of our
annuity reinsurance agreement with Ohio National, the recapture cost of our MetLife agreement of
approximately $3,540,000 and the cost of recapture transactions completed with 25 additional ceding
companies that totaled approximately $50,190,000 in the aggregate. In addition to the costs associated with the recapture and termination of those agreements, we
experienced losses during 2003 amounting to approximately $24,843,000 on the agreements that were
recaptured or terminated during the year. This includes a loss of approximately $6,379,000 for our
contract with MetLife and a net loss of approximately $5,866,000 for our reinsurance agreements
with XL Life. We also recorded a net loss related to the recaptured Hartford Life treaty amounting
to $6,537,000 in 2003. The remaining business recaptured in 2003 generated approximately
$6,062,000 in losses. We also recorded a loss of approximately $3,067,000 for our annuity reinsurance agreement with
Transamerica during 2003. This agreement was our largest annuity reinsurance agreement, and
represented approximately $604 million, or approximately 90%, of our Funds withheld at interest
receivable as of December 31, 2003. Our GMDB/GMIB contract with CIGNA resulted in a loss of
approximately $1,934,000 in 2003. Other life and annuity reinsurance agreements that were not
recaptured in 2003 resulted in losses of approximately $5,778,000, and operating expenses exceeded
investment income and net realized investment gains by approximately $5,703,000 in 2003. Net Premiums.Net premium revenue for the year ended December 31, 2003 was $166,972,840, a
decrease of 51% from net premium revenue of $344,097,441 for the year ended December 31, 2002. The
majority of premium revenue in both years was derived from traditional ordinary life reinsurance.
The decline in premium revenue reflects the decision to cease writing new business in 2003 and the
significant reduction of business in force resulting from the recapture and termination of
reinsurance agreements in the fourth quarter of 2002 and during the year 2003. Net premiums for
2003 related to agreements that were recaptured or terminated in 2003 were approximately
$103,876,000. At December 31, 2003, the total face amount of life insurance in force was
approximately $17.5 billion, as compared with approximately $117.5 billion at December 31, 2002.
Our now largest life reinsurance agreement represented approximately $7.9 billion of life insurance
in force at December 31, 2003. We have stopped writing new reinsurance agreements and are not
accepting any new business under existing treaties. The recaptures and terminations of reinsurance
agreements during 2003 will further reduce net premiums in future periods. Net Investment Income.Net investment income for the year ended December 31, 2003 was
$29,042,223, a decrease of 72% from net investment income of $102,138,985 for the year ended
December 31, 2002. The decrease in net investment income was primarily the result of a significant
decrease in invested assets underlying our Funds withheld receivable as a result of the termination
of several annuity reinsurance contracts, including our agreement with Ohio National, and lapses on
policies underlying our annuity reinsurance agreement with Transamerica. Net investment income
earned on Funds withheld for the year ended December 31, 2003 was $22,106,000, as compared with
$76,208,000 for the year ended December 31, 2002. The decrease in net investment income for the
year ended December 31, 2003 was also the result of our return of approximately $147,000,000 of
invested assets on December 31, 2002 in connection with 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. Lower investment returns resulting from our decision to shift a large portion of our
invested assets into short duration assets also contributed to the reductions in net investment
income. The average yield rate earned on our general account assets declined to approximately
2.53% for the year ended December 31, 2003, as compared with 5.28% for the year ended December 31,
2002. The average yield rate earned on Funds withheld was 2.68% for the year ended December 31,
2003, as compared with 5.25% for the year ended December 31, 2002. This reduction in yield rates is
primarily the result of the termination of our annuity reinsurance agreement with Ohio National in
the first quarter of 2003 and a lower yield on the assets supporting our obligations under our
Transamerica annuity reinsurance agreement. For purposes of calculating the average yield rates
earned on our Funds withheld at interest, we - 35 -




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only include net realized capital gains and losses as reported by us through our settlements
with our ceding companies. Net investment income for 2003 related to agreements that were
recaptured or terminated in 2003 was $4,777,000. Because the amount of our cash and invested
assets has decreased significantly due to operating losses, and because the amount of invested
assets underlying our Funds withheld receivable has decreased significantly due to the recapture
and termination of certain of our reinsurance agreements, we expect our net investment income for
2004 to be less than 2003. Net Realized Investment Gains.Net realized investment gains were $6,406,587 for the year
ended December 31, 2003, as compared with realized gains of $19,749,266 for the year ended December
31, 2002. The decrease in net realized investment gains for the year ended December 31, 2003 was
the result of a smaller invested asset base and the decision to maintain a significant portion of
our portfolio in short duration investments. We plan to continue to hold a relatively large portion
of our assets in short duration investments until interest rate rise or we conclude they are not
going to rise in the foreseeable future. Accordingly, although realized gains and losses will
fluctuate from period to period, we do not anticipate realizing significant investment gains or
losses in 2004 due to our smaller invested asset base and our current decision to hold those assets
predominantly in short duration investments. However, we will adjust our investment strategy based
on developments in the markets and our business and those adjustments may result in realized gains
or losses being recognized. We make decisions concerning the sales of invested assets based on a
variety of market, business and other factors. Net Change in Fair Value of Embedded Derivatives.Under SFAS No. 133, we are required to
bifurcate and separately account for the embedded derivatives contained in certain of our annuity
reinsurance contracts, and unrealized changes in the fair value of those embedded derivatives are
reflected in our results of operations. The net change in fair value of embedded derivatives for
the year ended December 31, 2003 was an unrealized gain of $16,692,688, as compared to an
unrealized loss of $(25,846,110) for the year ended December 31, 2002. The unrealized gain during
2003 includes the reversal of previously reported losses of $12,323,000 upon the termination of our
agreement with Ohio National in February 2003 and the termination of other annuity reinsurance
agreements in 2003, including the termination of our annuity reinsurance agreements with an
affiliate of XL Life as part of our comprehensive settlement with XL Life. Widening credit spreads
and bond defaults in the portfolio of assets supporting these agreements had caused unrealized
losses in our embedded derivatives in prior years. As of December 31, 2003, we have one remaining
embedded derivative related to an annuity reinsurance agreement that we must bifurcate and
separately account for, and that embedded derivative had an unrealized loss of approximately
$7,790,000 at December 31, 2003. Surrender Fees and Other Revenue. Surrender fees and other revenue were $7,297,015 for the
year ended December 31, 2003, as compared with $16,156,437 for the year ended December 31, 2002.
This income is primarily derived from surrender fees related to our annuity reinsurance agreement
with Transamerica. The decrease in revenue is due to a smaller policyholder base resulting in a
lower absolute level of withdrawals and lower surrender rates during 2003, both as compared with
the prior year. Claims and Policy Benefits.Claims and policy benefits includes both life and variable annuity
benefits, including guaranteed minimum death benefits, guaranteed minimum income benefits and
enhanced earnings benefits. Claims and policy benefits for the year ended December 31, 2003 were
$198,002,905 or 119% of net premium, as compared with $352,408,801 or 102% of net premium for the
year ended December 31, 2002. The absolute declines in claim and policy benefits in 2003 were the
result of the significant reduction of life insurance in force from $117.5 billion at December 31,
2002 to approximately $17.5 billion at December 31, 2003 and the termination of several annuity
reinsurance agreements during 2003. Claims and policy benefits for 2003 related to agreements that
were recaptured or terminated in 2003 were $ 143,179,000. As a result of the recaptures and
terminations of reinsurance agreements during 2003, we began 2004 with a book of business that is
significantly smaller than we had during 2003. This will reduce claims and policy benefits in
absolute terms in future periods, but may increase volatility in the level of claims and policy
benefits as a percentage of premiums. We continue to monitor and analyze our experience under our remaining life and annuity
reinsurance agreements. During the year 2003, we decreased our reserves associated with variable
annuity reinsurance - 36 -




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products by $7,400,000, bringing our total carried reserve for these products to $11,000,000
at December 31, 2003. The decrease was a direct result of the recapture by Hartford Life in the
second quarter of 2003 of its agreement with us, which was previously our largest variable annuity
reinsurance agreement. The reduction in the reserves caused by the recapture of the Hartford Life
agreement was partially offset by a $3,180,000 increase in reserves associated with our guaranteed
minimum death benefit and guaranteed minimum income benefit agreement with CIGNA. Throughout 2003, we updated our analysis of carried reserves for incurred but not reported
(IBNR) claims. In determining the amount of IBNR required at December 31, 2003, we considered
the full trending of claims reported through December 31, 2003. As a result of our review and
reflecting the decrease in life reinsurance in force, our reserve for IBNR at December 31, 2003 was
$4,500,000, as compared to $9,000,000 at December 31, 2002. We will continue to examine these IBNR
reserve levels in relation to past experience each quarter. Interest Credited to Interest Sensitive Products.Interest credited to interest sensitive
products, which represents liabilities to policyholders we assume under certain annuity reinsurance
agreements, was $13,980,723 for the year ended December 31, 2003, as compared with $71,370,616 for
the year ended December 31, 2002. The decline in Interest credited to interest sensitive contracts
liabilities for the year ended December 31, 2003 was primarily the result of the termination and
recapture of several annuity reinsurance agreements, particularly our agreements with Ohio National
and an affiliate of XL Life during 2003. We terminated our annuity reinsurance agreement with Ohio
National on February 14, 2003, another large annuity reinsurance agreement on April 1, 2003 and two
annuity reinsurance agreements with an affiliate of XL Life effective as of July 1, 2003. In 2003,
we recorded $6,595,000 of interest credited to interest sensitive products related to agreements
that were recaptured or terminated. Interest credited to interest sensitive products in 2003
includes approximately $16,120,000 in minimum interest guarantee payments, which was partially
offset by a $10,000,000 deemed recovery of minimum interest guarantee payments in connection with
the comprehensive settlement with XL Life. We incurred approximately $26,760,000 of minimum
interest guarantee payments in 2002. The minimum interest guarantee payments in both years
resulted from prior poor investment performance of the invested premiums managed by the primary
insurance company under our annuity reinsurance contract with Transamerica. The reduction in
minimum interest guarantee payments in 2003 was primarily due to improving lapse and total returns
on our annuity reinsurance contract with Transamerica during 2003. Policy Acquisition Costs and Other Insurance Expenses.Policy acquisition costs and other
insurance expenses, consisting primarily of allowances and amortization or write downs of deferred
policy acquisition costs, were $128,549,288 for the year ended December 31, 2003, as compared with
$125,877,980 for the year ended December 31, 2002. The expense is primarily comprised of the
write-downs of deferred acquisition costs associated with the recaptures and terminations of life
and annuity reinsurance agreements during 2003 of approximately $85,931,000. In addition to those
write downs, we also amortized $17,400,000 of deferred acquisition costs associated with our
Transamerica annuity reinsurance agreement, of which $10,000,000 was a result of our deemed
recovery of minimum interest guarantee payments in connection with the comprehensive settlement
with XL Life. In 2002, we wrote down deferred acquisition costs on our Transamerica contract by
approximately $27,474,000. This write down was the result of higher than expected surrender rates
on the policies underlying our reinsurance agreement with Transamerica, and our reduced estimate of
expected gross profits under the contract in future periods due to minimum interest guarantee
payments. The change in amortization of the deferred acquisition cost as a result of the change in
the fair value of our embedded derivatives was an increase of approximately $6,954,000 in 2003, as
compared to a reduction in amortization of approximately $8,274,000 in 2002. Collateral Costs.Collateral costs in 2002 comprised fees charged by a reinsurer to provide
cash deposits to us and other related expenses. This arrangement was terminated as of December 31,
2002 and we therefore recorded no such collateral costs in 2003. In 2002, these deposits had been
used to fund excess statutory reserve requirements of our clients and had been recorded on our
consolidated balance sheet as a deposit liability. Collateral costs were $12,948,115 for the year
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Operating Expenses.Operating expenses were $18,034,021 or 9% of total revenue (excluding the
net change in fair value of embedded derivatives) for the year ended December 31, 2003, as compared
to $22,577,792 or 5% of total revenue (excluding the net change in fair value of embedded
derivatives) for the year ended December 31, 2002. Our expense ratio deteriorated due to our
significantly reduced revenue base. Operating expenses for 2003 include the write off of
approximately $2,100,000 of goodwill associated with our United States operating subsidiary in the
second quarter of 2003, costs associated with renegotiating employment arrangements and other
employee compensation, increased costs of directors and officers liability insurance 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, our remaining modified coinsurance annuity reinsurance agreement has features that
constitute embedded derivatives that require bifurcation and separate accounting under SFAS No. 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 upon the amount of
stockholders equity deployed to the segment. Costs associated with our efforts to raise capital
and pursue other strategic alternatives and the anticipated costs of settling the purported
shareholder class action lawsuit have been completely allocated to the corporate segment. Segment
results are reported in Note 15 to our consolidated financial statements. Life Segment.Our life segment is our largest segment as measured by revenues. Life segment
loss for the year ended December 31, 2004 was $(118,095), as compared to segment loss of
$(90,436,276) for the year ended December 31, 2003. Our life segment loss for the year ended
December 31, 2004 includes the write-down of deferred acquisition costs in excess of the release of
life reinsurance reserves related to the life reinsurance agreements that were novated to
Transamerica as of December 31, 2004. We recorded a gain of approximately $3,995,000 in connection
with the novation of our life reinsurance agreement with Scottish Re, and incurred a charge of
approximately $10,570,000 in connection with the novation of our life reinsurance agreement with
F&G. The net charge from these novations was partially offset by operating income of approximately
$5,824,000 on our life reinsurance agreement with Scottish Re and an operating loss of $1,397,000
was incurred under our life reinsurance agreement with F&G during 2004. Our life segment loss for
the year ended December 31, 2003 reflects charges for recaptures of life reinsurance agreements of
approximately $60,510,000. These charges reflect net costs of approximately $11,680,000 due to the
recapture of our 50% quota share reinsurance agreement with XL Life, the recapture cost of our
MetLife agreement of approximately $3,540,000 and the cost of recapture transactions completed with
22 additional ceding companies totaling approximately $45,290,000 in the aggregate. Life segment revenues declined 70% to $50,153,025 for the year ended December 31, 2004, as
compared with $166,333,033 for the year ended December 31, 2003. These declines reflect our reduced
levels of life reinsurance in force as a result of recaptures of life reinsurance agreements during
2003. In addition, net investment income attributable to the life segment for 2004 decreased
approximately $2,800,000, as compared with 2003, primarily reflecting a reduction in invested
assets allocated to the life segment as a result of the terminations and recaptures in 2003. Life segment policy benefits and expenses for the year ended December 31, 2004 declined 80% to
$50,271,120 from $256,769,309 for the year ended December 31, 2003. Policy benefits and expenses
for 2004 includes approximately $24,900,000 for the write-down of deferred acquisition costs
partially offset by the release of life reinsurance reserves of approximately $18,300,000 related
to our agreements with Scottish Re and F&G that were novated to Transamerica as of December 31,
2004. Claims and policy - 38 -




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benefits for 2003 related to agreements that were recaptured in 2003 were $103,586,000. The
balance of the decline in 2004 is attributable to the significant reduction in life insurance in
force compared to the comparable periods during 2003, as well as reported claims under our life
reinsurance agreements that had exceeded our expectations during 2003. While the recaptures and
novations of life reinsurance agreements during 2003 and 2004 will reduce claims and policy
benefits in absolute terms in future periods, they may increase volatility in the level of claims
and policy benefits as a percentage of premiums in the future. Annuity Segment.Our annuity reinsurance segment has historically consisted of the reinsurance
of general account fixed deferred annuities and certain minimum guarantees arising from variable
annuities. We currently have only one remaining annuity reinsurance agreement, which covers
individual general account single premium deferred annuity policies, which involve the tax-deferred
accumulation of interest on a single premium paid by the policyholder (accumulation phase
policies). Accumulation phase policies are subject primarily to investment risk and persistency
(lapse) risk. Historically, we have also reinsured certain guarantees associated with variable
annuity agreements, including GMDB and GMIB. As of December 31, 2004, we no longer reinsured any
GMDB or GMIB due to the recapture of our reinsurance agreement with CIGNA. Our annuity segment has historically contained the majority of our assets and exposed us to
significant volatility in our results from operations from three sources. First, under SFAS No. 133
 Accounting for Derivative Instruments and Hedging Activities, we must currently bifurcate and
separately account for the embedded derivative associated with our annuity reinsurance agreement
with Lafayette, and we have had to do so for other annuity reinsurance agreements in the past. This
unrealized change in the value of the derivative is reported in our statement of operations 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, as a result of our adoption of AICPA
Statement of Position (SOP) 03-1, changes in our reserve levels for our Transamerica annuity
reinsurance agreement resulting from underlying asset value changes were not offset with
corresponding changes in our Funds withheld asset values, which caused volatility in our results of
operations. To the extent that the minimum guarantee payable under the policies underlying the
Transamerica agreement exceeded the payment that would be required as a result of the market value
adjustment in those policies, the reserves required under the SOP would be based upon the minimum
guarantee and the mismatch between liabilities and assets was less significant. Third, our
Transamerica annuity reinsurance agreement exhibited volatility in the past due to write downs of
our deferred acquisition cost balance which were based upon managements estimates of future
investment performance and lapse experience. On December 31, 2004, we entered into a binding letter
of intent with Transamerica that provided that Transamerica would terminate its annuity reinsurance
agreement with us and recapture all business ceded under the agreement effective as of December 1,
2004. Pursuant to our letter of intent with Transamerica, on January 31, 2005, we executed
definitive documents and completed the termination and recapture of our annuity reinsurance
agreement with Transamerica. As a result, as of December 31, 2004, our only remaining annuity
reinsurance agreement was with Lafayette, significantly reducing the assets contained in our
annuity segment. For the year ended December 31, 2004, segment loss before the cumulative effect of a change in
accounting principle was $(59,658,730), as compared to a loss of $(44,370,938) for the year ended
December 31, 2003. The loss for the year ended December 31, 2004 reflects a loss of approximately
$57,730,000 (excluding the cumulative charge of approximately $2,244,000 upon the adoption of the
SOP) incurred on our annuity agreement with Transamerica, a loss of approximately $1,539,000
incurred on our GMDB/GMIB agreement with CIGNA (including a $2,421,000 charge in connection with
the recapture of our GMDB/GMIB reinsurance agreement with CIGNA), and a loss of $732,000 from our
annuity reinsurance agreement with Lafayette. The loss from our Transamerica agreement reflects a
charge of approximately $54,100,000 for the termination of our annuity reinsurance agreement in
2004. The charge includes the write-off of deferred policy acquisition costs of approximately
$63,100,000 along with a termination premium of $14,000,000, partially offset by the release of
reserves for interest sensitive contract liabilities in excess of the write-down of funds withheld
at interest assets of approximately $23,000,000. - 39 -




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Upon the adoption of the SOP on January 1, 2004, the amount of reserves for future policy
benefits for our GMDB/GMIB reinsurance agreement with CIGNA was reduced by $1,878,760, favorably
impacting our results of operations. The impact of the adoption of the SOP on our accounting for
the Transamerica annuity reinsurance agreement was a cumulative charge of $2,244,720 as a result of
an increase in Interest sensitive contracts liability of $38,398,730 partially offset by an
increase in deferred policy acquisition costs of $36,154,010. The cumulative effect of a change in
accounting principle was a net loss of $365,960, resulting in net segment loss of $(60,024,690) for
the year ended December 31, 2004. The 2003 loss includes Hartford Lifes recapture of its GMDB reinsurance agreement, which
generated a $20,400,000 loss, a net charge of $5,020,000 related to the termination of our annuity
reinsurance agreement with Ohio National, a net cost of $4,900,000 from the recapture of three
smaller annuity agreements, losses of $4,687,000 on annuity reinsurance agreements terminated or
recaptured during 2003, a $1,934,000 loss under our GMDB/GMIB agreement with CIGNA, as well as a
loss of $3,067,000 on our annuity reinsurance agreement with Transamerica. The net unrealized gain
on our embedded derivatives during the year ended December 31, 2003 was approximately $16,693,000
and largely reflects the reversal of previously reported losses caused by the termination of our
annuity reinsurance agreement with Ohio National and certain of other annuity reinsurance
agreements during the year, including our annuity reinsurance agreements with an affiliate of XL
Life. This gain was partially offset by a related increase in the amortization of deferred
acquisition costs of approximately $6,954,000. Annuity segment revenue for the year ended December 31, 2004 declined 54% to $23,847,196 from
$52,122,419 for the year ended December 31, 2003. This decline is due to a decrease in embedded
derivative gains of approximately $14,512,000, as well as a reduction in investment income of
approximately $5,744,000 and reduced surrender fees from our Transamerica annuity reinsurance
agreement, which decreased by approximately $3,765,000 for the year ended December 31, 2004 as
compared to the year ended December 31, 2003. Policy benefits and expenses for the annuity segment decreased 13% to $83,505,926 for the year
ended December 31, 2004 compared to $96,493,357 for the year ended December 31, 2003. The primary
components of these expenses are interest credited to policyholders, LMIG payments, payments and
reserve changes for minimum guarantees associated with variable annuity contracts and write downs
and amortization of deferred acquisition costs. The decline in policy benefits and expenses is
primarily due the termination of several of our annuity reinsurance agreements during 2003. In
addition, as a result of a smaller base of policyholders, improved investment returns and lower
lapse rates on the Transamerica annuity reinsurance agreement, LMIG payments under the agreement
declined from approximately $16,200,000 for 2003 to approximately $9,990,000 for 2004. Policy
benefits and expenses for 2004 include a write-down of deferred acquisition costs of $63,100,000
and the termination premium of $14,000,000 in connection with the recapture of the Transamerica
annuity reinsurance agreement, partially offset by the release of reserves for interest sensitive
contract liabilities in excess of the write-down of funds withheld at interest assets of
approximately $23,000,000. Policy benefits and expenses for 2003 included a charge of $20,400,000
for the recapture of our then largest GMDB agreement with Hartford Life. Corporate Segment.The corporate segment includes all of our capital gains and losses,
investment income on undeployed invested assets, costs associated with our efforts to raise capital
and pursue other strategic alternatives, costs relating to the anticipated settlement of the
purported shareholder class action lawsuit 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. For the year ended December 31, 2004, segment loss was $(8,183,670) compared to segment income
of $2,651,630 for the year ended December 31, 2003 The loss primarily reflects the $5,000,000
accrual for the anticipated settlement of the purported shareholder class action lawsuit, as well
as increased consulting fees in connection with our efforts to pursue strategic alternatives in
2004. Costs associated with capital raising efforts were approximately $914,000 for the year ended
December 31, 2004. Also, the decline in - 40 -




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segment results for the year ended December 31, 2004 was due to net realized investment gains
declining to $439,536, as compared to $6,406,587 for the year ended December 31, 2003. Pro Forma Effect of Novations, Recaptures and Terminations During 2004, we novated, negotiated the recapture of and terminated a significant amount of
our reinsurance business. In particular, as discussed elsewhere in this report, we negotiated the
termination and recapture of our annuity reinsurance agreement with Transamerica, novated certain
life reinsurance agreements to Transamerica and negotiated the recapture of our GMDB/GMIB agreement
with CIGNA. Our audited consolidated statement of operations for the year ended December 31, 2004
included in this report reflects revenues and expenses from each novated, recaptured or terminated
agreement from January 1, 2004 through the effective date of its novation, recapture or
termination, as well as the cost of its novation, recapture or termination, as well as the cost of
its novation, recapture or termination. We expect that our statement of operations will be
substantially different in 2005 and subsequent years as a result of these transactions.
Accordingly, we have prepared a pro forma statement of operations to assist you in understanding
the operating results generated in 2004 by our remaining book of business. The pro forma statement
of operations is set forth in Item 6. Selected Financial Data  Pro Forma Selected Financial Data
included elsewhere in this report. Financial Condition Investments At December 31, 2004 and December 31, 2003, a large portion of our invested assets, including
cash and cash equivalents, 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 December 31, 2004, our invested assets,
including cash and cash equivalents, had an aggregate fair value of $138,428,894, as compared with
an aggregate fair value of $197,880,755 at December 31, 2003. The decline in our invested assets
during 2004 was due to approximately $23,300,000 of payments we made in connection with the
settlement of the recapture of our life reinsurance agreement with Metropolitan Life Insurance
Companies, payments of approximately $23,900,000 to Transamerica under our annuity reinsurance
agreement, and an $11,000,000 payment made in connection with the recapture of our combined
GMDB/GMIB reinsurance agreement with CIGNA. At December 31, 2004, gross unrealized gains totaled
$1,266,517, as compared to gross unrealized gains of $2,218,246 at December 31, 2003. At December
31, 2004 and December 31, 2003, the weighted average duration of the fixed income securities
included in our invested assets was 2.9 and 3.9 years, respectively, and the weighted average
investment quality rating was AA at the end of each period. 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 and limit investment in fixed income securities that are non-rated or
below investment grade at the time of purchase to an aggregate of $3,000,000. In 2004, we invested
approximately $900,000 in securities that were non-rated at the time of their purchase. While any
investment carries some risk, the risks associated with non-rated or lower-rated securities
generally are greater than the risks associated with investment grade securities. 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 issuers;
however, the issuers capacity to meet its financial commitment on the security is still considered
to be strong. We currently do not invest in any fixed income securities in emerging markets. Prudential Investment Corporation serves as our advisor for our general account investment
portfolio. Our management agreement with Prudential may be terminated by either party with 45 days
notice. Our Board of Directors periodically reviews the performance of Prudential and the fees
associated with this arrangement. - 41 -




