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## UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

## FORM 10-Q

(Mark One)

|X|               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2004

OR

|_|               TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from
to
Commission file number 1-12338

VESTA INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)

|Delaware                                 | 63-1097283         
|---------------------------------------- | -------------------
|(State of other jurisdiction of          | (I.R.S. Employer   
|incorporation or organization)           | Identification No.)
|                                         |                    
|3760 River Run Drive                     | 35243              
|Birmingham, Alabama                      | (Zip Code)         
|(Address of principal executive offices) |                    

(205) 970-7000(Registrant's telephone number, including area code)

Not Applicable(Former name, former address and former fiscal year, if changed since last report)

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. |X|   Yes      |_|    No

Indicate the number of
shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.

The number of shares outstanding of the registrant's common stock,
$.01 par value, as of May 7, 2004
36,067,740

---

Vesta Insurance Group, Inc.

Index

|        |  |                                                                                                     
|------- |  | ----------------------------------------------------------------------------------------------------
|Part I  |  | Financial Information                                                                               
|Item 1  |  | Financial Statements:                                                                               
|        |  | Consolidated Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003                  
|        |  | Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003 (unaudited)
|        |  | Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 (unaudited)
|        |  | Notes to Consolidated Financial Statements                                                          
|Item 2  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations               
|Item 3  |  | Quantitative and Qualitative Disclosures About Market Risk                                          
|Item 4  |  | Controls and Procedures                                                                             
|        |  |                                                                                                     
|Part II |  | Other Information                                                                                   
|Item 1  |  | Legal Proceedings                                                                                   
|Item 2  |  | Changes in Securities                                                                               
|Item 3  |  | Defaults Upon Senior Securities                                                                     
|Item 4  |  | Submission of Matters to a Vote of Security Holders                                                 
|Item 5  |  | Other Information                                                                                   
|Item 6  |  | Exhibits and Reports on Form 8-K                                                                    
|        |  | Signatures                                                                                          

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##### Part I
Item 1. Financial Statements
Vesta Insurance Group, Inc.
Consolidated Balance Sheets
(amounts in thousands, except share and per share data)

|                                                                             | March 31, | December 31,
|---------------------------------------------------------------------------- | --------- | ------------
|
|
|Assets:                                                                      |           |             
|Fixed maturities available for sale - at fair value (cost:  2004 - $691,924; |          
|2003 - $674,623)                                                             |           | $704,144    
|Fixed maturities - trading                                                   |           | 162,618     
|Equity securities-at fair value: (cost: 2004-$29,214; 2003- $28,454)         |           | 30,740      
|Mortgage loans                                                               |           | 8,335       
|Policy loans                                                                 |           | 55,549      
|Short-term investments                                                       |           | 9,820       
|Other invested assets                                                        |           | 29,840      
|                                                                             |           |             
|Total investments                                                            |           | 1,001,046   
|Cash                                                                         |           | 97,144      
|Accrued investment income                                                    |           | 11,432      
|Premiums in course of collection (net of allowances for losses               |          
|of $1,176 in 2004 and 2003)                                                  |           | 131,622     
|Reinsurance balances receivable                                              |           | 429,499     
|Reinsurance recoverable on paid losses                                       |           | 52,627      
|Deferred policy acquisition costs                                            |           | 48,433      
|Property and equipment                                                       |           | 20,896      
|Goodwill                                                                     |           | 133,448     
|Other intangible assets                                                      |           | 16,056      
|Other assets                                                                 |           | 21,241      
|                                                                             |           |             
|Total assets                                                                 |           | $1,963,444  
|                                                                             |           |             
|Liabilities:                                                                 |          
|Policy liabilities                                                           |           | $674,755    
|Losses and loss adjustment expenses                                          |           | 356,902     
|Unearned premiums                                                            |           | 332,744     
|Federal Home Loan Bank advances                                              |           | 166,403     
|Reinsurance balances payable                                                 |           | 67,394      
|Deferred income taxes                                                        |           | 8,463       
|Line of credit                                                               |           | 30,000      
|Long term debt                                                               |           | 75,932      
|Other liabilities                                                            |           | 126,252     
|                                                                             |           |             
|Total liabilities                                                            |           | 1,838,845   
|Commitments and contingencies: See Note B                                    |          
|Stockholders' equity:                                                        |          
|Preferred stock, $.01 par value, 5,000,000 shares authorized, issued:        |          
|2004 - 0 and 2003 - 0                                                        |           | --          
|Common stock, $.01 par value, 100,000,000 shares authorized,  issued:        |          
|2004 - 38,547,740 and 2003 - 38,545,788                                      |           | 385         
|Additional paid-in capital                                                   |           | 246,302     
|Accumulated other comprehensive income, (net of  tax expense                 |          
|of $8,603 and $6,451 in 2004 and 2003, respectively)                         |           | 15,978      
|Accumulated deficit                                                          |           | (113,881    
|Treasury stock (2,479,977 shares at cost at March 31, 2004 and               |          
|2,479,977 at December 31, 2003)                                              |           | (18,263     
|Unearned stock                                                               |           | (5,922      
|                                                                             |           |             
|Total stockholders' equity                                                   |           | 124,599     
|                                                                             |           |             
|Total liabilities and stockholders' equity                                   |           | $1,963,444  
|                                                                             |           |             

See accompanying Notes to Consolidated Financial Statements

1

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##### Vesta Insurance Group, Inc.
Consolidated Statements of Operations and Comprehensive Income (Loss)
Statements of Operations
(amounts in thousands, except per share data)

|                                                                   | Three months ended March 31,
|------------------------------------------------------------------ | ----------------------------
|
|
|Revenues:                                                          |                             
|Net premiums written                                               |                             
|Change in unearned premiums                                        |                             
|                                                                   |                             
|Net premiums earned                                                |                             
|Policy fees                                                        |                             
|Agency fees and commissions                                        |                             
|Net investment income                                              |                             
|Realized gains                                                     |                             
|Other                                                              |                             
|                                                                   |                             
|Total revenues                                                     |                             
|Expenses:                                                          |                             
|Policyholder benefits                                              |                             
|Losses and loss adjustment expenses incurred                       |                             
|Policy acquisition expenses                                        |                             
|Operating expenses                                                 |                             
|Interest on debt                                                   |                             
|Deferrable capital distributions                                   |                             
|                                                                   |                             
|Total expenses                                                     |                             
|                                                                   |                             
|Income from continuing operations before income taxes, minority    |                             
|interest and deferrable capital securities distributions           |                             
|Income tax expense                                                 |                             
|Minority interest, net of tax                                      |                             
|Deferrable capital security distributions, net of tax              |                             
|                                                                   |                             
|Income from continuing operations                                  |                             
|Loss from discontinued operations, net of tax                      |                             
|                                                                   |                             
|Income  before cumulative effect of change in accounting principle |                             
|Cumulative effect of change in accounting principle, net of tax    |                             
|                                                                   |                             
|Net income                                                         |                             
|                                                                   |                             
|Income from continuing operations per share - Basic                |                             
|                                                                   |                             
|Net income per share - Basic                                       |                             
|                                                                   |                             
|Income from continuing operations per share - Diluted              |                             
|                                                                   |                             
|Net income available to common shareholders per share - Diluted    |                             
|                                                                   |                             

See accompanying Notes to Consolidated Financial Statements

2

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##### Vesta Insurance Group, Inc.
Consolidated Statement of Cash Flows
(amounts in thousands)

|                                                                             | Three months ended March 31,
|---------------------------------------------------------------------------- | ----------------------------
|
|
|Operating Activities:                                                        |                             
|Net income                                                                   |                             
|Adjustments to reconcile net income to cash provided by (used in) operations |                             
|Changes in:                                                                  |                             
|Loss and LAE reserves, and future policy liabilities                         |                             
|Unearned premium reserves                                                    |                             
|Reinsurance balances receivable                                              |                             
|Premiums in course of collection                                             |                             
|Reinsurance recoverable on paid losses                                       |                             
|Reinsurance balances payable                                                 |                             
|Other assets and liabilities                                                 |                             
|Policy acquisition costs deferred                                            |                             
|Policy acquisition costs amortized                                           |                             
|Realized gains                                                               |                             
|Sale of fixed maturities trading                                             |                             
|Purchases of fixed maturities trading                                        |                             
|Amortization and depreciation                                                |                             
|                                                                             |                             
|Net cash provided by (used in) operations                                    |                             
|Investing Activities:                                                        |                             
|Investments sold:                                                            |                             
|Fixed maturities available for sale                                          |                             
|Equity securities                                                            |                             
|Investments acquired:                                                        |                             
|Fixed maturities available for sale                                          |                             
|Equity securities                                                            |                             
|Maturities, paydowns, calls and other                                        |                             
|Fixed maturities available for sale                                          |                             
|Net decrease in other invested assets                                        |                             
|Net cash paid for acquisitions                                               |                             
|Net increase in short-term investments                                       |                             
|Assets held for sale                                                         |                             
|Additions to property and equipment                                          |                             
|Disposal of property and equipment                                           |                             
|                                                                             |                             
|Net cash used in investing activities                                        |                             
|Financing Activities:                                                        |                             
|Net change in FHLB borrowings                                                |                             
|Change in long and short-term debt                                           |                             
|Repayment of acquisition contingent consideration                            |                             
|Net withdrawals (deposits) from insurance liabilities                        |                             
|Dividends paid                                                               |                             
|                                                                             |                             
|Net cash provided by (used) in financing activities                          |                             
|(Decrease) increase in cash                                                  |                             
|Cash at beginning of period                                                  |                             
|                                                                             |                             
|Cash at end of period                                                        |                             
|                                                                             |                             

See accompanying Notes to Consolidated Financial Statements

3

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##### Vesta Insurance Group, Inc.
Notes to Consolidated Financial Statements
(amounts in thousands except per share amounts)

Note A-Significant Accounting Policies

Basis of Presentation:  The accompanying  unaudited interim consolidated  financial statements of Vesta Insurance Group, Inc. (the
Company") have been prepared in conformity with accounting  principles  generally accepted in the United States of America for interim
financial  information and with the  instructions of Form 10-Q and Article 10 of Regulation S-X. These financial  statements  should be
read in conjunction  with the consolidated  financial  statements and the notes thereto included in the Company's Annual Report on Form
10-K for the year ended  December  31,  2003.  Accordingly,  they do not  include  all of the  information  and  footnotes  required by
accounting  principles  generally  accepted  in the United  States of America  for  complete  financial  statements.  In the opinion of
management,  all adjustments (consisting of normal recurring accruals and other adjustments,  such as impairments) considered necessary
for a fair  presentation  have been  included.  The results of  operations  and cash flows for any interim  period are not  necessarily
indicative of results for the full year.

Reclassifications:  Certain  amounts  in the  financial  statements  presented  have been  reclassified  from  amounts  previously
reported in order to be  comparable  between  periods.  These  reclassifications  have no effect on previously  reported  stockholders'
equity or net income during the periods presented.

New Accounting  Standards:  In January 2003, the FASB issued FIN 46 "Consolidation  of Variable Interest  Entities" ("FIN 46"). In
December 2003, the FASB issued FIN 46-R,  which replaces FIN 46. FIN 46-R  clarifies the  application of Accounting  Research  Bulletin
No. 51,  "Consolidated  Financial  Statements,"  to certain  entities in which equity  investors do not have the  characteristics  of a
controlling  financial  interest or do not have sufficient equity at risk for the entity to finance its activities  without  additional
subordinated  support form other  parties.  The  effective  date of FIN 46-R is March 31, 2004.  However,  FIN 46-R was  applicable  to
entities  that are  considered  special-purpose  entities as of December 31,  2003.  The  application  of FIN 46-R had no effect on our
consolidated  financial  statements  as  of  December  31,  2003.  The  provisions  of  FIN  46-R  on  entities  not  considered  to be
special-purpose  entities  was  adopted  as of March 31,  2004 and did not  impact  the  Company's  financial  position  or  results of
operations.

