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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 June 30, 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 August 6, 2004
36,079,564

---

|        |  |                                                                                                  
|------- |  | -------------------------------------------------------------------------------------------------
|Part I  |  | Financial Information                                                                            
|Item 1  |  | Financial Statements:                                                                            
|        |  | Consolidated Balance Sheets as of June 30, 2004 (unaudited) and December 31, 2003                
|        |  | Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2004           
|        |  | and 2003 (unaudited)                                                                             
|        |  | Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003 (unaudited)
|        |  | Notes to Consolidated Financial Statements (unaudited)                                           
|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                                                                                       

---

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

|                                                                                       | June 30, | December 31,
|-------------------------------------------------------------------------------------- | -------- | ------------
|
|
|Assets:                                                                                |          |             
|Fixed maturities available for sale - at fair value (amortized cost:  2004 - $685,798; |         
|2003 - $674,623)                                                                       |          | $    686,931
|Fixed maturities - trading                                                             |          | 153,563     
|Equity securities-at fair value: (cost: 2004- $29,674; 2003- $28,454)                  |          | 30,491      
|Mortgage loans                                                                         |          | 10,077      
|Policy loans                                                                           |          | 56,422      
|Short-term investments                                                                 |          | 8,492       
|Other invested assets                                                                  |          | 30,520      
|                                                                                       |          |             
|Total investments                                                                      |          | 976,496     
|Cash                                                                                   |          | 91,562      
|Accrued investment income                                                              |          | 10,570      
|Premiums in course of collection (net of allowances for losses                         |         
|of $339 in 2004 and 2003)                                                              |          | 135,052     
|Reinsurance balances receivable                                                        |          | 396,788     
|Reinsurance recoverable on paid losses                                                 |          | 76,840      
|Deferred policy acquisition costs                                                      |          | 48,397      
|Property and equipment                                                                 |          | 20,739      
|Goodwill                                                                               |          | 133,448     
|Other intangible assets                                                                |          | 16,040      
|Other assets                                                                           |          | 21,670      
|                                                                                       |          |             
|Total assets                                                                           |          | $ 1,927,602 
|                                                                                       |          |             
|Liabilities:                                                                           |         
|Policy liabilities                                                                     |          | $    672,827
|Losses and loss adjustment expenses                                                    |          | 364,801     
|Unearned premiums                                                                      |          | 326,924     
|Federal Home Loan Bank advances                                                        |          | 164,003     
|Reinsurance balances payable                                                           |          | 41,103      
|Deferred income taxes                                                                  |          | 5,528       
|Line of credit                                                                         |          | 30,000      
|Long term debt                                                                         |          | 75,932      
|Other liabilities                                                                      |          | 126,441     
|                                                                                       |          |             
|Total liabilities                                                                      |          | 1,807,559   
|                                                                                       |          |             
|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 - 38,559,541 and 2003 - 38,545,788                                                |          | 386         
|Additional paid-in capital                                                             |          | 246,302     
|Accumulated other comprehensive income, (net of  deferred tax expense                  |         
|of $1,330 and $6,451 in 2004 and 2003, respectively)                                   |          | 2,471       
|Accumulated deficit                                                                    |          | (105,153    
|Treasury stock (2,479,977 shares at cost at June 30, 2004 and                          |         
|2,479,977 at December 31, 2003)                                                        |          | (18,263     
|Unearned stock                                                                         |          | (5,700      
|                                                                                       |          |             
|Total stockholders' equity                                                             |          | 120,043     
|                                                                                       |          |             
|Total liabilities and stockholders' equity                                             |          | $ 1,927,602 
|                                                                                       |          |             

See accompanying Notes to Consolidated Financial Statements

1

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##### Vesta Insurance Group, Inc.
Statement of Operations
(amounts in thousands except per share data)

|                                                                       | Three months ended | Six months ended
|---------------------------------------------------------------------- | ------------------ | ----------------
|
|
|
|Revenues:                                                              |                    |                 
|Net premiums written                                                   |                    | $ 147,241       
|Change in unearned premiums                                            |                    | (3,098          
|                                                                       |                    |                 
|Net premiums earned                                                    |                    | 144,143         
|Policy fees                                                            |                    | 8,831           
|Agency fees and commissions                                            |                    | 15,883          
|Net investment income                                                  |                    | 9,221           
|Realized gains                                                         |                    | 1,700           
|Other                                                                  |                    | 670             
|                                                                       |                    |                 
|Total revenues                                                         |                    | 180,448         
|Expenses:                                                              |                   
|Policyholder benefits                                                  |                    | 5,249           
|Losses and loss adjustment expenses incurred                           |                    | 102,461         
|Policy acquisition expenses                                            |                    | 23,729          
|Litigation settlement and arbitration award gain                       |                    | (3,846          
|Operating expenses                                                     |                    | 34,653          
|Interest on debt                                                       |                    | 2,911           
|Deferrable capital security distributions                              |                    | 431             
|                                                                       |                    |                 
|Total expenses                                                         |                    | 165,588         
|Income (loss) from continuing operations before income taxes,          |                   
|minority interest, and deferrable capital securities                   |                    | 14,860          
|Income tax expense (benefit)                                           |                    | 2,365           
|Minority interest, net of tax                                          |                    | 286             
|Deferrable capital security distributions, net of tax                  |                    | 0               
|                                                                       |                    |                 
|Net income (loss) from continuing operations                           |                    | 12,209          
|Loss from discontinued operations, net of tax                          |                    | (3,481          
|                                                                       |                    |                 
|Income (loss)  before cumulative effect of change                      |                   
|in accounting principle                                                |                    | 8,728           
|Cumulative effect of change in accounting principle, net of tax        |                    | --              
|                                                                       |                    |                 
|Net income (loss)                                                      |                    | $     8,728     
|                                                                       |                    |                 
|Net income (loss) from continuing operations per share - Basic         |                    | $       0.34    
|                                                                       |                    |                 
|Net income (loss) available to common shareholders per share - Basic   |                    | $       0.25    
|                                                                       |                    |                 
|Net income (loss) from continuing operations per share - Diluted       |                    | $       0.34    
|                                                                       |                    |                 
|Net income (loss) available to common shareholders per share - Diluted |                    | $       0.24    
|                                                                       |                    |                 

See accompanying Notes to Consolidated Financial Statements

2

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

|                                                                           | Six months ended June 30,
|-------------------------------------------------------------------------- | -------------------------
|
|
|Operating Activities:                                                      |                          
|Net income                                                                 |                          
|Adjustments to reconcile net loss 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                                      |                          
|Maturities, paydowns, calls and other -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 acquisition                                              |                          
|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                                         |                          
|Payment of acquisition contingent consideration                            |                          
|Net deposits and withdrawals from insurance liabilities                    |                          
|Dividends paid                                                             |                          
|                                                                           |                          
|Net cash 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

---

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

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 June 30, 2004 is  reflected as a component of total
liabilities from the previous "mezzanine" debt classification.  Furthermore,  Deferrable Capital Security distributions of $0.4 million
and $0.9  million  for the three and six months  ended June 30,  2004,  respectively,  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, in the
first  quarter  of fiscal  year 2004.  The  charge 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 six months ended June 30, 2004.