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We do not engage in trading activities to generate realized investment gains and, thus, do not
have a trading portfolio. However, we evaluate the desirability of continuing to hold a security
when market conditions, creditworthiness or other measurement factors change. These changes may
relate to a change in the credit risk of an issuer and a decision to sell may be made to avoid
further declines in realizable value. Securities also may be sold prior to maturity to provide
liquidity, as was the case in 2003 and 2004. As a result, our securities are classified as
available for sale and are carried at fair value on our balance sheet. At December 31, 2004 and at December 31, 2003, there were no below investment-grade securities
held in the portfolio. The market value of non-rated securities held at December 31, 2004 was
approximately $1,000,000. 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 require our overall fixed income portfolio to maintain a
minimum weighted average credit quality of A and limit the amount of our investments in fixed
income securities that are non-rated or below investment grade at the time of purchase. 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 December 31, 2004 and 2003, there were no
impaired securities in our portfolio. At December 31, 2004, mortgage-backed securities represented approximately 7% of our invested
assets, including cash and cash equivalents, as compared with approximately 11% at December 31,
2003. 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 December 31, 2004 and 2003. At December 31, 2004, approximately 17% of our mortgage-backed investment portfolio consisted
of securities with planned repayment schedules, as compared with 7% at December 31, 2003. 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. Our results of operations and our financial condition are significantly affected by the
performance of our investments and by changes in interest rates. During a period of declining
interest rates, if our investments are prematurely sold, called, prepaid or redeemed, we may be
unable to reinvest the proceeds in securities of equivalent risk with comparable rates of return.
During a period of rising interest rates, the fair value of our invested assets could decline. In
addition, rising interest rates could also cause disintermediation, which in turn could cause us to
sell investments at prices and times when the fair values of such investments are less than their
amortized cost. We believe that our traditional life insurance liabilities are not highly interest
rate sensitive and, therefore, the effects of fluctuating interest rates on these liabilities are
not significant. For interest sensitive liabilities, we are primarily dependent upon asset/
liability matching or other strategies to minimize the impact of changes in interest rates. If we
do not appropriately match our asset management strategy to our obligations, we could sustain
losses. We may use interest rate swaps and other financial instruments as tools to mitigate the
effects of asset/liability mismatches or the effect of interest rate changes on our balance sheet.
In general, however, we do not hedge our investment risk. Our results of operations are also
affected by the performance of assets held and managed by our ceding companies under our remaining
modified coinsurance and coinsurance funds withheld arrangements, as discussed below under Funds
Withheld at Interest. - 42 -




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The following table summarizes the investment results of our general account portfolio for the
periods indicated: Investment Results Twelve Months Ended December 31,2004
    
    
    2003
    
    
    2002(Dollars in thousands)Total invested assets, including cash and equivalents (1)
    
    $
    138,429
    
    
    $
    197,881
    
    
    $
    306,346Investment income, net of related expenses
    
    $
    5,335
    
    
    $
    5,924
    
    
    $
    25,931Effective yield rate (2)
    
    
    3.51
    %
    
    
    2.53
    %
    
    
    5.28
    %Realized investment gains
    
    $
    440
    
    
    $
    6,407
    
    
    $
    19,749
   (1)
    
    Fair value at the end of the indicated period.(2)
    
    The effective yield rate equals (i) net investment income divided by (ii) the average of total adjusted
invested assets (fixed maturities at amortized cost, including assets on deposit with reinsurers) at the end of
each calendar quarter included in the indicated period. Funds Withheld at Interest As of December 31, 2004, our ceding companies had approximately $56.4 million in assets that
were held and managed by or for them under our modified coinsurance and coinsurance funds withheld
arrangements. Approximately $51.3 million of the funds withheld at interest relates to our
modified coinsurance annuity reinsurance agreement with Lafayette, with the remaining $5.1 million
related to a coinsurance funds withheld life reinsurance agreement. At December 31, 2004, the
assets held and managed under our agreement with Lafayette were invested in fixed income securities
having a weighted average credit quality of A and a weighted average duration of 3.7 years. At
December 31, 2004, none of the assets were invested in below investment grade securities. Our remaining annuity reinsurance agreement covers general account fixed deferred annuity
policies and is structured as a modified coinsurance arrangement. In this type of arrangement, the
ceding company invests the premiums received from policyholders or engages an investment manager to
do so, credits interest to policyholders accounts, processes surrenders and engages in other
administrative activities. The ceding company is also required to carry reserves for these annuity
policies based upon certain statutory rules in the state in which the ceding company is domiciled.
The underlying investments purchased with the premiums received from policyholders support these
statutory reserves. Historically, when a ceding company enters into an annuity reinsurance agreement structured as
a modified coinsurance arrangement with us, a portion of the ceding companys liability to the
policyholders is ceded to us. Our remaining modified coinsurance arrangement is 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 that is equal to our fixed portion of the statutory reserves carried
by the ceding company. 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
statutory reserve. The average yield rate earned on the assets held and managed by our ceding companies under our
annuity reinsurance agreements, which included Transamerica through November 2004, was
approximately 2.88% for the year ended December 31, 2004. The average yield rates earned on the
assets held and managed by our ceding companies under our annuity reinsurance agreements was
approximately 2.68% for the year ended December 31, 2003. The average yield rate earned on the
invested premiums funding our annuity obligations for the Transamerica annuity reinsurance
agreement was approximately 2.65% for the - 43 -




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year ended December 31, 2004. The average yield rate earned on the invested premiums funding
our annuity obligations for our annuity reinsurance agreement with Lafayette was approximately
4.79% for the year ended December 31, 2004. For purposes of calculating the average yield rate
earned on assets held and managed by our ceding companies, we include our share of the investment
income and net realized capital gains and losses as reported to us through our settlements with our
ceding companies. As noted elsewhere in this report, our annuity reinsurance agreement with
Transamerica was terminated, and Transamerica recaptured all business ceded under the agreement
effective as of December 1, 2004. As a result the aforementioned yield rates include the yield
earned on invested premiums that funded our obligations under the Transamerica reinsurance
agreement until the effective termination date. The performance of the assets held and managed by our ceding companies depends to a great
extent on the ability of the ceding company and its investment managers to make appropriate
investments consistent with their investment guidelines. If these assets do not achieve investment
returns sufficient to meet our obligations on the underlying policies, we could experience
unexpected losses, as has happened under our annuity reinsurance agreement with Transamerica, where
the minimum interest guarantees on the underlying policies have exceeded the underlying
policyholder account values due to poor investment performance, and we have been forced to fund our
proportionate share of the shortfall. Lafayette Annuity Reinsurance Agreement Our only remaining annuity reinsurance agreement at December 31, 2004 is with Lafayette.
Approximately $51.3 million, or 91%, of our funds withheld at interest receivable, approximately
$57.8 million, or 100%, of our interest sensitive contracts liability, and approximately $3.4
million, or 55%, of the deferred acquisition costs on our balance sheet related to this agreement
as of December 31, 2004. As a result of the changes to our remaining book of business, especially
the termination of our annuity reinsurance agreement with Ohio National in February 2003 and the
termination of our annuity reinsurance agreement with Transamerica in December 2004, we expect that
the assets and liabilities associated with the Lafayette agreement will represent a significant
portion of our total assets and liabilities in future periods. The amount of deferred acquisition
costs we record as an asset on our balance sheet related to our agreement with Lafayette is based
on a series of assumptions related to the investment performance of the assets supporting our
liabilities under the agreement, as well as future lapse rates for the underlying policies. These
assumed lapse rates include assumptions regarding future full surrenders, partial withdrawals,
annuitizations and policyholder deaths. While we believe the investment and lapse estimates to be
reasonable, they are estimates of future events and we cannot assure you that they will prove to be
accurate. If such assumptions turn out to be inaccurate, we could be required to write off
additional deferred acquisition costs, which would have a significant adverse impact on our results
of operations in future periods. The assets funding the policyholder obligations under our annuity reinsurance agreement with
Lafayette have an average credit quality of A- and an average duration of 3.7 years. The premiums
paid in connection with the underlying policies have been invested in investment grade bonds and
mortgage backed securities. According to information provided by Lafayette, at December 31, 2004, the assets funding the
policyholder obligations under our annuity reinsurance agreement were comprised of the following: - 44 -




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% of TotalType of Security
    
    Book Value (1)
    
    
    Market Value
    
    
    Market ValueInvestment grade US corporate bonds
    
    $
    47,408,632
    
    
    $
    49,659,347
    
    
    
    83.2
    %Mortgage backed securities
    
    
    6,209,128
    
    
    
    6,741,886
    
    
    
    11.3
    %Short-term securities
    
    
    3,281,352
    
    
    
    3,281,353
    
    
    
    5.5
    %Total invested assets
    
    $
    56,899,112
    
    
    $
    59,682,586
    
    
    
    100.0
    %Accrued investment income
    
    
    
    
    
    
    816,992Total market value, including accrued investment income
    
    
    
    
    
    $
    60,499,578
   (1)
    
    Book values are statutory book values reported to us by the ceding
company for the underlying investments and represent the value of our
Funds withheld at interest receivable. We present statutory book
values in the above table because that is the basis upon which we
settle with the ceding company under the agreement. We believe this
presents a better understanding of potential future returns and cash
flows under the agreement. According to information provided by Lafayette, at December 31, 2004 the credit ratings of the
assets (excluding accrued investment income) funding the policyholder obligations under our annuity
reinsurance agreement were approximately as follows: % of TotalRatings (1)
    
    Book Value (2)
    
    
    Market Value
    
    
    Market ValueAAA
    
    $
    6,162,623
    
    
    $
    6,124,325
    
    
    
    10.3
    %AA
    
    
    3,267,674
    
    
    
    3,405,138
    
    
    
    5.7
    %A
    
    
    16,055,236
    
    
    
    16,940,203
    
    
    
    28.4
    %BBB
    
    
    31,413,579
    
    
    
    33,212,920
    
    
    
    55.6
    %Total invested assets
    
    $
    56,899,112
    
    
    $
    59,682,586
    
    
    
    100.0
    %Accrued investment income
    
    
    
    
    
    
    816,992Total market value,
including accrued
investment income
    
    
    
    
    
    $
    60,499,578
   (1)
    
    As assigned by Standard & Poors, or, if unrated by Standard & Poors,
based on equivalent rating assigned by the National Association of
Insurance Commissioners.(2)
    
    Book values are statutory book values reported to us by the ceding
company for the underlying investments and represent the value of our
Funds withheld at interest receivable. We present statutory book
values in the above table because that is the basis upon which we
settle with the ceding company under the agreement. We believe this
presents a better understanding of potential future returns and cash
flows under the agreement. - 45 -




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According to information provided by Lafayette, at December 31, 2004, the maturity
distribution of the assets funding the policyholder obligations under our annuity reinsurance
agreement was approximately as follows: % of TotalMaturity
    
    Book Value (1)
    
    
    Market Value
    
    
    Book ValueWithin one year
    
    $
    11,293,241
    
    
    $
    11,469,687
    
    
    
    19.2
    %From one to five years
    
    
    19,566,378
    
    
    
    20,889,726
    
    
    
    35.0
    %From six to ten years
    
    
    19,586,896
    
    
    
    20,476,650
    
    
    
    34.3
    %More than ten years
    
    
    6,452,597
    
    
    
    6,846,523
    
    
    
    11.5
    %Total all years
    
    $
    56,899,112
    
    
    $
    59,682,586
    
    
    
    100.0
    %
   (1)
    
    Book values are those statutory book values reported to us by the
ceding company for the underlying investments and represent the value
of our Funds withheld at interest receivable. We present statutory
book values in the above table because that is the basis upon which we
settle with the ceding company under the contract. We believe this
presents a better understanding of potential future returns and cash
flows under the contract. Off Balance Sheet Arrangements We have no material off balance sheet arrangements. Contractual Obligations and Commitments The following table shows our contractual obligations and commitments including our payments
due by period. The table does not include any obligations under our annuity and life reinsurance
agreements. Less Than
    
    
    
    
    
    
    
    
    
    
    More Than1 Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    5 Years
    
    
    TotalOperating Leases (1)
    
    $
    275,000
    
    
    $
    86,000
    
    
    
    
    
    
    
    
    
    
    $
    361,000EmploymentAgreements (2)
    
    $
    2,107,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    2,107,000
    (2) The amounts due under employment agreements represent base salary and housing and travel
allowances for employees with the Company as of December 31, 2004. The amounts presented do not
include any pension benefits, bonuses earned or other compensation incentives that may be payable
under the employment agreements. Pursuant to an engagement letter dated January 19, 2004, as amended in March 2005 (Engagement
Letter), we engaged UBS Securities LLC (UBS) to serve as our financial advisor and capital
markets advisor in connection with identifying strategic alternatives available to us. The
Engagement Letter provides that if, during the term of the Engagement Letter, we close an equity
investment, we are obligated - 46 -




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##### Table of Contents



to pay UBS a minimum transaction fee of $1,000,000. If we close a sale transaction during the
term of the
Engagement Letter, we are obligated to pay UBS a minimum fee either $1,500,000 or $2,000,000,
depending on whether the other party to that transaction is one identified in the Engagement
Letter. In any case, the transaction fee payable to UBS may increase as the transaction value
increases. Any transaction fee payable to UBS under the Engagement Letter will be offset by certain
fees paid by us to UBS prior to the closing of the equity investment or sale transaction. At
December 31, 2004, such fees totaled $240,000. We are also obligated to pay a transaction fee to
UBS if, during the one year period following the expiration or termination of the Engagement
Letter, we either consummate or enter into an agreement that results in an equity investment or
sale transaction with any party identified to us by UBS as part of their engagement or with which
we had discussions during the term of the Engagement Letter. The table above does not include any
amounts that may be payable pursuant to the Engagement Letter. 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. Our principal obligations and uses of
the funds are to post collateral for the statutory reserves ceded to us by U.S. based insurers 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 ceding
companies. At December 31, 2004 and December 31, 2003, letters of credit totaling $35,100,000 and
$53,700,000, 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 December 31, 2004 and December 31, 2003, cash and
investments of approximately $41,300,000 and $56,800,000, respectively, were pledged as collateral
for letters of credit. At December 31, 2004 and December 31, 2003, cash and investments of
approximately $28,900,000 and $96,000,000, respectively, were held in trust for the benefit of
certain of our ceding insurance companies to provide security and to meet regulatory requirements.
At December 31, 2004, we had satisfied the collateral requirements of all of our ceding companies. We have two reinsurance operating subsidiaries, one of which is based in and operates out of
Bermuda, and the other of which 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 also 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 December 31, 2004, approximately $51,300,000 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 connection with the novations of the life reinsurance agreements, approximately $28,900,000
of collateral held in a trust established with respect to our life reinsurance agreement with
Scottish Re was transferred to Transamerica. In addition, $23,800,000 of the letters of credit we
posted on behalf of our life reinsurance agreement with F&G were cancelled and the collateral
securing those letters of credit was released to us. Approximately $39,600,000 was paid to
Transamerica in connection with the novation and recapture transactions from this collateral,
including $18,500,000 as consideration for the novations, a $14,000,000 termination premium and
approximately $7,100,000 for amounts due to Transamerica as of December 1, 2004. Following those
payments, approximately $13,100,000 of cash and securities previously posted as collateral was
released to us. We recorded a loss of approximately $60,627,000 during the fourth quarter of 2004
relating to these novation and recapture transactions. On
March 30, 2005, we received a demand letter from Transamerica
stating that $7,000,000 was owed to Transamerica as an adjustment to
the F&G policy benefit reserves. If we and Transamerica are
unable to resolve this issue through continued discussions, we would
seek adjudication of the dispute in accordance with the provisions of
the Master Agreement, which calls for the matter to be submitted to a
Fellow of the Society of Actuaries whose determination shall be
final, binding and conclusive. While there can be no assurances, we
believe that Transamerica is not entitled to this $7,000,000.
Presently, we are unable to determine the amounts, if any, that may
be due to or from Transamerica resulting from adjustments to the
policy benefit reserves. - 47 -




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Although our liquidity position has improved following the novation and recapture transactions
we completed with Transamerica, a large portion of our cash and investments is held by our U.S.
operating subsidiary or is posted as collateral under our remaining life reinsurance agreements and
is unavailable to fund our operations or those of our Bermuda operating subsidiary. At December 31, 2004, our total capitalization, which consisted entirely of equity, was
$66,417,212. During 2001, our Board of Directors approved a share repurchase program of up to an
aggregate of $25,000,000 of our common shares from time to time in the future if market conditions
so dictate. As of December 31, 2004, no shares had been repurchased under this program. For the year ended December 31, 2004, we utilized $59,066,808 of our cash and equivalents to
fund operating activities, as compared with using cash and equivalents of $112,176,985 to fund our
operating activities for the year ended December 31, 2003. The utilization of our cash and
equivalents during 2004 primarily reflects approximately $23,300,000 of payments for unearned
premiums associated with the recapture of our life reinsurance agreement with the Metropolitan Life
Insurance Companies that was effective in 2003, payments of approximately $23,900,000 to
Transamerica, and an $11,000,000 payment of policy benefits associated with the recapture of our
GMDB/GMIB reinsurance agreement with CIGNA. We have no material commitments for capital expenditures as of December 31, 2004. We plan to
continue to receive premiums and pay claims under our remaining reinsurance treaties; however, we
are not currently underwriting any new treaties or accepting any new business from our existing
treaties. While we believe we have sufficient operating liquidity to sustain our operations through
at least the next twelve months, we continue to explore strategic alternatives to attempt to
maximize shareholder value. These alternatives include, but are not limited to, a merger, sale,
joint venture, sale of assets, including our remaining reinsurance agreements, or other comparable
transaction. We do not know the terms upon which these transactions might be available, if at all. 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 and since December 31, 2002, we have not declared a
dividend to shareholders and we do not expect to declare or pay dividends to shareholders in the
near future. 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 results of operations 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. For a discussion of other factors affecting our ability to pay dividends,
see Item 1. Business  Regulation and Results of Operations  Liquidity and Capital Resources and
Note 17 to our consolidated condensed financial statements included elsewhere in this report. 
 Item 7A.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 December 31, 2004. Our primary market risk exposures for the year ended
December 31, 2004 have changed significantly since the year ended December 31, 2003 as a result of
a decrease in the amount of our invested assets and funds withheld at interest, the recapture of
our combined GMDB/GMIB reinsurance agreement with CIGNA and the recent recapture and termination of
our annuity reinsurance agreement with Transamerica. - 48 -




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We have no equity securities in our general account or in the assets underlying our modified
coinsurance or coinsurance funds withheld agreements. 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. For our general fixed-income portfolio, which is comprised of fixed-income securities, our
major market risk is changing interest rates, primarily in the United States. Changes in interest
rates will affect the fair value of our investments and may affect our operating results and
financial condition. Interest rate risk is managed with effective maturity structures and with the
application of duration management practices. The table below presents as of December 31, 2004 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. Weighted Average Interest Rates by Maturity WeightedAverageCash and Cash
    
    
    Weighted Average
    
    
    Fixed income
    
    
    InterestMaturity Year
    
    Equivalents
    
    
    Interest Rate
    
    
    Investments
    
    
    Rate(dollars in thousands)2005
    
    $
    56,394
    
    
    
    1.74
    %
    
    $
    9,031
    
    
    
    7.03
    %2006
    
    
    
    
    
    
    
    
    
    
    18,190
    
    
    
    6.01
    %2007
    
    
    
    
    
    
    
    
    
    
    9,778
    
    
    
    5.63
    %2009
    
    
    
    
    
    
    
    
    
    
    2,712
    
    
    
    5.73
    %2010
    
    
    
    
    
    
    
    
    
    
    4,871
    
    
    
    6.55
    %Thereafter
    
    
    
    
    
    
    
    
    
    
    36,186
    
    
    
    5.63
    %Total
    
    $
    56,394
    
    
    
    1.74
    %
    
    $
    80,768Fair value
    
    $
    56,394
    
    
    
    
    
    
    $
    82,034
 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 $2,323,000 based on a 100 basis point
increase in interest rates as of December 31, 2004. Conversely, the model produces gains of similar
amounts with a 100 basis point decrease in interest rates. Actual results may differ from the
hypothetical change in fair values assumed in this disclosure. We believe that our life insurance liabilities are not highly interest rate sensitive as they
arise from traditional reinsurance arrangements and, therefore, the effects of fluctuating interest
rates on these liability cash flows are not significant. Our remaining annuity reinsurance
agreement is generally regarded as interest rate sensitive. The future earnings and cash flows of
that annuity reinsurance agreement are primarily dependent on earning a spread (the difference
between the interest earned on the supporting asset base and the rate credited to policyholders)
and persistency of the underlying business. Our ceding company under the annuity reinsurance
agreement manages all assets supporting our interest sensitive contracts liabilities. If these
assets do not achieve investment returns at rates sufficient to meet our obligations on the
underlying policies, we could experience losses. - 49 -




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##### Table of Contents



Our remaining modified coinsurance annuity reinsurance agreement has features that constitute
an embedded derivative that requires bifurcation and separate accounting under SFAS No. 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 this agreement. The valuation of this embedded
derivative requires complex cash flow modeling and assumptions, most notably with respect to
expected future cash flows under the reinsurance agreement. The net fair value of this derivative
is classified on our balance sheet as a component of our Funds withheld at interest asset. Changes
in the fair value of the derivative are reported in our results of operations as the 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. The methodology we use to determine the fair value of the embedded derivative is to determine
the fair value of the host contract (notional asset) based upon expected future cash flows under
the annuity contract. 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 results in a
valuation of the embedded derivative reflecting the market risk inherent in the underlying
contract. Sensitivity analysis on the assets and liabilities associated with the underlying
reinsurance agreement is conducted periodically. As of December 31, 2004, the net impact on our embedded derivative of a 20 basis point
increase or decrease in credit spreads is a loss or gain on the embedded derivative of
approximately $203,000. The net impact on our embedded derivative 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 $83,000. The duration of the actual assets is approximately 3.66 years
and the duration of the notional asset is approximately 3.60 years. As a result, we believe the
impact of interest rate movements on the embedded derivative will be small. The table below shows
the change in our embedded derivative for what is now our only remaining modified coinsurance
annuity reinsurance agreement by quarter for 2004 and 2003: Change in Embedded
    
    
    Embedded DerivativeDerivative Value
    
    
    at Fair ValueFirst Quarter 2003
    
    $
    3,157,059
    
    
    $
    (9,003,072
    )Second Quarter 2003
    
    $
    (655,313
    )
    
    $
    (9,658,385
    )Third Quarter 2003
    
    $
    21,315
    
    
    $
    (9,637,070
    )Fourth Quarter 2003
    
    $
    1,846,939
    
    
    $
    (7,790,131
    )First Quarter 2004
    
    $
    607,388
    
    
    $
    (7,182,743
    )Second Quarter 2004
    
    $
    518,786
    
    
    $
    (6,663,957
    )Third Quarter 2004
    
    $
    565,939
    
    
    $
    (6,098,018
    )Fourth Quarter 2004
    
    $
    488,957
    
    
    $
    (5,609,061
    )
   The statements above are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act. See Forward-Looking Statements beginning on page 23. - 50 -




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Item 8.Financial Statements and Supplementary Data. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE ANNUITY AND LIFE RE (HOLDINGS), LTD. AND SUBSIDIARIES PageFinancial StatementsReports
of Independent Registered Public Accounting Firms
    
    
    52Consolidated
Balance Sheets at December 31, 2004 and 2003
    
    
    54Consolidated Statements of Operations for the years ended
December 31, 2004, 2003, and 2002
    
    
    55Consolidated Statements of Comprehensive Loss for the
years ended December 31, 2004, 2003, and 2002
    
    
    56Consolidated Statements of Changes in Stockholders
Equity for the years ended December 31, 2004, 2003 and
2002
    
    
    57Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002
    
    
    58Notes
to Consolidated Financial Statements
    
    
    59Financial Statement ScheduleSchedule II
Financial Information of Registrant
    
    
    82
 All other schedules for which provision is made in the applicable accounting regulations of the
Securities and Exchange Commission are not required under the related instructions or are
inapplicable and therefore have been omitted, or the information is presented in the consolidated
financial statements or accompanying notes. - 51 -




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Audit Committee of the Board of Directors and Stockholders
Annuity and Life Re (Holdings), Ltd. We have audited the accompanying consolidated balance sheets of Annuity and Life Re
(Holdings), Ltd. and subsidiaries (the Company) as of December 31, 2004, and the related
consolidated statements of operations, comprehensive loss, changes in stockholders equity, and cash
flows for the year ended December 31, 2004. Our audit also included financial statement schedule
II, condensed financial information for the Registrant as of December 31, 2004 and for the year
then ended. These consolidated financial statements and financial statement schedule are the
responsibility of the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our audits. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Annuity and Life Re (Holdings), Ltd. and its
subsidiaries as of December 31, 2004 and the results of their operations and cash flows for the
year ended December 31, 2004, in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information contained therein. As discussed in Note 4(l) to the consolidated financial statements, as of January 1, 2004, the
Company changed its method of accounting for certain nontraditional long-duration contracts. We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Companys internal control over financial
reporting as of December 31, 2004, based on the criteria established in Internal ControlIntegrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated February 11, 2005 expressed an unqualified opinion on managements assessment of the
effectiveness of the Companys internal control over financial reporting and an adverse opinion on
the effectiveness of the Companys internal control over financial reporting because of the
existence of material weaknesses. /s/     Marcum & Kliegman LLP Melville, New York
February 11, 2005
Except for the first paragraph of Note 12,
as to which the date is March 30, 2005 - 52 -




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Report of the Independent Registered Public Accounting Firm The Board of Directors and Shareholders
Annuity and Life Re (Holdings), Ltd. We have audited the accompanying consolidated balance sheet of Annuity and Life Re (Holdings), Ltd.
and subsidiaries as of December 31, 2003 and the related consolidated statements of operations,
comprehensive loss, stockholders equity and cash flows for each of the years in the two-year
period ended December 31, 2003. In connection with our audits of the consolidated financial
statements, we have also audited the accompanying financial statement schedule as of December 31,
2003 and for each of the years in the two-year period ended December 31, 2003. These consolidated
financial statements and financial statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated financial statements
and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Annuity and Life Re (Holdings), Ltd. and its
subsidiaries as of December 31, 2003 and the results of their operations and cash flows for the
years ended December 31, 2003 and 2002 in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, the related financial statement schedule as
of December 31, 2003 and for each of the years in the two-year period ended December 31, 2003, when
considered in relation to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information contained therein. The consolidated financial statements and financial statement schedule for the years ended December
31, 2003 and 2002 have been prepared assuming that the Company will continue as a going concern. As
discussed in Note 3 to the consolidated financial statements, the Company has suffered significant
losses from operations and experienced liquidity demands that raise substantial doubt about its
ability to continue as a going concern. Managements plans with regard to these matters are also
described in Note 3. The consolidated financial statements and financial statement schedule do not
include any adjustments that might result from the outcome of this uncertainty. KPMG Chartered Accountants
Hamilton, Bermuda
March 5, 2004 - 53 -




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##### Table of Contents



ANNUITY AND LIFE RE (HOLDINGS), LTD. 
 CONSOLIDATED BALANCE SHEETS
(U.S. Dollars) December 31,2004
    
    
    2003AssetsCash and cash equivalents
    
    $
    56,394,484
    
    
    $
    80,068,310Fixed income investments at fair value (amortized cost
of $80,767,893 and $115,594,199 at December 31, 2004
and December 31, 2003, respectively)
    
    
    82,034,410
    
    
    
    117,812,445Funds withheld at interest
    
    
    56,415,386
    
    
    