On October 1, 2003,  the  Company  adopted  Derivatives  Implementation  Group Issue No.  B-36,  "Embedded  Derivatives:  Modified
Coinsurance  Arrangements and Debt Instruments That Incorporate  Credit Risk Exposures That Are Unrelated or Only Partially  Related to
the  Creditworthiness  of the Obligor under Those Instruments" ("DIG B-36"). DIG B-36 requires the bifurcation of embedded  derivatives
within certain modified  coinsurance and funds withheld  coinsurance  arrangements that expose the creditor to credit risk of a company
other than the debtor,  even if the debtor owns as invested  assets the  third-party  securities  to which the creditor is exposed.  In
connection with the adoption of DIG B-36, the Company elected to reclassify to trading  securities the  investments,  which are held in
a separate trust,  supporting a funds withheld treaty.  In addition,  the Company  recognized in the fourth quarter of 2003 a loss from
the  cumulative  effect from the  adoption of DIG B-36 of $1.2  million,  net of tax, in  connection  with  recording  the  derivatives
embedded in its modified coinsurance and funds withheld coinsurance arrangements.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial  Instruments with Characteristics of both Liabilities
and Equity"  ("SFAS No.  150").  SFAS No. 150  establishes  how an issuer  classifies  and  measures  certain free  standing  financial
instruments  with  characteristics  of both  liabilities  and equity and requires that such  instruments be classified as  liabilities.
SFAS No. 150 is effective  for financial  instruments  entered into or modified  after May 31, 2003,  and otherwise is effective at the
beginning  of the first  interim  period  beginning  after  June 15,  2003 for those  existing  financial  instruments  subject  to the
provisions  of SFAS No. 150.  The Company has not entered  into any  financial  instruments  within the scope of SFAS No. 150 since May
31, 2003. The Company's  Deferrable  Capital  Securities are subject to the provisions of SFAS No. 150.  Accordingly,  the  outstanding
balance of the  Company's  Deferrable  Capital  Securities  of $20.3  million as of March 31, 2004 is reflected as a component of total
liabilities from the previous "mezzanine" debt classification.  Furthermore,  Deferrable Capital Security distributions of $0.4 millionfor the three months ended March 31, 2004 are reflected as a component of income from continuing  operations in our  consolidated  2004
statement of operations.  The classification of Deferrable  Capital  Securities and Deferrable  Capital Security  distributions for the
prior period remains unchanged, pursuant to the provisions of SFAS No. 150.

In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1,  "Accounting and Reporting
by Insurance  Enterprises  for Certain  Nontraditional  Long-Duration  Contracts  and for Separate  Accounts"  ("SOP  03-1").  SOP 03-1
provides  guidance on the reporting  method and presentation of separate  accounts,  recognition of gains and losses on the transfer of
assets  from the general  account to a separate  account,  as well as several  liability  valuation  issues  related to  nontraditional
long-duration  contracts such as universal  life and annuity  contracts.  The  provisions of SOP 03-1 became  effective for the Company
on January 1,  2004.  In  applying  the  provisions  of SOP 03-1 to our life  insurance  products  offered  through  American  Founders
Financial Corporation  ("American  Founders"),  the holding company for our life insurance  operations,  we changed our methodology for
accruing  reserves on our single premium  deferred  annuity  product to accrue reserves at the enhanced fund rate as defined within the
annuity contracts.  As a result of this change in methodology,  we recorded a loss of $5.2 million,  net of tax of $2.8 million,  which
is classified as a cumulative effect of change in accounting principle on the accompanying  consolidated  statement of operations.  The
recording of this loss reduced both basic and diluted net income per share by $0.15 for the three months ended March 31, 2004.

Restricted  Assets:  As part of a modified  coinsurance  agreement with ERC Life Reinsurance  Corporation  ("ERC Life"),  American
Founders is holding  $162.6  million of assets,  at March 31, 2004,  for the benefit of ERC Life,  all of which is  classified as fixed
maturities - trading on the accompanying  consolidated balance sheet.  Additionally,  we have pledged investments having a market value
of $182.6 million to the Federal Home Loan Bank.

Income per Share: Basic EPS is computed by dividing income available to common  shareholders by the weighted average common shares
outstanding  for the period.  Diluted EPS is  calculated  by adding to shares  outstanding  the  additional  net effect of  potentially
dilutive  securities or contracts  which could be exercised or converted  into common shares  except when the  additional  shares would
produce anti-dilutive results.

4

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The reconciliation of net income and average shares outstanding for the three months ending March 31, 2004 and 2003 is as follows:

|                                            | Three months ended March 31,
|------------------------------------------- | ----------------------------
|
|Net income                                  |                             
|                                            |                             
|Weighted average shares outstanding-basic   |                             
|Stock options and restricted stock          |                             
|                                            |                             
|Weighted average shares outstanding-diluted |                             
|                                            |                             

For the three months ended March 31, 2004,  options to purchase 683 thousand  shares of common stock was excluded from the  calculation
of the diluted weighted average shares outstanding since they were anti-dilutive.

Earnings per share for discontinued operations for the three months ended March 31, 2004 and 2003 are as follows:

|                            | 2004 | 2003
|--------------------------- | ---- | ----
|Basic Earnings per share:   |      |     
|Discontinued Operations     |      | $(0 
|Diluted Earnings Per Share: |     
|Discontinued Operations     |      | $(0 

Stock-Based  Compensation:  In December 2002, the FASB issued SFAS No. 148,  "Accounting for Stock-Based  Compensation - Transition and
Disclosure"  ("SFAS  No  148").  This  statement  became  effective  in 2003 and  amends  SFAS No.  123,  "Accounting  for  Stock-Based
Compensation"  ("SFAS No. 123"), by providing  alternative  methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee  compensation.  In addition,  SFAS No. 148 requires additional disclosures related to the effect
of stock-based  compensation on reported  results.  As allowed by SFAS No. 123 and SFAS No. 148, the Company has elected to continue to
apply the  intrinsic-value-based  method of accounting for stock-based compensation and has adopted only the disclosure requirements of
SFAS No. 123. The following table  illustrates the effect on net income (loss) if the  fair-value-based  method had been applied to all
outstanding and unvested awards for the three months ended March 31, 2004 and 2003 (in thousands).

|                                                                   | 2004 | 2003  
|------------------------------------------------------------------ | ---- | ------
|Net income as reported                                             |      | $8,784
|Add: Stock-based employee compensation expense included            |     
|in net income, net of tax                                          |      | 222   
|Deduct: Total stock-based employee compensation expense determined |     
|under fair-value-based method for all awards, net of tax           |      | (449  
|                                                                   |      |       
|Pro forma net income                                               |      | $8,557
|                                                                   |      |       
|Net income per share - basic                                       |     
|As reported                                                        |      | $0    
|Pro forma                                                          |      | $0    
|Net income per share - diluted                                     |     
|As reported                                                        |      | $0    
|Pro forma                                                          |      | $0    

5

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Comprehensive Income:  Comprehensive income for the three months ended March 31, 2004 and 2003 is as follows (in thousands):

|                                          | 2004 | 2003   
|----------------------------------------- | ---- | -------
|Net income                                |      | $8,784 
|Net change in unrealized gain, net of tax |      | 3,995  
|                                          |      |        
|Total comprehensive income                |      | $12,779
|                                          |      |        

Note B-Commitments and Contingencies

Life insurance related lawsuits

Our subsidiary,  American Founders, is a defendant in a lawsuit brought by a judgment creditor of IFS Holdings, Inc. - the former
holder of American  Founders'  series A and C preferred  stock - alleging  that  American  Founders  redeemed its Series A and Series C
preferred stock from IFS Holdings,  Inc. for less than "reasonably equivalent value," and, therefore,  engaged in a voidable fraudulent
transfer.  American  Founders  believes (i) that the redemption  transaction  was for reasonably  equivalent  value;  and (ii) that the
allegations  brought  against it in this lawsuit are without  merit.  Due to IFS's  bankruptcy  in 2001,  the real party in interest to
pursue this claim is the bankruptcy  trustee  administering  IFS' estate in bankruptcy.  Since assuming this position,  the trustee has
not pursued any discovery or otherwise  attempted to resolve this case. In the opinion of management,  resolution of the lawsuit is not
expected to have a material adverse effect on our financial  position.  However,  depending upon the amount and timing,  an unfavorable
resolution  of this matter  could  materially  affect  American  Founders'  future  operations  or cash flows in a  particular  period.
Furthermore,  Vesta will remain liable to any adverse  results from this lawsuit  regardless of the outcome of the pending  divestiture
of American Founders.

Health insurance related lawsuits

Vesta and two  former  officers  of Vesta are  defendants  in a lawsuit  styled  James H.  Cashion,  Jr.  d/b/a  American  Health
Underwriters v. Vesta Insurance Group,  Inc., et al. Plaintiff,  a former general agent of our subsidiary States General Life Insurance
Company,  which we purchased in 2001 and disposed of in 2003,  alleges that the defendants engaged in an actionable civil conspiracy to
tortiously  interfere with his agency  contracts.  The civil conspiracy  claim is premised,  in part, on certain payments made to these
two former officers of Vesta by another agent who replaced Mr.  Cashion.  The plaintiff is seeking actual and punitive  damages.  Vesta
denies  tortiously  interfering  with  plaintiff's  agency  contract,  believes the claims  asserted  against it have no merit,  and is
vigorously  defending this lawsuit.  The trial court recently denied the defendant's  motion to compel  arbitration,  which decision is
currently on appeal to the Texas  Supreme  Court.  Discovery  has been stayed  pending  resolution  of this  appeal.  In the opinion of
management, resolution of this lawsuit is not expected to have a material adverse effect on our financial position.

Indemnification Agreements and Liability Insurance

Pursuant to Delaware  law and our  by-laws,  we are  obligated to indemnify  our current and former  officers and  directors  for
certain  liabilities  arising from their  employment  with or services to Vesta,  provided  that their  conduct  complied  with certain
requirements.  Pursuant to these  obligations,  we have been advancing costs of defense and other expenses on behalf of certain current
and former officers and directors,  subject to an undertaking  from such individuals to repay any amounts advanced in the event a court
determines  that they are not entitled to  indemnification.  During the three months  ended March 31,  2004,  funding of such  expenses
was approximately $7 thousand.

Reinsurance Arbitration/Litigation

As discussed in previous SEC filings,  in 1998 we corrected our accounting for assumed  reinsurance  business through restatement
of our previously  issued  financial  statements.  Similar  corrections  were made on a statutory  accounting  basis through  recording
cumulative  adjustments  in Vesta Fire's 1997  statutory  financial  statements.  The impact of this  correction  has been reflected in
amounts  ceded under our 20 percent whole account quota share  treaty,  which was  terminated on June 30, 1998 on a run-off  basis.  We
believed such treatment was appropriate under the terms of this treaty and calculated the quarterly  reinsurance  billings presented to
the three treaty participants accordingly.

NRMA Insurance Limited ("NRMA"),  one of the participants in the 20 percent whole account quota share treaty,  filed a lawsuit in
the United States District Court for the Northern District of Alabama contesting our billings.

NRMA sought  rescission  of the treaty and a temporary  restraining  order  preventing us from drawing down  approximately  $34.5
million of collateral.  We filed a demand for  arbitration as provided for in the treaty and also filed a motion to compel  arbitration
which was granted in the United  States  District  Court action.  Vesta reached an agreement  with NRMA to collect the $34.5 million of
collateral  in exchange  for posting a $25 million  letter of credit in favor of NRMA to provide  collateral  for any amounts  NRMA may
recover as a result of the  arbitration.  Pursuant to an order of the NRMA  arbitration  panel Vesta posted an additional  $4.8 million
letter of credit in October,  2003 in favor of NRMA. We also filed for arbitration  against Alfa Mutual Insurance  Company ("Alfa") and
Dorinco Reinsurance Company ("Dorinco"), the other two participants on the treaty.

On March 1, 2004 the NRMA panel ruled in favor of NRMA and as a result, the Company incurred a charge of $33.5 million to its 2003
fourth quarter earnings. While the NRMA ruling does not set a binding precedent regarding Vesta's other arbitrations and while there
are distinct facts and circumstances underlying and affecting our disputes with the other participants, for financial reporting
purposes, the Company incurred a charge to its recoverable from the other treaty participants of $30.1 million in the fourth quarter
of 2003. On March 4, 2004, Vesta filed a motion to vacate this arbitration award in the United

6

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States  District  Court for the  Northern  District of Alabama,  Southern  Division.  The grounds for this motion are the evident
partiality of the neutral  umpire.  On May 5, 2004, the court issued an order granting  Vesta's  request for limited  discovery and set
an evidentiary hearing on Vesta's motion to vacate the arbitration  award for August 25, 2004.

The hearing on the merits of the  arbitration  with Alfa was scheduled  for May,  2003,  however on April 21, 2003,  Alfa filed a
lawsuit  against Vesta Fire in the state court in Montgomery,  Alabama seeking a declaration  from the court on certain  procedural and
organizational  matters and requesting that the court stay the arbitration  proceedings  during the pendency of the litigation in state
court in  Alabama.  On April 24,  2003,  the court  issued a  temporary  restraining  order  staying the  proceedings  in the  on-going
arbitration in order to maintain the status quo until the merits of Alfa's  petition could be heard and  determined.  After the hearing
in the Circuit Court of  Montgomery  County on December 8 and 9, 2003,  the court decided the  procedural  and  organizational  matters
partially in favor of the Company and partially for Alfa. The hearing has been  rescheduled  for the weeks of March 7th and March 14th,
2005.