Restricted  Assets:  As part of a modified  coinsurance  agreement with ERC Life Reinsurance  Corporation  ("ERC Life"),  American
Founders is holding  $153.6  million of assets,  at June 30, 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 $205.2 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

---

The  reconciliation  of net income (loss)and  average shares  outstanding for the three months and six months ending June 30, 2004
and 2003 is as follows:

|                                            | Three months ended June 30,
|------------------------------------------- | ---------------------------
|
|Net income (loss)                           |                            
|                                            |                            
|Weighted average shares outstanding-basic   |                            
|Stock options and restricted stock          |                            
|                                            |                            
|Weighted average shares outstanding-diluted |                            
|                                            |                            

|                                            | Six months ended June 30,
|------------------------------------------- | -------------------------
|
|Net income (loss)                           |                          
|                                            |                          
|Weighted average shares outstanding-basic   |                          
|Stock options and restricted stock          |                          
|                                            |                          
|Weighted average shares outstanding-diluted |                          
|                                            |                          

For the three  months  ended June 30, 2004 and 2003,  options to purchase  329  thousand  shares and 44 thousand  shares of common
stock,  respectively,  were  excluded  from the  calculation  of the  diluted  weighted  average  shares  outstanding  since  they were
anti-dilutive.  For the six months ended June 30,  2004 and 2003,  options to purchase  419  thousand  shares and 446 thousand  shares of common
stock,  respectively,  were  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 and six months ended June 30, 2004 and 2003 are as follows:

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

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 and six months ended June 30, 2004 and 2003 (in thousands).

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

5

---

Comprehensive Income:  Comprehensive income for the three and six months ended June 30, 2004 and 2003 is as follows (in thousands):

|                                          | 2004 | 2003
|----------------------------------------- | ---- | ----
|
|Net income                                |      |     
|Realized gains                            |      |     
|Net change in unrealized gain, net of tax |      |     
|                                          |      |     
|Total comprehensive income                |      |     
|                                          |      |     

Note B-Commitments and Contingencies

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 was 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.  During the second  quarter of 2004,  this matter was settled by the parties for a
payment  of $25  million by Vesta to NRMA.  As a result of the  settlement,  the  Company  recorded  a gain of $3.8  million in the 2nd
quarter.  Vesta  made  such  payment  in July of 2004 and  cancelled  the  letters  of  credit  of $29.8  million  related  to the NRMA
arbitration.

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 is currently 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 October 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.

6

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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. Document discovery has 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.

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 six  months  ended  June  30,  2004,  funding  of  such  expenses  was
approximately $10 thousand.

Other

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's 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 for any adverse  results from this lawsuit  regardless of the outcome of the pending  divestiture
of American Founders.

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.

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 into a $30 million  revolving  credit  arrangement  with First  Commercial  Bank of Birmingham,
Alabama ("First  Commercial"),  collateralized by a pledge of 4.7 million shares of our holding company's ownership in the common stock
of Affirmative  Insurance  Holdings,  Inc. The facility bears interest at First Commercial's prime rate and will mature no earlier than
June 30, 2005.  As of June 30, 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 June 30, 2004, the Company was in
non-compliance  with its  consolidated  debt to capital ratio and GAAP net worth  covenants.  First  Commercial has waived its right to
declare an Event of  Default  under the credit  agreement  due to our  failure  to comply  with  these  covenants  at any time prior to
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.

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.

7

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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 standard  property  and casualty  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. At June 30, 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 June 30, 2004 and 2003 is as follows (in thousands):

|2004                                      | Standard Property-Casualty | Life Insurance | Non-Standard Underwriting | Non-Standard Agency | Corporate and Other | Eliminations | Total  
|----------------------------------------- | -------------------------- | -------------- | ------------------------- | ------------------- | ------------------- | ------------ | -------
|Revenues:                                 |                            |                |                           |                     |                     |              |        
|Premiums earned                           |                            |                | $                         | 58,854              |                     | $            | 1,891  
|Agency fees and commissions               |                            |                |                           | --                  |                     |              | --     
|Net investment income                     |                            |                |                           | --                  |                     |              | 6,610  
|Policy fees                               |                            |                |                           | 2,016               |                     |              | 716    
|Realized gains (losses)                   |                            |                |                           | --                  |                     |              | 1,162  
|Other                                     |                            |                |                           | 150                 |                     |              | 531    
|                                          |                            |                |                           |                     |                     |              |        
|Total revenues                            |                            |                |                           | 61,020              |                     |              | 10,910 
|Expenses:                                 |                            |               
|Loss, LAE and policyholder benefits       |                            |                |                           | 43,334              |                     |              | 5,249  
|Policy acquisition costs                  |                            |                |                           | 4,178               |                     |              | 9      
|Litigation settlement and arbitration     |                            |                |                           |                     |                     |              |        
|award gain                                |                            |                |                           |                     |                     |              |        
|Operating expenses                        |                            |                |                           | 10,748              |                     |              | 2,113  
|Interest on debt                          |                            |                |                           | --                  |                     |              | 1,261  
|Deferrable capital security distributions |                            |                |                           | --                  |                     |              | --     
|                                          |                            |                |                           |                     |                     |              |        
|Total expenses                            |                            |                |                           | 58,260              |                     |              | 8,632  
|                                          |                            |                |                           |                     |                     |              |        
|Pre-tax income (loss)                     |                            |               
|from continuing operations                |                            |                | $                         | 2,760               |                     | $            | 2,278  
|                                          |                            |                |                           |                     |                     |              |        
|Operating segment assets:                 |                            |               
|Investments and other assets              |                            |                | $                         | 390,019             |                     | $            | 837,703
|Deferred acquisition costs                |                            |                |                           | 15,058              |                     |              | 20,982 
|Goodwill and other intangibles            |                            |                |                           | 59,238              |                     |              | 10,760 
|                                          |                            |                |                           |                     |                     |              |        
|                                          |                            |                | $                         | 464,315             |                     | $            | 869,445
|                                          |                            |                |                           |                     |                     |              |        