    667,824,819Accrued investment income
    
    
    1,155,762
    
    
    
    1,491,170Receivable for reinsurance ceded
    
    
    82,433,270
    
    
    
    88,480,172Other reinsurance receivables
    
    
    4,306,931
    
    
    
    4,580,745Deferred policy acquisition costs
    
    
    6,084,488
    
    
    
    68,942,628Other assets
    
    
    580,625
    
    
    
    682,050Total Assets
    
    $
    289,405,356
    
    
    $
    1,029,882,339LiabilitiesReserves for future policy benefits
    
    $
    109,860,843
    
    
    $
    161,105,541Interest sensitive contracts liability
    
    
    57,754,009
    
    
    
    670,717,546Other reinsurance liabilities
    
    
    49,186,297
    
    
    
    55,826,940Accounts payable and accrued expenses
    
    
    6,186,995
    
    
    
    7,059,733Total Liabilities
    
    
    222,988,144
    
    
    
    894,709,760Stockholders EquityPreferred shares (par value $1.00; 50,000,000 shares
authorized; no shares outstanding)
    
    
    
    
    
    
    Common shares (par value $1.00; 100,000,000 shares
authorized; 26,338,528 and 26,454,195 shares outstanding
at December 31, 2004 and December 31, 2003, respectively)
    
    
    26,338,528
    
    
    
    26,454,195Additional paid-in capital
    
    
    333,810,766
    
    
    
    334,418,029Stock warrants
    
    
    1,350,000
    
    
    
    1,250,000Unamortized stock-based compensation
    
    
    (490,415
    )
    
    
    (1,509,022
    )Accumulated other comprehensive income
    
    
    1,016,260
    
    
    
    1,840,849Accumulated deficit
    
    
    (295,607,927
    )
    
    
    (227,281,472
    )Total Stockholders Equity
    
    
    66,417,212
    
    
    
    135,172,579Total Liabilities and Stockholders Equity
    
    $
    289,405,356
    
    
    $
    1,029,882,339
 See accompanying notes to consolidated financial statements - 54 -




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##### Table of Contents



ANNUITY AND LIFE RE (HOLDINGS), LTD. 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(U.S. Dollars) For the Year Ended December 31,2004
    
    
    2003
    
    
    2002RevenuesNet premiums
    
    $
    48,297,706
    
    
    $
    166,972,840
    
    
    $
    344,097,441Investment income, net of related expenses
    
    
    21,697,563
    
    
    
    29,042,223
    
    
    
    102,138,985Net realized investment gains
    
    
    439,536
    
    
    
    6,406,587
    
    
    
    19,749,266Net change in fair value of embedded derivatives
    
    
    2,181,070
    
    
    
    16,692,688
    
    
    
    (25,846,110
    )Surrender fees and other revenues
    
    
    4,475,691
    
    
    
    7,297,015
    
    
    
    16,156,437Total Revenues
    
    
    77,091,566
    
    
    
    226,411,353
    
    
    
    456,296,019Benefits and ExpensesClaims and policy benefits
    
    
    14,101,129
    
    
    
    198,002,905
    
    
    
    352,408,801Interest credited to interest sensitive products
    
    
    5,399,460
    
    
    
    13,980,723
    
    
    
    71,370,616Policy acquisition costs and other insurance expenses
    
    
    110,922,948
    
    
    
    128,549,288
    
    
    
    125,877,980Collateral costs
    
    
    
    
    
    
    
    
    
    
    12,948,115Operating expenses
    
    
    14,628,524
    
    
    
    18,034,021
    
    
    
    22,577,792Total Benefits and Expenses
    
    
    145,052,061
    
    
    
    358,566,937
    
    
    
    585,183,304Loss before cumulative effect of a
change in accounting principle
    
    
    (67,960,495
    )
    
    
    (132,155,584
    )
    
    
    (128,887,285
    )Cumulative effect of a change in accounting principle
    
    
    (365,960
    )
    
    
    
    
    
    
    Net Loss
    
    $
    (68,326,455
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )Loss per common share before cumulative effect of a
change in accounting principle per common shareBasic
    
    $
    (2.63
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )Diluted
    
    $
    (2.63
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )Cumulative effect of a change in accounting
principle per common shareBasic
    
    $
    (0.01
    )
    
    $
    
    
    
    $
    Diluted
    
    $
    (0.01
    )
    
    $
    
    
    
    $
    Net loss per common shareBasic
    
    $
    (2.64
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )Diluted
    
    $
    (2.64
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )
 See accompanying notes to consolidated financial statements - 55 -




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##### Table of Contents



ANNUITY AND LIFE RE (HOLDINGS), LTD. 
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(U.S. Dollars) For the Year Ended December 31,2004
    
    
    2003
    
    
    2002Net loss for the period
    
    $
    (68,326,455
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )Other comprehensive loss:Unrealized holding
(loss) gains on fixed
income investments
arising during the
period
    
    
    (385,053
    )
    
    
    2,084,911
    
    
    
    19,493,322Less reclassification
adjustment for net
realized investment
gains in net loss
    
    
    439,536
    
    
    
    6,406,587
    
    
    
    19,749,266Other comprehensive loss
    
    
    (824,589
    )
    
    
    (4,321,676
    )
    
    
    (255,944
    )Total Comprehensive Loss
    
    $
    (69,151,044
    )
    
    $
    (136,477,260
    )
    
    $
    (129,143,229
    )
 See accompanying notes to consolidated financial statements - 56 -




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##### Table of Contents



ANNUITY AND LIFE RE
(HOLDINGS), LTD. 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
 For the Year Ended December 31,2004
    
    
    2003
    
    
    2002Preferred shares par value $1.00Balance at beginning and end of period
    
    $
    
    
    
    $
    
    
    
    $
    Common shares par value $1.00Balance at beginning of period
    
    $
    26,454,195
    
    
    $
    26,106,328
    
    
    $
    25,705,328Issuance of shares
    
    
    
    
    
    
    575,000
    
    
    
    401,000Cancellation of shares
    
    
    (115,667
    )
    
    
    (227,133
    )
    
    
    Balance at end of period
    
    $
    26,338,528
    
    
    $
    26,454,195
    
    
    $
    26,106,328Additional paid-in capitalBalance at beginning of period
    
    $
    334,418,029
    
    
    $
    335,334,932
    
    
    $
    332,447,062Issuance of shares and stock options
    
    
    15,000
    
    
    
    426,700
    
    
    
    2,887,870Cancellation of shares and stock options
    
    
    (622,263
    )
    
    
    (1,343,603
    )
    
    
    Balance at end of period
    
    $
    333,810,766
    
    
    $
    334,418,029
    
    
    $
    335,334,932Notes receivable from stock salesBalance at beginning of period
    
    $
    
    
    
    $
    (1,626,493
    )
    
    $
    (1,317,259
    )Repayments (Issuances)
    
    
    
    
    
    
    1,250,000
    
    
    
    (250,000
    )Interest collected on notes receivable
    
    
    
    
    
    
    420,491
    
    
    
    38,620Accrued interest during period
    
    
    
    
    
    
    (43,998
    )
    
    
    (97,854
    )Balance at end of period
    
    $
    
    
    
    $
    
    
    
    $
    (1,626,493
    )Stock warrantsBalance at beginning of period
    
    $
    1,250,000
    
    
    $
    
    
    
    $
    Issuance of warrants
    
    
    100,000
    
    
    
    1,250,000Balance at end of period
    
    $
    1,350,000
    
    
    $
    1,250,000
    
    
    $
    Unamortized stock-based compensationBalance at beginning of period
    
    $
    (1,509,022
    )
    
    $
    (2,514,693
    )
    
    $
    Cancellation of stock-based compensation
    
    
    737,930
    
    
    
    1,570,736
    
    
    
    Issuance of stock-based compensation
    
    
    (15,000
    )
    
    
    (1,001,700
    )
    
    
    (3,288,870
    )Amortization of stock-based compensation
    
    
    295,677
    
    
    
    436,635
    
    
    
    774,177Balance at end of period
    
    $
    (490,415
    )
    
    $
    (1,509,022
    )
    
    $
    (2,514,693
    )Accumulated other comprehensive incomeBalance at beginning of period
    
    $
    1,840,849
    
    
    $
    6,162,525
    
    
    $
    6,418,469Net unrealized (losses) on fixed income
investments
    
    
    (824,589
    )
    
    
    (4,321,676
    )
    
    
    (255,944
    )Balance at end of period
    
    $
    1,016,260
    
    
    $
    1,840,849
    
    
    $
    6,162,525Accumulated DeficitBalance at beginning of period
    
    $
    (227,281,472
    )
    
    
    (95,125,888
    )
    
    $
    38,935,242Net loss
    
    
    (68,326,455
    )
    
    
    (132,155,584
    )
    
    
    (128,887,285
    )Stockholder dividends
    
    
    
    
    
    
    
    
    
    
    (5,173,845
    )Balance at end of period
    
    $
    (295,607,927
    )
    
    $
    (227,281,472
    )
    
    $
    (95,125,888
    )Total Stockholders Equity
    
    $
    66,417,212
    
    
    $
    135,172,579
    
    
    $
    268,336,711
 See accompanying notes to consolidated financial statements - 57 -




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##### Table of Contents



ANNUITY AND LIFE RE (HOLDINGS), LTD 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. Dollars) For the Year Ended December 31,2004
    
    
    2003
    
    
    2002Cash flows from operating activitiesNet loss
    
    $
    (68,326,455
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )Adjustments to reconcile net loss to cash used by
operating activities:Net realized investment gains
    
    
    (439,536
    )
    
    
    (6,406,587
    )
    
    
    (19,749,266
    )Net change in fair value of embedded derivatives
    
    
    (2,181,070
    )
    
    
    (16,692,688
    )
    
    
    25,846,110Cumulative effect of change in accounting principle
    
    
    365,960
    
    
    
    
    
    
    
    Amortization of stock based compensation
    
    
    295,677
    
    
    
    436,635
    
    
    
    774,177Stock warrants expense
    
    
    100,000
    
    
    
    1,250,000
    
    
    
    Changes in:Accrued investment income
    
    
    335,408
    
    
    
    650,168
    
    
    
    2,755,725Deferred policy acquisition costs
    
    
    99,012,150
    
    
    
    118,971,020
    
    
    
    21,160,544Other reinsurance receivables
    
    
    6,320,716
    
    
    
    25,633,710
    
    
    
    14,502,125Other assets
    
    
    101,425
    
    
    
    1,826,808
    
    
    
    6,852,113Reserves for future policy benefits
    
    
    (49,365,938
    )
    
    
    (108,514,268
    )
    
    
    47,754,054Interest sensitive contracts, net of funds withheld
    
    
    (37,771,764
    )
    
    
    3,535,715
    
    
    
    (39,703,138
    )Other reinsurance liabilities
    
    
    (6,640,643
    )
    
    
    4,687,776
    
    
    
    33,798,860Accounts payable and accrued expenses
    
    
    (872,738
    )
    
    
    (5,399,690
    )
    
    
    1,708,325Net cash used by operating activities
    
    $
    (59,066,808
    )
    
    $
    (112,176,985
    )
    
    $
    (33,187,656
    )Cash flows from investing activitiesProceeds from sales and maturities of fixed income
investments
    
    $
    54,941,179
    
    
    $
    336,303,814
    
    
    $
    336,648,268Purchases of fixed income investments
    
    
    (19,548,197
    )
    
    
    (298,615,920
    )
    
    
    (153,589,644
    )Net cash provided by investing activities
    
    $
    35,392,982
    
    
    $
    37,687,894
    
    
    $
    183,058,624Cash flows from financing activitiesInterest accrued on notes receivable
    
    $
    
    
    
    $
    (43,998
    )
    
    $
    (97,854
    )Interest collected on notes receivable
    
    
    
    
    
    
    420,491
    
    
    
    38,620Repayment (issuance) of notes receivable
    
    
    
    
    
    
    1,250,000
    
    
    
    (250,000
    )Dividends paid to stockholders
    
    
    
    
    
    
    
    
    
    
    (5,173,845
    )(Decrease) in deposit liability
    
    
    
    
    
    
    
    
    
    
    (96,250,000
    )Net cash provided (used) by financing activities
    
    $
    
    
    
    $
    1,626,493
    
    
    $
    (101,733,079
    )(Decrease) increase in cash and cash equivalents
    
    $
    (23,673,826
    )
    
    $
    (72,862,598
    )
    
    $
    48,137,889Cash and cash equivalents, beginning of period
    
    
    80,068,310
    
    
    
    152,930,908
    
    
    
    104,793,019Cash and cash equivalents, end period
    
    $
    56,394,484
    
    
    $
    80,068,310
    
    
    $
    152,930,908Non-Cash disclosures: amounts recorded in
connection with the cumulative effect of a change in
accounting principleDeferred policy acquisition costs
    
    $
    (36,154,010
    )
    
    $
    
    
    
    $
    Reserves for future policy benefits
    
    
    (1,878,760
    )
    
    
    
    
    
    
    Interest sensitive contracts, net of funds withheld
    
    
    38,398,730
    
    
    
    
    
    
    
    Cumulative effect of a change in accounting principle
    
    $
    365,960
    
    
    $
    
    
    
    $
    
 See accompanying notes to consolidated financial statements - 58 -




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##### Table of Contents



ANNUITY AND LIFE RE (HOLDINGS), LTD. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Description of Business 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, Ltd.,
Annuity and Life Re America, Inc. and Annuity and Life Reassurance America, Inc. are collectively
referred to herein as the Company. The Company has encountered significant difficulties during the last four years. In addition
to reporting significant operating losses for those years, the Company has reduced its operations
significantly through the novation, termination and recapture of many of its life and annuity
reinsurance agreements. The Company plans to continue to receive premiums and pay claims under its
remaining reinsurance treaties; however, it is not currently underwriting any new treaties or
accepting any new business from its existing treaties. 2. Significant Events and Resolution of Contingencies (a) Significant Events On December 31, 2004, the Company entered into a binding letter of intent with Transamerica
Occidental Life Insurance Company (Transamerica) that provided for the novation of its life
reinsurance agreements with Scottish Re Limited (Scottish Re) and Fidelity and Guaranty Life
Insurance Company (F&G) to Transamerica as of December 31, 2004. The letter of intent also
provided that, upon consummation of the novation of the life reinsurance agreements, Transamerica
would terminate its annuity reinsurance agreement with the Company and recapture all business ceded
under the agreement effective as of December 1, 2004. Pursuant to the letter of intent with Transamerica, on January 31, 2005, the Company executed
definitive documents and novated its life reinsurance agreements with Scottish Re and F&G to
Transamerica as of December 31, 2004. In consideration of these novations, the Company paid
Transamerica $18.5 million, representing a transfer of reserves related to the novated life
reinsurance agreements. Also, on January 31, 2005, the Company executed an amendment to its annuity
reinsurance agreement with Transamerica pursuant to which the annuity reinsurance agreement with
Transamerica was terminated, and Transamerica recaptured all business ceded under the agreement
effective as of December 1, 2004. In consideration of the recapture, the Company paid Transamerica
all amounts owed under the annuity reinsurance agreement through November 30, 2004, which was
approximately $7.1 million, along with a termination premium of $14.0 million. In connection with the novations of the life reinsurance agreements, approximately $28.9
million of collateral held in a trust established with respect to the Companys life reinsurance
agreement with Scottish Re was transferred to Transamerica. In addition, $23.8 million of the
letters of credit the Company posted on behalf of its life reinsurance agreement with F&G were
cancelled and the collateral securing those letters of credit was released to the Company.
Approximately $39.6 million was paid to Transamerica in connection with the novation and recapture
transactions from this collateral, including $18.5 million as consideration for the novations, a
$14.0 termination premium and approximately $7.1 million for amounts due to Transamerica as of
December 1, 2004. Following those payments, approximately $13.1 million of - 59 -




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##### Table of Contents



cash and securities previously posted as collateral were released to the Company. On July 28, 2004, Connecticut General Life Insurance Company (CIGNA), the ceding company
under the Companys then only remaining guaranteed minimum death benefit (GMDB) and guaranteed
minimum income benefit (GMIB) reinsurance agreement drew $11 million on a letter of credit that
had been issued for CIGNAs benefit. As of June 30, 2004, CIGNA was seeking $49 million of
collateral in addition to the $11 million of collateral the Company had previously provided in the
form of a fully collateralized letter of credit. The Company did not agree that the aggregate $60
million collateral requirement asserted by CIGNA was required to be posted and did not post any
additional collateral for this agreement. On October 26, 2004, the Company entered into a
Commutation and Release Agreement with CIGNA providing for the recapture by CIGNA of the GMDB/GMIB
agreement. The Commutation and Release Agreement also provides for a mutual release by each of the
parties of all past, present and future claims under the GMDB/GMIB agreement, including all
obligations for claims and premiums that had accrued under the agreement since July 1, 2004. The
parties also agreed to a mutual release of all claims under the letter of credit, and that CIGNA
would retain the $11 million it previously drew under the letter of credit. In addition, the
Company issued CIGNA a warrant dated as of September 30, 2004 to acquire one million of its common
shares at an exercise price of $1.00 per share (as per Note 7). The warrant expires on September
30, 2014. After giving effect to the Commutation and Release Agreement with CIGNA, the Company no
longer has any exposure to GMDB or GMIB. On and since December 4, 2002, certain of the Companys stockholders, seeking to act as class
representatives, filed 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. The plaintiffs filed a single consolidated amended complaint
in July 2003, adding as defendants XL Capital Ltd and two additional directors. On October 1, 2003,
the Company answered the amended and consolidated complaint and denied liability on the claims the
plaintiffs have asserted. In January 2004, the court ordered that a related action that the
plaintiffs filed against the KPMG LLP (United States) and KPMG in Bermuda be consolidated with the
action against the Company. In February 2004, the court denied certain individual defendants
motions to dismiss the action. In March 2004, the court denied motions to dismiss filed by certain
other individual defendants and XL Capital Ltd. Also in March 2004, KPMG LLP (United States) and
KPMG in Bermuda filed motions to dismiss the action. The court has not yet ruled on KPMG LLPs
(United States) and KPMG in Bermudas respective motions to dismiss. On July 20, 2004, the Company announced that it had reached an agreement in principle with the
plaintiffs, subject to full documentation by the parties to the settlement, notice to the class,
court approval and other steps required to consummate a class action settlement, to settle the
lawsuit. In August 2004, the parties to the settlement executed and filed a Stipulation setting
forth their settlement agreement, and sought court approval. The parties to the settlement are the
plaintiffs and the class (which consists, subject to certain exclusions, of persons who purchased
the Companys common shares between March 15, 2000 and November 19, 2002), the Company, all
individual defendants and XL Capital Ltd. The settlement is without any admission of liability or
wrongdoing. The Company, along with its directors and officers liability carrier, and XL Capital
Ltd have agreed to pay an aggregate of $16.5 million. The Companys share of the settlement was
$2.5 million in cash, which it paid into escrow in August 2004, and an additional $2.5 million to
be paid in cash or in common shares (subject to a cap of 19.9% of the Companys outstanding shares)
at the Companys election. On January 10, 2005, the Company elected to pay the remaining $2.5
million in cash, which it paid into escrow on that date. The Company recorded its $5.0 million
portion of the settlement as an operating expense in 2004. - 60 -




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##### Table of Contents



In October 2004, the court ordered that notice of the settlement be given to class members,
set deadlines for class members to exclude themselves from the class or file objections to the
settlement, and scheduled a Settlement Fairness Hearing for January 2005. Following the Settlement
Fairness Hearing, the District Court entered an order and final judgment approving the settlement
in January 2005. Robert P. Johnson, one of the Companys current directors, has filed a proof of
claim to participate in the settlement based on his transactions in the Companys stock during the
class period and prior to rejoining its board of directors. (b) Resolution of Contingencies The terminations and novations of the reinsurance agreements described in Note 2 (a) reduced
the Companys obligations to post collateral and reduced the cash drain on operations. These
terminations and novations combined with the settlement of the class action lawsuit described in
Note 2 (a), resolved a number of the contingencies that faced the Company as of December 31, 2003
(see Note 3). After taking into consideration the Companys current security and regulatory
requirements (see Note 5), and the return of approximately $13.1 million of cash and securities
pledged as collateral for letters of credit (see Note 2 (a)), the Company believes it has
sufficient cash and investments as of December 31, 2004 to fund its operations for at least the
next 12 months. The termination, recapture and novation transactions consummated by the Company in 2004 had a
material impact on the Companys results of operations. The following unaudited table shows
summarized results of operations assuming that all of the termination, recapture and novation
transactions occurred on January 1, 2004. Annuity and Life Re (Holdings), Ltd.
Pro Forma Condensed Consolidated Statement of Operation for the Years Ended December 31, 2004
(Unaudited and in U.S. Dollars) Pro Forma2004Total Revenues
    
    $
    29,069,399Total Benefits and Expenses
    
    
    35,612,349Loss before cumulative effect of a change in accounting principle
    
    $
    (6,542,950
    )Cumulative effect of a change in accounting principle
    
    
    Net Loss
    
    $
    (6,542,950
    )Loss per common share before cumulative effect of a change in
accounting principle per common share:Basic
    
    $
    (0.25
    )Diluted
    
    $
    (0.25
    )Cumulative effect of a change in accounting principle per common share:Basic
    
    $
    0.00Diluted
    
    $
    0.00Net loss per common share:Basic
    
    $
    (0.25
    )Diluted
    
    $
    (0.25
    )
 3. Going Concern Basis of
Presentation  2003 Financial Statements The footnotes to our consolidated financial statements for the year ended December 31, 2003
included the following discussion regarding the going concern basis of accounting that was used as
a basis for preparing those consolidated financial statements. See
Note 2(b) for the status of the following matters. The accompanying consolidated financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of liabilities in the
normal course of - 61 -




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business. However, the Company has incurred significant operating losses. 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. At the
Companys request, all three financial ratings have been withdrawn. In addition, the Company is required to post collateral for the statutory reserves ceded to it
by U.S. based insurers and did not have sufficient available cash and investments at December 31,
2003 to satisfy the collateral requirements asserted by Connecticut General Life Insurance Company
(CIGNA), the ceding company under the Companys remaining guaranteed minimum death benefit
(GMDB) and guaranteed minimum income benefit (GMIB) agreement. As of December 31, 2002, CIGNA
had asserted that the Company was required to post $59 million of collateral in addition to the $11
million of collateral the Company had previously provided. As of December 31, 2003, CIGNA was
seeking $49 million of collateral in addition to the $11 million of collateral the Company had
previously provided. The Company does not agree that the aggregate $60 million collateral
requirement currently asserted by CIGNA is required to be posted, and has not posted any additional
collateral for the agreement. As a result, CIGNA may institute arbitration or litigation
proceedings against the Company. If the Company does not prevail in any such arbitration or
litigation proceedings, 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 December 31, 2003, the
Company had met all the collateral obligations of its remaining ceding companies with the exception
of those asserted by CIGNA. Transamerica Occidental Life Insurance Company (Transamerica) has alleged that the Company,
as of October 31, 2003, owed $17.6 million under its annuity reinsurance agreement with
Transamerica. On February 3, 2004, the Company paid Transamerica $12.6 million representing the net
amount the Company believed was due under the reinsurance agreement as of October 31, 2003 after
deducting $5.0 million for investment related expenses that the Company believes was owed to it by
Transamerica. Transamerica is currently pursuing arbitration with the Company, asserting that the
$5.0 million offset is not justified and that the Company owes Transamerica that amount and
interest on the amounts that Transamerica previously alleged were due. In addition, the Company has been attempting to engage Transamerica, and ultimately IL Annuity
and Insurance Company, the primary insurance company under the Transamerica agreement, in
discussions aimed at improving investment returns from the convertible bond portfolio and
potentially redesigning the VisionMark product to reduce the minimum guarantee exposures from the
Transamerica agreement. If the Company is not successful in convincing Transamerica and IL Annuity
to restructure the portfolio and/or to redesign the product, it may incur additional losses on the
agreement in the future. 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
is currently not writing new reinsurance agreements and is not accepting any new business under
existing treaties. In addition, the Company is a defendant in a purported shareholder class action
suit. The plaintiffs have not disclosed the damages sought. There can be no assurance that the Company will be able to maintain its operations and
liquidity. The Companys plans involve repositioning its investment portfolio to achieve a
substantially higher yield within its investment guidelines, and seeking to successfully defend
itself against the pending purported shareholder class action suit, improve the performance of its
reinsurance agreement with Transamerica and restructure its reinsurance agreement with CIGNA. If
the Company is not successful in implementing its plans, management believes the Company may not be
able to meet its obligations in 2004. The Companys failure to achieve any one of the foregoing
items could have a material adverse effect on its financial condition and results of operations.
These aforementioned factors raise substantial doubt about the Companys ability to continue as a
going concern. The accompanying consolidated financial statements do not include any adjustments
that might be necessary should the Company be unable to continue as a going concern. - 62 -




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4. Summary of Significant Accounting Policies The accompanying consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America which require management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the consolidated financial statements. Actual
results could differ from those estimates. The following are the significant accounting policies
adopted by the Company: (a) Basis of consolidation The consolidated financial statements include the accounts of Holdings and its subsidiaries,
Annuity and Life Reassurance, Ltd., Annuity and Life Re America, Inc. and Annuity and Life
Reassurance America, Inc. All significant inter-company accounts and transactions have been
eliminated upon consolidation. (b) Revenues Reinsurance premiums from traditional life and annuity policies with life contingencies, where
premiums collected match the period over which benefits are provided, are recognized as revenue
when due from policyholders. Traditional life policies include those contracts with fixed and
guaranteed premiums and benefits, and consist principally of whole life and term insurance
policies. Benefits and expenses are matched with revenue so as to result in the recognition of
profits over the life of the contracts. This is achieved by means of the provision for liabilities
for future policy benefits and deferral and subsequent amortization of policy acquisition costs. For contracts with a single premium or a limited number of premium payments due over a
significantly shorter period than the total period over which benefits are provided (limited
payment contracts), reinsurance premiums are recorded as net premiums when due with any excess
profit deferred and recognized in net premiums in a constant relationship to the insurance in force
or, for annuities, in relation to the amount of expected future benefit payments. Amounts collected on universal life and investment-type contracts are considered deposits and
are reported in the 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. Deposit accounting procedures are applied to considerations received or paid
relating to reinsurance contracts that do not qualify for reinsurance accounting, with any revenue
or expense associated with such deposits reflected in net investment income and other insurance
expenses, respectively. (c) 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. Where a ceding company pays a bonus
interest amount in the first year of a policy to induce a policyholder to acquire the product, and
this bonus interest amount is distinct from and incremental to the expected ongoing interest
crediting amount, the bonus interest is capitalized and amortized to policy acquisition costs in a
manner similar to deferred acquisition costs. Deferred policy acquisition costs are subject to
recoverability testing at the time of policy issuance and loss recognition testing at the end of
each accounting period. 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 the results of
operations in the period such deviations occur. For these contracts, the amortization periods are
generally the estimated life of the policies. - 63 -