The hearing in the Dorinco arbitration was previously  scheduled for the two weeks of March 8 through March 12, and April 26 thru
April 30, 2004.  Recently,  those hearing  dates were  adjourned and the new hearing dates are scheduled for the weeks of April 4th and
April 11th, 2005.

Muhl vs. Vesta is a case pending in the supreme Court of the State of New York, County of New York,  brought by the Liquidator of
Midland Insurance Company  ("Midland"),  claiming  recoveries under two alleged  retrocession  agreements (Pool I and Pool III) between
Midland and Interstate Fire Insurance Company, Vesta's predecessor in interest.

Third party auditors hired by Vesta have  identified  coverage  issues that cast doubt on the validity of a number of claims.  In
addition,  there is no actual  retrocessional  agreement that evidences the terms and conditions of Pool III which involves 60% or more
of the incurred  losses at issue.  Although  there are other  tangential  documents that the Liquidator may attempt to rely on to prove
liability  under Pool III, we believe  that the  Liquidator  will not be able to  establish  liability  for any portion of the Pool III
claims.  We also believe that a number of the losses allegedly  incurred in connection with Pool I may be avoided on specific  coverage
grounds.  We are defending this matter vigorously and are reasonably  optimistic  regarding the ultimate  outcome,  although an adverse
ruling in this case could have a material effect on our financial condition.  This case is currently set for trial in September 2004.

Vesta vs. New Cap Re is an arbitration  against an Australian  reinsurer,  to collect  reinsurance  recoverables  pursuant to two
accident year excess of loss ratio reinsurance agreements.  In the arbitration,  New Cap Re challenged Vesta's earlier draw on a Letter
of Credit for $7.5 million which was held in connection  with one of the two contracts.  Shortly after the arbitration  commenced,  New
Cap Re became the subject of insolvency  proceedings  in Australia  and an ancillary  proceeding  in the U.S.  Bankruptcy  Court in New
York.  The  Bankruptcy  Court stayed all pending  litigation  and  arbitration  against New Cap Re, and we appealed  that ruling to the
Southern  District of New York,  and  ultimately  to the U.S.  Court of Appeals for the Second  Circuit,  which  recently  affirmed the
Bankruptcy  Court's stay of the  arbitration  against New Cap Re. Hence,  our efforts to recover losses as well as New Cap Re's efforts
to  challenge  the  earlier  draw on the $7.5  million  Letter of Credit by us are stayed and the  company's  options may be limited to
seeking adjudication of the dispute in Australia.

On September 5, 2002,  New Cap Re served us with an  Application  pursuant to Section 588FF of the  Australian  Corporations  Act
seeking  an order  directing  us to pay New Cap Re and its  liquidator  $1.0  million  that  Vesta  allegedly  received  as an  "unfair
preference" and/or arising out of an "uncommercial  transaction," as those terms are defined by the Corporations Act. We filed a Notice
of Appearance on October 31, 2002. The  liquidator  filed a Statement of Claim on August 13, 2003, and the Company filed its defense on
December 18, 2003.  Discovery has not commenced.  While  management  intends to vigorously  defend this matter,  given the  preliminary
nature of these proceedings, it is too early to evaluate the likelihood of success.

Other

Vesta, through its subsidiaries,  is routinely a party to pending or threatened legal proceedings and arbitration relating to the
regular conduct of its insurance  business.  These  proceedings  involve alleged breaches of contract,  torts,  including bad faith and
fraud claims and miscellaneous  other specified relief.  Based upon information  presently  available,  and in light of legal and other
defenses  available to Vesta and its  subsidiaries,  management does not consider  liability from any threatened or pending  litigation
regarding routine matters to be material.

Credit Facilities

Effective  February 1, 2003, we entered a $30 million  revolving  credit  arrangement  with First  Commercial Bank of Birmingham,
Alabama ("First  Commercial"),  collateralized by a pledge of 358,375 shares of our holding company's  ownership in the common stock of
Affirmative Insurance Holdings,  Inc. representing  approximately 40.6% of Affirmative's issued and outstanding shares of capital stock
as of March 31,  2004.  The new  facility  bears  interest at First  Commercial's  prime rate and will mature no earlier  than June 30,
2005.  As of March 31, 2004, we had drawn the entire $30 million available under this Agreement.

This credit agreement contains covenants which require us to maintain (i) consolidated GAAP net income (excluding  realized gains
and losses) of at least $15 million for any calendar year, (ii)  consolidated  debt to capital ratio of no more than 39%, measured on a
quarterly basis, (iii) an A.M. Best rating of "B" or better,  measured continuously,  (iv) consolidated GAAP net worth of at least $208
million,  measured  quarterly,  (v) an interest  coverage  ratio of not less than 1.5 to 1 for any  calendar  year and (vi)  risk-based
capital of not less than 150% of the NAIC's authorized control level, measured  continuously.  As of March 31, 2004, the Company was in
non-compliance  with its consolidated  debt to capital ratio and GAAP net worth covenants.  First Commercial has waived compliance with
these covenants through December 31, 2004.

Although  management  does not  anticipate  an event of default in 2004 with  respect to  covenants  not already  waived by First
Commercial,  there can be no assurance  that we will remain in  compliance  with these  covenants in the future.  Furthermore,  current
dividend  levels from Vesta Fire and J. Gordon  Gaines would not be  sufficient to repay the  anticipated  outstanding  balance of this
credit facility were we to violate a covenant without seeking prior approval.  Although  management  believes the Company would be able
to secure  waivers on any future  covenant  violations,  the failure to obtain such waivers of the  potential  covenant  violations  or
refinance the credit  facility on similar terms could have a material  adverse  impact on our financial  condition.  The failure of the
Company to secure  refinancing of the credit  facility would force the Company to secure other forms of financing as current  operating
cash flows would not be sufficient to cover the contractually  required debt service  requirements.  The Company's  inability to secure
other financing to refinance the credit  facility would have a material  adverse impact on the Company.  Additionally,  refinancing the
Credit Facility with other financing at higher interest rates could negatively impact the Company's financial performance.

7

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Note C-Segment Information

We report  financial  results  according to five business  segments,  which are  distinguished  by their product  offerings or
business  activities.  The accounting policies of the operating segments are described in Note A in the Company's Annual Report on Form
10-K for the year-ended  December 31, 2003. Segment pre-tax income is income from continuing  operations before income taxes,  minority
interest and deferrable capital securities  distributions.  Premiums,  policy fees, other income, loss and benefit expenses,  operating
expenses and policy  acquisition  expenses are  attributed  directly to each  operating  segment.  Net  investment  income and interest
expense are allocated only to those  segments for which such amounts are considered an integral part of the financial  results for that
segment.

A brief description of each segment is as follows:

Standard property-casualty segment

The standard  property-casualty  segment consists of two principal lines of business:  (1) underwriting only residential  property
insurance in capacity  constrained states; and (2) underwriting  residential  property and automobile  insurance in states where we can
profitably offer both products through independent agents.  Vesta's insurance products are distributed  primarily through approximately
2,525 independent agencies in 16 states. Our residential  property lines target families (1) with multiple insurance policies;  (2) who
own more than one  automobile;  and (3) who live in a home valued  between  $100,000  and  $350,000.  Our standard  personal  auto line
targets drivers over age thirty-five with above average driving records.

Non-standard agency segment

Our  non-standard  agency  segment does not engage in  underwriting  activities.  The primary  focus of our agency  segment is the
distribution of non-standard auto insurance  products for various retail and wholesale  insurance  carriers in exchange for commissions
and fees. Our non-standard  insurance  policies,  which generally are issued for the minimum limits of liability  coverage  mandated by
state laws,  provide  coverage to drivers who find it difficult to obtain insurance from standard  insurance  companies due to a number
of factors, including lack of prior coverage, failure to maintain continuous coverage, age, prior accidents,  driving violations,  type
of vehicle or limited financial resources.  Typically,  non-standard auto insurance customers are considered  higher-risk than standard
customers, and premiums for non-standard insurance are generally more expensive.

Non-standard underwriting segment

Our non-standard  insurance  policies,  which generally are issued for the minimum limits of liability  coverage mandated by state
laws,  provide  coverage to drivers who find it difficult to obtain  insurance  from  standard  insurance  companies due to a number of
factors, including lack of prior coverage, failure to maintain continuous coverage, age, prior accidents,  driving violations,  type of
vehicle or limited financial  resources.  Most of the non-standard  policies issued by our insurance  companies are administered by our
affiliated underwriting agencies,  which perform or supervise all of the administrative  functions associated with the design, sale and
subsequent  servicing of a non-standard  personal  automobile  insurance policy. Our insurance  companies also issue insurance policies
that are administered by unaffiliated  underwriting  agencies with  established  customer bases in order to capture business in markets
other than those targeted by our affiliated  underwriting  agencies. In these instances,  we collect fees to compensate us both for the
use of our  certificates  of authority  to transact  insurance  business in selected  markets as well as for assuming the risk that the
unaffiliated  underwriting  agency will  continuously  and  effectively  administer  these  policies.  We  generally  reinsure a higher
percentage of this business relative to the business administered by our affiliated underwriting agencies.

Life insurance segment

We provide a variety of life insurance  products through American Founders Financial  Corporation,  a holding company for two life
insurance  companies  domiciled  in Texas.  In 2000,  we  purchased a 72%  interest in American  Founders.  On February  18,  2003,  we
purchased the remaining shares held by minority holders and now own 100% of American  Founders.  At March 31, 2004,  American  Founders
had in force  approximately  $2.0  billion  (face value) of life and annuity  products.  American  Founders  markets  traditional  life
products,  universal life products,  fixed-rate  annuities,  pension contracts and related products through  independent agents located
throughout the U.S.

Corporate and other segment

Our corporate and other segment  consists  primarily of (1)  investment  income and realized  gains/losses  earned on  investments
associated  with our standard  property-casualty  and  non-standard  auto segments;  (2) interest  expenses  associated  with all debt,
excluding debt for certain  non-standard  agency  acquisitions and our life insurance  segment;  and (3) overhead expenses not directly
associated with any other business segment.

8

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A summary of segment results for the three months ended March 31, 2004 and 2003 is as follows (in thousands):

|2004                                             |  |          |  |          |  |          | 
|------------------------------------------------ |  | -------- |  | -------- |  | -------- | 
|
|Revenues:                                        |  |          |  |          |  |          | 
|Premiums earned                                  |  | $60,487  |  | $2,300   |  | $47,208  | 
|Agency fees and commissions                      |  | --       |  | --       |  | --       | 
|Net investment income                            |  | --       |  | 7,137    |  | --       | 
|Policy fees                                      |  | 2,247    |  | 622      |  | 6,067    | 
|Realized gains (losses)                          |  | --       |  | 454      |  | --       | 
|Other                                            |  | 227      |  | 433      |  | 369      | 
|                                                 |  |          |  |          |  |          | 
|Total revenues                                   |  | 62,961   |  | 10,946   |  | 53,644   | 
|Expenses:                                        | 
|Loss, LAE and policyholder benefits              |  | 41,565   |  | 6,112    |  | 31,296   | 
|Policy acquisition costs                         |  | 3,617    |  | 210      |  | 13,560   | 
|Operating expenses                               |  | 11,064   |  | 2,159    |  | 5,826    | 
|Interest on debt                                 |  | --       |  | 1,301    |  | --       | 
|Deferrable Capital Security distributions        |  | --       |  | --       |  | --       | 
|                                                 |  |          |  |          |  |          | 
|Total expenses                                   |  | 56,246   |  | 9,782    |  | 50,682   | 
|                                                 |  |          |  |          |  |          | 
|Pre-tax income (loss) from continuing operations |  | $6,715   |  | $1,164   |  | $2,962   | 
|                                                 |  |          |  |          |  |          | 
|Operating segment assets:                        | 
|Investments and other assets                     |  | $373,695 |  | $838,232 |  | $179,922 | 
|Deferred acquisition costs                       |  | 16,382   |  | 21,012   |  | 11,039   | 
|Goodwill and other intangibles                   |  | 59,322   |  | 10,760   |  |          | 
|                                                 |  |          |  |          |  |          | 
|                                                 |  | $449,399 |  | $870,004 |  | $190,961 | 
|                                                 |  |          |  |          |  |          | 

|2003                                  |  |          |   |          |   |          | 
|------------------------------------- |  | -------- | - | -------- | - | -------- | 
|
|Revenues:                             |  |          |   |          |   |          | 
|Premiums earned                       |  | $76,412  |   | $2,410   |   | $38,671  | 
|Agency fees and commissions           |  | --       |   | --       |   | --       | 
|Net investment income                 |  | --       |   | 7,695    |   | --       | 
|Policy fees                           |  | 2,062    |   | 493      |   | 5,083    | 
|Realized gains (losses)               |  | --       |   | (8       | ) | --       | 
|Other                                 |  | 242      |   | 642      |   | 912      | 
|                                      |  |          |   |          |   |          | 
|Total revenues                        |  | 78,716   |   | 11,232   |   | 44,666   | 
|Expenses:                             | 
|Loss, LAE and policyholder benefits   |  | 52,994   |   | 5,090    |   | 26,512   | 
|Policy acquisition costs              |  | 18,628   |   | 369      |   | 10,788   | 
|Operating expenses                    |  | 11,005   |   | 2,452    |   | 4,352    | 
|Interest on debt                      |  | --       |   | 1,453    |   | --       | 
|                                      |  |          |   |          |   |          | 
|Total expenses                        |  | 82,627   |   | 9,364    |   | 41,652   | 
|                                      |  |          |   |          |   |          | 
|Pre-tax income (loss) from continuing | 
|operations                            |  | $(3,911  | ) | $1,868   |   | $3,014   | 
|                                      |  |          |   |          |   |          | 
|Operating segment assets:             | 
|Investments and other assets          |  | $355,748 |   | $887,696 |   | $154,601 | 
|Deferred acquisition costs            |  | 42,203   |   | 19,256   |   | 12,843   | 
|Goodwill and other intangibles        |  | 56,206   |   | 10,760   |   | --       | 
|                                      |  |          |   |          |   |          | 
|                                      |  | $454,157 |   | $917,712 |   | $167,444 | 
|                                      |  |          |   |          |   |          | 

Note D-Stock & Debt Transactions

During the 4th quarter of 2003,  we  redeemed  $2.2  million  face  amount of  Deferrable  Capital  Securities  in  exchange  for
approximately 402 thousand shares of common stock resulting in a gain of $.6 million.