|2003                                | Standard Property-Casualty | Life Insurance | Non-Standard Underwriting | Non-Standard Agency | Corporate and Other | Eliminations | Total  
|----------------------------------- | -------------------------- | -------------- | ------------------------- | ------------------- | ------------------- | ------------ | -------
|Revenues:                           |                            |                |                           |                     |                     |              |        
|Premiums earned                     |                            |                | $                         | 79,348              |                     | $            | 2,317  
|Agency fees and commissions         |                            |                |                           | --                  |                     |              | --     
|Net investment income               |                            |                |                           | --                  |                     |              | 7,078  
|Policy fees                         |                            |                |                           | 2,892               |                     |              | 632    
|Realized gains (losses)             |                            |                |                           | --                  |                     |              | 242    
|Other                               |                            |                |                           | 164                 |                     |              | 719    
|                                    |                            |                |                           |                     |                     |              |        
|Total revenues                      |                            |                |                           | 82,404              |                     |              | 10,988 
|Expenses:                           |                            |               
|Loss, LAE and policyholder benefits |                            |                |                           | 64,997              |                     |              | 5,214  
|Policy acquisition costs            |                            |                |                           | 17,785              |                     |              | 41     
|Operating expenses                  |                            |                |                           | 11,264              |                     |              | 2,407  
|Interest on debt                    |                            |                |                           | --                  |                     |              | 1,436  
|                                    |                            |                |                           |                     |                     |              |        
|Total expenses                      |                            |                |                           | 94,046              |                     |              | 9,098  
|                                    |                            |                |                           |                     |                     |              |        
|Pre-tax income (loss)               |                            |               
|from continuing operations          |                            |                | $                         | (11,642             | )                   | $            | 1,890  
|                                    |                            |                |                           |                     |                     |              |        
|Operating segment assets:           |                            |               
|Investments and other assets        |                            |                | $                         | 379,745             |                     | $            | 864,069
|Deferred acquisition costs          |                            |                |                           | 42,909              |                     |              | 20,142 
|Goodwill and other intangibles      |                            |                |                           | 59,574              |                     |              | 10,760 
|                                    |                            |                |                           |                     |                     |              |        
|                                    |                            |                | $                         | 482,228             |                     | $            | 894,971
|                                    |                            |                |                           |                     |                     |              |        

9

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A summary of segment results for the six months ended June 30, 2004 and 2003 is as follows (in thousands):

|2004                                             | Standard Property-Casualty | Life Insurance | Non-Standard Underwriting | Non-Standard Agency | Corporate and Other | Eliminations | Total 
|------------------------------------------------ | -------------------------- | -------------- | ------------------------- | ------------------- | ------------------- | ------------ | ------
|
|Revenues:                                        |                            |                |                           |                     |                     |              |       
|Premiums earned                                  |                            |                | $                         | 119,341             |                     | $            | 4,191 
|Agency fees and commissions                      |                            |                |                           | --                  |                     |              | --    
|Net investment income                            |                            |                |                           | --                  |                     |              | 13,747
|Policy fees                                      |                            |                |                           | 4,263               |                     |              | 1,338 
|Realized gains (losses)                          |                            |                |                           | --                  |                     |              | 1,617 
|Other                                            |                            |                |                           | 377                 |                     |              | 964   
|                                                 |                            |                |                           |                     |                     |              |       
|Total revenues                                   |                            |                |                           | 123,981             |                     |              | 21,857
|Expenses:                                        |                            |               
|Loss, LAE and policyholder benefits              |                            |                |                           | 84,899              |                     |              | 11,361
|Policy acquisition costs                         |                            |                |                           | 7,795               |                     |              | 220   
|Litigation settlement and arbitration            |                            |                |                           |                     |                     |              |       
|award gain                                       |                            |                |                           |                     |                     |              |       
|Operating expenses                               |                            |                |                           | 21,812              |                     |              | 4,272 
|Interest on debt                                 |                            |                |                           |                     |                     |              | 2,562 
|Deferred capital security distributions          |                            |                |                           | --                  |                     |              | --    
|                                                 |                            |                |                           |                     |                     |              |       
|Total expenses                                   |                            |                |                           | 114,506             |                     |              | 18,415
|                                                 |                            |                |                           |                     |                     |              |       
|Pre-tax income (loss) from continuing operations |                            |                | $                         | 9,475               |                     | $            | 3,442 
|                                                 |                            |                |                           |                     |                     |              |       

|2003                                | Standard Property-Casualty | Life Insurance | Non-Standard Underwriting | Non-Standard Agency | Corporate and Other | Eliminations | Total 
|----------------------------------- | -------------------------- | -------------- | ------------------------- | ------------------- | ------------------- | ------------ | ------
|
|Revenues:                           |                            |                |                           |                     |                     |              |       
|Premiums earned                     |                            |                | $                         | 155,760             |                     | $            | 4,727 
|Agency fees and commissions         |                            |                |                           | --                  |                     |              | --    
|Net investment income               |                            |                |                           | --                  |                     |              | 14,773
|Policy fees                         |                            |                |                           | 4,954               |                     |              | 1,125 
|Realized gains (losses)             |                            |                |                           | --                  |                     |              | 232   
|Other                               |                            |                |                           | 406                 |                     |              | 1,361 
|                                    |                            |                |                           |                     |                     |              |       
|Total revenues                      |                            |                |                           | 161,120             |                     |              | 22,218
|Expenses:                           |                            |               
|Loss, LAE and policyholder benefits |                            |                |                           | 117,991             |                     |              | 10,304
|Policy acquisition costs            |                            |                |                           | 36,413              |                     |              | 409   
|Operating expenses                  |                            |                |                           | 22,269              |                     |              | 4,859 
|Interest on debt                    |                            |                |                           | --                  |                     |              | 2,889 
|                                    |                            |                |                           |                     |                     |              |       
|Total expenses                      |                            |                |                           | 176,673             |                     |              | 18,461
|                                    |                            |                |                           |                     |                     |              |       
|Pre-tax income (loss)               |                            |               
|from continuing operations          |                            |                | $                         | (15,553             | )                   | $            | 3,757 
|                                    |                            |                |                           |                     |                     |              |       

As  discussed  in more detail in Note E, we  consummated  an initial  public  offering of  Affirmative  Insurance  Holdings,  Inc.
("AIHI"),  our non-standard  underwriting and non-standard agency holding company. Based on this transaction and our post-IPO ownership
of AIHI,  we will not  consolidate  the  operating  results of the  non-standard  underwriting  and  agency  operations.  As such,  the
operating  results of these  segments will be  eliminated  from our segment  reporting in the future and our pro-rata  share of the net
earnings of AIHI will be reflected in our Corporate segment.

10

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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.