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##### Table of Contents



For universal life and investment-type contracts, deferred policy acquisition costs are
amortized over the expected average life of the contracts as a constant percentage of the present
value of estimated gross profits arising principally from investment results, mortality and expense
margins and surrender charges based on historical and anticipated future experience, which is
updated at the end of each accounting period. In computing amortization, interest accrues to the
unamortized balance of capitalized policy acquisition costs at the rate used to discount expected
gross profit. The effect on the amortization of deferred policy acquisition costs of revisions to
estimated gross profits are reflected in the results of operations in the period such estimated
gross profits are revised. Changes in deferred policy acquisition costs for the year ended December 31, 2004 is as
follows: 2004Balance, January 1
    
    $
    68,942,628Adoption of
SOP 03-1
    
    
    36,154,010Capitalization of deferred acquisition costs
    
    
    4,550,392Amortization of deferred acquisition costs
    
    
    (14,212,780
    )Write downs of deferred acquisition costs due to
terminations and recaptures
    
    
    (89,349,762
    )Balance, December 31
    
    $
    6,084,488
 (d) Insurance licenses, net of amortization The Company has classified as insurance licenses the cost in excess of fair value of net
assets acquired in a purchase transaction. Prior to January 1, 2002, the Company had been
amortizing these insurance licenses on a straight-line basis over 20 years. In June 2001, the
Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 142  Goodwill and Other Intangible Assets. Under SFAS No. 142 the insurance licenses
are no longer amortized, but are subjected to an initial impairment test on adoption of SFAS No.
142 and an annual impairment test in subsequent years. The Company adopted SFAS No. 142 on January
1, 2002. In 2003, the Company determined that an impairment charge was necessary and the entire
amount was written off and charged to operating expenses. The amount carried at December 31, 2002
was $2,128,000. (e) Reserves for future policy benefits and interest sensitive contracts liability The development of reserves for policy benefits and for claims incurred but not reported
(IBNR) for the Companys products requires management to make estimates and assumptions regarding
mortality, lapse, persistency, expenses 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. Management considers all of the Companys reinsurance
contracts to be long duration contracts. Management monitors actual experience and, where
circumstances warrant, will revise its assumptions and the related reserve estimates. The Companys liability for contracts providing reinsurance for life insurance policies is
recorded in the balance sheet as reserves for future policy benefits. The reserve is estimated
using a net level premium method utilizing actuarial assumptions for mortality, persistency,
interest and expenses established when the contract is underwritten. These assumptions are based on
anticipated experience with a margin for adverse deviation. If the reserves for future policy
benefits plus the present value of expected future gross premiums are insufficient to provide for
expected future benefits and expenses, deferred policy acquisition costs are written down and, if
required, a premium deficiency reserve is established, by a charge to claims and policy benefits.
Benefit liabilities for traditional annuities that contain mortality risk are recorded at the
present value of expected future benefit payments. Reserves are also established to cover death
claims that - 64 -




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##### Table of Contents



may have been incurred and reported to the ceding company, but not yet reported to the Company
due to timing delays. The average discount rate used to compute the Companys reserves for future
policy benefits, net of any receivable for reinsurance ceded, was approximately 5.1% for 2004. Amounts collected on universal life and investment-type contracts and benefit liabilities for
traditional annuities (during the accumulation period) are reported in the balance sheet as
interest sensitive contracts liability. Universal life and investment-type contracts are recorded
at their accumulated policyholder values (without reduction for potential surrender or withdrawal
charges). Revenues from these 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 account and other benefits in excess of related policyholders account
balances, including minimum interest guarantee payments. The Company historically reinsured certain minimum guarantees, including GMDB and GMIB,
associated with variable annuity contracts, although as of December 31, 2004, it no longer
reinsured these types of contracts. The Companys accounting policy was designed to establish
reserves for expected benefit payments over the life of the underlying policies, based upon the
original pricing assumptions. The Companys reserving policy allows the Company to increase
reserves if claim amounts or claims volume exceed what was anticipated in pricing. (f) Investments The Company classifies its investments in fixed income securities as available for sale and,
accordingly, such securities are carried at fair value. The cost of fixed income securities is
adjusted for amortization of premiums and discounts. The carrying value of fixed income securities
is adjusted for declines in value that are considered other than temporary and any such adjustment
is considered a realized loss. Realized gains and losses on investments are recognized in the results of operations, using
the specific identification method. Changes in fair values of securities classified as available
for sale are reflected in accumulated other comprehensive income. (g) Translation of foreign currencies The Companys functional currency is the United States dollar. Premiums written and receivable
in foreign currencies and liabilities for future benefits payable in foreign currencies are
recorded at exchange rates prevailing at the time such assets and liabilities are first recorded.
Exchange gains or losses resulting from the periodic revaluation and settlement of such assets and
liabilities are recorded in the Companys statement of operations. There were no transactions in
foreign currencies for the year ended December 31, 2004. (h) Earnings per common share The Company calculates basic earnings per common share and earnings per common share assuming
dilution. Basic earnings per common share is calculated by dividing net income attributable to
common stockholders by the weighted average number of common shares outstanding during the period.
Restricted common stock issued to employees (see Note 10) is not included in calculating basic
earnings per common share until it has vested. Diluted earnings per common share is calculated by dividing the net income attributable to
common stockholders by the weighted average number of common shares outstanding during the period,
plus potential dilutive common shares. Options and warrants issued by the Company are considered
potential dilutive common shares and are included in the calculation using the treasury stock
method, unless their inclusion would be considered anti-dilutive. - 65 -




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(i) Cash and cash equivalents For the purposes of the statements of cash flows, the Company considers all time deposits and
short-term investments with an original maturity of 90 days or less as equivalent to cash. (j) Stock plans In December 2002, the FASB issued SFAS No. 148 - Accounting for Stock-Based Compensation 
Transition and Disclosure, an amendment of SFAS No. 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 SFAS No. 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,
whereby all stock options granted were at market value with no corresponding charges to
compensation expense. SFAS No. 148 also amends the disclosure requirements of SFAS No. 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 SFAS No. 148. Year Ended December 31,2004
    
    
    2003
    
    
    2002Net loss - as reported
    
    $
    (68,326,455
    )
    
    
    (132,155,584
    )
    
    
    (128,887,285
    )Stock option expense recognized
    
    
    79,883
    
    
    
    111,583Pro forma effect on net loss of
applying fair value accounting
to all stock option grants
    
    
    (575,981
    )
    
    
    (1,067,642
    )
    
    
    (3,448,484
    )Net loss  pro forma
    
    $
    (68,822,553
    )
    
    
    (133,111,643
    )
    
    $
    (132,335,769
    )Net loss per common share - as
reported:Basic
    
    $
    (2.64
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )Diluted
    
    $
    (2.64
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )Net loss per common share - pro
forma:Basic
    
    $
    (2.66
    )
    
    $
    (5.14
    )
    
    $
    (5.14
    )Diluted
    
    $
    (2.66
    )
    
    $
    (5.14
    )
    
    $
    (5.14
    )
 The stock-based compensation expense, including restricted common stock issued to
employees, for the year ended December 31, 2004 was $295,678. The fair value of the options is estimated on the date of grant using the Black-Scholes
option-pricing model. The following table details the assumptions and fair values for options
issued in the past four years: Dividend
    
    
    Expected
    
    
    Weighted Average
    
    
    Weighted AverageYear of Grant
    
    Yield
    
    
    Volatility
    
    
    Risk Free Rate
    
    
    Fair Value2001
    
    
    0.69
    %
    
    
    37.07
    %
    
    
    5.05
    %
    
    $
    15.192002
    
    
    1.22
    %
    
    
    62.19
    %
    
    
    4.99
    %
    
    $
    10.622003
    
    
    0.00
    %
    
    
    241.10
    %
    
    
    3.68
    %
    
    $
    1.032004
    
    
    0.00
    %
    
    
    50.00
    %
    
    
    4.46
    %
    
    $
    0.30
 (k) Funds withheld at interest and embedded derivatives Funds withheld at interest represents a receivable balance equivalent to the Companys
proportionate share of its ceding companies statutory reserves related to policies reinsured by
the Company under - 66 -




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##### Table of Contents



reinsurance agreements written on a modified coinsurance or coinsurance funds withheld basis.
The premiums received by a ceding company on the policies underlying these types of reinsurance
agreements are used to purchase investment securities that are managed by that ceding company or
investment managers appointed by it. Net investment income includes the Companys proportionate
share of the investment income and realized capital gains and losses on the sale of investments
purchased with those premiums, as well as distributions from the embedded derivatives contained in
certain of these agreements. A portion of the Companys funds withheld at interest receivable asset contains embedded
derivatives, which require bifurcation and separate accounting under SFAS No. 133  Accounting for
Derivative Instruments and Hedging Activities, which the Company adopted as of January 1, 2001. The
net fair value of these embedded derivatives is classified as part of the Companys funds withheld
asset on its balance sheet. The change in the fair value of these embedded derivatives is recorded
in the Companys statement of operations as Net change in fair value of embedded derivatives, which
is a non-cash item. The Company, with the assistance of outside advisors, has developed a cash flow
model to arrive at an estimate of the fair value of these embedded derivatives that uses various
assumptions regarding future cash flows under the affected annuity reinsurance contracts. While the
Company has made an estimate of the fair value of these embedded derivatives using a model that it
believes is appropriate and based upon reasonable assumptions, the assumptions used are subjective
and may require adjustment in the future. The Company did not bifurcate and separately account for
the embedded derivatives contained in its annuity reinsurance agreement with Transamerica and its
guaranteed minimum income benefit reinsurance agreement with CIGNA, because the Company acquired
those agreements prior to the transition date it elected under SFAS No. 133, as amended. (l) Accounting pronouncements Emerging Issues Task Force The Emerging Issues Task Force (EITF) of the FASB issued EITF Issue No. 03-1, The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments in late 2003. It
contains two aspects that impact the Company. Firstly, it provides details regarding disclosures
about unrealized losses on available-for-sale debt and equity securities accounted for under SFAS
No. 115, Accounting for Certain Investments in Debt and Equity Securities. These disclosures were
effective in annual financial statements for fiscal years ended after December 15, 2003. Secondly,
it provides additional guidance for evaluating whether an investment is other-than-temporarily
impaired. This guidance was scheduled to be effective for reporting periods beginning after June
30, 2004. However, the FASB has since determined that a delay in the effective date of these
provisions was necessary until it can issue additional guidance on the application of EITF Issue
No. 03-1. The Company will assess whether this guidance will have a material impact on the
Companys results of operations or financial condition once it is released. Variable Interest Entities In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest
Entities (as amended in December 2003, FIN 46), an interpretation of Accounting Research
Bulletin No. 51. FIN 46 expands upon and strengthens existing accounting guidance that addresses
when a company should include in its financial statements the assets, liabilities and activities of
another entity. A variable interest entity is any legal structure used for business purposes that
either does not have equity investors with voting rights or has equity investors that do not
provide sufficient financial resources for the entity to support its activities. FIN 46 requires a
variable interest entity to be consolidated by a company if that company is subject to a majority
of the risk of loss from the variable interest entitys activities or entitled to receive a
majority of the entitys residual returns or both. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003. The consolidation
requirements apply to entities created before January 31, 2003 in the first fiscal year or interim
period beginning after March 15, 2004. The effect of the adoption of this new accounting
pronouncement did not have any impact on the Companys consolidated financial statements. - 67 -




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##### Table of Contents



AICPA Statement of Position (SOP) 03-1 In July 2003, the Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants (AICPA) issued Statement of Position (SOP) 03-1, Accounting and
Reporting by Insurance Enterprises for Certain Non-Traditional Long-Duration Contracts and for
Separate Accounts. The SOP is effective for financial statements for fiscal years beginning after
December 15, 2003 and provides guidance on accounting and reporting by insurance enterprises for
certain nontraditional long-duration contracts and for separate accounts. The SOP changed the
manner in which life insurance companies account for certain types of insurance and reinsurance
contracts. The SOP provides guidance for reserving for contracts with guaranteed minimum death and
guaranteed minimum income benefits. The SOP requires projections of a wide number of future
economic scenarios that impact the present value of premiums earned and claims paid. Based on these
projections and historical experience, a Benefit Ratio is determined. The reserve is then
determined by applying the Benefit Ratio to premiums received and then deducting claims paid, both
with interest. The SOP also provides guidance for reserving for annuity agreements with more than
one potential account balance. These types of exposures are reserved for based upon the highest
contractually determinable balance for each policyholder, without consideration of surrender fees. On January 1, 2004, the Company adopted this new accounting standard. At that time, the
Company had a combined GMDB/GMIB agreement with CIGNA and an annuity reinsurance agreement with
Transamerica that were both affected by the adoption of the new SOP. The cumulative effect of the
change in accounting principle was a net loss of $365,960. As a result of adopting the SOP, the
amount of reserves carried for the Companys GMDB/GMIB reinsurance agreement with CIGNA was reduced
by $1,878,760, favorably impacting the Companys results of operations. Also, as a result of the
SOP, the Company increased its reserves for interest sensitive contracts liability for its
Transamerica contract by $38,398,730 to $611,486,170, and increased its deferred policy acquisition
costs for that contract by $36,154,010 to $65,907,500. The impact of the adoption of the SOP on the
Companys accounting for the Transamerica annuity reinsurance agreement was a net charge to income
of $2,244,720. The SOP is no longer applicable under the Companys remaining contracts (see Note 2). The
Company was unable to analyze and account for the impact of the adoption of the SOP on its
accounting for the Transamerica annuity reinsurance agreement and its agreement with CIGNA for
periods prior to its adoption on January 1, 2004. Share-Based Payments On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS
No. 123R). SFAS No. 123R replaces SFAS No. 123 Accounting for Stock-Based Compensation and
supersedes APB opinion No. 25 Accounting for Stock Issued to Employees. The statement requires
all entities to recognize compensation expense in an amount equal to the fair value of share-based
payments granted to employees and is effective as of the beginning of the first interim or annual
reporting period that begins after June 15, 2005. Since the Company applies fair value accounting
to all employee stock options granted or modified subsequent to December 31, 2002, the impact of
this statement will be to record compensation expense utilizing fair value accounting for awards
vesting on or after July 1, 2005 that were granted on or before December 31, 2002. The Pro forma
table in Note 4j illustrates the impact on the Companys consolidated statement of operations; SFAS
No. 123R will have no impact on the Companys consolidated balance sheet. - 68 -




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##### Table of Contents



(m) Presentation of prior year information Prior year financial information is reclassified, when necessary, to be consistent with
current year presentation. 5. Investments (a)The amortized cost and fair values of investments in fixed income securities classified as
available for sale at December 31, 2004 and 2003 are as follows: Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Fair2004
    
    Cost
    
    
    Gain
    
    
    Loss
    
    
    ValueU.S. Government Securities
    
    $
    13,936,764
    
    
    $
    97,150
    
    
    $
    (137,871
    )
    
    $
    13,896,043Non U.S. Government Securities
    
    
    2,645,786
    
    
    
    54,474
    
    
    
    
    
    
    
    2,700,260U.S. Corporate Securities
    
    
    49,160,980
    
    
    
    942,565
    
    
    
    (92,340
    )
    
    
    50,011,205Non U.S. Corporate Securities
    
    
    5,171,239
    
    
    
    95,963
    
    
    
    (32,511
    )
    
    
    5,234,691Mortgage Securities
    
    
    9,853,124
    
    
    
    350,455
    
    
    
    (11,368
    )
    
    
    10,192,211$
    80,767,893
    
    
    $
    1,540,607
    
    
    $
    (274,090
    )
    
    $
    82,034,410
 Amortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Fair2003
    
    Cost
    
    
    Gain
    
    
    Loss
    
    
    ValueU.S. Government Securities
    
    $
    26,430,266
    
    
    $
    313,192
    
    
    $
    (99,970
    )
    
    $
    26,643,488Non U.S. Government Securities
    
    
    3,049,346
    
    
    
    19,227
    
    
    
    
    
    
    
    3,068,573U.S. Corporate Securities
    
    
    59,547,627
    
    
    
    1,441,874
    
    
    
    (133,896
    )
    
    
    60,855,605Non U.S. Corporate Securities
    
    
    5,794,559
    
    
    
    75,029
    
    
    
    (35,039
    )
    
    
    5,834,549Mortgage Securities
    
    
    20,772,401
    
    
    
    637,829
    
    
    
    
    
    
    
    21,410,230$
    115,594,199
    
    
    $
    2,487,151
    
    
    $
    (268,905
    )
    
    $
    117,812,445
  (b)
    The following table sets forth certain information regarding the investment ratings of the
Companys fixed income securities portfolio at December 31, 2004 and 2003. 2004
    
    
    2003Ratings (1)
    
    Amortized Cost
    
    
    %
    
    
    Amortized Cost
    
    
    %AAA
    
    $
    26,446,323
    
    
    
    32.7
    %
    
    $
    52,748,482
    
    
    
    45.6
    %AA
    
    
    13,959,513
    
    
    
    17.3
    %
    
    
    17,577,721
    
    
    
    15.2
    %A
    
    
    25,057,816
    
    
    
    31.0
    %
    
    
    35,669,294
    
    
    
    30.9
    %BAA
    
    
    13,332,326
    
    
    
    16.5
    %
    
    
    9,448,886
    
    
    
    8.2
    %BA
    
    
    949,683
    
    
    
    1.2
    %
    
    
    149,816
    
    
    
    0.1
    %Non Rated
    
    
    1,022,232
    
    
    
    1.3
    %
    
    
    
    
    
    
    0.0
    %$
    80,767,893
    
    
    
    100.0
    %
    
    $
    115,594,199
    
    
    
    100.0
    %
   (1)
    
    Ratings as assigned by Moodys.  (c)
    At December 31, 2004 and 2003, letters of credit totaling approximately $35,100,000
and $53,700,000, respectively, issued in the ordinary course of the Companys business, had
been issued by its bankers - 69 -




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##### Table of Contents



in favor of certain ceding insurance companies to provide security and meet regulatory
requirements. At December 31, 2004 and 2003, cash and investments of approximately $41,300,000
and $56,800,000, respectively, were pledged as collateral for letters of credit.At December 31, 2004 and 2003, cash and investments of approximately $28,900,000 and
$96,000,000, respectively, were held in trust for the benefit of certain ceding insurance
companies to provide security and to meet regulatory requirements. Approximately $51,300,000 of
cash and investments held at December 31, 2004 were held by the Companys U.S. operating
subsidiary and was unavailable to fund the operations of the Companys Bermuda operating
subsidiary.At December 31, 2004, cash and investments of approximately $7,200,000 were held on deposit
with various states in which the Companys U.S. operating subsidiary is licensed to operate in
the United States to provide security and meet regulatory requirements.(d)
    The maturity distribution of fixed income securities held as of December 31, 2004 and 2003 is
shown below. Actual maturity dates may differ from contractual maturity dates because certain
borrowers have the ability to prepay their obligations without penalty. 2004
    
    
    2003Amortized
    
    
    Fair
    
    
    Amortized
    
    
    FairCost
    
    
    Value
    
    
    Cost
    
    
    ValueWithin one year
    
    $
    8,828,595
    
    
    $
    8,852,139
    
    
    $
    6,027,504
    
    
    $
    6,121,704From one year to five years
    
    
    29,657,989
    
    
    
    25,295,585
    
    
    
    32,486,349
    
    
    
    33,020,061From six to ten years
    
    
    19,673,564
    
    
    
    24,524,027
    
    
    
    46,165,045
    
    
    
    46,939,720More than ten years
    
    
    12,754,622
    
    
    
    13,170,449
    
    
    
    10,142,900
    
    
    
    10,320,730Mortgage securities
    
    
    9,853,123
    
    
    
    10,192,210
    
    
    
    20,772,401
    
    
    
    21,410,230$
    80,767,893
    
    
    $
    82,034,410
    
    
    $
    115,594,199
    
    
    $
    117,812,445
  (e)
    Investment income, net of related expenses, earned during the years ended December 31, 2004,
2003 and 2002 was as follows: 2004
    
    
    2003
    
    
    2002Interest income
    
    $
    6,790,108
    
    
    $
    7,748,231
    
    
    $
    27,396,270Investment income earned
on funds withheld under
modified coinsurance
agreements
    
    
    16,362,237
    
    
    
    22,106,175
    
    
    
    76,207,803Amortization of premiums
paid on fixed income
investments
    
    
    (1,141,637
    )
    
    
    (264,789
    )
    
    
    (560,172
    )Investment expenses
    
    
    (313,145
    )
    
    
    (547,394
    )
    
    
    (904,916
    )$
    21,697,563
    
    
    $
    29,042,223
    
    
    $
    102,138,985
  (f)
    During the year ended December 31, 2002, the Company recognized a charge of $900,000 for
securities that were impaired on other than a temporary basis. 6. Operating Lease Obligations The following table shows the Companys contractual obligations under its operating leases
over the periods indicated: - 70 -




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##### Table of Contents



2005
    
    
    2006
    
    
    2007
    
    
    Thereafter
    
    
    TotalOperating Leases (1)
    
    $
    275,000
    
    
    $
    84,000
    
    
    $
    2,000
    
    
    
    
    
    
    $
    361,000
    7. Stockholders Equity Preferred Stock The Company is authorized to issue 50,000,000 preferred shares of par value $1.00 each.
Currently, there are no preferred shares issued or outstanding. Common Stock The Company is authorized to issue 100,000,000 common shares of par value $1.00 each. The
common stockholders have no pre-emptive, redemption, conversion or sinking fund rights. Subject to
certain voting restrictions, which limit the voting power of United States persons to less than
10%, and non-United States persons to less than 17%, of the combined voting power of the issued
voting shares of the Company, each holder is entitled to one vote per share. In the event of a liquidation, dissolution or winding up of the Company, the holders of the
common shares are able to share equally in the assets of the Company, if any remain after payment
of all liabilities and the liquidation preference of any outstanding preferred shares. Certain
restrictions exist with respect to the transfer of shares, should such a transfer cause the number
of shares held by one United States person to be 10% or more, or a non-United States person to be
17% or more, of the Companys outstanding common shares. Class A Warrants In connection with the initial capitalization of the Company, the Company issued Class A
Warrants that initially entitled the holders to purchase up to 3,059,990 common shares of the
Company. The initial exercise price of the Class A Warrants was $15.00, which was equal to the
price of the Companys common shares in the initial public offering. As the result of our issuance
of warrants to Hartford Life Insurance Co. and CIGNA, discussed below, the effect of anti-dilution
adjustment provisions in the Class A Warrants has increased the number of shares issuable upon
exercise of the Class A Warrants to 3,265,515 common shares and the exercise price of the Class A
Warrants has been adjusted to $14.06. The Class A Warrants are all currently exercisable and will
expire on January 15, 2008. No Class A Warrants had been exercised at December 31, 2004. Class B Warrants In connection with the direct sales of equity securities to certain Strategic Investors in
connection with the Companys initial public offering, the Company issued Class B Warrants that
initially enabled the holders to purchase an aggregate of 397,500 common shares of the Company. The
initial exercise price of the Class B Warrants was $15.00 per share, which was equal to the price
of the common shares in the initial public offering. As the result of our issuance of warrants to
Hartford Life and CIGNA, discussed below the effect of anti-dilution adjustment provisions in the
Class B Warrants has increased the number of shares issuable upon exercise of the Class B Warrants
to 424,198 common shares and the exercise price of
the Class B Warrants has been adjusted to $14.06. The Class B Warrants are all currently
exercisable and expire on April 15, 2008. No Class B Warrants had been exercised at December 31,
2004. - 71 -




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##### Table of Contents



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 ceding company
under the Companys then largest guaranteed minimum death benefit reinsurance agreement. The
warrants were issued in connection with the recapture of that agreement and expire on June 30,
2013, and are currently exercisable. At June 30, 2003, the fair value of these warrants, using a
Black-Scholes pricing model, was estimated at $1,250,000, which was included in a charge associated
with the recapture that the Company recorded during the second quarter of 2003 as a component of
Claims and policy benefits expense. The expense of issuing these warrants is presented as Stock
warrants in the stockholders equity section of the Companys consolidated balance sheet as at
December 31, 2004. In connection with the recapture of the Companys GMDB/GMIB reinsurance agreement with CIGNA
on October 26, 2004, the Company issued CIGNA a warrant dated as of September 30, 2004 to acquire
one million common shares of the Company at an exercise price of $1.00 per share. The warrant
expires on September 30, 2014 and is currently exercisable. At September 30, 2004, the fair value
of this warrant, using a Black-Scholes pricing model, was estimated at $100,000, which was included
in a charge associated with the recapture that the Company recorded during the third quarter of
2004 as a component of Claim and policy benefits expense. The expense of issuing this warrant is
presented as Stock warrants in the stockholders equity section of the Companys consolidated
balance sheet as at December 31, 2004. 8. Loss per Common Share The following table sets forth the computation of basic and diluted loss per common share for
the year ended December 31: 2004
    
    
    2003
    
    
    2002Loss before cumulative effect
of a change in accounting principle
    
    $
    (67,960,495
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )Cumulative effect of a change in accounting principle
    
    
    (365,960
    )
    
    
    
    
    
    
    Net loss
    
    $
    (68,326,455
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )Basic:Weighted average number of common shares outstanding
    
    
    25,856,995
    
    
    
    25,880,202
    
    
    
    25,738,724Net loss per common share before cumulative
effect of a change in accounting principle
    
    $
    (2.63
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )Cumulative effect of a change in accounting principle
per common share
    
    
    (0.01
    )
    
    
    
    
    
    
    Net loss per common share
    
    $
    (2.64
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )Diluted:Weighted average number of common shares outstanding
    
    
    25,856,995
    
    
    
    25,880,202
    
    
    
    25,738,724Plus: incremental shares from assumed exercise of
options and warrants
    
    
    
    
    
    
    
    
    
    
    Diluted weighted average number of common shares
outstanding
    
    
    25,856,995
    
    
    
    25,880,202
    
    
    
    25,738,724Net loss per common share before cumulative
effect of a change in accounting principle
    
    $
    (2.63
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )Cumulative effect of a change in accounting principle
per common share
    