9

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Note E-Acquisitions and Dispositions

The Company executed a definitive agreement on March 12, 2004 to sell American Founders Financial Corporation ("AFFC"), our life
insurance subsidiary, for a total purchase price of approximately $63.5 million, consisting of $25 million in cash at closing and a
promissory note in the amount of approximately $38.5 million.  The note will bear a floating interest rate of LIBOR plus 200 basis
points and will be repaid over a six-year term, with the interest payments only in the first year and the principal repayments in
five equal annual payments thereafter.  The note will be collateralized by a pledge of the stock of both AFFC and all capital stock
and surplus debentures issued by AFFC's immediate subsidiary, Laurel Life Insurance Company, which owns 100% of the capital stock of
American Founders Life Insurance Company.  The divestiture of AFFC will not result in a significant impact to our GAAP equity, but
will have a significant positive impact on our statutory surplus.  We anticipate an increase in statutory surplus of approximately
$19.5 million upon the closing of this transaction.  Although we have executed a definitive agreement, the consummation of this
transaction is subject to regulatory approval from various state departments of insurance and other factors. Such approval is beyond
our control and no assurance can be given that this transaction will receive the required regulatory approval.

Effective September 30, 2003, we consummated a stock purchase agreement for the sale of all common stock of our health insurance
operations, which included Aegis Financial Corporation (Aegis) and its subsidiary States General Life Insurance Company (States
General) for $4.6 million.  The sales price was financed through a $5.0 million note issued by the buyer payable toVesta Fire.  The
note bears interest at a fixed rate of 6%, with interest payments due semi-annually and principal due in September 2006.   The note
is secured by the common stock of Aegis.   The results of Aegis have been reclassified to discontinued operations for all periods
presented.

During the second  quarter of 2003, the  Affirmative  Insurance  Holdings,  Inc.  acquired the 20% minority  interest in InsureOne
Independent Agency, LLC for $10.3 million.  The transaction has been accounted for as a purchase.

In the second quarter of 2003, the Company settled certain contingent consideration provisions related to prior period
standard property-casualty acquisitions.  The result of the settlement of the contingent consideration provisions was an increase of
goodwill of $3.2 million.

In February 2003, we completed the  acquisition of the  approximate  27% remaining  ownership from the minority owners of American
Founders  Financial  Corporation.  The purchase price for this acquisition was $12.9 million,  which approximated the recorded minority
interest balance.

Note F-Discontinued Operations

In the fourth quarter of 2002, we made the decision to exit the health  insurance and  consulting  business lines and disposed of
these segments in 2003.  Accordingly,  our health insurance and consulting lines results for the three months ended March 31, 2003 have
been  classified in our financial  statements as part of  discontinued  operations.  Due to the disposal of these segments in 2003, our
financial  statements  as of and for the three months ended March 31, 2004 were not impacted  from our previous  health  insurance  and
consulting business lines.

In 2000 and 1999, we exited the reinsurance  assumed and commercial lines businesses,  respectively.  As a result,  the reporting
for these  business  lines is included in  discontinued  operations  in our financial  statements.  At the time we made the decision to
exit each of these  business  lines,  we estimated the reserves  required to fulfill our expected  future  obligations  with respect to
these  discontinued  operations.  However,  we continue to monitor our recorded  estimates  with respect to ultimate  settlement  on an
ongoing basis.

For the three months ended March 31, 2004, we recorded a loss for reinsurance assumed and commercial lines businesses of $0.9
million.  These losses are primarily related to costs associated with commuting certain reinsurance treaties, partially offset by
recoveries on other treaties.

Based upon available  information,  we believe the recorded reserves for discontinued  operations at March 31, 2004 are adequate.
However,  we will continue to monitor these  reserves and their related  claims  activity and  experience.  Further  adjustments to our
estimates could be necessary as we continue to run off the remaining outstanding claims.

Note G - Income Taxes

Deferred income taxes are provided for temporary differences between amounts of assets and liabilities for financial
reporting purposes and the basis of such assets and liabilities as measured by tax laws and regulations, as well as net operating
losses, tax credits and other carryforwards. SFAS No. 109, "Accounting for Income Taxes", requires that deferred tax assets be
reduced by a valuation allowance if, based on available evidence, it is more likely than not that all of the recorded deferred tax
assets will not be realized in future periods.  This assessment requires significant judgment, and an evaluation of both objective
and subjective positive and negative factors.

We evaluate the recoverability of our deferred tax assets on an ongoing basis. In making this evaluation during 2003, we
considered all available positive and negative evidence, including our past results, the existence of significant cumulative losses
in recent years, and our estimate of future taxable income.

While we anticipate being profitable in future periods, the combination of significant cumulative losses in recent years and
uncertainty with respect to the recoverability of our year-end deferred tax asset balances within a reasonable time frame, warrants
the recording of a valuation allowance under SFAS No. 109. Accordingly, we recorded a valuation allowance of $75.4 million for the
year ended December 31, 2003, which represents our net deferred tax asset balance for which corresponding deferred tax liabilities
did not offset.  This valuation allowance, coupled with valuation allowances recorded in prior years associated with certain purchase
acquisitions, resulted in an aggregate valuation allowance of $82.7 million as of December 31, 2003.

As a result of the determination made in 2003 that a full deferred tax asset valuation was warranted, our results for the three
months ended March 31, 2004 only reflects income tax expense and income tax benefits related to our life insurance operations, which
are not included in the Vesta Insurance Group, Inc. consolidated income tax return and certain state income taxes not impacted by our
deferred tax asset valuations.  For the three months ended March 31, 2004,changes in our deferred tax balances and the utilization of net operating loss carryforwards resulted in the lowering the
aggregate deferred tax asset valuation allowance to $81.8 million.

10

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We will continue to review our estimated taxable income in relation to our actual results on an ongoing basis. In the event
that certain planned transactions are consummated or management believes that existing uncertainties regarding our forecasted taxable
income are minimized, the existing valuation allowance may be reversed.

Note H - Reinsurance

The Company entered into a 50% quota share agreement ("2003 50% Quota Share Agreement"), effective September 30, 2003, on our
residential property book of business in the states of Alabama, Alaska, Arizona, California, Connecticut, Florida, Hawaii,
Massachusetts, New Jersey, New York, Pennsylvania, Rhode Island, South Carolina, Tennessee, and West Virginia ("Continuing States"),
representing the states in which the Company intends to continue to write new property and casualty business. Effective December 1,
2003, the residential property book of business in Texas was added to this 2003 50% Quota Share Agreement, which had been previously
reinsured under a separate treaty covering only residential property business in Texas ("2002 50% Quota Share Agreements") from
December 1, 2002 to November 30, 2003.  The 2003 50% Quota Share Agreement expires on September 30, 2004, but may be terminated on a
cut-off basis on June 30, 2004 by either party.

Effective January 1, 2004, the Company entered into three non-standard auto quota share reinsurance agreements with unaffiliated
reinsurers with variable cession percentages.  For business written through our affiliated underwriting agencies in Illinois, Indiana
and Missouri, the Company will cede 60% of gross written premium in the first six months of 2004 with an option to reduce the cession
to 20% for the second six months of 2004.  For business written through our affiliated underwriting agencies in New Mexico and South
Carolina, the Company will cede 75% of gross written premium in the first six months of 2004 and have the option to reduce the
cession to 30% for the second six months of 2004.  These reinsurance agreements require notification to the reinsurer 30 days prior
to making the change in ceding percentages for the second half of 2004.  Furthermore, the Company may terminate any of these
agreements on December 31, 2004 on a cut off basis.

For business written through A-Affordable, one of the Company's affiliated underwriting agencies in Texas, the Company entered
into a quota share reinsurance agreement effective January 1, 2004 under which we will assume a portion of the business produced by
our Texas-based A-Affordable underwriting agency and written by Old American Country Mutual Fire Insurance Company, an unaffiliated
insurance company.  The Company will assume 25% of the gross premium written in the first six months of 2004, with an option to
increase our participation to 70% in the second six months of 2004.

For business written through American Agencies, one of the Company's affiliated underwriting agencies in Texas, the Company
entered into a quota share reinsurance agreement effective January 1, 2004 under which we will assume 5% of businesses written by Old
American County Mutual Fire Insurance Company.

In addition to the three quota share reinsurance agreements effective January 1, 2004, we currently cede 40% of the non standard
auto business written through our affiliated underwriting agency in Florida.  This reinsurance agreement expires May 1. 2004.

11

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

The following  discussion should be read in conjunction with management's  discussion and analysis of the financial  condition and
results of operations and all of the other information,  including the discussion of Vesta's critical  accounting  policies,  appearing
in Vesta's 2003 Annual Report as filed with the  Securities  and Exchange  Commission  on Form 10-K and with the  financial  statements
included therein and the notes thereto.

Results of Operations

Overview

Vesta conducts business in three areas of the personal  insurance  industry:  (1) standard property and casualty  insurance;  (2)
non-standard  automobile  insurance;  and (3) life  insurance.  Our  consolidated  revenue is  derived  principally  from  risk-bearing
premiums,  commissions  and fees,  investment  income and realized  investment  gains and losses.  Our  consolidated  expenses  consist
primarily of payments for claims and expenses associated with underwriting activities, agents' commissions and operations.

In an effort to strengthen our capital position, we began a capital evaluation in March of 2003.  To date, management's
capital evaluation has resulted in the following significant events aimed at improving our overall financial condition including the
increased utilization of quota share reinsurance of our standard property-casualty and non-standard underwriting operations and the
sale of our health insurance operations.

In addition  to the sale of our health  insurance  operations  and the  increased  use of  reinsurance,  we are  pursuing  the
divestiture  of our life insurance and  non-standard  businesses in an effort to strengthen  our capital  position.  In relation to the
divestiture of our life insurance  business,  we executed a definitive  agreement on March 12, 2004 to sell American Founders Financial
Corporation  ("AFFC"),  our life insurance  subsidiary,  for a total purchase price of approximately  $63.5 million,  consisting of $25
million  in cash at  closing  and a  promissory  note in the  amount of  approximately  $38.5  million.  The note will bear a  floating
interest  rate of LIBOR plus 200 basis points and will be repaid over a six-year  term,  with the interest  payments  only in the first
year and the principal  repayments in five equal annual payments  thereafter.  The note will be collateralized by a pledge of the stock
of both AFFC and all capital stock and surplus debentures issued by AFFC's immediate subsidiary,  Laurel Life Insurance Company,  which
owns 100% of the capital  stock of American  Founders  Life  Insurance  Company.  The  divestiture  of AFFC will not have a significant
impact on our GAAP  equity,  but will have a  significant  positive  impact on our  statutory  surplus.  We  anticipate  an increase in
statutory  surplus of  approximately  $19.5  million  upon the  closing of this  transaction.  The  request  for the  approval  of this
transaction has been submitted to the applicable regulatory agencies.