Note E-Acquisitions and Dispositions

Effective July 9, 2004, the initial public offering of 8.2 million shares of Affirmative  Insurance Holdings,  Inc. ("AIHI"),  the
Company's  non-standard  auto holding  company,  was  consummated  at a price of $14 per share.  Of the shares sold, 4.4 million shares
were newly issued shares  offered by AIHI while 3.8 million shares were by offered by the Company.  Additionally,  on July 26, 2004 the
underwriters  of AIHI's  initial  public  offering  exercised in full the  over-allotment  option to purchase an additional 1.2 million
shares of AIHI common  stock at a price of $14 per share.  Of the shares  sold in  connection  with the  over-allotment,  663  thousand
shares were newly issued shares offered by Affirmative while 562 thousand shares were offered by the Company.

The Company received total net proceeds from these  transactions of approximately  $55.4 million and retains  approximately 43% of
the  outstanding  shares of AIHI.  The  Company  anticipates  that the  gross  gain from  these  transactions  will be in excess of $10
million,  which will be recorded in the third  quarter.  The Company's  remaining  ownership in AIHI will be recorded  using the equity
method  beginning  in the third  quarter of 2004.  As such,  the Company  will not  consolidate  the  balance  sheet and  statement  of
operations of AIHI.  Rather,  the Company will reflect its pro rata share of its  investment in the equity of AIHI as an investment and
its share of the operating  results of AIHI in the Company's  consolidated  statement of operations.  The Company will be filing a Form
8-K by August 13, 2004 providing pro-forma financial information following the initial public offering of AIHI.

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,  AIHI  acquired  the 20%  minority  interest  in  InsureOne  Independent  Agency,  LLC for
$10.3 million.  The transaction was 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 all periods presented 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 and six months ended June 30, 2004 were not materially  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 and six months ended June 30, 2004, we recorded a loss for reinsurance  assumed and commercial  lines  businesses of
$3.2  million  and $4.1  million,  respectively.  These  losses  are  primarily  related to costs  associated  with  commuting  certain
reinsurance treaties and development of losses on these lines beyond our original estimates.

Based upon available  information,  we believe the recorded  reserves for  discontinued  operations at June 30, 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

11

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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,  warranted
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
and six months ended June 30, 2004 only reflects  income tax expense related to our life insurance  operations,  which are not included
in the Vesta Insurance Group, Inc.  consolidated  income tax return,  certain state income taxes not impacted by our deferred tax asset
valuations and changes to our deferred tax balances related to our  available-for-sale  investment securities that are reflected in our
consolidated  financial  statements  at fair value.  For the six months ended June 30,  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
$74.7 million.

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.

Effective  June 30, 2004,  the Company  commuted the 2003 50% Quota Share  Agreement  on a cut-off  basis.  Under the terms of the
commutation,  the Company will receive  payment for all reserves  previously  ceded to the reinsurers  and will be responsible  for all
losses incurred on or prior to June 30, 2004 from policies subject to this agreement.

Simultaneous  with the  commutation  of the 2003 50% Quota  Share  Agreement,  the  Company  entered  into a new 50% quota share
agreement  ("2004 50% Quota Share  Agreement").  The 2004 50% Quota Share  Agreement is effective for residential  property  business in
our  Continuing  States,  including  Texas and  retains  similar  economic  terms  including  ceding  commissions  and  profit  sharing
commissions.  The initial  term of the  contract is one year,  with the Company  retaining  the option to reduce the quota share amount
ceded under this contract to 25%, effective January 1, 2005.

The impact of the  commutation of the 2003 50% Quota Share  Agreement and the execution of the 2004 50% Quota Share  Agreement was
to increase  reinsurance  balances  recoverable on paid losses of  approximately  $30.0  million,  representing  the amounts due for  commissions  and the
previously ceded reserves.

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.

Effective December 31, 2003, the Company executed certain internal  reinsurance  contracts,  the results of which were to cede all
future  premiums and losses,  loss adjustment  expenses earned or incurred after December 31, 2003 to the insurance  companies owned by
AIHI. Based on the terms of these reinsurance  contracts,  Vesta Fire Insurance  Company retained its loss and loss adjustment  expense
reserves  as of  December  31,  2003 and  remains  liable for any  losses  incurred  on or prior to  December  31,  2003 as well as any
subsequent development of loss and loss adjustment reserves related to those losses.

The Company recorded a cumulative  adjustment  during the second quarter of 2004 related to a mutually agreed upon  interpretation
by a  third-party  reinsurer  and the  Company of certain  provisions  of a  reinsurance  contract  incepted  in 2001.  The  cumulative
adjustment  resulted in an increase to net written  premiums and net earned  premiums of $39.7 million,  an increase to losses and loss
adjustment  expenses of $30.8 million and an increase to policy  acquisition  expenses of $8.8 million.  The cumulative  adjustment was
recorded in our non-standard underwriting segment.

Our reinsurance agreements, including our standard property and casualty quota share agreements, contain various provisions
such as profit sharing arrangements, loss ratio limitations, and occurrence limitations that limit the reinsurers' aggregate exposure
to loss and thereby reducing the ultimate cost to us as the ceding company.  The features also have the effect of potentially
reducing the amount of reinsurance recoveries available for us under the various contracts.

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Furthermore, these reinsurance agreements do not relieve the Company from its primary obligation to policyholders, as it remains liable to its policyholders to the extent that any reinsurer does not meet its obligations for reinsurance ceded to it under reinsurance contracts.

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 and to address our insurance  companies'  financial  strength ratings by A.M. Best
and other rating agencies,  we began a capital  evaluation in March of 2003. To date,  management's  capital evaluation has resulted in
the  completion  of several  significant  transactions  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  business in an effort to strengthen our capital position.  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.

A significant  component of our capital evaluation related to our divestiture of our non-standard auto business through an initial
public  offering.  Effective July 9, 2003, the initial public offering of 8.2 million shares of Affirmative  Insurance  Holdings,  Inc.
("AIHI"),  the Company's  non-standard  auto holding  company,  was  consummated  at a price of $14 per share.  Of the shares sold, 4.4
million  shares were newly issued shares offered by AIHI while 3.8 million  shares were offered by the Company.  Additionally,  on July
26, 2004 the underwriters of AIHI's initial public offering exercised the  over-allotment  option to purchase an additional 1.2 million
shares of AIHI common  stock at a price of $14 per share.  Of the shares  sold in  connection  with the  over-allotment,  663  thousand
shares were newly issued shares offered by Affirmative while 562 thousand shares were offered by the Company.