    
    (0.01
    )
    
    
    
    
    
    
    Net loss per common share
    
    $
    (2.64
    )
    
    $
    (5.11
    )
    
    $
    (5.01
    )
 As of December 31, 2004, 2003, and 2002 the Company had 719,035, 955,869, and 1,144,535
stock options outstanding, respectively. There were Class A and Class B warrants outstanding
representing the right to acquire 3,689,713 shares, 3,565,216 shares and 3,457,490 shares as of
December 31, 2004, 2003, - 72 -




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and 2002, respectively. Warrants issued to Hartford Life to acquire
1,000,000 shares were outstanding at December 31, 2003 and 2004. Warrants issued to CIGNA to
acquire 1,000,000 shares were outstanding at December 31, 2004. The calculation of the diluted loss per common share does not include the incremental number
of shares from the assumed exercise of options and warrants, or the vesting of unvested restricted
stock grants. At December 31, 2004, 5,689,713 warrants, 719,035 options, and 377,368 shares of
unvested restricted stock were outstanding. The inclusion of these potential common shares would be
considered antidilutive due to the decrease in loss per common share resulting from the conversion,
exercise, or contingent issuance of these securities. 9. Agreements with Related Parties XL Capital Ltd and XL Life Ltd Michael P. Esposito, Jr., a director of the Company, currently serves as the non-executive
Chairman of the Board of XL Capital Ltd (XL Capital). Henry C.V. Keeling is a former director of
the Company and currently serves as an officer of XL Capital and is the Chief Executive Officer of
XL Re Ltd, a subsidiary of XL Capital. Robert M. Lichten, a director of the Company, serves as a
director of a United States-based subsidiary of XL Capital. XL Capital is a major stockholder of
the Company. 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
agreement 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 provided that XL
Life would receive an additional payment of $5.0 million if, during the 18 months following the
agreement, the Company received new capital funding of at least $35.0 million and the Companys
stock traded at a price at or above $5.00 per share for a period of 20 out of 30 consecutive
trading days. On August 5, 2003, XL Life served the Company with notice of its intention to recapture the
50% quota share reinsurance agreement with the Company. As a result, the Company determined it
would not be able to recover the deferred acquisition costs carried for this agreement from future
expected income, and wrote down approximately $21.0 million of such deferred acquisition costs in
the three months ended June 30, 2003. During 2003, the Company and XL Life had been in discussions with respect to each partys
rights and obligations under the novation and retrocession agreements entered into at December 31,
2002, as well as a $10.0 million excess of loss reinsurance policy and a catastrophe excess of loss
cover that were each purchased by the Company from XL Life in the first quarter of 2002 and two
annuity reinsurance agreements ceded to the Company by an affiliate of XL Life. The $10.0 million
excess of loss reinsurance policy was purchased to protect against lifetime minimum interest
guarantee payments under the Companys annuity reinsurance agreement with Transamerica, and full
recovery under the policy had been anticipated in establishing the Companys deferred acquisition
cost asset. The catastrophe excess of loss cover expired by its terms on December 31, 2002, but the
parties had continued to discuss with XL Life the remaining obligations asserted under the
agreement. The two annuity reinsurance agreements had been in effect since December 17, 1999, and
represented approximately $95.9 million (including a cumulative loss from embedded derivatives of
approximately $2.8 million) of the Companys Funds withheld at interest
and approximately $95.6 million of the Companys Interest sensitive contract and other
liabilities on July 1, 2003, the effective date of recapture. - 73 -




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As a result of the Companys discussions with XL Life, the Company and XL Life and its
affiliate agreed to mutually discharge their respective rights and obligations under all of the
agreements described in the preceding paragraph in a comprehensive settlement effective as of July
1, 2003. Under the terms of the comprehensive settlement, the Company paid $6.0 million to XL Life
and was released from any and all obligations to XL Life and its affiliate under all of the
agreements among the parties. In addition, as part of the comprehensive settlement, the Company was
obligated to pay $2.0 million to XL Life if prior to June 30, 2004 the Companys stock traded above
$2.00 per share for a period of 20 out of any 30 consecutive trading days and the Company raised an
aggregate $35.0 million of equity or debt. Because these two events did not occur prior to June 30,
2004, the Company was not required to make any such payment to XL Life and is no longer obligated
to do so. Indemnification Payments In accordance with the Companys Amended and Restated Bye-laws, the Company indemnifies its
officers and directors to the fullest extent permissible under Bermuda law. Pursuant to the
Bye-laws, the Company will make payments for the expenses incurred in connection with defending any
action for which indemnification has properly been sought. In connection with a purported
shareholder class action lawsuit (as discussed in Note 3) filed against the Company and certain of
its current and former officers and directors, the Company had, as of December 31, 2004, made
payments of approximately $140,000 and $53,000 to John F. Burke, its Chief Executive Officer and a
director, and Frederick S. Hammer, the non-executive Chairman of its Board of Directors,
respectively, for payment of their expenses related to defending this lawsuit. Payments on behalf
of Mr. Burke during the year ended December 31, 2004 were approximately $37,000. Payments on behalf
of Mr. Hammer during the year ended December 31, 2004 were approximately $4,000. 10. Compensation Plans In 1998, the Board of Directors adopted a Stock Option Plan (the Plan) under which it may
grant, subject to certain restrictions, Incentive Stock Options (ISOs) and Non-Qualified Stock
Options (NQSOs). The aggregate number of common shares for which options may be granted under
the Plan was initially limited to 1,552,500 Common Shares. In 1999, the Plan was amended such that
options may be granted in any fiscal year equal to not more than 2% of the adjusted average of the
outstanding common shares of the Company, as that number is determined by the Company to calculate
diluted earnings per share. Only eligible employees of the Company are entitled to ISOs, while
NQSOs may be granted to eligible employees, non-employee directors and consultants. The
Compensation Committee of the Board of Directors administers the Plan. The term of the options granted under the Plan will not be more than ten years from the date
of grant. Unless otherwise provided in the option agreement related to a specific grant, options
granted under the Plan will be exercisable in three equal annual installments, commencing on the
first anniversary of the grant date. Each person who becomes an eligible non-employee director, as defined in the plan, is
automatically granted an option to purchase 15,000 common shares on the date he or she becomes an
eligible non-employee director. These options have an exercise price equal to the greater of par
value per common share or the fair market value of the optioned common shares on the date the
options are granted and are exercisable in three equal installments commencing with the first
anniversary of the grant date. In addition, subject to certain conditions, each non-employee
director is automatically granted an option to purchase 5,000 common shares at each successive
annual general meeting. These options have an exercise price equal to the greater of fair market
value of the optioned common shares on the date the options are granted or par value and are
immediately exercisable if granted after April 8, 1999. - 74 -




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2004
    
    
    2003Weighted
    
    
    
    
    
    
    WeightedNumber
    
    
    Average
    
    
    Number
    
    
    Averageof Shares
    
    
    Exercise Price
    
    
    of Shares
    
    
    Exercise PriceOutstanding at beginning of year
    
    
    955,869
    
    
    $
    13.03
    
    
    
    1,144,535
    
    
    $
    19.90Granted
    
    
    50,000
    
    
    $
    1.00
    
    
    
    340,000
    
    
    $
    1.03Exercised
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    Forfeitures
    
    
    (286,834
    )
    
    $
    (17.92
    )
    
    
    (528,666
    )
    
    $
    (20.67
    )Outstanding at end of year
    
    
    719,035
    
    
    $
    10.38
    
    
    
    955,869
    
    
    $
    13.03
 At December 31, 2004, options to acquire 488,365 common shares were exercisable. The
weighted average remaining contractual life of these exercisable options was approximately 7 years.
The following table summarizes information about the Companys stock options for options
outstanding and exercisable as of December 31, 2004: Options Outstanding
    
    
    Options ExercisableAverage
    
    
    AverageRange of Exercise
    
    
    Number of
    
    
    Remaining
    
    
    Exercise
    
    
    Number of
    
    
    AveragePrices
    
    
    Options
    
    
    Contractual Life
    
    
    Price
    
    
    Options
    
    
    Exercise Price$
    1.00
    $
    1.17
    
    
    
    367,500
    
    
    
    8.40
    
    
    $
    1.03
    
    
    
    160,833
    
    
    $
    1.03$
    15.00
    $
    19.64
    
    
    
    213,535
    
    
    
    5.17
    
    
    $
    15.93
    
    
    
    189,532
    
    
    $
    15.89$
    20.13
    $
    22.38
    
    
    
    55,500
    
    
    
    4.80
    
    
    $
    21.75
    
    
    
    55,500
    
    
    $
    21.75$

    27.75
    $
    27.88
    
    
    
    35,000
    
    
    
    5.78
    
    
    $
    27.84
    
    
    
    35,000
    
    
    $
    27.84$
    28.50
    $
    32.85
    
    
    
    47,500
    
    
    
    6.69
    
    
    $
    31.71
    
    
    
    47,500
    
    
    $
    31.71$
    1.00
    $
    32.85
    
    
    
    719,035
    
    
    
    6.92
    
    
    $
    10.38
    
    
    
    488,365
    
    
    $
    14.06
 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 SFAS No. 148.
Under this method, the Company applies fair value accounting to all grants of employee stock
options subsequent to December 31, 2002. Accordingly, $348,000 has been recognized in stockholders
equity as the fair value of the options granted at the measurement date and outstanding as of
December 31, 2004. Based on the vesting of the options granted, and offset partially by
cancellations of options, approximately $80,000 and $112,000 was expensed in 2004 and 2003,
respectively. Approximately $156,000 is deferred and will be expensed over the remaining vesting
period and is reflected as unamortized stock-based compensation at December 31, 2004. The fair
value of stock options awarded to employees and new directors will be amortized into income over
the three-year vesting period. The fair value of stock options awarded to all other directors will
be expensed immediately as their options are exercisable on the day of grant and vest upon their
award. In 2002, the Board of Directors adopted a Restricted Stock Plan (the Plan) under which it
may grant common shares to key employees. The aggregate number of common shares that may be granted
under the Plan is 1,200,000, and the Compensation Committee of the Board of Directors administers
the Plan. Since the inception of the Plan, the Company has issued 976,000 shares of restricted
stock. As a result of certain employees terminating their employment with the Company, 227,133
shares of restricted stock were cancelled in 2003 and 115,667 shares of restricted stock were
cancelled in 2004. Also, 47,500 shares of restricted stock vested in 2003 and 2004 prior to certain
employees terminating their employment with the Company. The following table summarizes the vesting
schedule for the shares of restricted stock issued to current employees and outstanding as of
December 31, 2004: - 75 -




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Employee SharesOutstanding at
    
    
    Shares Vested at
    
    
    Shares Vesting
    
    
    Shares Vesting inGrant Date
    
    December 31, 2004
    
    
    December 31, 2004
    
    
    in 2005
    
    
    2006February 13, 2002
    
    
    40,700
    
    
    
    
    
    
    
    40,700
    
    
    
    September 30, 2002
    
    
    80,000
    
    
    
    53,333
    
    
    
    26,667
    
    
    
    February 28, 2003
    
    
    200,000
    
    
    
    66,666
    
    
    
    66,667
    
    
    
    66,667June 25, 2003
    
    
    265,000
    
    
    
    88,333
    
    
    
    88,333
    
    
    
    88,334Total
    
    
    585,700
    
    
    
    208,332
    
    
    
    222,367
    
    
    
    155,001
 The fair value as determined at the date of grant of the restricted stock awards that
were outstanding on December 31, 2004 was approximately $1,514,000 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. Based on the vesting of the restricted stock, and offset partially by cancellations
of restricted stock, approximately $216,000 was expensed in the year ended December 31, 2004. The
unamortized balance of outstanding restricted stock is reflected in the balance sheet as a
component of unamortized stock-based compensation and was approximately $334,000 at December 31,
2004 and was approximately $1,269,000 at December 31, 2003. 11. Retrocession Agreements The Company has a retrocession agreement that generally enables it to limit the amount of life
reinsurance it retains to $1,000,000 per single life. The contract is automatic and effective for
risks assumed and in force from January 1, 1997. At December 31, 2004 and 2003, the Company had
ceded approximately $342 million and $380 million of in force insurance coverage, respectively, to
other reinsurers. Total amounts of $102,000 and $465,000 were recoverable from reinsurers at
December 31, 2004 and 2003, respectively, and were recorded in other reinsurance receivables on the
Companys balance sheets. Prior to its acquisition by Annuity and Life Re America, Inc. on June 1, 2000, the in force
insurance business of Capitol Bankers Life Insurance Company was 100% reinsured with its former
owner, Reassure America Life Insurance Company (Reassure), a subsidiary of Swiss Reinsurance
Company, who continues to administer the business reinsured. The amounts related to the reinsured
business are included on the Companys consolidated balance sheet in assets as receivable for
reinsurance ceded and an identical amount in liabilities as reserves for future policy benefits. At
December 31, 2004 and 2003, these amounts were $82.2 million and $88.2 million, respectively.
Capital Bankers Life Insurance Company was renamed Annuity and Life Reassurance America, Inc. in
December 2000. Retrocession agreements do not relieve the Company from its obligations to its ceding
companies and failure of the Companys reinsurers to honor their obligations could result in losses
to the Company. The Company evaluates the financial condition of its reinsurers and monitors any
concentrations of credit risk that may develop to minimize its exposure. The parties to the
retrocession agreements described above have current credit rating of A+ or better, as assigned by
A.M. Best. 12. Contingencies As
described in Note 2(a), the Company and Transamerica entered
into a Master Agreement to novate the Companys reinsurance
contracts with F&G and Scottish Re to Transamerica effective
December 31, 2004. In accordance with the terms of the Master
Agreement, the Company and Transamerica have been in discussions
regarding possible adjustments to the policy benefit reserves
transferred to Transamerica as part of the F&G novation. On
March 30, 2005, the Company received a demand letter from
Transamerica stating that $7,000,000 was owed to Transamerica as an
adjustment to the F&G policy benefit reserves. If the Company and
Transamerica are unable to resolve this issue through continued
discussions, the Company would seek adjudication of the dispute in
accordance with the provisions of the Master Agreement, which calls
for the matter to be submitted to a Fellow of the Society of
Actuaries whose determination shall be final, binding and conclusive.
While there can be no assurances, the Company believes that
Transamerica is not entitled to this $7,000,000. Presently, the
Company is unable to determine the amounts, if any, that may be due
to or from Transamerica resulting from adjustments to the policy
benefit reserves. - 76 -




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##### Table of Contents



On October 8, 2003, the Company was served with a statutory demand for $640,000 from Imagine
Group Holdings Limited (Imagine), a Bermuda based reinsurance company, which was subsequently
withdrawn. Imagine has since instituted a civil proceeding in the Bermuda Supreme Court against the
Company, alleging that the Company is obligated to reimburse it for $640,000 of expenses incurred
by Imagine in connection with a proposed December 2002 capital raising transaction that was not
consummated. On March 11, 2004, the Company filed an amended defense with the court to which
Imagine responded on April 26, 2004. The Company does not believe that Imagine is entitled to
reimbursement of these expenses under the applicable agreement and is defending itself against
Imagines claims. The United States Internal Revenue Service (IRS) is currently conducting an audit of the
Companys United States operating subsidiaries. Those companies currently have a significant tax
based net operating loss carryforward. In addition, the IRS has requested certain information and
documents related to the Companys Bermuda operations. While the Companys United States operating
subsidiaries have complied with the IRS requests for information, both the Company and its Bermuda
operating subsidiary have declined to supply the IRS with certain information in response to its
initial requests for information on May 7, 2002 and July 1, 2002. The Company did provide the IRS
with certain publicly available information in addition to minutes of the Board of Directors
meetings and committee meetings held from 1999 through to 2001. The Company has not received any
additional requests for information since July 1, 2002. If the IRS were to determine that the
Company or its Bermuda operating subsidiary were engaged in business in the United States, those
entities could be subject to United States tax at regular corporate rates on their taxable income
that is attributable to a permanent establishment, if any, in the United States plus an additional
30% branch profits tax on such income remaining after the regular tax. Such taxes would have a
material effect on the Companys results of operation and financial condition. Pursuant to an engagement letter dated January 19, 2004, as amended (the Engagement Letter),
the Company engaged UBS Securities LLC (UBS) to serve as its financial advisor and capital
markets advisor in connection with identifying strategic alternatives available to the Company.
The Engagement Letter provides that if, during the term of the Engagement Letter, the Company
closes an equity investment, the Company is obligated to pay UBS a minimum transaction fee of
$1,000,000. If the Company closes a sale transaction during the term of the Engagement Letter, the
Company is obligated to pay UBS a minimum transaction fee of either $1,500,000 or $2,000,000,
depending on whether the other party to that transaction is one identified in the Engagement
Letter. In any case, the transaction fee payable to UBS may increase as the transaction value
increases. Any transaction fee payable to UBS under the Engagement Letter will be offset by certain
fees paid by the Company to UBS prior to the closing of the equity investment or sale transaction.
At December 31, 2004, such fees totaled $240,000. The Company is also obligated to pay a
transaction fee to UBS if, during the one year period following the expiration or termination of
the Engagement Letter, the Company either consummates or enters into an agreement that results in
an equity investment or sale transaction with any party identified to the Company by UBS as part of
their engagement or with which the Company had discussions during the term of the Engagement
Letter. 13. Vulnerability Due to Concentrations As a result of the life reinsurance agreements that were novated to Transamerica as of
December 31, 2004, certain of the Companys remaining agreements, which previously did not
represent a significant percentage of the Companys business, have become more prominent. The
Companys three largest life reinsurance agreements are now with National States Insurance Company
(National States), John Hancock Mutual Life Insurance Company (John Hancock) and Omega
Reinsurance Corporation (Omega). For the year ended December 31, 2004, the Company recorded
losses of approximately $2.8 million related to its life reinsurance agreement with National
States. Premiums associated with this agreement for the year ended December 31, 2004 were
approximately $11.3 million. For the year ended December 31, 2004, the Company recorded gross
profits of approximately $1.8 million related to its life reinsurance agreement with John Hancock.
Premiums associated with this agreement for the year ended December 31, 2004 were approximately
$2.1 million. For the year ended December 31, 2004, the Company recorded gross profits of
approximately $1.0 million related to its life reinsurance agreement with - 77 -




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Omega. Premiums associated with this agreement for the year ended December 31, 2004 were
approximately $1.4 million. The Company has a significant deferred annuity reinsurance agreement with Lafayette Life
Insurance Company (Lafayette). Due to the size of this agreement, there is a material
concentration of net investment income, interest credited to interest sensitive products, funds
withheld at interest, deferred policy acquisition costs and interest sensitive contract
liabilities. Approximately $51.3 million, or 91%, of the Companys funds withheld at interest
receivable, approximately $57.8 million, or 100%, of the Companys interest sensitive contracts
liability, and approximately $3.4 million, or 55%, of the deferred acquisition costs on the
Companys consolidated balance sheet was related to its reinsurance agreement with Lafayette as of
December 31, 2004. As discussed in Note 11, 100% of Annuity and Life Reassurance Americas life and annuity
policies that were in force prior to the Companys acquisition of Capitol Bankers Life Insurance
Company were reinsured with Reassure. Following the acquisition, the policies continue to be 100%
reinsured with Reassure; however, Annuity and Life Reassurance America remains the primary carrier.
Reassure is required to indemnify Annuity and Life Reassurance America for any losses associated
with these policies. However, Annuity and Life Reassurance America Inc is not discharged from its
primary liability as the direct insurer of the risks reinsured should Reassure become default on
its obligations. Reserves ceded under its reinsurance agreement amounted to approximately $82.2
million and $88.2 million at December 31, 2004 and December 31, 2003, respectively. As of December
31, 2004, Reassure is rated A+ (g) (superior) by A.M. Best. 14. Fair Value of Financial Instruments The following discussion outlines the methodologies and assumptions used to determine the
estimated fair value of the Companys financial instruments. Considerable judgment is required to
develop these fair values. Accordingly, the estimates shown are not necessarily indicative of the
amounts that would be realized in a one-time, current market exchange of all of the Companys
financial instruments. Fixed Income Securities Fair values for fixed income securities are based on quoted market prices, where available.
For fixed income securities not actively traded, fair values are estimated using values obtained
from independent pricing services. Cash and Cash Equivalents The carrying value of assets classified as cash and cash equivalents approximates fair value. Embedded Derivatives At December 31, 2004, the Companys remaining modified coinsurance annuity reinsurance
agreement had a feature that constitutes an embedded derivative that requires bifurcation and
separate accounting under SFAS No. 133  Accounting for Derivative Instruments and Hedging
Activities. The valuation of this embedded derivative requires cash flow modeling that uses various
assumptions regarding future cash flows under the agreement. The fair value of this derivative is
reported as a component of Funds withheld at interest. At December 31, 2004, the fair value of this
embedded derivative was a loss of approximately $(5,609,000). At December 31, 2003, the fair value
of this embedded derivative was a loss of $(7,790,000). Other Items Fair value disclosures are not required for reinsurance balances recoverable, deferred policy
acquisition costs, or liabilities arising from insurance and annuity contracts. As a result, the
Company has not - 78 -




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determined such disclosures. Fair values of other assets and liabilities approximate their
carrying values due to their short-term nature. 15. Segments We separately track financial results of our life and annuity operations in segments. Each
segment is defined by a dominant risk characteristic inherent in all products in that segment. The
life segment consists of all products where the dominant risk characteristic is mortality risk. The
annuity segment comprises all products where the dominant risk characteristic is investment risk,
including those products which provide minimum guarantees on variable annuity products. In
addition, since January 1, 2001, 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 SFAS No. 133  Accounting for Derivative
Instruments and Hedging Activities. The cumulative effect of the application of SFAS No. 133
through January 1, 2001 and the change in the fair value of these embedded derivatives since that
date are included in the annuity segment. Both the life and annuity segments have specific assets, liabilities, stockholders 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 upon the amount of stockholders equity deployed to the segment.
Costs associated with our efforts to raise capital and pursue other strategic alternatives and the
anticipated costs of settling the purported shareholder class action lawsuit have been completely
allocated to the corporate segment. Life
    
    
    Annuity2004
    
    Reinsurance
    
    
    Reinsurance
    
    
    Corporate
    
    
    ConsolidatedRevenues
    
    $
    50,153,025
    
    
    $
    23,847,196
    
    
    $
    3,091,345
    
    
    $
    77,091,566Expenses
    
    
    50,271,120
    
    
    
    83,505,926
    
    
    
    11,275,015
    
    
    
    145,052,061Loss before
cumulative effect
of a change in
accounting
principle
    
    
    (118,095
    )
    
    
    (59,658,730
    )
    
    
    (8,183,670
    )
    
    
    (67,960,495
    )Cumulative effect
of a change in
accounting
principle
    
    
    
    
    
    
    (365,960
    )
    
    
    
    
    
    
    (365,960
    )Net Loss
    
    $
    (118,095
    )
    
    $
    (60,024,690
    )
    
    $
    (8,183,670
    )
    
    $
    (68,326,455
    )Total Assets
    
    $
    163,747,140
    
    
    $
    59,554,009
    
    
    $
    66,104,207
    
    
    $
    289,405,356
 Life
    
    
    AnnuityScottish Re and
    
    
    TransamericaF&G Novations
    
    
    Recapture
    
    
    Corporate
    
    
    ConsolidatedDeferred policy acquisition costs
    
    $
    (24,929,642
    )
    
    $
    (63,083,919
    )
    
    
    
    
    
    $
    (88,013,561
    )Funds held at interest
    
    
    
    
    
    
    (522,778,128
    )
    
    
    
    
    
    
    (522,778,128
    )Reserves for future policy benefits
    
    
    36,854,506
    
    
    
    
    
    
    
    
    
    
    
    36,854,506Interest sensitive contract liabilities
    
    
    
    
    
    
    545,810,176
    
    
    
    
    
    
    
    545,810,176Other reinsurance liabilities
    
    
    (18,500,000
    )
    
    
    (14,000,000
    )
    
    
    
    
    
    
    (32,500,000
    )Net non-cash elements of the
Transamerica recapture and novation
transaction
    
    $
    (6,575,136
    )
    
    $
    (54,051,871
    )
    
    
    
    
    
    $
    (60,627,007
    )
 - 79 -




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Life
    
    
    Annuity2003
    
    Reinsurance
    
    
    Reinsurance
    
    
    Corporate
    
    
    ConsolidatedRevenues
    
    $
    166,333,033
    
    
    $
    52,122,419
    
    
    $
    7,955,901
    
    
    $
    226,411,353Expenses
    
    
    256,769,309
    
    
    
    96,493,357
    
    
    
    5,304,271
    
    
    
    358,566,937Net (Loss) Income
    
    $
    (90,436,276
    )
    
    $
    (44,370,938
    )
    
    $
    2,651,630
    
    
    $
    (132,155,584
    )Total Assets
    
    $
    250,732,481
    
    
    $
    695,317,546
    
    
    $
    83,832,312
    
    
    $
    1,029,882,339
 Life
    
    
    Annuity2002
    
    Reinsurance
    
    
    Reinsurance
    
    
    Corporate
    
    
    ConsolidatedRevenues
    
    $
    352,183,178
    
    
    $
    78,427,733
    
    
    $
    25,685,108
    
    
    $
    456,296,019Expenses
    
    
    419,364,331
    
    
    
    156,674,132
    
    
    
    9,144,841
    
    
    
    585,183,304Net (Loss) Income
    
    $
    (67,181,153
    )
    
    $
    (78,246,399
    )
    
    $
    16,540,267
    
    
    $
    (128,887,285
    )Total Assets
    
    $
    502,281,795
    
    
    $
    1,553,638,311
    
    
    $
    (11,221,919
    )
    