In relation to the divestiture of our  non-standard  business,  we completed,  effective  December 31, 2003 the combination of
our non-standard auto  underwriting  operations with our non-standard  agency operations under a distinct holding company,  Affirmative
Insurance  Holdings,  Inc. Effective  December 31, 2003, we transferred to Affirmative  Insurance  Holdings,  Inc. 100% of the stock of
two insurance  company  subsidiaries  - Affirmative  Insurance  Company and its wholly owned  subsidiary  Insura  Property and Casualty
Insurance  Company - in  exchange  for  additional  shares of  Affirmative's  common  stock.  Also  effective  December  31,  2003,  we
restructured  our internal  reinsurance to effectively  transfer to Affirmative  Insurance  Company and Insura all of our  non-standard
personal  automobile  insurance  policies  in  force as of  December  31,  2003 as well as any new and  renewal  non-standard  personal
automobile  insurance policies issued by our insurance company subsidiaries and produced by Affirmative's  underwriting  agencies on or
subsequent to December 31, 2003.

In March of 2004,  we filed a  registration  statement  relating to our proposed  initial  public  offering of  securities  of
Affirmative Insurance Holdings, Inc.

Although  we  believe  the above  mentioned  measures  enacted in 2003  coupled  with our  improved  results  from  continuing
operations and the anticipated  divestiture of our life and  non-standard  auto businesses  provide us with a strong basis to expect an
improved  financial  strength rating for our standard  property and casualty  business,  uncertainty  exists as to the  consummation of
these  transactions.  Uncertainties  exist due to the fact that the sale of our life  insurance and  non-standard  auto  operations are
subject to regulatory approval,  approval by our Board of Directors and other factors.  These uncertainties,  coupled with the negative
impact to our statutory  surplus from the statutory  charge  associated  with our 1997 20 percent whole account quota share,  result in
our inability to provide assurance that we will be able to retain and improve our current financial strength rating.

A.M. Best has announced that their  financial  strength  ratings of our  property-casualty  subsidiaries  are currently  under
review "with negative  implications".  Management believes that our  property-casualty  subsidiaries will remain under review until the
uncertainties  surrounding  the  divestiture  of our  life  insurance  segment  and the  consummation  of our  IPO of our  non-standard
operations  are  resolved.  Management  is unable to  quantify  the impact to our future  business in the event we are unable to retain
and improve our current  financial  strength  rating;  however,  the  retention or  downgrade  of our rating could lead to  significant
deterioration in selected  portions of our standard  property and casualty premium volume and adversely impact the financial results of
this segment going forward.

Standard property-casualty and non-standard underwriting

The financial results of our property-casualty  underwriting activities (including our standard property-casualty segment and the
non-standard  underwriting  segment)  primarily  depend upon two variables:  (1) the amount of premiums we collect,  which is dependent
upon rates and volume; and (2) the costs we incur to adjust and pay claims submitted by individuals we have insured.

Earned premium revenue levels for our standard  property-casualty and non-standard underwriting activities are dependent upon two
significant  factors:  premium rates and premium  volumes.  Subject to competitive and market trends and regulatory  approval,  premium
rates are  generally  within our  control,  and we  continuously  monitor and seek to adjust  rates as  appropriate.  During  2003,  we
received  approval  for six rate  increases  in our standard  automobile  business  line in the states of North  Carolina,  Ohio,  West
Virginia and Pennsylvania,  which represented a weighted average premium increase of approximately  5.5% on estimated  annualized gross
written  premiums of $45.4  million.  In addition,  we received  approval for an additional  6.1% rate increase in the first quarter of
2004 for West Virginia.

During 2003, we also received approval of 17 rate increases in our standard residential property line in the states of West
Virginia, Ohio, Pennsylvania, Tennessee, South Carolina, Arizona, Florida and New York which represented a weighted average premium
increase of approximately 18.6% on estimated annual gross written premiums of $126.7 million.  During the first quarter of 2004, we
received approval for a weighted average premium increase of approximately 16.4% in New Jersey, New York, Alaska, Alabama, and West
Virginia, on estimated annual gross written premiums of approximately $26.7

12

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million. In regards to our non-standard  underwriting  segment, we did not request significant rate changes during 2003 or during
the first three months of 2004, reflecting our current favorable loss ratio experience.

The degree to which the Company is able to realize the positive  impact from these rate  increases is contingent  upon the degree
to  which  we can  sustain  current  net  written  premium  levels.  Decreased  written  premium  levels  due to  competition,  adverse
developments  from our financial  strength ratings or changes in the degree to which we utilize  reinsurance would reduce the impact of
these rate increases.  Furthermore,  the impact of these rate increases may be reduced through future rate reductions  enacted by state
regulatory agencies.

With respect to volume,  our ability to increase  written  premium in our  property-casualty  underwriting  activities is largely
dependent upon our surplus  leverage ratio,  which reflects our  underwriting  operations' net written  premiums  relative to statutory
surplus at the end of a period.  Currently,  our surplus  leverage ratio does not indicate  capacity for significant  growth in our net
premiums  written.  However,  we believe that the  completion  of our capital  strengthening  initiatives  noted above will provide our
remaining  property-casualty  segment with improved  surplus and enable the Company to more fully realize premium growth  opportunities
through  increased  writings as well as possible  reductions in the use of  reinsurance  and better  capture the positive  underwriting
results of our property and casualty business.

The costs we incur to adjust and pay claims,  known as loss and loss  adjustment  expenses,  are  largely  beyond our control and
depend  primarily upon the frequency and/or severity of claims made by our  policyholders.  One measure of performance in the insurance
industry  is the  "loss  ratio,"  which is the  ratio of (i) the sum of loss and loss  adjustment  expenses;  to (ii) the sum of earned
premiums and policy fees.  Our loss ratio will  generally  increase or decrease  according to the frequency  and/or  severity of claims
made by our policyholders.

Another key  performance  measure for insurance  companies is the "combined  ratio." The combined  ratio  compares (i) the sum of
loss, loss adjustment expenses,  operating expenses and policy acquisition  expenses;  to (ii) total earned premiums and policy fees. A
combined ratio of less than 100% indicates  underwriting  profitability,  without regard to investment income earned from investing the
premium received.

Non-standard agency

The financial  results of our agency  activities  primarily depend upon the amount of fees and commissions we can collect from the
sale of  insurance  products  and the  expenses  we incur to  conduct  our  day-to-day  operations.  Although  we  expect  the  minimum
commissions  and policy fees that we earn under a typical  agency  contract to be  relatively  stable,  we expect to earn a substantial
amount of additional  "profit  sharing"  commissions  in excess of the  contractual  minimums.  These profit  sharing  commissions  are
dependent upon whether the  non-standard  auto policies that we produce for other  insurers  result in a level of losses in relation to
written  premium  (i.e.,  loss ratios)  below the levels  stated in our agency  contracts.  Accordingly,  the frequency and severity of
claims made on the policies our agencies produce may impact our profit sharing commissions.

Life insurance

The  financial  results of our life  insurance  operations  primarily  depend upon (1) the amount we collect as  premium;  (2) the
amount of  investment  income  earned on  invested  premium;  and (3) the  benefits  we pay to insureds  upon their  death.  Unlike the
standard  property-casualty  reporting  segments,  we include the investment  income earned on invested  premium in the results for our
life  insurance  segment.  The  greatest  variable in our  revenue in the life  segment is the amount of income we can earn on invested
assets,  which is dependent upon general  interest  rates and market  conditions.  The greatest  variable in our expense from period to
period is the mortality rate of our insureds,  as mortality rates in excess of our actuarially  predicted  levels will adversely impact
financial results in any given period.

Corporate and other

The  financial  results of our  corporate  and other  segment  reflect  other  revenue and expenses  that are not allocated to any
particular segment, including (i) investment income related to our property-casualty  underwriting operations;  (ii) corporate interest
expense;  (iii) general corporate operating  expenses;  and (iv) realized investment gains and losses and gains from repurchases of our
own debt securities at a discount.

In addition to the above-mentioned  factors,  such items as weather-related  events including hurricanes and tornadoes and changes
in regulations  governing the insurance  industry may also impact our financial  results.  Also, our ability to effectively  compete in
the insurance markets we serve is influenced by the financial strength ratings assigned to our companies by A.M. Best.

Comparison of First Quarter 2004 to First Quarter 2003

For the quarter ended March 31, 2004, we reported net income available to common shareholders of $8.8 million, or $0.25 per diluted
share, compared with a net income available to shareholders of $3.7 million, or $0.11 per diluted share, reported for the previous
year.

The primary factors that impacted our financial results in the first quarter of 2004 were as follows:

- Our combined  ratio in the standard  property-casualty  segment was 89.7% as compared to 105.3% for the first quarter of 2003.
            The combined ratio for the current  quarter  reflects an improvement in the loss ratio from 67.5% in the prior year
            to 66.3% in the first  quarter of 2004 and a $15.0 million  reduction in policy  acquisition  expenses  principally
            due to our increased use of reinsurance.
- The first quarter is typically  one of the  strongest  for the  non-standard  auto  business.  Revenues from our  non-standard
            agency  segment  increased  8.9%  from the  first  quarter  of 2003.  In  addition,  higher  levels  of  profit sharing
            commissions  recognized  in the first  quarter of 2004  resulted in an increase in our  non-standard  agency margin
            from 12.7% in the prior year to 18.2% in the first quarter of 2004.
- A decline in market interest rates,  higher level of prepayments on our mortgage-backed  securities,  lower levels of invested
            assets and changes in the mix of invested assets  adversely  impacted net investment  income.  The weighted average
            annualized  yield  (excluding  realized and unrealized  gains)  decreased from 4.7% for the quarter ended March 31,
            2003 to 4.1% for the quarter ended March 31, 2004 while average  invested  assets  (excluding  assets held in trust
            related to our reinsurance  agreement with ERC Life Reinsurance  Corporation)  decreased from $989.2 million during
            the first  quarter  of 2003 to $933.0  million  during  the first  quarter of 2004.  Additionally,  our  investment
            security  sales  activity  during the first  quarter of 2004  resulting  in a decrease  in  realized  gains of $2.7
            million from the first quarter of 2003.

13
- The establishment of a full valuation  allowance for our net deferred tax assets in 2003,  coupled with the utilization of net
            operating loss  caryforwards  during the current  quarter,  reduced the amount of income tax expenses  reflected in
            the first quarter of 2004.
- Our initial  adoption of  Statement  of  Position  03-1,  "Accounting  and  Reporting  by  Insurance  Enterprises  for Certain
            Nontraditional  Long-Duration  Contracts and for Separate  Accounts"  ("SOP 03-1") in the first quarter of 2004 reduced
            net income by $5.2 million, net of tax.

For a depiction of the various  components of revenue,  expense and financial results for each of our business segments for
the quarter ending March 31, 2004, refer to Note C included in this report.

Standard property-casualty segment

In our standard  property-casualty segment, we underwrite or sell personal automobile and residential property insurance through
approximately  2,525  independent  insurance  sales  agencies.  In the first quarter of 2004,  the standard  property-casualty  segment
generated approximately $63.0 million in revenue, or approximately 42.6% of consolidated revenue.

We entered into a 50% quota share agreement ("2003 50% Quota Share Agreement"), effective September 30, 2003, on our residential
property book of business in the states of Alabama, Alaska, Arizona, California, Connecticut, Florida, Hawaii, Massachusetts, New
Jersey, New York, Pennsylvania, Rhode Island, South Carolina, Tennessee, and West Virginia ("Continuing States"), representing the
states in which we intend to continue to write new property and casualty business. Effective December 1, 2003, we added our
residential property book of business in Texas to this 2003 50% Quota Share Agreement, which had been previously reinsured under a
separate treaty covering only residential property business in Texas ("2002 50% Quota Share Agreements") from December 1, 2002 to
November 30, 2003. The 2003 50% Quota Share Agreement expires on September 30, 2004, but may be terminated on a cut-off basis on June
30, 2004 by either party. Depending on various factors such as our statutory surplus, loss experience on this book of business and
the prevailing reinsurance market rates, we may elect to terminate or reduce the aggregate amounts ceded under this reinsurance
contract in 2004.

Net written premiums decreased $24.5 million, or 30.0%, to $57.1 million during the three months ended March 31, 2004 compared
to net written premiums of $81.6 million for the three months ended March 31, 2003 reflecting a $17.7 million reduction in net
written premiums resulting from the abovementioned 50% quota share agreement.  The remaining $6.8 million reduction in net written
premiums is principally due to decreased homeowners and automobile writings in the Midwest and Mid-Atlantic regions in connection
with our decision to withdraw from certain states.   Net premiums earned during the three months ended March 31, 2004 decreased $15.9
million, or 20.8%, as compared to the first quarter of 2003.   As with the decrease in net written premiums, the decrease in net
premiums earned is primarily attributable to the 2003 50% Quota Share Agreement and the run-off of premiums in those states from
which we are withdrawing.

Policy fees,  which are fees earned by our insurance  companies  based on gross written  premiums,  were $2.3 million during the
three months ended March 31, 2004 compared to $2.1 million for the same period in the prior year.