The Company received total net proceeds from these  transactions of approximately  $55.4 million and retains  approximately 43% of
the outstanding shares of AIHI. The Company  anticipates the gross gain from these  transactions to be in excess of $10 million,  which
will be recorded in the third quarter.  The Company's  remaining  ownership in AIHI will be recorded using the equity method  beginning
in the third  quarter of 2004.  As such,  the Company will not  consolidate  the balance  sheet and  statement of  operations  of AIHI.
Rather,  the Company  will reflect its pro rata share of its  investment  in the equity of AIHI as an  investment  and its share of the
operating results of AIHI in the Company's  consolidated  statement of operations.  The Company will be filing a Form 8-K by August 13,
2004 providing pro-forma financial information following the initial public offering of AIHI.

The significance of the consummation of the initial public offering for AIHI in relation to our overall  financial  condition is
threefold.  First, the separation of our  non-standard  auto premium writings greatly reduces the net premium writings of our remaining
standard property and casualty  insurance  companies.  The reduced  aggregate  writings will improve our statutory  financial  strength
ratios.  Additionally,  our remaining  ownership in AIHI is more liquid than was  previously the case.  This  increased  liquidity will
allow the Company better  flexibility to redeploy  capital to better support the  operations of our remaining  segments.  Finally,  our
financial  condition,  from a statutory  perspective,  could be further  improved  with  increases in AIHI's stock price,  although our
insurance companies are subject to downside risk as well.

During the first  quarter of 2004,  A.M.  Best  announced  that their  financial  strength  ratings of our property and casualty
insurance  companies were under review "with negative  implications",  reflecting  what we believed to be the impact from the announced
$55.8 million  statutory charge recorded by the Company in the first quarter of 2004 as well as the general  uncertainties  relating to
the  consummation of our various capital  improvement  transactions.  Subsequent to the  consummation of the initial public offering of
AIHI, A.M. Best announced an affirmation of our B (Fair) rating with a "stable  outlook".  Management  believes that the affirmation of
our B rating  reflects the improved  financial  condition of the Company  following the initial public  offering of AIHI.  Furthermore,
management  believes  that with the  consummation  of the AIHI  initial  public  offering,  the  Company's  opportunity  to improve its
financial ratings is now largely dependent upon our continued  improved  operating results and, to a lesser degree, the consummation of
our divestiture of our life insurance business.

Improving the financial  strength ratings of the standard  property and casualty  insurance  companies remains a top priority of
the  Company.  Management  is  continuing  to focus its efforts on  improving  these  financial  condition  ratings as evidenced by the
renewal of the 50% quota share  agreement  on our  homeowners  book of business and the  implementation  of  long-term  cost  reduction
initiatives.  While we believe our on-going  operations,  coupled with the use of  reinsurance  and cost  reduction  initiatives,  will
result in improvements in our financial  stability,  the Company's on-going segments remain exposed to various external factors such as
catastrophic  weather  events,  regulatory  oversight,  and  competition  from other  insurance  companies.  Such factors  could have a
material  adverse  impact on our results of operations  and could greatly  hamper the Company's  ability to obtain an improved  rating.
Management  is unable to  quantify  the impact to our future  business  in the event we are unable to  improve  our  current  financial
strength rating.

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Standard property-casualty and non-standard underwriting segments

The financial results of our property-casualty  underwriting activities (including our standard property-casualty segment and the
non-standard  underwriting  segments)  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, which has estimated annualized written premiums of $20.5 million.

During 2003,  we also received  approval for 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 million.  In the second quarter, we received approval for
a weighted average premium increase of approximately 18.6% in Arizona,  Massachusetts,  Alaska and New Jersey on estimated annual gross
written premiums of approximately $25.9 million.

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 current  surplus  levels,  coupled  with the  decrease in net written  premiums  resulting  from our
separation of our non-standard  automobile  underwriting  segment and our current utilization of reinsurance,  is such that the Company
is now in a position to increase  written premium  levels.  In addition,  continued  improvements in our surplus levels from consistent
profitability  of our standard  property and casualty  segment may allow the Company to reduce its current  level of  reinsurance  as a
means to increase net written  premiums.  However,  such  opportunities  are largely  dependent  upon  underwriting  decisions,  future
operating  results and the overall  competitive  environment.  Tightening  underwriting  guidelines  and lower policy holder  retention
renewal levels resulting from rate increases could negatively  impact our ability to increase net written  premiums.  Furthermore,  the
failure of the  Company to improve its current B financial  strength  rating  could also  negatively  impact  current  written  premium
levels.  As such, no assurances can be made that premium volumes will be retained or increased.

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.

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Comparison of Second Quarter 2004 to Second Quarter 2003

For the quarter  ended June 30,  2004,  we reported net income  available to common  shareholders  of $8.7  million,  or $0.24 per
diluted  share,  compared with a net loss available to  shareholders  of $11.6  million,  or $0.33 per diluted share,  reported for the
previous year.

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

- Our
 combined  ratio in the  standard  property-casualty  segment was 95.7% as  compared  to
114.4% for the second  quarter of                     2003.  The  combined  ratio for the
current  quarter  reflects an  improvement  in the loss ratio from 79.0% in the
                    prior year to 71.2% in the second quarter of 2004  reflecting the
reduction in catastrophe  losses from $20 million                     in the prior period
compared to $5.4 million in the current quarter.  Furthermore,  the current quarter's
 combined                     ratio reflects a $13.6 million  reduction in policy
 acquisition  expenses  principally due to our increased use of
                    reinsurance and improved terms on this reinsurance.
- Revenues
from our  non-standard  agency segment  increased  18.2% from the second quarter of 2003.
In addition,  higher levels                     of  profit  sharing  commissions
 recognized  in  the  second  quarter  of  2004  resulted  in an  increase  in our
                    non-standard agency margin from 10.2% in the prior year to 15.2% in
the second quarter of 2004.
- A
gain of $3.8 million was recognized in the second  quarter of the current year related to
the settlement of our  arbitration                     with NRMA on our 1997 20% whole
account quota share treaty.
- The
establishment of a full valuation  allowance for our net deferred tax assets in 2003,
 coupled with the utilization of net                     operating loss  carryforwards
 during the current quarter,  reduced the amount of income tax expenses  reflected in
                    the second quarter of 2004 from the effective rate experienced in
prior years.

For a depiction of the various  components  of revenue,  expense and financial  results for each of our business  segments for the
three and six months ending June 30, 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 second quarter of 2004, the standard  property-casualty  segment
generated approximately $61.0 million in revenue, or approximately 33.8% of consolidated revenue.

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.

Effective  June 30, 2004,  the Company  commuted the 2003 50% Quota Share  Agreement  on a cut-off  basis.  Under the terms of the
commutation,  the Company will receive  payment for all reserves  previously  ceded to the reinsurers  and will be responsible  for all
losses incurred on or prior to June 30, 2004 from policies subject to this agreement.