    $
    2,044,698,187
 16. Taxation The effective tax rate provided for in the financial statements is computed at a rate of zero.
A substantial portion of the Companys operations is based in Bermuda and as a result income is
exempt from taxation. Under current Bermuda law, there is no income or capital gains tax payable by the Company or
Annuity and Life Reassurance. The Company and Annuity and Life Reassurance have received from the
Bermuda Minister of Finance, under The Exempted Undertakings Tax Protection Act 1966 of Bermuda,
assurances to the effect that in the event of there being enacted by Bermuda any legislation
imposing tax computed on profits or income, or computed on any capital asset, gain or appreciation,
or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax
shall not be applicable to them or to any of their respective operations or to their shares,
debentures or other obligations until March 28, 2016. This is not to be construed so as to prevent
the application of any tax or duty to such persons as are ordinarily resident in Bermuda or to
prevent the application of any tax payable in accordance with the provisions of The Land Tax Act
1967 of Bermuda or otherwise payable in relation to any property leased to the Company or its
Bermuda subsidiary. Annuity and Life Re America and Annuity and Life Reassurance America, the Companys United
States operating subsidiaries, are subject to all applicable Federal and State taxes of the United
States. U.S. income taxes applicable to the Companys U.S. operations are not material to the
consolidated financial statements and, therefore, no separate item appears on the income statement
or balance sheet. At December 31, 2004 and 2003 the Company had recorded a deferred tax liability
of $250,000 and $377,000, respectively, related to U.S. income taxes on unrealized gains on
investments held by its U.S. operations. These deferred tax amounts have been netted against the
unrealized gains in computing other comprehensive loss in the consolidated statements of
operations. No deferred tax asset or liability related to operations has been recognized. Stand alone net
operating results for the Companys U.S. operations for the year ended 2004, 2003, and 2002 was a
loss of $(610,000), a loss of $(12,230,000), and a loss of $(781,000), respectively. The tax basis
net operating loss carry forward at December 31, 2004 was $9,661,000, which begins expiring in
2015. The Company does not expect that its future taxable net income will be sufficient to offset
its deferred tax asset within a - 80 -




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reasonable time period. Therefore, the Company has established valuation allowances of
$3,672,000 and $3,818,000 at December 31, 2004 and 2003, respectively, against its deferred tax
asset. 17. Statutory Requirements and Dividend Restrictions The Company and Annuity and Life Reassurance are required to comply with the provisions of the
Companies Act that regulate the payment of dividends and the making of distributions from
contributed surplus. Neither the Company 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 and since December 31, 2002, the Company has not declared a dividend. The
Companys ability to pay dividends depends on the ability of its operating subsidiaries to pay
dividends to the Company, which may be subject to regulatory constraints that affect their ability
to pay dividends to the Company. As long-term insurer, Annuity and Life Reassurance must maintain long-term business assets of
a value of at least $250,000 greater than its long-term business liabilities. Annuity and Life
Reassurance is prohibited from declaring or paying dividends unless the value of its long-term
business assets exceed the amount of its long-term business liabilities (as certified by an
approved actuary), by the amount of the dividend and by at least $250,000. Additionally, the
amounts of any such dividend must not exceed the aggregate of that excess and other funds properly
available for the payment of dividends, including funds arising out of its business aside from its
long-term business. Annuity and Life Reassurance America, Inc is subject to statutory regulations of the state of
Connecticut of the United States that restrict the payment of dividends. It may not pay dividends
in any 12-month period in excess of the greater of the statutory net gain from operations for the
immediately proceeding calendar year excluding pro rata distributions of any class of Annuity and
Life Reassurance Americas securities or 10% of Annuity and Life Reassurance Americas statutory
surplus as regards policyholders as of the immediately preceding December 31 at the end of the
preceding year, without regulatory approval. Connecticut regulations also require that dividends be
paid from earned surplus unless prior regulatory approval is granted. At December 31, 2004 the
statutory capital and surplus of Annuity and Life Reassurance America was $10,766,000. - 81 -




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18. Unaudited Quarterly Financial Data The Unaudited quarterly financial data for the following years ended December 31 are as
follows: First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter2004Net premiums
    
    $
    14,310,641
    
    
    $
    10,348,881
    
    
    $
    9,906,337
    
    
    $
    13,731,847Investment income, net of related expenses
    
    
    9,250,735
    
    
    
    3,844,066
    
    
    
    4,780,211
    
    
    
    3,822,551Net realized investment gains (losses)
    
    
    678,925
    
    
    
    (137,885
    )
    
    
    (84,868
    )
    
    
    (16,636
    )Net change in fair value of embedded derivatives
    
    
    607,388
    
    
    
    518,786
    
    
    
    565,939
    
    
    
    488,957Claims and policy benefits
    
    
    10,244,658
    
    
    
    8,769,049
    
    
    
    5,669,394
    
    
    
    (10,581,972
    )Interest credited to interest sensitive products
    
    
    3,529,250
    
    
    
    1,822,643
    
    
    
    5,513,653
    
    
    
    (5,466,086
    )Policy acquisition and other insurance expenses
    
    
    8,180,997
    
    
    
    4,654,527
    
    
    
    5,693,745
    
    
    
    92,393,679Net income
(loss) before cumulative effect
of a change in accounting principle
    
    
    1,200,354
    
    
    
    (6,430,378
    )
    
    
    (3,095,705
    )
    
    
    (59,634,766
    )Net income
(loss) per common share (diluted) before
cumulative effect of a change in accounting
principle
    
    $
    0.04
    
    
    $
    (0.25
    )
    
    $
    (0.12
    )
    
    $
    (2.30
    )Cumulative effect of a change in accounting
principle
    
    
    (365,960
    )
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    
    834,394
    
    
    
    (6,430,378
    )
    
    
    (3,095,705
    )
    
    
    (59,634,766
    )Net income (loss) per common share (diluted)
    
    $
    0.03
    
    
    $
    (0.25
    )
    
    $
    (0.12
    )
    
    $
    (2.30
    )2003Net premiums
    
    $
    61,365,914
    
    
    $
    58,563,721
    
    
    $
    28,657,264
    
    
    $
    18,385,942Investment income, net of related expenses
    
    
    8,158,689
    
    
    
    5,734,738
    
    
    
    16,250,225
    
    
    
    (1,101,429
    )Net realized investment gains (losses)
    
    
    1,663,868
    
    
    
    4,896,176
    
    
    
    (52,025
    )
    
    
    (101,432
    )Change in fair value of embedded derivatives
    
    
    13,754,859
    
    
    
    (1,717,537
    )
    
    
    2,808,427
    
    
    
    1,846,939Claims and policy benefits
    
    
    75,089,440
    
    
    
    84,425,206
    
    
    
    19,075,004
    
    
    
    19,413,255Interest credited to interest sensitive products
    
    
    4,871,759
    
    
    
    4,217,542
    
    
    
    7,642,151
    
    
    
    (2,750,729
    )Policy acquisition & other insurance expenses
    
    
    52,501,064
    
    
    
    44,631,210
    
    
    
    22,796,448
    
    
    
    8,620,567Net loss
    
    
    (52,474,816
    )
    
    
    (68,716,440
    )
    
    
    (3,786,905
    )
    
    
    (7,177,423
    )Net loss per common share (diluted)
    
    $
    (2.03
    )
    
    $
    (2.66
    )
    
    $
    (0.15
    )
    
    $
    (0.28
    )2002Net premiums
    
    $
    78,006,891
    
    
    $
    92,065,743
    
    
    $
    84,934,401
    
    
    $
    89,090,406Investment income, net of related expenses
    
    
    24,589,790
    
    
    
    26,366,669
    
    
    
    31,127,396
    
    
    
    20,055,130Net realized investment (losses) gains
    
    
    (321,708
    )
    
    
    1,837,672
    
    
    
    9,297,351
    
    
    
    8,935,951Net change in fair value of embedded derivatives
    
    
    1,590,098
    
    
    
    (6,566,805
    )
    
    
    (13,277,822
    )
    
    
    (7,591,580
    )Claims and policy benefits
    
    
    58,815,606
    
    
    
    74,443,139
    
    
    
    91,381,831
    
    
    
    127,768,226Interest credited to interest sensitive products
    
    
    17,922,346
    
    
    
    20,948,167
    
    
    
    18,345,349
    
    
    
    14,154,754Policy acquisition & other insurance expenses
    
    
    15,636,118
    
    
    
    40,571,869
    
    
    
    17,492,342
    
    
    
    52,177,650Net income (loss)
    
    
    10,433,630
    
    
    
    (20,293,998
    )
    
    
    (19,147,016
    )
    
    
    (99,879,901
    )Net income (loss) per common share (diluted)
    
    $
    0.39
    
    
    $
    (0.79
    )
    
    $
    (0.74
    )
    
    $
    (3.88
    )
 - 82 -




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ANNUITY AND LIFE RE (HOLDINGS), LTD. CONDENSED FINANCIAL INFORMATION OF REGISTRANT 
 SCHEDULE II BALANCE SHEETS (Parent Company in U.S. Dollars) December 31,2004
    
    
    2003AssetsInvestment in common stock of subsidiaries (1)
    
    $
    72,372,258
    
    
    $
    141,761,304Other assets
    
    
    368,806
    
    
    
    732,197Cash and cash equivalents
    
    
    2,577,279
    
    
    
    548,664Total assets
    
    $
    75,318,343
    
    
    $
    143,042,165LiabilitiesAccounts payable and accrued expenses
    
    $
    8,901,131
    
    
    $
    7,869,586Total Liabilities
    
    
    8,901,131
    
    
    
    7,869,586Stockholders EquityPreferred shares (par value $1.00; 50,000,000
shares authorized; no shares outstanding)
    
    
    
    
    
    
    Common shares (par value $1.00; 100,000,000
shares authorized; 26,338,528 and 26,454,195
shares outstanding at December 31, 2004 and
December 31, 2003, respectively)
    
    
    26,338,528
    
    
    
    26,454,195Additional paid-in capital
    
    
    333,810,766
    
    
    
    334,418,029Stock warrants
    
    
    1,350,000
    
    
    
    1,250,000Unamortized stock based compensation
    
    
    (490,415
    )
    
    
    (1,509,022
    )Accumulated other comprehensive income
    
    
    1,016,260
    
    
    
    1,840,849Accumulated Deficit
    
    
    (295,607,927
    )
    
    
    (227,281,472
    )Total Stockholders Equity
    
    $
    66,417,212
    
    
    $
    135,172,579Total Liabilities and Stockholders Equity
    
    $
    75,318,343
    
    
    $
    143,042,165
   (1)
    
    Eliminated on consolidation - 83 -




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ANNUITY AND LIFE RE (HOLDINGS), LTD. CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II STATEMENTS OF OPERATIONS (Parent Company in U.S. Dollars) For the Year Ended December 31,2004
    
    
    2003
    
    
    2002RevenuesInterest income
    
    $
    17,017
    
    
    $
    48,534
    
    
    $
    109,796Total Revenues
    
    $
    17,017
    
    
    $
    48,534
    
    
    $
    109,796ExpensesOperating expenses
    
    $
    6,029,015
    
    
    $
    5,693,629
    
    
    $
    4,145,838Net loss before equity in loss of subsidiaries
    
    
    (6,011,998
    )
    
    
    (5,645,095
    )
    
    
    (4,036,042
    )Equity in loss of subsidiaries
    
    
    (62,314,457
    )
    
    
    (126,510,489
    )
    
    
    (124,851,243
    )Net loss
    
    $
    (68,326,455
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )
 - 84 -




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ANNUITY AND LIFE RE (HOLDINGS), LTD. CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II STATEMENTS OF CASH FLOWS (Parent Company in U.S. Dollars) For the Year Ended December 31,2004
    
    
    2003
    
    
    2002Operating ActivitiesNet loss
    
    $
    (68,326,455
    )
    
    $
    (132,155,584
    )
    
    $
    (128,887,285
    )Amortization of stock-based compensation
    

    
    295,678
    
    
    
    436,635
    
    
    
    774,177Adjustments to reconcile net (loss) to net cash (used)
provided by operations:Equity in loss of subsidiaries
    
    
    62,314,457
    
    
    
    126,510,489
    
    
    
    124,851,243Other assets
    
    
    363,390
    
    
    
    (732,197
    )
    
    
    Accounts payable
    
    
    1,031,545
    
    
    
    3,535,327
    
    
    
    4,070,433Net cash (used) provided by operating activities
    
    $
    (4,321,385
    )
    
    $
    (2,405,330
    )
    
    $
    808,568Investing ActivitiesDividends received from subsidiary
    
    $
    
    
    
    $
    
    
    
    $
    3,660,266Return of capital from subsidiary
    
    
    5,000,000
    
    
    
    
    
    
    
    Investment in subsidiary
    
    
    
    
    
    
    
    
    
    
    Net cash provided by investing activities
    
    $
    5,000,000
    
    
    $
    
    
    
    $
    3,660,266Financing ActivitiesWarrants issued and transferred to Parent Company (1)
    
    $
    1,350,000
    
    
    $
    
    
    
    $
    Repayment (issuance) of notes receivable, less accrued interest
    
    
    
    
    
    
    1,626,493
    
    
    
    (309,234
    )Dividends paid to stockholders
    
    
    
    
    
    
    
    
    
    
    (5,173,846
    )Net cash provided (used) by financing activities
    
    $
    1,350,000
    
    
    $
    1,626,493
    
    
    $
    (5,483,080
    )Increase (decrease) in cash and cash equivalents
    
    $
    2,028,615
    
    
    $
    (778,837
    )
    
    $
    (1,014,246
    )Cash and equivalents, beginning of period
    
    
    548,664
    
    
    
    1,327,501
    
    
    
    2,341,747Cash and equivalents, end of period
    
    $
    2,577,279
    
    
    $
    548,664
    
    
    $
    1,327,501
   (1)
    
    Issue of stock warrants includes $1,250,000 that was issued to Hartford Life in
2003 but recorded in the Parent Company as of January 1, 2004. In 2003, the warrants
had been recorded in the Bermuda operating subsidiary. - 85 -




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##### Table of Contents



Item 9.Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. None. 
 Item 9A.Controls and Procedures. Evaluation of disclosure controls and procedures The Companys principal executive officer and its principal financial officer, based on their
evaluation of the Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under
the Securities Exchange Act of 1934, as amended (the Exchange Act)), have concluded that the
Companys disclosure controls and procedures were effective for the purposes set forth in the
definition thereof in Exchange Act Rule 13a-15(e) as of December 31, 2004. Managements annual report on internal control over financial reporting The management of Annuity and Life Re (Holdings), Ltd. and its subsidiaries (the Company) is
responsible for establishing and maintaining adequate internal control over financial reporting for
the Company, as defined in Exchange Act Rule 13a-15(f). Management is also responsible for
evaluating the effectiveness of the system of internal control. A companys internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with accounting principles generally
accepted in the United States. A companys internal control over financial reporting includes
policies and procedures that (1) pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with accounting principles generally accepted in the United
States, and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use or disposition of the
companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. A material weakness is a significant deficiency (within the meaning of PCAOB Auditing Standard
No. 2), or a combination of significant deficiencies, that results in there being more than a
remote likelihood that a material misstatement of the annual or interim financial statements will
not be prevented or detected on a timely basis by employees in the normal course of their assigned
functions. Management of the Company assessed the effectiveness of the Companys internal control over
financial reporting as of December 31, 2004. In making this assessment, the Company used the
criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO Standards). Managements assessment
identified the following material weaknesses in the design of the Companys internal control over
financial reporting: - 86 -




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
    A lack of adequate segregation of duties related to the Companys Information
Technology Infrastructure. The Companys Director of Information Technology serves as
the Companys computer network administrator, possessing the highest level of security
access over the Companys computer network. He also provides database support,
including the electronic translation of data provided to the Company by its ceding
companies, to the Companys Reinsurance Administration Actuary and Chief Actuary.
Under the COSO Standards, this lack of segregation of duties is defined as a material
weakness.
    A series of significant deficiencies were noted in the Companys system of internal
control over financial reporting including: lack of audits of ceding company data,
over-reliance on spreadsheets and over-reliance on analytics as preventive controls.
The combination of these significant deficiencies is a material weakness under the
COSO Standards. Because of the material weaknesses described above, management believes that, as of December
31, 2004, the Company did not maintain effective internal control over financial reporting based on
the COSO standards. The Companys independent registered public accounting firm, Marcum & Kliegman LLP, has issued
an attestation report on managements assessment of the Companys internal control over financial
reporting. That report appears below under  Attestation report of the Companys registered public
accounting firm. Changes in internal control over financial reporting In the fourth quarter of 2004, the Company strengthened its internal control over its cash
disbursements process related to wire transfers by adding an additional control to the process.
All wire transfers exceeding $10,000 are now initiated by a single individual and must be posted
for release not less than 24 hours subsequent to posting. A second individual must then approve the
wire for release in the banks electronic banking system. There were no other changes to the
Companys system of internal control during the fourth quarter that have materially affected, or
are reasonably likely to materially affect, the Companys internal control over financial
reporting. - 87 -




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Attestation report of the Companys registered public accounting firm REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Audit Committee of the Board of Directors and Stockholders of
Annuity & Life Re (Holdings), Ltd.
Hamilton, Bermuda We have audited managements assessment, included in the accompanying Managements Annual
Report on Internal Control Over Financial Reporting, that Annuity & Life Re (Holdings), Ltd. and
its subsidiaries (collectively, the Company) did not maintain effective internal control over
financial reporting as of December 31, 2004 because of the effect of material weaknesses relating
to a lack of segregation of duties within the Companys Information Technology structure and a
series of significant deficiencies with respect to the Companys system of internal control that in
the aggregate are a material weaknesses based on the criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO Standards). The Companys management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an opinion on
managements assessment and an opinion on the effectiveness of the Companys internal control over
financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion. A companys internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting
principles. A companys internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys assets that could have
a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of the effectiveness of the internal
control over financial reporting to future periods are subject to the risk that the controls may
become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate. A material weakness is a control deficiency, or combination of control deficiencies, that
results in a more than remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. The following material weaknesses have
been identified and included in managements assessment: - 88 -




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
    A lack of adequate segregation of duties related to the Companys Information
Technology Infrastructure. The Companys Director of Information Technology serves as
the Companys computer network administrator, possessing the highest level of security
access over the Companys computer network. He also provides database support,
including the electronic translation of data provided to the Company by its ceding
companies, to the Companys Reinsurance Administration Actuary and Chief Actuary.
Under the COSO Standards, this lack of segregation of duties is defined as a material
weakness.
    A series of significant deficiencies were noted in the Companys system of internal
control over financial reporting including: lack of audits of ceding company data,
over-reliance on spreadsheets, and over-reliance on analytics as preventive controls.
The combination of these significant deficiencies is a material weakness under the
COSO Standards. These material weaknesses were considered in determining the nature, timing, and extent of
audit tests applied in our audit of the consolidated financial statements and financial statement
schedule as of and for the year ended December 31, 2004 and this
report dated February 11, 2005, except for the first paragraph
of Note 12 to which the date is March 30, 2005, on
these financial statements and financial statement schedule expressed an unqualified
opinion and made reference to a change in the Companys method of accounting for certain
non-traditional long duration contracts. In our opinion, managements assessment that the Company did not maintain effective internal
control over financial reporting as of December 31, 2004, is fairly stated, in all material
respects, based on the criteria established in Internal ControlIntegrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, because of the effect
of the material weaknesses described above on the achievement of objectives of the control
criteria, the Company has not maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2004 based on the criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. /s/ MARCUM & KLIEGMAN LLP
Melville, New York
February 11, 2005 
 Item 9B.Other Information. None. - 89 -




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PART III 
 Item 10.Directors and Executive Officers of the Registrant. Directors The following provides the name, principal occupation and other pertinent information
concerning the current directors of the Company. Martin A. Berkowitz, age 56, has served as a director of the Company since being appointed by
the Board in 2003. On January 2, 2005, Mr. Berkowitz was named Chief Financial Officer of
Miami-Dade County Public School District. From March 2004 until December 2004, Mr. Berkowitz served
as President and Chief Executive Officer of the National Veterans Business Development Corporation,
a provider of assistance to small businesses owned by veterans, where he had served as Senior Vice
President and Chief Financial Officer since January 2001. From November 2000 through January 2001,
Mr. Berkowitz was an independent consultant. Prior thereto, Mr. Berkowitz held various positions,
including as a Senior Vice President and as Principal Controller, at Prudential Insurance Company
of America Inc., a financial services company. John F. Burke, age 50, has served as a director of the Company since 2003, and is President
and Chief Executive Officer of the Company. Mr. Burke was hired as the Companys Chief Financial
Officer in September 2001 and assumed responsibility as the Companys President and Chief Executive
Officer effective February 2003. Mr. Burke ceased being Chief Financial Officer of the Company on
February 18, 2004 upon the appointment of John W. Lockwood to that office. Mr. Burke has worked in
the insurance industry for over 25 years and held multiple positions with The Hartford Insurance
Group beginning in 1982, and served as President of Hartford Financial Services Fidelity and Surety
operations from 1997 to 1998. Mr. Burke also provided consulting services to Funds Express and
served as President of FX Insurance Agency, an Internet start up company, in 1999. From 2000 to
2001, Mr. Burke served as Director of Business Development, Financial Services, at IONA
Technologies, an e-business infrastructure company. Albert R. Dowden, age 63, has served as a director of the Company since 2003. Prior to his
retirement in 1998, Mr. Dowden served as President and Chief Executive Officer of Volvo Group North
America, Inc. and Senior Vice President of its Swedish parent company, AB Volvo. Prior to joining
Volvo in 1974 as General Counsel to its North American operations, he practiced law with the New
York based international law firm of Rogers & Wells (now Clifford Chance). Mr. Dowden currently
serves as a Director of the AIM/ Invesco Mutual Funds and Magellan Insurance, a Bermuda based
reinsurance company, and is a founder and Managing Director of The Boss Group, a Houston and London
based private investment and management firm. Mr. Dowden also serves as Chairman of The Cortland
Trust, a New York based money market fund. He also serves as a director or chairman of various New
York based, and as well as internationally focused, charities. Mr. Dowden had previously served as
a director of the Company from 1998 to 2000. Michael P. Esposito, Jr., age 65, has served as a director of the Company since its formation
in 1997. He has been non-executive Chairman of the Board of XL Capital Ltd since 1995 and a
director since 1986. He also serves as a director of Forest City Enterprises, Inc. and Sedgewick
CMS Holdings, Inc. and has been the Chairman of the Board of Primus Guaranty Ltd. since March 2002.
Mr. Esposito served as Co-Chairman of Inter-Atlantic Capital Partners, Inc. from 1998 to 2000,
having previously served as Vice Chairman from 1994 to 1998. Inter-Atlantic provides financial
consulting services for insurance companies and other financial services firms. Mr. Esposito served
as Executive Vice President and Chief Corporate Compliance, Control and Administration Officer of
The Chase Manhattan Corporation from 1992 to 1995, having previously served as Executive Vice
President and Chief Financial Officer from 1987 to 1992. Lee M. Gammill, Jr., age 70, has served as a director of the Company since 1998. Since 1997,
Mr. Gammill has served as Chairman of the Gammill Group, a provider of financial and consulting
services to - 90 -




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the insurance industry. From 1994 to 1997, Mr. Gammill served as Vice Chairman of the Board of New
York Life Insurance Company, where he was employed for more than 40 years. He currently serves as a
trustee of the American College Foundation and as a director of Sigaba Corporation. Frederick S. Hammer, age 68, has served as Chairman of the Board and a director of the Company
since its formation in 1997. Mr. Hammer has been Co-Chairman of Inter-Atlantic Capital Partners,
Inc. and the Inter-Atlantic Group, since 1998. Inter-Atlantic provides financial consulting
services for insurance companies and other financial services firms. He previously served as a
Vice-Chairman of Inter-Atlantic from 1994 to 1998. He currently serves as a trustee of the Madison
Square Boys and Girls Club and ING Clarion Real Estate Funds. Mr. Hammer served as Chairman and
Chief Executive Officer of Mutual of America Capital Management Corporation from 1993 to 1994 and
as President of SEI Asset Management Group from 1989 to 1993. From 1985 to 1989, Mr. Hammer was
Chairman and Chief Executive Officer of Meritor Savings Bank, and prior thereto he was an Executive
Vice President of The Chase Manhattan Corporation, where he was responsible for its global consumer
activities. Robert P. Johnson, age 59, has served as a director of the Company since 2003. Since March
2002, Mr. Johnson has been an independent consulting actuary. Mr. Johnson was President and Chief
Executive Officer of Hamilton Harbour Re from August 2000 through February 2002 and was President
and Chief Executive Officer of Marathon Re from January 2000 through July 2000; both Hamilton
Harbour Re and Marathon Re were start up insurance companies for which capital raising plans were
unsuccessful. From 1993 through December 1999, Mr. Johnson was an independent consulting actuary.
Prior thereto, from 1971 through 1993, Mr. Johnson held various positions at North American
Reinsurance Corporation and its affiliate, North American Reassurance Company, including Executive
Vice President of Atrium Corporation, a subsidiary of North American Reinsurance. Mr. Johnson is a
Fellow of the Society of Actuaries. Robert M. Lichten, age 64, has served as a director of the Company since its formation in
1997. Mr. Lichten has been Co-Chairman of Inter-Atlantic Capital Partners, Inc. and the
Inter-Atlantic Group since 1998. Inter-Atlantic provides financial consulting services for
insurance companies and other financial services firms. He previously served as a Vice-Chairman of
Inter-Atlantic from 1994 to 1998. He currently serves as a director of XL Capital Assurance, which
is a United States-based subsidiary of XL Capital Ltd. Mr. Lichten served as a Managing Director of
Smith Barney Inc. from 1990 to 1994 and as a Managing Director of Lehman Brothers Inc. from 1988 to
1990. Prior thereto, he served as an Executive Vice President of The Chase Manhattan Corporation,
where he was responsible for asset liability management and was President of The Chase Investment
Bank. Jeffrey D. Watkins, age 44, has served as a director since 2003. Mr. Watkins is currently the
President of Prescott Group Capital Management, LLC, a registered investment advisor, and serves as
the co-manager of the Prescott Tradition Fund, L.P. and Prescott Mid Cap, L.P. Prior to joining
Prescott in July 2001, Mr. Watkins served for 18 years as a portfolio manager for Capital Advisors,
Inc., a registered investment advisor, located in Tulsa, Oklahoma. Jon W. Yoskin, II, age 65, has served as a director of the Company since 1998. Mr. Yoskin has
been Chairman of the Board and Chief Executive Officer of Tri-Arc Financial Services, Inc., an
insurance broker, since 1988, and has served as Chairman of the Board and Chief Executive Officer
of Magellan Insurance Company, Ltd. since 1996. The terms for Albert R. Dowden, Lee M. Gammill, Jr., Frederick S. Hammer and Jon W. Yoskin, II
will expire at the 2005 annual meeting of shareholders. The terms for John F. Burke and Robert M.
Lichten will expire at the 2006 annual meeting of shareholders. The terms for Martin A. Berkowitz,
Michael P. Esposito, Jr., Robert P. Johnson and Jeffrey D. Watkins will expire at the 2007 annual
meeting of shareholders. - 91 -