Loss and loss adjustment  expenses (LAE) for standard  property  casualty lines for the period ended March 31, 2004 decreased by
$11.4  million,  or 21.5%,  to $41.6 million from $53.0 million in the prior year.  The decrease in loss and loss  adjustment  expenses
incurred was  primarily  attributable  to the 2003 50% Quota Share  Agreement and slight  improvements  in loss  experience  during the
current  year period.  The loss ratio for  standard  property-casualty  segment  decreased to 66.3% for the first  quarter of 2004 from
67.5% for the three months ended March 31, 2003.

For the quarter ended March 31, 2004, policy acquisition  expenses decreased by $15.0 million to $3.6 million from $18.6 million
for the same period of the prior year.  Improved terms under our current reinsurance  agreements,  as compared to those in place in the
prior year,  accounted  for $11.5  million of the decrease in policy  acquisition  expenses.  In addition,  the decrease in overall net
premiums earned resulting from the increased use of reinsurance  resulted in the remaining $3.5 million  decrease.  Policy  acquisition
costs as a  percentage  of net premiums  earned for the quarter  ended March 31, 2004 was 6.0% as compared to 24.4% for the same period
in the prior year.

Operating  expenses  increased $0.1 million to $11.1 million during the three months ended March 31, 2004 from $11.0 million for
the same period in the prior year,  reflecting the consistent level of operating expenses  experienced by this segment over the past 12
months.

Non-standard agency segment

Our non-standard  agency segment does not retain any underwriting  risk.  Rather,  the primary focus of our agency segment is the
distribution of non-standard  auto insurance  products for various  insurance  carriers in exchange for commissions and fees. Since our
entry into the  non-standard  auto  business in late 2000,  revenue for our agency  segment has increased  significantly.  In the first
quarter of 2004, our non-standard  agency segment generated  approximately  $42.4 million of commission and fees-based revenue, or 24.5
% of aggregate revenue, before eliminations.

For the quarter  ended March 31, 2004,  fees and  commissions  in our agency  segment  increased by $3.5 million due to increased
sales of  non-standard  products.  The increase in fees and  commission  in our agency  segment is  principally  due to more  favorable
commission  rates and an increase of $1.9 million in  profit sharing  commissions  related to positive loss ratio  development.  Our agency
segment  pre-tax income  increased $2.7 million,  or 54.0%,  to $7.7 million for the three months ended March 31, 2004 compared to $5.0
million for 2003.  The gross  margin of the agency  segment was 18.2% of total  revenues in the current  year  compared to 12.7% in the
prior year,  reflecting the higher level of profit sharing  commission in the current year and cost reductions  stemming  principally  from
headcount reductions.

Non-standard underwriting segment

Our non-standard  underwriting segment can be separated into two lines of business: (1) underwriting  non-standard auto insurance
products sold by our affiliated agency operations and (2) underwriting  non-standard auto insurance sold by unaffiliated  agencies.  In
each of these business lines, we utilize quota share reinsurance to minimize our exposure to loss.

Since entering the non-standard auto business in late 2000, our non-standard underwriting revenues have increased significantly.  In
the first quarter of 2004, our non-standard underwriting segment generated approximately $53.6 million of revenue, representing
approximately 36.3% of consolidated revenue.

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For the quarter ended March 31, 2004, net premiums written for non-standard  lines decreased by $8.2 million,  or 17.4%, to $38.8
million from $47.0 million in 2003. For the same period,  net premiums  earned for  non-standard  lines  increased by $8.5 million,  or
22.0%, to $47.2 million from $38.7 million.  The decrease in net premiums  written is  attributable  to changes in certain  reinsurance
contracts  on  products  sold by our  affiliated  agency  operations  that  resulted  in  more  premiums  being  ceded  to  reinsurers.
Specifically,  we increased our  reinsurance  on our American  Agencies and InsureOne  affiliated  agencies,  resulting in 95% and 60%,
respectively,  of  written  premiums  being  ceded  to  third  party  reinsurers  in the  current  quarter,  compared  to 75% and  40%,
respectively,  being ceded in the prior year.  The increase in net premiums  earned in the current  quarter is primarily  due to higher
levels of retained premiums written in prior periods being earned in the current period.

Of our total  non-standard  net written  premiums of $38.8 million during the first quarter of 2004, the net premiums  written on
policies produced by our affiliated  agencies were  approximately  $27.6 million.  The largest component of our net premiums written on
policies sold by affiliated  agencies was  approximately  $13.2 million net premium written through  InsureOne,  our affiliated  agency
operation  based in  Chicago,  Illinois.  Although  the volume of  policies  sold by  affiliated  agencies,  including  InsureOne,  and
unaffiliated  agencies  remained  consistent  during  2003 and the first three  months of 2004,  we expect net  written  premiums  will
decrease as compared to 2003 as result of the  increased  use of  reinsurance  during the latter half of 2003 and the first  quarter of
2004.

Policy fees,  which are fees earned by our insurance  companies based on gross written  premiums,  increased $1.0 million during
the three months  ended March 31, 2004 to $6.1  million  from $5.1 million for the same period in the prior year.  Policy fee income as
a percentage of earned premiums decreased slightly from 13.1% in the prior year to 12.8% in the current year.

Non-standard net written premiums produced by unaffiliated  agencies was approximately  $11.2 million,  with approximately  $11.3
million of gross written  premium ceded to third party  reinsurers.  For the quarter ended March 31, 2004, we also  collected  "issuing
carrier" or  "fronting"  fees of  approximately  $0.4  million,  down from $0.9  million in 2003.  The  decrease  in fronting  fees was
primarily  attributable  to a decrease in the fronting fees earned in relation to a program in California  that has been operating on a
renewal-only basis during 2003 and 2004.

Loss and loss adjustment  expenses for the non-standard  underwriting  segment increased by $4.8 million,  or 18.1%, in the first
quarter of 2004, to $31.3 million from $26.5 million in 2003.  The loss ratio for our  non-standard  underwriting  segment at March 31,
2004 was 58.7%,  compared  with 60.6% at March 31,  2003.  The decrease in the loss and loss  adjustment  expense  ratio was  primarily
attributable to certain rate increases  implemented in 2003, the run-off of high loss books of business in certain states,  and overall
improvements in loss experience.

For the quarter ended March 31, 2004, policy acquisition  expenses and operating expenses increased $4.3 million to $19.4 million
from $15.1  million in 2003.  Policy  acquisition  expenses and operating  expenses as a percentage of earned  premiums and policy fees
increased to 41.1% for the quarter ended March 31, 2004 from 39.2% in 2004,  primarily  attributable to higher  profit sharing  commissions
recognized during the current quarter as compared to the prior quarter offset by higher ceding commission received on ceded business.

Life insurance segment

We provide a variety of life insurance products through American Founders Financial  Corporation,  a holding company for two life
insurance  companies  domiciled in Texas.  American Founders' business is driven primarily by the acquisitions of closed blocks of life
insurance  policies and, to a lesser extent,  by marketing and distributing  its fixed annuity  products.  Our life insurance  products
are sold through marketing firms,  financial  institutions and 400 independent  agents located throughout 41 states and the District of
Columbia.  At March 31, 2004,  American  Founders had  approximately  $2.0 billion (face value) of life and annuity  products in force,
and approximately $744.9 million in invested assets.

In the first quarter,  our life insurance  segment generated  approximately  $11.0 million in revenue,  or approximately  7.4% of
consolidated  revenue.  Our life insurance  segment  pre-tax income  decreased  $0.7 million,  or 36.8%,  to $1.2 million for the three
months  ended March 31, 2004  compared to $1.9  million for 2003.  This  decrease is  attributed  to several  factors  including  lower
investment income and higher policyholder benefits associated with the adoption of SOP 03-1.

Investment  income  decreased  $0.6  million  from $7.7  million for the three months ended March 31, 2003 to $7.1 million in the
current year due to increased  reinsurance,  higher volumes of paydowns on our  mortgage-backed  securities  and an overall  decline in
market  interest  rates during the three months ended March 31, 2004.  The weighted  average  annualized  yield on invested  assets for
2004 (excluding realized and unrealized  gains/losses and assets held in trust related to our reinsurance  agreement with ERC) was 4.9%
compared with 5.5% for the prior year period.  Offsetting  the decrease in yield on our invested  assets was a 5.3% increase in average
invested assets.  Policyholder  benefits  increased $1.0 million,  or 19.6%,  from $5.1 million to $6.1 million  principally due to the
adoption of SOP 03-1,  which required us to modify our reserving  methodologies  to increase  reserves on our single  premium  deferred
annuity products.  See Note A to the consolidated financial statements.

Corporate and other segment

For the quarter ended March 31, 2004, net investment income related to our  property-casualty  underwriting  operations decreased
by $1.5 million to $2.4 million from $3.9 million in 2003. The decrease in investment  income was primarily  attributable  to a decline
in  market  interest  rates,  a higher  level  of  prepayments  on our  mortgage-backed  securities,  and  lower  levels  of  invested.
Additionally,  the  property-casualty  investment  portfolio held a higher level of cash during the current  quarter as a result of the
adverse  resinsurance  arbitration  ruling that we received in March of 2004,  further  impacting  the yields  realized on our invested
assets.  Average  invested  assets  decreased  from  $436.7  million in the prior  quarter to $350.7  million in the  current  quarter,
reflecting  the impact of  increased  use of  reinsurance  during the latter half of 2003 and through  the first  quarter of 2004.  The
weighted  average  annualized  yield on  invested  assets for the  quarter  ended March 31, 2004  (excluding  realized  and  unrealized
gains/losses) was 2.7% compared with 3.7% for the prior year period.

Our interest  expense  includes  interest  payable on our 8.75% senior  debentures  due in 2025 and borrowings and our commercial
credit  borrowings.  Interest  expense  decreased by  approximately  $0.3 million  compared with 2003,  primarily due to lower interest
rates and lower average balances outstanding on our line of credit.

The Company's adoption of the provisions of SFAS No. 150,  "Accounting for Certain Financial  Instruments with Characteristics of
both  Liabilities and Equity" ("SFAS No. 150") resulted in the Deferrable  Capital  Security  distributions  for the three months ended
March  31,  2004  being  included  as a  component  of  pre-tax  income  (loss).  Pursuant  to the  provisions  of SFAS  No.  150,  the
classification  of  Deferrable  Capital  Security  distributions  for prior  periods was not changed.  As a result,  an expense of $0.4
million was included as a component of pre-tax income (loss) in the corporate and other segment.

15

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In 2004,  operating  expenses  remained  approximately  unchanged from the prior year.  However,  the components of our operating
expenses changed from prior year as compensation  and lease costs decreased  offset by increases in legal expenses mainly  attributable
to our reinsurance arbitrations.

Discontinued operations

In the fourth quarter of 2002, we made the decision to exit the health  insurance and  consulting  business lines and disposed of
these segments in 2003.  Accordingly,  our health insurance and consulting lines results for the three months ended March 31, 2003 have
been  classified in our financial  statements as part of  discontinued  operations.  Due to the disposal of these segments in 2003, the
our financial  statements as of and for the three months ended March 31, 2004 were not impacted from our previous health  insurance and
consulting business lines.

Previously, in 2000 and 1999, we exited the reinsurance assumed and commercial lines businesses,  respectively.  As a result, the
reporting  for these  business  lines is included in  discontinued  operations  in our  financial  statements.  At the time we made the
decision to exit each of these business  lines,  we estimated the reserves  required to fulfill our expected  future  obligations  with
respect to these discontinued  operations.  However,  we continue to monitor our recorded estimates with respect to ultimate settlement
on an ongoing basis.

For the three months ended March 31, 2004, we recorded a loss for reinsurance assumed and commercial lines businesses of $0.9
million.  These losses are primarily related to costs associated with commuting certain reinsurance treaties, partially offset by
recoveries on other treaties.

Based upon available  information,  we believe the recorded reserves for discontinued  operations at March 31, 2004 are adequate.
However,  we will continue to monitor these  reserves and their related  claims  activity and  experience.  Further  adjustments to our
estimates could be necessary as we continue to run off the remaining outstanding claims.

Income taxes

As a result  of the  determination  made in 2003 that a full  deferred  tax  asset  valuation  allowance  was  warranted  and the
utilization  of net operating  loss  carryforwards  during the current  quarter,  our results for the three months ended March 31, 2004
only  reflects  income tax expense and income tax  benefits  related to our life  insurance  operations,  which are not included in the
Vesta  Insurance  Group,  Inc.  consolidated  income tax return,  and certain state income taxes not impacted by our deferred tax asset
valuations.