Simultaneous  with the  commutation  of the 2003 50% Quota  Share  Agreement,  the  Company  entered  into a new 50% quota share
agreement  ("2004 50% Quota Share  Agreement").  The 2004 50% Quota Share  Agreement is effective for residential  property  business in
our  Continuing  States,  including  Texas and  retains  similar  economic  terms  including  ceding  commissions  and  profit  sharing
commissions.  The initial  term of the  contract is one year,  with the Company  retaining  the option to reduce the quota share amount
ceded under this contract to 25%, effective January 1, 2005.

Net written premiums  decreased $25.2 million,  or 30.9%, to $56.3 million during the three months ended June 30, 2004 compared to
net written  premiums of $81.5  million for the three months ended June 30, 2003  reflecting a $19.5  million  reduction in net written
premiums  resulting  from the  abovementioned  50% quota share  agreement.  Additionally,  the Company's  decision to withdraw from the
homeowners  and  standard  automobile  lines  in the  Midwest  and  Mid-Atlantic  regions  further  reduced  net  written  premiums  by
approximately  $2.8  million.  The  remaining  $2.9  million  decrease is primarily  attributable  to tighter  underwriting  guidelines
implemented in the latter half of 2003, our increased  premium rates in various states,  and other  competitive  factors.  Net premiums
earned during the three months ended June 30, 2004  decreased  $20.5 million,  or 25.8%,  as compared to the second 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, the run-off of premiums in those states from which we are withdrawing and other competitive factors.

Policy fees, which are fees earned by our insurance companies based on gross written premiums,  were $2.0 million during the three
months  ended June 30, 2004  compared to $2.9  million for the same period in the prior year.  The decrease in policy fees is primarily
due to the higher level of policy fee cessions to reinsurers in the current quarter as compared to the prior quarter.

Loss and loss  adjustment  expenses  (LAE) for standard  property  casualty  lines for the period ended June 30, 2004 decreased by
$21.7  million,  or 33.4%,  to $43.3 million from $65.0 million in the prior year.  The decrease in loss and loss  adjustment  expenses
incurred  was  primarily  attributable  to a reduction  of  catastrophe  losses from $20 million in the second  quarter of 2003 to $5.4
million in the second quarter of 2004 and the cession of losses in the current quarter  related to the 2003 50% Quota Share  Agreement,
offset  by  higher  loss  ratios  in  certain  western  states  and the  Northeastern  United  States.  The  loss  ratio  for  standard
property-casualty  segment  decreased  to 71.2% for the second  quarter of 2004 from 79.0% for the three  months  ended June 30,  2003.
Excluding  the impact of  catastrophe  losses,  the loss ratio for the current  period was 62.3%  compared to 54.7% in the prior period
reflecting adverse loss experience in certain western states and the Northeastern United States.

For the quarter ended June 30, 2004,  policy  acquisition  expenses  decreased by $13.6 million to $4.2 million from $17.8 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 $6.7  million of the decrease

15

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in policy  acquisition  expenses.  In  addition,  the decrease in overall net
premiums earned resulting from the increased use of reinsurance  resulted in the remaining $6.9 million  decrease.  Policy  acquisition
costs as a percentage  of net premiums  earned for the quarter ended June 30, 2004 was 7.1% as compared to 22.4% for the same period in
the prior year.

Operating  expenses decreased $0.5 million to $10.7 million during the three months ended June 30, 2004 from $11.3 million for the
same period in the prior year.  The decrease in  operating  expenses is primarily  attributable  to a lower level of standard  property
and casualty related legal expenses.

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 second
quarter of 2004, our non-standard  agency segment generated  approximately  $40.1 million of commission and fees-based revenue, or 19.6
% of aggregate revenue, before eliminations.

For the quarter ended June 30, 2004,  fees and commissions in our agency segment  increased by $6.2 million.  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 $2.6 million,  or 74.3%,
to $6.1  million for the three months ended June 30, 2004  compared to $3.5  million for 2003.  The gross margin of the agency  segment
was 15.2% of total revenues in the current year compared to 10.2% in the prior year,  reflecting the more favorable  commission  rates,
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 second quarter of 2004, our non-standard  underwriting  segment generated  approximately $89.5 million of revenue,  representing
approximately 49.6% of consolidated revenue.

For the quarter ended June 30, 2004, net premiums earned for  non-standard  lines increased by $41.6 million to $83.4 million from
$41.8  million in the prior  period.  The  significant  increase in net  premiums  earned is primarily  due to a cumulative  adjustment
during the second  quarter of 2004 related to a mutually  agreed upon  interpretation  by a  third-party  reinsurer  and the Company of
certain  provisions  of a  reinsurance  contract  incepted in 2001.  The  cumulative  adjustment  resulted in an increase to net earned
premiums of $39.7 million.  The remaining $1.9 million  increase is primarily due to a new non-standard  auto program  initiated in the
second quarter of 2003 in the state of California and various changes to our reinsurance programs.

Policy fees, which are fees earned by our insurance  companies based on gross written premiums,  increased $0.6 million during the
three  months  ended June 30, 2004 to $6.1  million  from $5.5  million  for the same period in the prior year.  Policy fee income as a
percentage of earned  premiums,  excluding the cumulative  adjustment noted above,  decreased  slightly from 13.2% in the prior year to
13.9% in the current year.

Loss and loss adjustment  expenses for the non-standard  underwriting  segment  increased by $30.5 million to $59.1 million in the
second  quarter of 2004  compared  to $28.6  million in second  quarter  of 2003.  The  primary  increase  in loss and loss  adjustment
expenses  relates to the  abovementioned  cumulative  adjustment,  which included a $30.8 million  increase in the second quarter.  The
loss ratio for our non-standard  underwriting  segment at June 30, 2004 was 66.1%,  compared with 60.4% at June 30, 2003. Excluding the
impact of the  abovementioned  adjustment,  the loss  ratio in the  second  quarter of 2004 was 56.7%  compared  to 60.4% in 2003.  The
decrease in this loss 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 June 30, 2004, policy  acquisition  expenses and operating expenses increased $10.0 million to $27.2 million
from $17.2 million in 2003.  The cumulative  adjustment  noted above  accounted for $8.8 million of the increase in policy  acquisition
expenses.  Policy  acquisition  expenses and  operating  expenses as a percentage  of earned  premiums and policy fees,  excluding  the
cumulative  adjustment,  increased to 37.0% for the quarter ended June 30, 2004 from 36.3% in 2003,  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 June 30, 2004,  American  Founders had  approximately  $2.0 billion  (face value) of life and annuity  products in force,
and approximately $722.7 million in invested assets.