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Executive Officers The following provides the name, principal occupation and other pertinent information
concerning the executive officers of the Company who do not also serve as directors; information
concerning Mr. Burke is set forth above under  Directors. John W. Lockwood, age 47, became Chief Financial Officer of the Company and
Annuity and Life Reassurance, Ltd., a wholly owned subsidiary of the Company, in February 2004. Mr.
Lockwood joined Annuity and Life Re America, Inc., the Companys United States-based subsidiary, in
December 1999, as Controller and Treasurer. From October 1998 until November 1999, Mr. Lockwood was
the Director of Statutory Reporting and Reinsurance Accounting at Hartford Steam Boiler Inspection
and Insurance Company, a property and casualty insurance company. Mr. Lockwood is currently Vice
President of and oversees the Companys United States operations. Mr. Lockwood has 20 years of
experience in the life insurance industry and held various positions over a 10 year period with
Security-Connecticut Life Insurance Company, including Controller and Corporate Risk Officer. Mr.
Lockwood is a graduate of Central Connecticut State University (B.S. Accounting, 1980) and
University of Hartford (M.S. Taxation, 1996) and passed the uniform certified public accountant
examination in 1988. Mr. Lockwood is also a Fellow of the Life Office Management Institute of the
Life Office Management Association. William H. Mawdsley, III, age 53, became Vice President of the Company and
Chief Actuary of Annuity and Life Reassurance, Ltd., a wholly owned subsidiary of the Company, in
January 2002. Mr. Mawdsley has over 25 years of experience in the life insurance and annuity
industries, and held multiple positions with Allmerica Financial from 1973 through October 2001. At
Allmerica, Mr. Mawdsleys responsibilities included all actuarial aspects of individual insurance,
and he focused on new individual product development and pricing. Mr. Mawdsley has been a Fellow of
the Society of Actuaries since 1976, a Member of the American Academy of Actuaries since 1979, and
a Chartered Life Underwriter since 1982. Audit Committee The Board has appointed an Audit Committee to assist the Board in its oversight
of (i) the integrity of the Companys financial statements; (ii) the independent auditors
qualifications, independence and performance; (iii) the performance of the Companys internal audit
function; and (iv) the Companys compliance with legal and regulatory requirements. The Audit
Committee presently consists of four directors (Messrs. Berkowitz (Chairman), Dowden, Gammill and
Johnson), each of whom is independent as independence is defined under the rules and regulations of
the Securities and Exchange Commission (SEC). In addition, Mr. Hammer, as the Chairman of the
Board, is invited to attend all Audit Committee meetings. The Board has determined that Mr.
Berkowitz qualifies as an audit committee financial expert, as defined by SEC regulations. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Exchange Act requires the Companys directors, executive officers
and persons beneficially owning more than ten percent of a registered class of the Companys equity
securities (collectively, the Covered Persons) to file reports of ownership and changes in
ownership of the Companys securities with the Commission. Copies of such reports also must be
provided to the Company. Based solely upon the Companys review of the reports provided to the Company
or filed with the Commission, and written representations of certain Covered Persons that no other
reports were required, to the Companys knowledge, all of the Section 16(a) filings required to be
made by Covered Persons during 2004 were made on a timely basis. - 92 -




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Item 11.Executive Compensation. The following table sets forth certain information for the Companys last three fiscal years
concerning the annual and long-term compensation paid to John F. Burke, the Companys Chief
Executive Officer, John W. Lockwood, the Companys Chief Financial Officer, and William H.
Mawdsley, III, the Companys Chief Actuary and Robert J. Reale, the Companys former Chief
Underwriting Officer (collectively, the Named Officers). The Company did not employ any other
executive officers in 2004. Other Annual
    
    
    Restricted
    
    
    SecuritiesCompensation
    
    
    Stock Awards
    
    
    Underlying
    
    
    All OtherName
    
    Principal Position
    
    Year
    
    Salary
    
    
    Bonus (1)
    
    
    (2)
    
    
    (3)
    
    
    Options
    
    
    Compensation (4)John F. Burke
    
    President and
    
    2004
    
    $
    500,000
    
    
    $
    250,000
    
    
    $
    120,000
    
    
    $
    0
    
    
    $
    0
    
    
    $
    50,000Chief Executive Officer
    
    2003
    
    $
    458,333
    
    
    $
    425,000
    
    
    $
    120,000
    
    
    $
    200,000
    
    
    $
    250,000
    
    
    $
    45,8332002
    
    $
    229,167
    
    
    $
    425,000
    
    
    $
    101,000
    
    
    $
    384,070
    
    
    $
    40,000
    
    
    $
    22,917John W. Lockwood...
    
    Senior Vice President
    
    2004
    
    $
    195,000
    
    
    $
    100,000
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    19,500Chief Financial Officer
    
    2003
    
    $
    140,000
    
    
    $
    90,000
    
    
    $
    0
    
    
    $
    60,000
    
    
    $
    0
    
    
    $
    14,000and Secretary (5)
    
    2002
    
    $
    124,000
    
    
    $
    45,000
    
    
    $
    0
    
    
    $
    84,000
    
    
    $
    5,000
    
    
    $
    12,400William H. Mawdsley
    
    Vice President and
    
    2004
    
    $
    190,000
    
    
    $
    125,000
    
    
    $
    100,000
    
    
    $
    0
    
    
    $
    0
    
    
    $
    19,000Chief Actuary
    
    2003
    
    $
    190,000
    
    
    $
    130,000
    
    
    $
    100,000
    
    
    $
    72,000
    
    
    $
    0
    
    
    $
    19,0002002
    
    $
    175,000
    
    
    $
    70,000
    
    
    $
    100,000
    
    
    $
    243,042
    
    
    $
    10,000
    
    
    $
    17,500Robert J. Reale......
    
    Senior Vice President
    
    2004
    
    $
    139,583
    
    
    $
    0
    
    
    $
    50,000
    
    
    $
    0
    
    
    $
    0
    
    
    $
    13,958and Chief Underwriter (6)
    
    2003
    
    $
    335,000
    
    
    $
    410,000
    
    
    $
    120,000
    
    
    $
    0
    
    
    $
    0
    
    
    $
    33,5002002
    
    $
    319,167
    
    
    $
    185,383
    
    
    $
    120,000
    
    
    $
    455,352
    
    
    $
    30,000
    
    
    $
    31,917
   (1)
    
    The amounts listed as bonuses for 2002, 2003 and 2004 are cash bonuses earned in each of
those respective years. A portion of the amounts listed as bonuses were paid during
subsequent fiscal years.(2)
    
    The amounts listed represent housing and travel allowances paid pursuant to employment
agreements.(3)
    
    Represents the dollar value of restricted share awards made to the Companys employees
during 2002 and 2003, as issued under the Companys Restricted Stock Plan, based on the
closing market price of the Common Shares on the grant dates. Dividends, if declared, will
be paid on the restricted shares. The Company did not grant any stock-based compensation,
including restricted stock and stock options, to the Named Officers during 2004. During
2002, the Company made two awards of an aggregate 401,000 restricted shares to its
employees. The shares granted under the first award in 2002 vested on February 12, 2005,
the third anniversary of the grant date. The shares granted under the second award in 2002
vest in three equal annual installments commencing on September 30, 2003, the first
anniversary of the grant date. However, if there is a Change in Control, as defined in
the Restricted Stock Plan, the restricted shares will immediately vest. During 2003, the
Company made additional awards of an aggregate 545,000 restricted shares to its employees.
The shares granted under the 2003 awards vest in three equal annual installments commencing
on September 25, 2004, the first anniversary of the grant date, but will vest immediately
upon a Change of Control. The number and value of the aggregate restricted share holdings
at December 31, 2004 for these awards to the Named Officers currently employed by the
Company are as follows: Mr. Burke: 238,500 shares valued at $109,710; Mr. Lockwood: 70,000
shares valued at $32,200; Mr. Mawdsley: 86,100 shares valued at $39,606. Aggregate market
value is based on the closing market price of the Companys Common Shares on December 31,
2004, which was $0.46.(4)
    
    The amounts listed include payments to the Companys defined contribution retirement program(5)
    
    Effective February 19, 2004, Mr. Lockwood assumed responsibility as Secretary and Chief
Financial Officer of the Company; he continued to serve as Controller and Treasurer of the
Companys US - 93 -




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subsidiary for the duration of the year. Mr. Lockwood joined Annuity and Life
Re America, Inc., the Companys United States operating subsidiary, in December 1999, as
Controller and Treasurer.(6)
    
    Mr. Reales employment contract was not renewed upon its expiration on May 31, 2004, at
which time he ceased being an employee of the Company. All of his unvested options and
restricted share awards were cancelled as of that date. Aggregated Option Exercises in 2004 and 2004 Year-End Option Values Number of Shares UnderlyingUnexercised Options at Fiscal
    
    
    Value of Unexercised In-the-MoneyShares
    
    
    
    
    
    
    Year End
    
    
    Options at Fiscal Year End(1)Acquired on
    
    
    ValueExercise
    
    
    Realized
    
    
    Exercisable
    
    
    Unexercisable
    
    
    Exercisable
    
    
    UnexercisableJohn F. Burke
    
    
    
    
    
    
    
    
    
    
    145,000
    
    
    
    180,000
    
    
    
    
    
    
    
    John W. Lockwood
    
    
    
    
    
    
    
    
    
    
    18,333
    
    
    
    1,667
    
    
    
    
    
    
    
    William H. Mawdsley
    
    
    
    
    
    
    
    
    
    
    6,667
    
    
    
    3,333
    
    
    
    
    
    
    
    Robert J. Reale (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
   (1)
    
    The value of unexercised options is based on the difference between the exercise price and
the closing price of the Companys Common Shares on December 31, 2004, which was $0.46.(2)
    
    Due to the non-renewal of Mr. Reales employment agreement upon its expiration on May 31,
2004, all of his unvested options were cancelled as of May 31, 2004. All of Mr. Reales
unexercised options expired on August 31, 2004. Employment Arrangements Messrs. Burke, Lockwood and Mawdsley are the Named Officers who, as of December 31, 2004, had
employment agreements with the Company (the Officers). Mr. Reales employment agreement was not
renewed upon its expiration on May 31, 2004. The Officers employment agreements were approved by the Board of Directors. The employment
agreements for Messrs. Burke and Mawdsley are for initial terms of three years, with consecutive
one-year renewal terms thereafter, subject to three months advance notice by either party of a
decision not to renew. The initial term of Mr. Lockwoods employment agreement expired on December
31, 2004, with consecutive one-year renewal terms thereafter, subject to three months advance
notice by either party of a decision not to renew. Mr. Burkes employment agreement provides that if the Company, for cause, terminates him or he
resigns without good reason, he will be entitled to receive an amount equal to his accrued but
unpaid annual base salary and any accrued vacation pay through the date of his termination, plus
reimbursable business expenses prior to termination. The employment agreements of Messrs. Lockwood
and Mawdsley provide that if the Company, for serious cause, terminates them or they resign without
good reason, they will forfeit all bonus amounts for the then current fiscal year, and the Company
will be liable to them only for accrued but unpaid salary, accrued but unpaid bonuses from a prior
fiscal year and reimbursable business expenses incurred prior to the termination. If the employment
of Mr. Burke is terminated by the Company without serious cause or by Mr. Burke with good reason,
the Company will pay Mr. Burke a lump sum equal to his accrued but unpaid annual base salary and
any accrued vacation pay through the date of his termination, plus reimbursable business expenses
prior to termination. Mr. Burke would also be entitled to receive a - 94 -




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lump sum equal to one years base salary, plus an amount equal to his annual bonus for the full
fiscal year preceding the year in which he was terminated, adjusted pro rata through the date of
his termination. In addition, Mr. Burke would be entitled to receive $60,000 for a cost of living
allowance and reasonable relocation expenses from Bermuda to the United States and any earned but
unpaid bonus from a prior fiscal year (on the date such bonus would otherwise be paid). If the
employment of Messrs. Lockwood or Mawdsley is terminated by the Company without serious cause or by
either of them with good reason, the Company will continue to pay their respective base salaries
for a period of one year from such termination, along with any accrued but unpaid salary, any
earned but unpaid bonus from a prior fiscal year and any reimbursable business expenses.
Additionally, Mr. Mawdsley will be entitled to travel and housing allowances for three months after
the date of termination and reasonable relocation expenses from Bermuda to the United States. Pursuant to each of the employment agreements, upon a change in control of the Company, the
Officers respective options to purchase Common Shares of the Company will become exercisable
immediately and all restricted Common Shares will vest immediately. If Mr. Burkes employment with
the Company is terminated without cause or if he terminates it for certain specified reasons within
one year following a change in control, he will be entitled to receive a lump sum payment equal to
two times his annual base salary, plus an amount equal to his annual bonus for the full fiscal year
preceding the year in which he was terminated, adjusted pro rata through the date of his
termination. If Messrs. Lockwoods or Mawdsleys employment with the Company is terminated without
serious cause or if either terminates his employment for certain specified reasons within six
months or one year, respectively, following a change in control, then he will be entitled to
receive a lump sum payment equal to two times his respective annual base salary. In addition, the
Officers will be entitled to receive any accrued but unpaid salary, any earned but unpaid bonus
from a prior fiscal year and reimbursable business expenses. Messrs. Burke and Mawdsley will also
be entitled to receive travel and housing allowances for twelve months from the date of termination
and reasonable relocation expenses from Bermuda to the United States, plus an amount equal to any
income taxes payable by them by reason of such payments occurring in connection with a change in
control. Compensation Committee Interlocks and Insider Participation No member of the Compensation Committee of the Companys Board of Directors is or was during
2004 an employee, or is or ever has been an officer, of the Company or its subsidiaries. No
executive officer of the Company served as a director or a member of the compensation committee of
another company, one of whose executive officers serves as a member of the Companys Board or
Compensation Committee. Compensation of Directors Directors who are employees of the Company or its subsidiaries are not paid any fees or
additional compensation for service as members of the Companys Board or any committee thereof.
Non-employee directors receive cash fees and are granted options to acquire Common Shares under the
Companys Initial Stock Option Plan for their service as directors and committee members. Through the date immediately preceding the annual meeting of the Companys shareholders held
during 2004 (the Annual Meeting), non-employee directors received cash in the amount of $25,000
per annum and $1,500 per Board and committee meeting attended, and Committee Chairmen received an
additional $500 for each meeting chaired. Since the date of the Annual Meeting, non-employee
directors are entitled to receive cash in the amount of $15,000 per annum and $1,500 per Board and
committee meeting attended, up to a maximum of $6,000 for all such Board meetings attended between
annual meetings of the Companys shareholders, and up to a maximum of $6,000 for all meetings of
each committee attended during the same period. The Chairman of the Board and each Committee
Chairman are entitled to receive an additional $500 for each meeting chaired, up to a maximum of an
additional $2,000 for all Board meetings chaired during such period and up to a maximum of an
additional $2,000 per committee for all committee meetings chaired. On March 25, 2005, the Board
of Directors approved revisions to the cash compensation payable to the companys non-employee
directors to make the compensation system more - 95 -




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closely resemble that which was in place prior to the Annual Meeting. Accordingly, effective
April 4, 2005, the Companys non-employee directors will be paid a $25,000 annual cash retainer
each year on April 4 (or, if such date is not a business day, on the next business day thereafter).
Also, effective April 4, 2005, each non-employee director will be entitled to receive $1,500 per
Board and committee meeting personally attended. The Chairman of the Board and each Committee
Chairman will be entitled to receive an additional $500 for each such meeting chaired. The
Companys non-employee directors will not be compensated for attending telephonic meetings. All
directors have been and will continue to be reimbursed for travel and other expenses incurred in
attending meetings of the Board or committees thereof. All new non-employee directors are automatically granted options to acquire 15,000 Common
Shares upon their initial election to the Companys Board. Such options become exercisable in
three equal annual installments commencing on the first anniversary of the date of grant. In
addition, commencing with the date of the Annual Meeting, a non-employee director whose term as a
director has not ended as of the date of each annual meeting of the Companys shareholders is
automatically granted immediately exercisable options to acquire 5,000 Common Shares. All options
granted to non-employee directors under the Initial Stock Option Plan have an exercise price equal
to the greater of the fair market value of the Common Shares on the date of grant or $1.00. In March 2005, Michael P. Esposito, Jr., one of our directors and Chairman of the Board of XL
Capital Ltd informed us that, pursuant to a recently enacted corporate policy at XL Capital, he
wished to waive his right to receive future compensation for service as a non-employee of our
company, including any option grants or cash compensation to which he would otherwise be entitled.
Pursuant to the same corporate policy, Mr. Esposito also requested that we cancel the options to
purchase 5,000 common shares of our company that were granted to him immediately following our 2004
annual general meeting of shareholders as part of the annual compensation paid to our non-employee
directors. 
 Item 12.Security Ownership of Certain Beneficial Owners and Management. Principal Shareholders The table below sets forth certain information regarding the beneficial ownership of
Common Shares by (a) each shareholder known to the Company to be the beneficial owner, as defined
in Rule 13d-3 under the Exchange Act, of more than 5% of the outstanding Common Shares, (b) each
director of the Company, (c) each of the Named Officers, other than Mr. Reale who is no longer with
the Company, and (d) all current executive officers and directors of the Company as a group. Each
of the shareholders named below has sole voting power and sole investment power with respect to the
shares indicated as beneficially owned, unless otherwise indicated. Information regarding
beneficial ownership of shareholders that are not directors and/or officers of the Company is based
on filings with the Commission available to the Company. Unless otherwise indicated below, the
information in the table represents beneficial ownership as of March 1, 2005 and the address for
each beneficial owner is c/o Annuity and Life Re (Holdings), Ltd., Cumberland House, 1 Victoria
Street, Hamilton, HM 11, Bermuda. - 96 -




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##### Table of Contents



Prescott Group Capital Management, LLC (1)
    
    
    3,885,400
    
    
    13.9%Summit Capital Management, LLC (2)
    
    
    3,769,900
    
    
    13.4%XL Capital Ltd (3)
    
    
    3,340,380
    
    
    11.8%Overseas Partners, Ltd. (4)
    
    
    1,773,050
    
    
    6.3%Michael P. Esposito, Jr. (5)
    
    
    701,868
    
    
    2.5%John F. Burke (6)
    
    
    496,166
    
    
    1.8%Frederick S. Hammer (7)
    
    
    490,400
    
    
    1.7%Robert M. Lichten (8)
    
    
    289,456
    
    
    1.0%Robert Johnson (9)
    
    
    169,225
    
    
    *William Mawdsley (10)
    
    
    96,100
    
    
    *John Lockwood (11)
    
    
    90,000
    
    
    *Jon W. Yoskin, II (12)
    
    
    43,900
    
    
    *Lee M. Gammill, Jr. (13)
    
    
    37,500
    
    
    *Martin Berkowitz (9)
    
    
    10,000
    
    
    *Jeffrey Watkins (9)
    
    
    10,000
    
    
    *Albert Dowden (9)
    
    
    10,000
    
    
    *All current directors and executive officers as a group
(twelve persons) (14)
    
    
    2,444,615
    
    
    8.7%
   *
    
    Less than 1%.1)
    
    Based on information provided pursuant to a Schedule 13G/A dated as of December 31,
2003 filed jointly by Prescott Group Capital Management, L.L.C., Prescott Group Aggressive
Small Cap Master Fund, G.P., Prescott Group Aggressive Small Cap, L.P., Prescott Group
Aggressive Small Cap II, L.P., Prescott Group Mid Cap, L.P. and Phil Frohlich with the
Commission on February 13, 2004. The address for each of the foregoing is 1924 South
Utica, Suite 1120, Tulsa, Oklahoma 74104. Jeffrey D. Watkins, a director of the Company,
is currently the President of Prescott Group Capital Management L.L.C. and may be
considered to have voting and investment control over the Common Shares owned by it; Mr.
Watkins disclaims beneficial ownership with respect to such shares, except to the extent
of any indirect pecuniary interest he may have by virtue of any ownership interest in the
Prescott Group entities. The Schedule 13G/A indicates that (i) Prescott Group Capital
Management, L.L.C. has beneficial ownership of, and sole voting and dispositive power over
3,662,000 Common Shares; (ii) Prescott Group Aggressive Small Cap Master Fund, G.P. has
beneficial ownership of, and sole voting and dispositive power over, 3,278,000 Common
Shares; (iii) Prescott Group Aggressive Small Cap, L.P. and Prescott Group Aggressive
Small Cap II, L.P. each has beneficial ownership of, and shares voting and dispositive
power over, 3,278,000 Common Shares; (iv) Prescott Group Mid Cap, L.P. has beneficial
ownership of, and sole voting and dispositive power over, 384,000 Common Shares; and (v)
Phil Frohlich has beneficial ownership of, and sole voting and dispositive power over,
223,400 Common Shares and, as the manager of Prescott Group Capital Management, L.L.C.,
has beneficial ownership of, and shares voting and dispositive power over, an additional
3,662,000 Common Shares.2)
    
    Based on information provided pursuant to a Schedule 13G/A dated as of December 31,
2004 filed jointly by Summit Capital Management, LLC, Summit Capital Partners, LP and John
C. Rudolf with the Commission on February 17, 2005. The address for each of the foregoing
is 601 Union Street, Suite 3900, Seattle, Washington 98101. The Schedule 13G/A indicates
that (i) Summit Capital Management, LLC has beneficial ownership of, and shares voting and
dispositive power over, 3,769,900 Common Shares; (ii) Summit Capital Partners, LP has
beneficial ownership of 1,184,350 Common Shares; and (iii) John C. Rudolf has beneficial
ownership of, and sole voting and dispositive power over, 727,150 Common Shares and has
beneficial ownership of, and shares voting and dispositive power over, an additional
3,042,750 Common Shares.3)
    
    Includes 213,433 Common Shares issuable upon exercise of Class B Warrants that are
currently - 97 -




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##### Table of Contents



exercisable. Michael P. Esposito, Jr., a director of the Company, is currently the
non-executive Chairman of the Board of XL Capital Ltd (XL). Mr. Esposito may be
considered to have voting and investment control over the Common Shares and warrants owned
by XL, as to which he disclaims beneficial ownership. The address for XL is XL House, 1
Bermudiana Road, P.O. Box 2245, Hamilton, HM JX, Bermuda.  4)
    Includes 133,396 Common Shares issuable upon exercise of Class B Warrants that are
currently exercisable. The address for Overseas Partners, Ltd. is Mintflower Place, 8
Par-la-Ville Road, P.O. Box HM 1581, Hamilton, HM 08, Bermuda.5)
    Includes 12,000 Common Shares issuable upon exercise of options that are currently
exercisable. Includes 100,000 Common Shares held by M.A.& M. Esposito Company, 22,500
Common Shares held by Red Towers Securities and 20,500 Common Shares held by Esposito
Company, each of which are companies in which Mr. Esposito has voting control. Includes
540,653 Common Shares issuable upon exercise of Class A Warrants that are currently
exercisable. Does not include 160,075 Common Shares issuable upon exercise of Class A
Warrants owned by adult children of Mr. Esposito, as to which he disclaims beneficial
ownership and 5,000 Common Shares issuable upon options granted to Mr. Esposito on August
5, 2005, which were forfeited on March 1, 2005 at Mr. Espositos request, pursuant to a
recently enacted corporate policy at XL. Mr. Esposito may be considered to have voting and
investment control over the Common Shares and warrants owned by XL, as to which he
disclaims beneficial ownership.6)
    Includes 241,666 Common Shares issuable upon exercise of options that are currently
exercisable. Does not include 83,334 Common Shares issuable upon exercise of options that
are not currently exercisable.7)
    Includes 17,000 Common Shares issuable upon exercise of options that are currently
exercisable. Includes 467,035 Common Shares issuable upon exercise of Class A Warrants
that are currently exercisable. Does not include 92,674 Common Shares issuable upon
exercise of Class A Warrants owned by certain trusts for the benefit of Mr. Hammers
children and grandchildren, as to which he disclaims beneficial ownership.8)
    Includes 17,000 Common Shares issuable upon exercise of options that are currently
exercisable. Includes 270,349 Common Shares issuable upon exercise of Class A Warrants
that are currently exercisable. Does not include 216,945 Common Shares issuable upon
exercise of Class A Warrants owned by certain trusts for the benefit of Mr. Lichtens
children and grandchildren, as to which he disclaims beneficial ownership.9)
    Includes 10,000 Common Shares issuable upon exercise of options that are currently
exercisable. Does not include 10,000 Common Shares issuable upon exercise of options that
are not currently exercisable. Please see footnote (1) above for additional information
relating to Mr. Watkins.10)
    Includes 10,000 Common Shares issuable upon exercise of options that are currently
exercisable.11)
    Includes 20,000 Common Shares issuable upon exercise of options that are currently
exercisable.12)
    Includes 32,000 Common Shares issuable upon exercise of options that are currently
exercisable. Includes 4,800 Common Shares held by Mr. Yoskins spouse, over which Mr.
Yoskin shares voting and dispositive control.13)
    Includes 32,000 Common Shares issuable upon exercise of options that are currently
exercisable.14)
    Includes 1,278,037 Common Shares issuable upon exercise of warrants that are
currently exercisable and 421,666 Common Shares issuable upon exercise of options that are
currently exercisable. - 98 -




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Equity Compensation Plan Information The following table summarizes the Companys equity compensation plans as of December 31, 2004: Number of SecuritiesRemaining Available forNumber of Securities
    
    
    
    
    
    
    Future Issuance Underto be Issued Upon
    
    
    Weighted-Average
    
    
    Equity CompensationExercise of
    
    
    Exercise Price of
    
    
    Plans (ExcludingOutstanding Options,
    
    
    Outstanding Options,
    
    
    Securities Reflected inPlan Category
    
    Warrants and Rights
    
    
    Warrants and Rights
    
    
    Column (a))(a)
    
    
    (b)
    
    
    (c)Equity compensation
plans approved by
security holders
    
    
    719,035
    (1)
    
    $
    10.38
    
    
    
    1,881,602
    (2)Equity compensation
plans not approved
by security holders
    
    
    
    
    
    
    
    
    
    
    566,800
    (3)Total
    
    
    719,035
    
    
    $
    10.38
    
    
    
    2,448,402
   (1)
    
    Includes options to acquire 488,365 Common Shares that were exercisable as of December 31,
2004 under the Annuity and Life Re (Holdings), Ltd. Initial Stock Option Plan, as amended and
restated (the Option Plan).(2)
    
    Reflects the number of options that may be granted under the Option Plan as of January 1,
2005. The total number of options that may be granted under the Option Plan is subject to an
annual adjustment, whereby additional options may be granted each calendar year to purchase
Common Shares up to an amount equal to two percent (2.0%) of the adjusted average of the
outstanding Common Shares for the preceding fiscal year, as such amount is determined in
calculating fully diluted earnings per share by the Company.(3)
    