Liquidity and Capital Resources

Liquidity and Capital Resources - Holding Company

Vesta  Insurance  Group,  Inc.  (Vesta) is a holding  company whose principal asset is its investment in the capital stock of the
companies  constituting  the Vesta Insurance  Group.  The principal uses of funds at the holding company level are to pay (1) operating
expenses; (2) principal and interest on outstanding  indebtedness and deferrable capital securities;  and (3) dividends to stockholders
as declared by the Board of Directors.

Vesta's  principal  source of liquidity and capital  resources to meet its holding  company  obligations is dividends paid by our
subsidiaries.  Given our  organizational  structure,  we rely on two  subsidiaries to pay dividends to our holding company or otherwise
fund the obligations of our holding company on its behalf:  Vesta Fire Insurance  Corporation,  an Illinois domiciled  insurer,  and J.
Gordon Gaines, Inc., a Delaware business corporation.

Dividends from Vesta Fire

Transactions  between  Vesta and its  insurance  subsidiaries,  including  the  payment  of  dividends,  are  subject  to certain
limitations under the insurance laws of those  subsidiaries'  domiciliary  states.  The insurance laws of the state of Illinois,  where
Vesta Fire is domiciled,  permit the payment of dividends out of unassigned  surplus in any year which,  together with other  dividends
or  distributions  made within the  preceding  12 months,  do not exceed the greater of 10% of  statutory  surplus as of the end of the
preceding  year or the net income for the  preceding  year,  with  larger  dividends  payable  only after  receipt of prior  regulatory
approval.  The Illinois  Insurance  Department  has  indicated  that these  dividend  limitations  prohibit the payment of dividends if
the insurer has  negative or zero  "unassigned  funds" at the end of the prior year,  as reported on its  statutorily  required  annual
statement.  Our lead insurance  subsidiary,  Vesta Fire, reported negative  "unassigned funds" on its annual statement for 2003, and is
expected to continue to report negative  unassigned funds for the foreseeable  future.  Accordingly,  we may not be able to declare and
pay a dividend  from our lead  insurance  company  subsidiary  for the  foreseeable  future  without  prior  approval.  There can be no
assurance  that Vesta Fire will be able to obtain the requisite  regulatory  approval for the payment of dividends.  Vesta Fire has not
paid any dividends during 2004.

Dividends from J. Gordon Gaines

J. Gordon Gaines, Inc. provides  administrative services to all of our property - casualty insurance subsidiaries in exchange for
fees  pursuant  to an  administrative  services  agreement  and,  with  respect  to our  Texas  Select  Lloyds  Insurance  Company,  an
attorney-in-fact  agreement.  These management  agreements are subject to certain  regulatory  standards which generally  require their
terms and fees to be fair and  reasonable.  The Illinois or Texas  Departments  of Insurance may review these  agreements  from time to
time to insure the  reasonableness  of their terms and fees,  and it is  possible  that such terms and fees could be modified to reduce
the amounts  available  to our holding  company.  Assuming  these  management  agreements  are not modified in a material  respect,  we
believe that J. Gordon Gaines,  Inc. will be able to pay dividends to Vesta,  or otherwise fund the  obligations of our holding company
on its  behalf,  sufficient  to fund our  anticipated  operating  cash flows and  scheduled  debt  service for at least the next twelve
months.

Credit Facilities

Effective February 1, 2003, we entered a $30 million revolving credit arrangement with First Commercial Bank of Birmingham,
Alabama ("First Commercial"), collateralized by a pledge of 358,375 shares of our holding company's ownership in the common stock of
Affirmative Insurance Holdings, Inc. representing approximately 40.6% of Affirmative's issued and outstanding shares of capital stock
as of December 31, 2003. The new facility bears interest at First Commercial's prime rate and will mature no earlier than June 30,
2005.  As of March 31, 2004, we had drawn the entire $30 million available under this Agreement.

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This credit agreement contains covenants which require us to maintain (i) consolidated GAAP net income (excluding realized gains and
losses) of at least $15 million for any calendar year, (ii) consolidated debt to capital ratio of no more than 39%, measured on a
quarterly basis, (iii) an A.M. Best rating of "B" or better, measured continuously, (iv) consolidated GAAP net worth of at least $208
million, measured quarterly, (v) an interest coverage ratio of not less than 1.5 to 1 for any calendar year and (vi) risk-based
capital of not less than 150% of the NAIC's authorized control level, measured continuously. As of March 31, 2004, the Company was in
non-compliance with its consolidated debt to capital ratio and GAAP net worth covenants. First Commercial has waived compliance with
these covenants through December 31, 2004.

Although  management  does not  anticipate  an event of default in 2004 with  respect to  covenants  not already  waived by First
Commercial,  there can be no assurance  that we will remain in  compliance  with these  covenants in the future.  Furthermore,  current
dividend  levels from Vesta Fire and J. Gordon  Gaines would not be  sufficient to repay the  anticipated  outstanding  balance of this
credit facility were we to violate a covenant without seeking prior approval.  Although  management  believes the Company would be able
to secure  waivers on any future  covenant  violations,  the failure to obtain such waivers of the  potential  covenant  violations  or
refinance the credit  facility on similar terms could have a material  adverse  impact on our financial  condition.  The failure of the
Company to secure  refinancing of the credit  facility would force the Company to secure other forms of financing as current  operating
cash flows would not be sufficient to cover the contractually  required debt service  requirements.  The Company's  inability to secure
other financing to refinance the credit  facility would have a material  adverse impact on the Company.  Additionally,  refinancing the
Credit Facility with other financing at higher interest rates could negatively impact the Company's financial performance.

Liquidity and Capital Resources - Subsidiary Operations

The principal  sources of funds for our insurance  subsidiaries  are  premiums,  investment  income and proceeds from the sale or
maturity  of  invested  assets.  The  principal  uses of funds in our  subsidiary  operations  are the  payment  of  claims,  operating
expenses,  commissions and the purchase of investments.  Our  subsidiaries  also borrow funds from the Federal Home Loan Bank from time
to time and invest the proceeds at higher interest rates.

Contingent Obligations

Our subsidiary  operations are also involved in ongoing  reinsurance  recoverable  disputes that could result in an obligation to
repay certain amounts to reinsurers from whom we have collected  funds.  In connection  with these  disputes,  our principal  operating
subsidiary,  Vesta Fire, has obtained  letters of credit for the benefit of reinsurers for which it is  contingently  liable.  At March
31, 2004, Vesta Fire was  contingently  liable for $38.5 million under the terms of letters of credit obtained in connection with these
reinsurance disputes.

Additionally,  we regularly  obtain letters of credit or otherwise  pledge  securities for the benefit of ceding  insurers in our
nonstandard  underwriting  segment  pursuant  to  reinsurance  contracts.  As of March 31,  2004,  we had pledged  approximately  $16.4
million in securities pursuant to these reinsurance contracts.

In the event we are  unsuccessful  in having the NRMA  arbitration  ruling  vacated,  Vesta Fire will be required to make a $28.1
million  payment to NRMA plus 6%  interest,  which  begins to accrue on April 1,  2004.  Vesta  Fire has a  sufficient  level of liquid
assets to meet this obligation in the event payment is required.

Inter-company obligations

In addition to the  contractual  obligations  of our holding  company to third  parties,  our holding  company  owes  contractual
obligations  to certain of our  subsidiaries  that are eliminated in the  consolidation  of our financial  statements.  As of March 31,
2004,  our insurance  company  subsidiaries  held $13.2 million face amount of our 8.75% Senior  Debentures  due 2025 and $44.1 million
face  amount of our 12.5%  Senior  Notes due in December  of 2005.  Our holding  company  paid these  subsidiaries  approximately  $1.7
million in interest payments in 2004 which was eliminated in consolidation.

Current  dividend  levels from Vesta Fire and J. Gordon  Gaines are not  sufficient  to repay the  entirety of the  inter-company
obligations.  Failure to repay  these  amounts  could have a material  adverse  effect on the  statutory  capital of our  subsidiaries.
Furthermore,  failure to receive  regulatory  approval to refinance these  obligations on favorable terms could  negatively  impact the
financial results of the Company.

Cash Flows

On a  consolidated  basis,  net cash provided by (used in) operations for the three months ended March 31, 2004 and 2003 was $6.0
million  and $(6.6)  million,  respectively.  Cash flow from  operations  was for the current  period  improved  from the prior  period
primarily  due  increased  net income,  decreased  cash  outflows  related to the policy  acquisition  costs and the timing of payments
associated with recoverables on paid losses,  offset with higher levels of premium  recievalbes.  Net cash used in investing activities
was $4.9 million and $44.4  million for the three months ended March 31, 2004 and 2003,  respectively  as the level of invest  security
purchases  decreased  during the current  quarter and the level of  acquisitions  decreased.  Net cash  provided by (used) in financing
activities was $3.7 million and $(12.3)  million for the period ending March 31, 2004 and 2003,  respectively.  In 2003,  repayments of
outstanding Federal Home Loan Bank borrowings drove our financing activities.

New Accounting Pronouncements

In January 2003,  the FASB issued FIN 46  "Consolidation  of Variable  Interest  Entities"  ("FIN 46"). In December 2003, the FASB
issued FIN 46-R,  which  replaces FIN 46. FIN 46-R  clarifies the  application of Accounting  Research  Bulletin No. 51,  "Consolidated
Financial  Statements,"  to certain  entities in which equity  investors do not have the  characteristics  of a  controlling  financial
interest or do not have sufficient  equity at risk for the entity to finance its activities  without  additional  subordinated  support
form  other  parties.  The  effective  date of FIN 46-R is March 31,  2004.  However,  FIN 46-R was  applicable  to  entities  that are
considered  special-purpose  entities as of December 31, 2003. The application of FIN 46-R had no effect on our consolidated  financial
statements as of December 31, 2003. The provisions of FIN 46-R on entities not  considered to be  special-purpose  entities was adopted
as of March 31, 2004 and did not impact the Company's financial position or results of operations.

On October 1, 2003, the Company adopted Derivatives Implementation Group Issue No. B-36, "Embedded Derivatives: Modified Coinsurance
Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the
Creditworthiness of the Obligor under Those Instruments" ("DIG B-36"). DIG B-36 requires the bifurcation of embedded derivatives
within certain modified coinsurance and funds withheld

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coinsurance  arrangements  that expose the creditor to credit risk of a company other than the debtor,  even if the debtor owns as
invested  assets the  third-party  securities  to which the  creditor is exposed.  In  connection  with the  adoption of DIG B-36,  the
Company elected to reclassify to trading  securities the investments,  which are held in a separate trust,  supporting a funds withheld
treaty.  In addition,  the Company  recognized in the fourth quarter of 2003 a loss from the cumulative effect from the adoption of DIG
B-36 of $1.2  million,  net of tax, in  connection  with  recording  the  derivatives  embedded in its modified  coinsurance  and funds
withheld coinsurance arrangements.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial  Instruments with Characteristics of both Liabilities
and Equity"  ("SFAS No.  150").  SFAS No. 150  establishes  how an issuer  classifies  and  measures  certain free  standing  financial
instruments  with  characteristics  of both  liabilities  and equity and requires that such  instruments be classified as  liabilities.
SFAS No. 150 is effective  for financial  instruments  entered into or modified  after May 31, 2003,  and otherwise is effective at the
beginning  of the first  interim  period  beginning  after  June 15,  2003 for those  existing  financial  instruments  subject  to the
provisions  of SFAS No. 150.  The Company has not entered  into any  financial  instruments  within the scope of SFAS No. 150 since May
31, 2003. The Company's  Deferrable  Capital  Securities are subject to the provisions of SFAS No. 150.  Accordingly,  the  outstanding
balance of the  Company's  Deferrable  Capital  Securities  of $20.3  million as of March 31, 2004 is reflected as a component of total
liabilities from the previous "mezzanine" debt classification.  Furthermore,  Deferrable Capital Security distributions of $0.4 million
for the three months ended March 31, 2004 are reflected as a component of income from continuing  operations in our  consolidated  2004
statement of operations.  The classification of Deferrable  Capital  Securities and Deferrable  Capital Security  distributions for the
prior period remains unchanged, pursuant to the provisions of SFAS No. 150.

In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1,  "Accounting and Reporting
by Insurance  Enterprises  for Certain  Nontraditional  Long-Duration  Contracts  and for Separate  Accounts"  ("SOP  03-1").  SOP 03-1
provides  guidance on the reporting  method and presentation of separate  accounts,  recognition of gains and losses on the transfer of
assets  from the general  account to a separate  account,  as well as several  liability  valuation  issues  related to  nontraditional
long-duration  contracts such as universal  life and annuity  contracts.  The  provisions of SOP 03-1 became  effective for the Company
on January 1,  2004.  In  applying  the  provisions  of SOP 03-1 to our life  insurance  products  offered  through  American  Founders
Financial Corporation  ("American  Founders"),  the holding company for our life insurance  operations,  we changed our methodology for
accruing  reserves on our single premium  deferred  annuity  product to accrue reserves at the enhanced fund rate as defined within the
annuity contracts.  As a result of this change in methodology,  we recorded a loss of $5.2 million,  net of tax of $2.8 million,  which
is classified as a cumulative effect of change in accounting principle on the accompanying  consolidated  statement of operations.  The
recording of this loss reduced both basic and diluted net income per share by $0.15 for the three months ended March 31, 2004.