In the second quarter of 2004, our life insurance segment generated  approximately $10.9 million in revenue, or approximately 6.0%
of consolidated  revenue.  Our life insurance  segment pre-tax income  increased $0.4 million,  or 21.1%, to $2.3 million for the three
months ended June 30, 2004 compared to $1.9 million for 2003.  This  increase is  attributed to higher levels of realized  gains in the
current quarter, offset by lower earned premiums and lower investment income.

Investment  income  decreased  $0.5  million  from $7.1  million for the three  months  ended June 30, 2003 to $6.6 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 since the first  quarter of 2003.  The  weighted  average  annualized  yield on invested  assets for the second
quarter of 2004 (excluding  realized and unrealized  gains/losses  and assets held in trust related to our  reinsurance  agreement with
ERC) was 4.6%  compared  with 5.1% for the prior year  period.  Offsetting  the  decrease  in yield on our  invested  assets was a 3.0%
increase in average  invested  assets.  Policyholder  benefits  remained  unchanged at $5.2 million for the second  quarter of 2004 and
2003.

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Corporate and other segment

For the quarter ended June 30, 2004, net investment income related to our property-casualty  underwriting  operations decreased by
$0.2 million to $2.6 million from $2.8 million in 2003.  Average  invested  assets  decreased  from $416.9 million in the prior quarter
to $346.1 million in the current  quarter,  reflecting the reduction of invested assets resulting from the increased use of reinsurance
during the latter half of 2003 and through the first half of 2004. The weighted  average  annualized  yield on invested  assets for the
quarter ended June 30, 2004 (excluding realized and unrealized gains/losses) was 3.0% compared with 2.8% 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 remained approximately unchanged from the prior year.

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
June 30, 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 in 2004.

In 2004,  operating  expenses  decreased $0.6 million from $5.1 million in the second quarter of 2003 to $4.5 in second quarter of
2004 reflecting a decrease in lease costs and lower 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 all periods presented 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 ended June 30, 2004 were not materially  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 June 30, 2004,  we recorded a loss for  reinsurance  assumed and  commercial  lines  business of $3.2
million.  These losses are primarily  related to costs  associated  with  commuting  certain  reinsurance  treaties and  development of
losses on these lines beyond our original estimates.

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 June 30, 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,  certain state income taxes not impacted by our deferred tax asset valuations
and  changes  to our  deferred  tax  balances  related  to our  available-for-sale  investment  securities  that are  reflected  in our
consolidated financial statements at fair value.

Comparison of Six Months Ended June 30, 2004 with Six Months Ended June 30, 2003

For the six months ended June 30, 2004, we reported net income  available to common  shareholders  of $17.5 million,  or $0.49 per
diluted  share,  compared with a net loss  available to  shareholders  of $7.9 million,  or $0.23 per diluted  share,  reported for the
previous year.

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

- Our
 combined  ratio in the  standard  property-casualty  segment  was 92.6% as compared to
109.9% for the first six months of                     2003.  The  combined  ratio for
the  current  period  reflects an  improvement  in the loss ratio from 73.4% in the
                    prior year to 68.7% in the first half of 2004  reflecting  the
reduction in  catastrophe  losses from $23.3 million                     in the prior
 period  compared to $7.6  million in the six months  ended June 30,  2004.  Furthermore,
 the current                     quarter's combined ratio reflects a $28.6 million
reduction in policy acquisition  expenses  principally due to our
                    increased use of reinsurance and improved terms on this reinsurance.
- Revenues
from our non-standard  agency segment  increased 13.2% from the first six months of 2003.
In addition,  higher levels                     of profit  sharing  commissions
 recognized in the first half of 2004  resulted in an increase in our  non-standard
                    agency margin from 11.5% in the prior year to 16.7% in the six months
ended June 30, 2004.
- A
gain of $3.8 million was recognized in the second  quarter of the current year related to
the settlement of our  arbitration                     with NRMA on our 1997 20% whole
account quota share treaty.
- The
establishment of a full valuation  allowance for our net deferred tax assets in 2003,
 coupled with the utilization of net                     operating loss  carryforwards
 during the current quarter,  reduced the amount of income tax expenses  reflected in
                    the first half of 2004 from the effective rate experienced in prior
years.

Standard property-casualty segment

In the first  half of 2004,  the  standard  property-casualty  segment  generated  approximately  $124.0  million in  revenue,  or
approximately 37.8% of consolidated revenue.

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Net written  premiums  decreased $49.8 million,  or 30.5%, to $113.3 million during the six months ended June 30, 2004 compared to
net written  premiums of $163.1  million for the six months  ended June 30, 2003  reflecting a $37.2  million  reduction in net written
premiums  resulting  from the  abovementioned  50% quota share  agreement.  Additionally,  the Company's  decision to withdraw from the
homeowners  and  standard  automobile  lines  in the  Midwest  and  Mid-Atlantic  regions  further  reduced  net  written  premiums  by
approximately  $10.7 million.  The remaining $1.9 million decrease is attributable to tighter  underwriting  guidelines  implemented in
the latter half of 2003, our increased  premium rates in various  states,  and other  competitive  factors.  Net premiums earned during
the six months ended June 30, 2004  decreased  $36.4  million,  or 23.4%,  as compared to the first half 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,  the
run-off of premiums in those states from which we are withdrawing and other competitive factors.

Policy fees, which are fees earned by our insurance  companies based on gross written  premiums,  were $4.3 million during the six
months  ended June 30, 2004  compared to $5.0  million for the same period in the prior year.  The decrease in policy fees is primarily
due to the higher level of policy fee cessions to reinsurers in the first six months of 2004 as compared to the prior year.

Loss and loss adjustment  expenses (LAE) for standard  property casualty lines for the six months ended June 30, 2004 decreased by
$33.1 million,  or 28.1%,  to $84.9 million from $118.0 million in the prior year.  The decrease in loss and loss  adjustment  expenses
incurred was primarily  attributable to a reduction of catastrophe  losses from $23.3 million in the first half of 2003 to $7.6 million
in the first half of 2004 and the  cession of losses in the current  period  related to the 2003 50% Quota  Share  Agreement.  The
loss ratio for  standard  property-casualty  segment  decreased to 68.7% for the first half of 2004 from 73.4% for the six months ended
June 30, 2003 reflecting the overall decrease in catastrophe  losses.  Excluding the impact of catastrophe  losses,  the loss ratio for
the current period was 62.5% compared to 58.9% in the prior period  reflecting  adverse loss  experience in certain  western states and
the Northeastern United States.