    The Company adopted the Annuity and Life Re (Holdings), Ltd. Restricted Stock Plan in
2002 (the Restricted Stock Plan) and as of December 31, 2004, there were 633,200 shares
outstanding that had been granted to current or former employees under the Restricted
Stock Plan. Those restricted shares are not included in the table, but are reflected in
the number of shares outstanding reported in the Companys consolidated financial
statements. Under the Restricted Stock Plan, no single employee may be granted more than
250,000 shares of restricted stock. The amounts set forth above are subject to adjustment to reflect any stock dividend, stock
split, share combination, or similar change in our capitalization. See Note 10 to the Companys
consolidated financial statements for the year ended December 31, 2004 included in this report for
information regarding the material features of the above plans. - 99 -




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Item 13.Certain Relationships and Related Transactions. Director Nominee Arrangements XL Capital Ltd and Overseas Partners, Ltd. each have the right to nominate one person for
election as a director of the Company for so long as they own at least 500,000 Common Shares. Henry
C.V. Keeling is an Executive Vice President of XL Capital and Chief Executive Officer of XL Re, and
he was the formal nominee of XL Capital until he retired from the Board of Directors on November 5,
2004. Overseas Partners, Ltd. has not designated a nominee. Indemnification Payments In accordance with the Companys Amended and Restated Bye-laws, the Company indemnifies its
officers and directors to the fullest extent permissible under Bermuda law. Pursuant to the
Bye-laws, the Company will make payments for the expenses incurred in connection with defending any
action for which indemnification has properly been sought. In connection with a purported
shareholder class action lawsuit filed against the Company and certain of its current and former
officers and directors, the Company had, as of December 31, 2004, made payments of approximately
$140,000 and $53,000 to John F. Burke, its Chief Executive Officer and a director, and Frederick S.
Hammer, the non-executive Chairman of its Board of Directors, respectively, for their expenses
related to defending this lawsuit. Payments on behalf of Mr. Burke during 2004 were approximately
$37,000. Payments on behalf of Mr. Hammer during 2004 were approximately $4,000. Transactions with Shareholders XL Capital Ltd and XL Life Ltd Michael P. Esposito, Jr., a director of the Company, currently serves as the non-executive
Chairman of the Board of XL Capital Ltd. Robert M. Lichten, a director of the Company, serves as a
director of a United States-based subsidiary of XL Capital. XL Capital is a major shareholder of
the Company. On December 31, 2002, the Company entered into a transaction with XL Life Ltd, 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 agreement with the
Company with respect to four of those blocks of business. The Company has also historically been a
party to various insurance and reinsurance relationships with XL Life and its affiliates, including
an excess of loss reinsurance policy related to minimum interest guarantee payments under the
Companys annuity reinsurance agreement with Transamerica. The Company and XL Life and its
affiliate agreed to mutually discharge their respective rights and obligations under all of the
parties insurance and reinsurance relationships in a comprehensive settlement effective as of July
1, 2003. Under the terms of the comprehensive settlement, the Company paid $6.0 million to XL Life
and was released from any and all obligations to XL Life and its affiliate under all of the
insurance and reinsurance agreements among the parties. As part of the comprehensive settlement,
the Company was obligated to pay an additional $2.0 million to XL Life if prior to June 30, 2004
the Companys stock traded above $2.00 per share for a period of 20 out of any 30 consecutive
trading days and the Company raised an aggregate $35.0 million of equity or debt. Because these two
events did not occur prior to June 30, 2004, the Company was not required to make any such payment
to XL Life and is no longer obligated to do so. - 100 -




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##### Table of Contents



Item 14.Principal Accountant Fees and Services. The
following summarizes the fees billed to the Company by Marcum & Kliegman LLP during 2004
in connection with the audit of the Companys annual financial statements for the years ended
December 31, 2004 and for the review of the financial statements included in each of the Companys
quarterly reports on Form 10-Q filed during 2004: Audit Fees:2004
    
    
    $700,0002003:
    
    
    NoneAudit-Related Fees:2004:
    
    
    None2003:
    
    
    NoneTax Fees:2004:
    
    
    None2003:
    
    
    NoneAll Other Fees:2004:
    
    
    None2003:
    
    
    None
 The Companys Audit Committee has established a pre-approval policy pursuant to which it
granted its approval for Marcum & Kliegman LLP to perform certain audit, audit-related, tax and
other services up to specified aggregate fee levels for each service. The Audit Committee will
periodically review, and revise if necessary, the list of pre-approved services that Marcum &
Kliegman LLP may provide. The Audit Committees policy also provides that any proposed services
that are not specifically pre-approved pursuant to the policy, as well as any proposed services
that exceed pre-approved cost levels established in the policy, will require the Audit Committees
separate pre-approval. In addition, the Audit Committee may delegate pre-approval authority to one
or more of its members, who must report, for information purposes only, any pre-approval decisions
to the Audit Committee at its next scheduled meeting. - 101 -




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PART IV 
 Item 15.Exhibits and Financial Statements. (a) The following documents are filed or incorporated by reference as part of this Form 10-K.  1.
    Financial Statements The audited consolidated financial statements of Annuity and Life Re (Holdings), Ltd. and the
related auditors report listed in the Index to Financial Statements and Financial Statement
Schedule appearing on page 55.  2.
    Financial Statement Schedule The schedule listed in the Index to Financial Statements and Financial Statement Schedule
appearing on pages 89. 3. Exhibits The following exhibits are filed or incorporated by reference as part of this Form 10-K: *2.1
    
    Master Agreement, dated as of December 31, 2002, by and among Annuity and Life
Reassurance Ltd. (the Operating Company), Viva Reassurance, Ltd. and XL Life
Ltd (Exhibit 2.1 to the Companys Form 8-K filed on January 16, 2003).*2.2
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Continental Assurance Company (Exhibit 2.2 to the
Companys Form 8-K filed on January 16, 2003).*2.3
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Valley Forge Life Insurance Company (Exhibit 2.3 to
the Companys Form 8-K filed on January 16, 2003).*2.4
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Zurich Life Insurance Company of America (Exhibit 2.4
to the Companys Form 8-K filed on January 16, 2003).*2.5
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Fidelity Life Association (Exhibit 2.5 to the
Companys Form 8-K filed on January 16, 2003).*2.6
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Federal Kemper Life Assurance Company (Exhibit 2.6 to
the Companys Form 8-K filed on January 16, 2003).*2.7
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Protective Life Insurance Company (Exhibit 2.7 to the
Companys Form 8-K filed on January 16, 2003).*2.8
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Phoenix Life and Annuity Company (Exhibit 2.8 to the
Companys Form 8-K filed on January 16, 2003).*2.9
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Phoenix Life Insurance Company (Exhibit 2.9 to the
Companys Form 8-K filed on January 16, 2003).*2.10
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Empire General Life Assurance Corporation (Exhibit
2.10 to the Companys Form 8-K filed on January 16, 2003).
 - 102 -




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*2.11
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and PHL Variable Insurance Company (Exhibit 2.11 to the
Companys Form 8-K filed on January 16, 2003).*2.12
    
    Retrocessional Reinsurance Agreement, dated as of December 31, 2002, by and
between the Operating Company and XL Life Ltd (Exhibit 2.12 to the Companys
Form 8-K filed on January 16, 2003).*2.13
    
    Reinsurance Termination Agreement, dated as of December 31, 2002, by and
between the Operating Company and Viva Reassurance, Ltd. (Exhibit 2.13 to the
Companys Form 8-K filed on January 16, 2003).*2.14
    
    Termination Agreement, dated as of February 14, 2003, by and between the
Operating Company and The Ohio National Life Insurance Company (Exhibit 2.1 to
the Companys Form 8-K filed on March 3, 2003).*3.1
    
    Memorandum of Association, as amended, of the Company (Exhibit 3.1 to the
Companys Registration Statement on Form S-1, Registration No. 333-43301,
declared effective on April 8, 1998 (the Registration Statement)).*3.2
    
    Bye-Laws, as amended, of the Company (Exhibit 3.1 to the Companys Form 10-Q
filed on May 15, 2002).*4.1
    
    Form of Amended and Restated Class A Warrant (Exhibit 4.2 to the Registration
Statement).*4.2
    
    Form of Class B Warrant (Exhibit 4.3 to the Registration Statement).*4.3
    
    Form of Warrant issued to Hartford Life and Annuity Insurance Company and
Hartford Life Insurance Company (Exhibit 4 to the Companys Form 10-Q filed on
August 14, 2003).*4.4
    
    Annuity and Life Re (Holdings), Ltd. Common Stock Purchase Warrant, issued to
Connecticut General Life Insurance Company, dated as of September 30, 2004
(Exhibit 99.2 to the Companys Form 8-K filed on October 28, 2004).*10.1
    
    Amended and Restated Employment Agreement, dated as of July 28, 2003, by and
between the Company, the Operating Company and John F. Burke (Exhibit 10.1 to
the Companys Form 10-Q filed on August 14, 2003).*10.2
    
    Employment Agreement, dated as of February 18, 2004, by and between the
Company, the Operating Company and John W. Lockwood (Exhibit 10.1 to the
Companys Form 10-Q filed on May 17, 2004)*10.3
    
    Employment Agreement, dated as of January 2, 2002, among the Company, the
Operating Company and William H. Mawdsley, III (Exhibit 10.1 to the Companys
Form 10-Q filed on May 15, 2002).*10.4
    
    Retention Agreement, dated as of September 4, 2002 (as revised December 19,
2002), between the Company and William H. Mawdsley, III (Exhibit 10.18 to the
Companys Form 10-K filed on April 16, 2003).*10.5
    
    Employment Agreement, dated as of June 10, 2003, among the Company, the
Operating Company and Robert Reale (Exhibit 10.2 to the Companys Form 10-Q
filed on August 14, 2003).*10.6
    
    Amendment No. 1, dated as of February 1, 1998, to Employment Agreement, dated
as of January 8, 1998, among Robert J. Reale, the Company and the Operating
Company (Exhibit 10.9 to the Registration Statement).*10.7
    
    Initial Stock Option Plan, as amended and restated effective April 29, 1999
(Exhibit 4 to the Companys Form 10-Q filed on May 10, 1999).*10.8
    
    Amendment to Amended and Restated Initial Stock Option Plan. (Exhibit 10.1 to
the Companys Form 10-Q filed on August 5, 2004).*10.9
    
    Annuity and Life Re (Holdings), Ltd. Restricted Stock Plan (Exhibit 10.2 to the
Companys Form 10-Q filed on May 15, 2002).*10.10
    
    Annuity and Life Re (Holdings), Ltd. Directors Deferred Compensation Plan
(Exhibit 10.3 to the Companys Form 10-Q filed on May 15, 2002).*10.11
    
    Form of Securities Purchase Agreement entered into between The Prudential
Insurance Company of America and the Company, EXEL Limited and the Company,
Risk Capital Reinsurance Company and the Company, Insurance Partners, L.P. and
the Company and
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Insurance Partners Offshore (Bermuda), L.P. and the Company (Exhibit 10.12 to the Registration Statement).*10.12
    
    Form of Registration Rights Agreement entered into between The Prudential
Insurance Company of America and the Company, EXEL Limited and the Company,
Risk Capital Reinsurance Company and the Company, Insurance Partners, L.P. and
the Company and Insurance Partners Offshore (Bermuda), L.P. and the Company
(Exhibit 10.13 to the Registration Statement).*10.13
    
    Registration Rights Agreement, dated as of January 9, 1998, between the Company
and the holders of the Class A Warrants (Exhibit 10.5 to the Registration
Statement).*10.14
    
    Letter Agreement, dated as of May 1, 2000, among Risk Capital Reinsurance
Company, the Company and XL Capital Ltd (Exhibit 10.13 to the Companys Form
10-K filed on March 15, 2001).*10.15
    
    Letter Agreement, dated as of March 19, 1998, among Insurance Partners, L.P.,
Insurance Partners Offshore (Bermuda), L.P. and the Company, which has been
assigned to Overseas Partners, Ltd. (Exhibit 10.18 to the Registration
Statement).*10.16
    
    Letter of Intent with XL Life Ltd, dated February 28, 2002, providing
catastrophe excess of loss cover (Exhibit 10.4 to the Companys Form 10-Q filed
on May 15, 2002).*10.17
    
    Letter of Intent with XL Life Ltd, dated as of February 28, 2002, providing
$10,000,000 of excess of loss protection for Transamerica Occidental Life LMIG
exposure (Exhibit 10.20 to the Companys Form 10-K filed on March 28, 2002).**10.18
    
    Retrocession Agreement, dated as of March 27, 2001, between the Company and XL
Re Ltd. (Exhibit 10.45 to the Companys Form 10-K filed on April 16, 2003).**10.19
    
    Retrocession Agreement, dated as of December 13, 2000, between the Company and
XL Mid Ocean Reinsurance Ltd. (Exhibit 10.46 to the Companys Form 10-K filed
on April 16, 2003).*10.20
    
    Letter of Intent with XL Mid Ocean Reinsurance Ltd, dated as of April 13, 2000.
(Exhibit 10.47 to the Companys Form 10-K filed on April 16, 2003).*10.21
    
    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 the Operating
Company (Exhibit 10.3 to the Companys Form 10-Q filed on August 14, 2003).*10.22
    
    Settlement and Commutation Agreement, dated as of November 4, 2003, by and
among XL Life Ltd, XL Re Ltd (formerly known as XL MidOcean Reinsurance Ltd),
the Operating Company and the Company (Exhibit 10.3 to the Companys Form 10-Q
filed on November 14, 2003).*10.23
    
    Commutation and Release Agreement, by and between Annuity & Life Reassurance,
Ltd. and Connecticut General Life Insurance Company, dated October 26, 2004
(incorporated herein by reference to Exhibit 99.1 to the Companys Form 8-K
filed on October 28, 2004).10.24
    
    Letter of Intent by and between Annuity and Life Reassurance, Ltd. and
Transamerica Occidental Life Insurance Company, dated as of December 31, 2004.*10.25
    
    Master Agreement by and between Annuity and Life Reassurance, Ltd. and
Transamerica Occidental Life Insurance Company, dated as of January 31, 2005
(Exhibit 10.1 to the Companys Form 8-K filed on February 4, 2005).*10.26
    
    Amendment by and between Transamerica Occidental Life Insurance Company and
Annuity and Life Reassurance, Ltd., effective December 1, 2004 (Exhibit 10.2 to
the Companys Form 8-K filed on February 4, 2005).*21.1
    
    Subsidiaries of the Company (Exhibit 21.1 to the Companys Form 10-K filed on
March 15, 2001).23.1
    
    Consent of Marcum & Kliegman LLP (Independent Accountants)23.2
    
    Consent of KPMG (Independent Accountants)31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of the Companys Chief Executive Officer.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of the Companys Chief Financial Officer.32.1
    
    Section 1350 Certification of the Companys Chief Executive Officer.32.2
    
    Section 1350 Certification of the Companys Chief Financial Officer.
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*
    
    Previously filed with the Commission and incorporated herein by reference.**
    
    Previously filed with the Commission and incorporated herein by reference. Material in this document was omitted pursuant
to a confidential treatment request. The omitted material was filed separately with the Commission.
    
    Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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.Date:     March 31, 2005
    
    By:
    
    /s/ John F. BurkeName:
    
    John F. BurkeTitle:
    
    Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report
has been signed below by the following persons on behalf of the Registrant and in the capacities
and on the dates indicated. Signature
    
    Date/s/ John F. Burke
    
    March 31, 2005John F. Burke, Chief Executive Officerand Director/s/ John W. Lockwood
    
    March 31, 2005John W. Lockwood, Chief Financial Officer andPrincipal Accounting OfficerMarch 31, 2005Frederick S. Hammer, Non-ExecutiveChairman and Director/s/
Martin A. Berkowitz
    
    March 31, 2005

Martin A. Berkowitz, Non-Executive DeputyChairman and Director/s/
Robert M. Lichten
    
    March 31, 2005Robert M. Lichten, Director
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Signature
    
    Date/s/
Albert R. Dowden
    
    March 31, 2005

Albert R. Dowden, Director/s/
Michael P. Esposito, Jr.
    
    March 31, 2005Michael P. Esposito, Jr., Director/s/
Lee M. Gammill, Jr.
    
    March 31, 2005Lee M. Gammill, Jr., Director/s/
Robert P. Johnson
    
    March 31, 2005Robert P. Johnson, Director/s/
Jeffrey D. Watkins
    
    March 31, 2005Jeffrey D. Watkins, Director/s/
Jon W. Yoskin, II
    
    March 31, 2005Jon W. Yoskin, II, Director
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Exhibit Index *2.1
    
    Master Agreement, dated as of December 31, 2002, by and among Annuity and Life
Reassurance Ltd. (the Operating Company), Viva Reassurance, Ltd. and XL Life
Ltd (Exhibit 2.1 to the Companys Form 8-K filed on January 16, 2003).*2.2
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Continental Assurance Company (Exhibit 2.2 to the
Companys Form 8-K filed on January 16, 2003).*2.3
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Valley Forge Life Insurance Company (Exhibit 2.3 to
the Companys Form 8-K filed on January 16, 2003).*2.4
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Zurich Life Insurance Company of America (Exhibit 2.4
to the Companys Form 8-K filed on January 16, 2003).*2.5
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Fidelity Life Association (Exhibit 2.5 to the
Companys Form 8-K filed on January 16, 2003).*2.6
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Federal Kemper Life Assurance Company (Exhibit 2.6 to
the Companys Form 8-K filed on January 16, 2003).*2.7
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Protective Life Insurance Company (Exhibit 2.7 to the
Companys Form 8-K filed on January 16, 2003).*2.8
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Phoenix Life and Annuity Company (Exhibit 2.8 to the
Companys Form 8-K filed on January 16, 2003).*2.9
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Phoenix Life Insurance Company (Exhibit 2.9 to the
Companys Form 8-K filed on January 16, 2003).*2.10
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and Empire General Life Assurance Corporation (Exhibit
2.10 to the Companys Form 8-K filed on January 16, 2003).*2.11
    
    Novation Agreement, dated as of December 31, 2002, by and among the Operating
Company, XL Life Ltd and PHL Variable Insurance Company (Exhibit 2.11 to the
Companys Form 8-K filed on January 16, 2003).*2.12
    
    Retrocessional Reinsurance Agreement, dated as of December 31, 2002, by and
between the Operating Company and XL Life Ltd (Exhibit 2.12 to the Companys
Form 8-K filed on January 16, 2003).*2.13
    
    Reinsurance Termination Agreement, dated as of December 31, 2002, by and
between the Operating Company and Viva Reassurance, Ltd. (Exhibit 2.13 to the
Companys Form 8-K filed on January 16, 2003).*2.14
    
    Termination Agreement, dated as of February 14, 2003, by and between the
Operating Company and The Ohio National Life Insurance Company (Exhibit 2.1 to
the Companys Form 8-K filed on March 3, 2003).*3.1
    
    Memorandum of Association, as amended, of the Company (Exhibit 3.1 to the
Companys Registration Statement on Form S-1, Registration No. 333-43301,
declared effective on April 8, 1998 (the Registration Statement)).*3.2
    
    Bye-Laws, as amended, of the Company (Exhibit 3.1 to the Companys Form 10-Q
filed on May 15, 2002).*4.1
    
    Form of Amended and Restated Class A Warrant (Exhibit 4.2 to the Registration
Statement).*4.2
    
    Form of Class B Warrant (Exhibit 4.3 to the Registration Statement).*4.3
    
    Form of Warrant issued to Hartford Life and Annuity Insurance Company and
Hartford Life Insurance Company (Exhibit 4 to the Companys Form 10-Q filed on
August 14, 2003).
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##### Table of Contents



*4.4
    
    Annuity and Life Re (Holdings), Ltd. Common Stock Purchase Warrant, issued to
Connecticut General Life Insurance Company, dated as of September 30, 2004
(Exhibit 99.2 to the Companys Form 8-K filed on October 28, 2004).*10.1
    
    Amended and Restated Employment Agreement, dated as of July 28, 2003, by and
between the Company, the Operating Company and John F. Burke (Exhibit 10.1 to
the Companys Form 10-Q filed on August 14, 2003).*10.2
    
    Employment Agreement, dated as of February 18, 2004, by and between the
Company, the Operating Company and John W. Lockwood (Exhibit 10.1 to the
Companys Form 10-Q filed on May 17, 2004)*10.3
    
    Employment Agreement, dated as of January 2, 2002, among the Company, the
Operating Company and William H. Mawdsley, III (Exhibit 10.1 to the Companys
Form 10-Q filed on May 15, 2002).*10.4
    
    Retention Agreement, dated as of September 4, 2002 (as revised December 19,
2002), between the Company and William H. Mawdsley, III (Exhibit 10.18 to the
Companys Form 10-K filed on April 16, 2003).*10.5
    
    Employment Agreement, dated as of June 10, 2003, among the Company, the
Operating Company and Robert Reale (Exhibit 10.2 to the Companys Form 10-Q
filed on August 14, 2003).*10.6
    
    Amendment No. 1, dated as of February 1, 1998, to Employment Agreement, dated
as of January 8, 1998, among Robert J. Reale, the Company and the Operating
Company (Exhibit 10.9 to the Registration Statement).*10.7
    
    Initial Stock Option Plan, as amended and restated effective April 29, 1999
(Exhibit 4 to the Companys Form 10-Q filed on May 10, 1999).*10.8
    
    Amendment to Amended and Restated Initial Stock Option Plan. (Exhibit 10.1 to
the Companys Form 10-Q filed on August 5, 2004).*10.9
    
    Annuity and Life Re (Holdings), Ltd. Restricted Stock Plan (Exhibit 10.2 to the
Companys Form 10-Q filed on May 15, 2002).*10.10
    
    Annuity and Life Re (Holdings), Ltd. Directors Deferred Compensation Plan
(Exhibit 10.3 to the Companys Form 10-Q filed on May 15, 2002).*10.11
    
    Form of Securities Purchase Agreement entered into between The Prudential
Insurance Company of America and the Company, EXEL Limited and the Company,
Risk Capital Reinsurance Company and the Company, Insurance Partners, L.P. and
the Company and Insurance Partners Offshore (Bermuda), L.P. and the Company
(Exhibit 10.12 to the Registration Statement).*10.12
    
    Form of Registration Rights Agreement entered into between The Prudential
Insurance Company of America and the Company, EXEL Limited and the Company,
Risk Capital Reinsurance Company and the Company, Insurance Partners, L.P. and
the Company and Insurance Partners Offshore (Bermuda), L.P. and the Company
(Exhibit 10.13 to the Registration Statement).*10.13
    
    Registration Rights Agreement, dated as of January 9, 1998, between the Company
and the holders of the Class A Warrants (Exhibit 10.5 to the Registration
Statement).*10.14
    
    Letter Agreement, dated as of May 1, 2000, among Risk Capital Reinsurance
Company, the Company and XL Capital Ltd (Exhibit 10.13 to the Companys Form
10-K filed on March 15, 2001).*10.15
    
    Letter Agreement, dated as of March 19, 1998, among Insurance Partners, L.P.,
Insurance Partners Offshore (Bermuda), L.P. and the Company, which has been
assigned to Overseas Partners, Ltd. (Exhibit 10.18 to the Registration
Statement).*10.16
    
    Letter of Intent with XL Life Ltd, dated February 28, 2002, providing
catastrophe excess of loss cover (Exhibit 10.4 to the Companys Form 10-Q filed
on May 15, 2002).*10.17
    
    Letter of Intent with XL Life Ltd, dated as of February 28, 2002, providing
$10,000,000 of excess of loss protection for Transamerica Occidental Life LMIG
exposure (Exhibit 10.20 to the Companys Form 10-K filed on March 28, 2002).**10.18
    
    Retrocession Agreement, dated as of March 27, 2001, between the Company and XL
Re Ltd.
 - 4 -




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##### Table of Contents



(Exhibit 10.45 to the Companys Form 10-K filed on April 16, 2003).**10.19
    
    Retrocession Agreement, dated as of December 13, 2000, between the Company and
XL Mid Ocean Reinsurance Ltd. (Exhibit 10.46 to the Companys Form 10-K filed on April 16, 2003).*10.20
    
    Letter of Intent with XL Mid Ocean Reinsurance Ltd, dated as of April 13, 2000.
(Exhibit 10.47 to the Companys Form 10-K filed on April 16, 2003).*10.21
    
    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 the Operating
Company (Exhibit 10.3 to the Companys Form 10-Q filed on August 14, 2003).*10.22
    
    Settlement and Commutation Agreement, dated as of November 4, 2003, by and
among XL Life Ltd, XL Re Ltd (formerly known as XL MidOcean Reinsurance Ltd),

the Operating Company and the Company (Exhibit 10.3 to the Companys Form 10-Q
filed on November 14, 2003).*10.23
    
    Commutation and Release Agreement, by and between Annuity & Life Reassurance,
Ltd. and Connecticut General Life Insurance Company, dated October 26, 2004
(incorporated herein by reference to Exhibit 99.1 to the Companys Form 8-K
filed on October 28, 2004).10.24
    
    Letter of Intent by and between Annuity and Life Reassurance, Ltd. and
Transamerica Occidental Life Insurance Company, dated as of December 31, 2004.*10.25
    
    Master Agreement by and between Annuity and Life Reassurance, Ltd. and
Transamerica Occidental Life Insurance Company, dated as of January 31, 2005
(Exhibit 10.1 to the Companys Form 8-K filed on February 4, 2005).*10.26
    
    Amendment by and between Transamerica Occidental Life Insurance Company and
Annuity and Life Reassurance, Ltd., effective December 1, 2004 (Exhibit 10.2 to
the Companys Form 8-K filed on February 4, 2005).*21.1
    
    Subsidiaries of the Company (Exhibit 21.1 to the Companys Form 10-K filed on
March 15, 2001).23.1
    
    Consent of Marcum & Kliegman LLP (Independent Accountants)23.2
    
    Consent of KPMG (Independent Accountants)31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of the Companys Chief Executive Officer.31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of the Companys Chief Financial Officer.32.1
    
    Section 1350 Certification of the Companys Chief Executive Officer.32.2
    
    Section 1350 Certification of the Companys Chief Financial Officer.
   *
    
    Previously filed with the Commission and incorporated herein by reference.**
    
    Previously filed with the Commission and incorporated herein by reference. Material in this document was omitted pursuant
to a confidential treatment request. The omitted material was filed separately with the Commission.
    
    Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K. - 5 -