Special Note Regarding Forward-Looking Statements

Any  statement  contained in this report which is not a historical  fact,  or which might  otherwise be  considered an opinion or
projection  concerning the Company or its business,  whether express or implied, is meant as and should be considered a forward-looking
statement as that term is defined in the Private  Securities  Litigation  Reform Act of 1996.  Forward-looking  statements are based on
assumptions and opinions  concerning a variety of known and unknown risks,  including but not necessarily  limited to changes in market
conditions,  natural disasters and other catastrophic events,  increased competition,  changes in availability and cost of reinsurance,
changes in governmental  regulations,  and general economic conditions, as well as other risks more completely described in our filings
with the  Securities  and Exchange  Commission,  including our most recent Annual Report on Form 10-K. If any of these  assumptions  or
opinions prove incorrect,  any  forward-looking  statements made on the basis of such assumptions or opinions may also prove materially
incorrect in one or more respects.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Vesta's  principal  assets are  financial  instruments,  which are subject to the market  risk of  potential  losses from  adverse
changes in market rates and prices.  Our primary risk  exposures are interest rate risk on fixed  maturity  investments,  mortgages and
collateral  loans and annuity  liabilities  and equity  price risk for stocks.  Vesta  manages its exposure to market risk by selecting
investment assets with characteristics such as duration,  yield and liquidity to reflect the underlying  characteristics of the related
insurance.  There have been no material  changes to the  information  about our market risk set forth in our Annual Report on Form 10-K
for the year ended December 31, 2003.

Item 4.  Controls and Procedures

We carried out an evaluation,  under the supervision and with the participation of our principal  executive officer and principal
financial  officer,  of the  effectiveness of the design and operation of our disclosure  controls and procedures as of March 31, 2004.
Based on this evaluation,  our principal  executive officer and principal  financial officer concluded that our disclosure controls and
procedures are effective in timely alerting them to material information  concerning Vesta and its consolidated  subsidiaries  required
to be included in our periodic SEC reports.

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PART IIItem 1. Legal Proceedings

Life insurance related lawsuits

Our subsidiary,  American Founders, is a defendant in a lawsuit brought by a judgment creditor of IFS Holdings, Inc. - the former
holder of American  Founders'  series A and C preferred  stock - alleging  that  American  Founders  redeemed its Series A and Series C
preferred stock from IFS Holdings,  Inc. for less than "reasonably equivalent value," and, therefore,  engaged in a voidable fraudulent
transfer.  American  Founders  believes (i) that the redemption  transaction  was for reasonably  equivalent  value;  and (ii) that the
allegations  brought  against it in this lawsuit are without  merit.  Due to IFS's  bankruptcy  in 2001,  the real party in interest to
pursue this claim is the bankruptcy  trustee  administering  IFS' estate in bankruptcy.  Since assuming this position,  the trustee has
not pursued any discovery or otherwise  attempted to resolve this case. In the opinion of management,  resolution of the lawsuit is not
expected to have a material adverse effect on our financial  position.  However,  depending upon the amount and timing,  an unfavorable
resolution  of this matter  could  materially  affect  American  Founders'  future  operations  or cash flows in a  particular  period.
Furthermore,  Vesta will remain liable to any adverse  results from this lawsuit  regardless of the outcome of the pending  divestiture
of American Founders.

Health insurance related lawsuits

Vesta and two  former  officers  of Vesta are  defendants  in a lawsuit  styled  James H.  Cashion,  Jr.  d/b/a  American  Health
Underwriters v. Vesta Insurance Group,  Inc., et al. Plaintiff,  a former general agent of our subsidiary States General Life Insurance
Company,  which we purchased in 2001 and disposed of in 2003,  alleges that the defendants engaged in an actionable civil conspiracy to
tortiously  interfere with his agency  contracts.  The civil conspiracy  claim is premised,  in part, on certain payments made to these
two former officers of Vesta by another agent who replaced Mr.  Cashion.  The plaintiff is seeking actual and punitive  damages.  Vesta
denies  tortiously  interfering  with  plaintiff's  agency  contract,  believes the claims  asserted  against it have no merit,  and is
vigorously  defending this lawsuit.  The trial court recently denied the defendant's  motion to compel  arbitration,  which decision is
currently on appeal to the Texas  Supreme  Court.  Discovery  has been stayed  pending  resolution  of this  appeal.  In the opinion of
management, resolution of this lawsuit is not expected to have a material adverse effect on our financial position.

Indemnification Agreements and Liability Insurance

Pursuant to Delaware  law and our  by-laws,  we are  obligated to indemnify  our current and former  officers and  directors  for
certain  liabilities  arising from their  employment  with or services to Vesta,  provided  that their  conduct  complied  with certain
requirements.  Pursuant to these  obligations,  we have been advancing costs of defense and other expenses on behalf of certain current
and former officers and directors,  subject to an undertaking  from such individuals to repay any amounts advanced in the event a court
determines  that they are not entitled to  indemnification.  During the three months  ended March 31,  2004,  funding of such  expenses
was approximately $7 thousand.

Reinsurance Arbitration/Litigation

As discussed in previous SEC filings,  in 1998 we corrected our accounting for assumed  reinsurance  business through restatement
of our previously  issued  financial  statements.  Similar  corrections  were made on a statutory  accounting  basis through  recording
cumulative  adjustments  in Vesta Fire's 1997  statutory  financial  statements.  The impact of this  correction  has been reflected in
amounts  ceded under our 20 percent whole account quota share  treaty,  which was  terminated on June 30, 1998 on a run-off  basis.  We
believed such treatment was appropriate under the terms of this treaty and calculated the quarterly  reinsurance  billings presented to
the three treaty participants accordingly.

NRMA Insurance Limited ("NRMA"),  one of the participants in the 20 percent whole account quota share treaty,  filed a lawsuit in
the United States District Court for the Northern District of Alabama contesting our billings.

NRMA sought  rescission  of the treaty and a temporary  restraining  order  preventing us from drawing down  approximately  $34.5
million of collateral.  We filed a demand for  arbitration as provided for in the treaty and also filed a motion to compel  arbitration
which was granted in the United  States  District  Court action.  Vesta reached an agreement  with NRMA to collect the $34.5 million of
collateral  in exchange  for posting a $25 million  letter of credit in favor of NRMA to provide  collateral  for any amounts  NRMA may
recover as a result of the  arbitration.  Pursuant to an order of the NRMA  arbitration  panel Vesta posted an additional  $4.8 million
letter of credit in October 2003 in favor of NRMA. We also filed for arbitration  against Alfa Mutual  Insurance  Company  ("Alfa") and
Dorinco Reinsurance Company ("Dorinco"), the other two participants on the treaty.

On March 1, 2004 the NRMA panel  ruled in favor of NRMA and as a result,  the Company  incurred a charge of $33.5  million to its
2003 fourth quarter  earnings.  While the NRMA ruling does not set a binding precedent  regarding Vesta's other  arbitrations and while
there are distinct facts and circumstances  underlying and affecting our disputes with the other participants,  for financial reporting
purposes,  the Company incurred a charge to its recoverable  from the other treaty  participants of $30.1 million in the fourth quarter
of 2003. On March 4, 2004, Vesta filed a motion to vacate this  arbitration  award in the United States District Court for the Northern
District of Alabama,  Southern  Division.  The grounds for this  motion are the evident  partiality  of the neutral  umpire.  On May 5,
2004,  the court issued an order granting  Vesta's  request for limited  discovery and set an evidentiary  hearing on Vesta's motion to
vacate the arbitration award for August 25, 2004.

The hearing on the merits of the  arbitration  with Alfa was scheduled  for May,  2003,  however on April 21, 2003,  Alfa filed a
lawsuit  against Vesta Fire in the state court in Montgomery,  Alabama seeking a declaration  from the court on certain  procedural and
organizational  matters and requesting that the court stay the arbitration  proceedings  during the pendency of the litigation in state
court in  Alabama.  On April 24,  2003,  the court  issued a  temporary  restraining  order  staying the  proceedings  in the  on-going
arbitration in order to maintain the status quo until the merits of Alfa's  petition could be heard and  determined.  After the hearing
in the Circuit Court of  Montgomery  County on December 8 and 9, 2003,  the court decided the  procedural  and  organizational  matters
partially in favor of the Company and partially for Alfa. The hearing has been  rescheduled  for the weeks of March 7th and March 14th,
2005.

The hearing in the Dorinco arbitration was previously  scheduled for the two weeks of March 8 through March 12, and April 26 thru
April 30, 2004.  Recently,  those hearing  dates were  adjourned and the new hearing dates are scheduled for the weeks of April 4th and
April 11th, 2005.

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Muhl vs. Vesta is a case pending in the supreme Court of the State of New York, County of New York,  brought by the Liquidator of
Midland Insurance Company  ("Midland"),  claiming  recoveries under two alleged  retrocession  agreements (Pool I and Pool III) between
Midland and Interstate Fire Insurance Company, Vesta's predecessor in interest.

Third party auditors hired by Vesta have  identified  coverage  issues that cast doubt on the validity of a number of claims.  In
addition,  there is no actual  retrocessional  agreement that evidences the terms and conditions of Pool III which involves 60% or more
of the incurred  losses at issue.  Although  there are other  tangential  documents that the Liquidator may attempt to rely on to prove
liability  under Pool III, we believe  that the  Liquidator  will not be able to  establish  liability  for any portion of the Pool III
claims.  We also believe that a number of the losses allegedly  incurred in connection with Pool I may be avoided on specific  coverage
grounds.  We are defending this matter vigorously and are reasonably  optimistic  regarding the ultimate  outcome,  although an adverse
ruling in this case could have a material effect on our financial condition.  This case is currently set for trial in September 2004.

Vesta vs. New Cap Re is an arbitration  against an Australian  reinsurer,  to collect  reinsurance  recoverables  pursuant to two
accident year excess of loss ratio reinsurance agreements.  In the arbitration,  New Cap Re challenged Vesta's earlier draw on a Letter
of Credit for $7.5 million, which was held in connection with one of the two contracts.  Shortly after the arbitration  commenced,  New
Cap Re became the subject of insolvency  proceedings  in Australia  and an ancillary  proceeding  in the U.S.  Bankruptcy  Court in New
York.  The  Bankruptcy  Court stayed all pending  litigation  and  arbitration  against New Cap Re, and we appealed  that ruling to the
Southern  District of New York,  and  ultimately  to the U.S.  Court of Appeals for the Second  Circuit,  which  recently  affirmed the
Bankruptcy  Court's stay of the  arbitration  against New Cap Re. Hence,  our efforts to recover losses as well as New Cap Re's efforts
to  challenge  the  earlier  draw on the $7.5  million  Letter of Credit by us are stayed and the  company's  options may be limited to
seeking adjudication of the dispute in Australia.

On September 5, 2002,  New Cap Re served us with an  Application  pursuant to Section 588FF of the  Australian  Corporations  Act
seeking  an order  directing  us to pay New Cap Re and its  liquidator  $1.0  million  that  Vesta  allegedly  received  as an  "unfair
preference" and/or arising out of an "uncommercial  transaction," as those terms are defined by the Corporations Act. We filed a Notice
of Appearance on October 31, 2002. The  liquidator  filed a Statement of Claim on August 13, 2003, and the Company filed its defense on
December 18, 2003.  Discovery has not commenced.  While  management  intends to vigorously  defend this matter,  given the  preliminary
nature of these proceedings, it is too early to evaluate the likelihood of success.

Other

Vesta, through its subsidiaries,  is routinely a party to pending or threatened legal proceedings and arbitration relating to the
regular conduct of its insurance  business.  These  proceedings  involve alleged breaches of contract,  torts,  including bad faith and
fraud claims and miscellaneous  other specified relief.  Based upon information  presently  available,  and in light of legal and other
defenses  available to Vesta and its  subsidiaries,  management does not consider  liability from any threatened or pending  litigation
regarding routine matters to be material.

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Item 2. Changes in Securities

None.

Item 3. Defaults Upon Senior Securities

None.

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

None.

Item 5.  Other Information

None.

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Item 6. Exhibits and Reports on Form 8-K

a)           EXHIBITS

31.1           Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2           Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32              Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

a)           Reports on Form 8-K.

Current reports were filed on Form 8-K on March 2, March 15, and March 22, 2004 in connection with press releases.

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Signatures

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

Vesta Insurance Group, Inc.

Date:  May 10, 2004

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