For the six months ended June 30, 2004, policy acquisition  expenses decreased by $28.6 million to $7.8 million from $36.4 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 $16.6  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 $12.0 million decrease.  Policy  acquisition
costs as a  percentage  of net premiums  earned for the six months  ended June 30, 2004 was 6.5% as compared to 23.4 % for the same period
in the prior year.

Operating  expenses  decreased  $0.5 million to $21.8 million  during the six months ended June 30, 2004 from $22.3 million in the
same period in the prior year.  The decrease in  operating  expenses is primarily  attributable  to a lower level of standard  property
and casualty related legal expenses.

Non-standard agency segment

In the first half of 2004, our non-standard  agency segment  generated  approximately  $82.5 million of commission and fees-based
revenue, or 21.9% of aggregate revenue,  before  eliminations,  reflecting the continued accretion of agency acquisitions made in prior
periods.

For the six months ended June 30, 2004,  fees and  commissions  in our agency segment  increased by $9.6 million.  The increase in
fees and  commission in our agency segment is principally  due to more  favorable  commission  rates and an increase of $3.8 million in
profit sharing  commissions  related to positive loss ratio development.  Our agency segment pre-tax income increased $5.4 million,  or
64.3%,  to $13.8  million for the six months  ended June 30, 2004  compared to $8.4  million for 2003.  The gross  margin of the agency
segment was 16.7% of total revenues in the current year compared to 11.5% in the prior year,  reflecting the more favorable  commission
rates,  higher  level of profit  sharing  commission  in the current  year and cost  reductions  stemming  principally  from  headcount
reductions.

Non-standard underwriting segment

In the first half of 2004, our non-standard  underwriting segment generated approximately $143.1 million of revenue,  representing
approximately 43.6% of consolidated revenue.

For the six months ended June 30, 2004, net premiums  earned for  non-standard  lines increased by $50.1 million to $130.6 million
from $80.5 million in the prior period.  The significant  increase in net premiums  earned is primarily due to a cumulative  adjustment
during the second  quarter of 2004 related to a mutually  agreed upon  interpretation  by a  third-party  reinsurer  and the Company of
certain  provisions  of a  reinsurance  contract  incepted in 2001.  The  cumulative  adjustment  resulted in an increase to net earned
premiums of $39.7 million.  The remaining  $10.4 million  increase is primarily due to new business  produced by our affiliated  agency
operations,  which acquired several agencies in late 2001 and early 2002, and a new non-standard  auto program  initiated in the second
quarter of 2003 in the state of California.

Policy fees, which are fees earned by our insurance  companies based on gross written premiums,  increased $1.6 million during the
six months  ended June 30, 2004 to $12.2  million  from $10.6  million  for the same  period in the prior year.  Policy fee income as a
percentage of earned  premiums,  excluding the cumulative  adjustment noted above,  decreased  slightly from 13.2% in the prior year to
13.4% in the current year.

Loss and loss adjustment  expenses for the non-standard  underwriting  segment  increased by $35.5 million to $90.4 million during
the six months ended June 30, 2004  compared  to $55.1  million in the first half of 2003.  The primary  increase  in loss and loss  adjustment
expenses  relates to the  abovementioned  cumulative  adjustment,  which included a $30.8 million  increase in the second quarter.  The
loss ratio for our non-standard  underwriting  segment at June 30, 2004 was 63.3%,  compared with 60.5% at June 30, 2003. Excluding the
impact of the  abovementioned  adjustment,  the loss  ratio in the  first half of 2004 was 57.8%  compared  to 60.5% in 2003.  The
decrease in this loss 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 six months ended June 30, 2004,  policy  acquisition  expenses and  operating  expenses  increased  $14.3 million to $46.6
million  from $32.3  million in 2003.  The  cumulative  adjustment  noted above  accounted  for $8.8  million of the increase in policy
acquisition  expenses.  Policy  acquisition  expenses  and  operating  expenses as a  percentage  of earned  premiums  and policy fees,
excluding  the  cumulative  adjustment,  increased  to 36.7% for the six  months  ended  June 30,  2004 from  35.5% in 2003,  primarily
attributable  to higher profit  sharing  commissions  recognized  during the current  quarter as compared to the prior period offset by
higher ceding commission received on ceded business.

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Life insurance segment

In the first half of 2004, our life insurance segment generated  approximately  $21.9 million in revenue, or approximately 6.7% of
consolidated  revenue.  Our life insurance segment pre-tax income decreased $0.4 million,  or 10.5%, to $3.4 million for the six months
ended June 30, 2004  compared to $3.8 million for 2003.  This  decrease is  attributed  to lower earned  premiums and lower  investment
income, partially offset by higher levels of realized gains.

Investment income decreased $1.1 million from $14.8 million for the six months ended June 30, 2003 to $13.7 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.  The weighted average annualized yield on invested assets for the first half of 2004 (excluding realized and
unrealized gains/losses and assets held in trust related to our reinsurance agreement with ERC) was 4.8% compared with 5.1% for the
prior year period.  Offsetting the decrease in yield on our invested assets was a 2.5% increase in average invested

assets.  Policyholder  benefits  increased $1.1 million in the current year primarily due to the adoption of Statement of Position
03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional  Long-Duration  Contracts and for Separate Accounts
("SOP 03-1"),  which 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 for additional information regarding the adoption of SOP 03-1.

Corporate and other segment

For the six months ended June 30, 2004, net investment income related to our property-casualty  underwriting  operations decreased
by $1.7 million to $5.0 million from $6.7 million in 2003.  Average  invested  assets  decreased  to $349.8 million in the current year
from $417.8 million in 2003,  reflecting the reduction of invested  assets  resulting from the increased use of reinsurance
during the latter half of 2003 and through the first half of 2004. The weighted  average  annualized  yield on invested  assets for the
quarter ended June 30, 2004 (excluding realized and unrealized gains/losses) was 2.9% compared with 3.3% 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 remained approximately unchanged from the prior year.

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 six months ended June
30, 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 $0.9 million was included as
a component of pre-tax income (loss) in the corporate and other segment in 2004.

In 2004,  operating  expenses decreased $0.8 million from $9.1 million in the first half of 2003 to $8.3 million in the first half
of 2004 reflecting a decrease in lease costs and lower legal expenses mainly attributable to our reinsurance arbitrations.

Discontinued operations

Due to the disposal of our health insurance and consulting business lines in 2003, our financial  statements as of and for the six
months ended June 30, 2004 were not materially impacted from our previous health insurance and consulting business lines.

For the six  months  ended June 30, 2004,  we recorded a loss for  reinsurance  assumed and  commercial  lines  business of $4.1
million.  These losses are primarily  related to costs  associated  with  commuting  certain  reinsurance  treaties and  development of
losses on these lines beyond our original estimates.

Based upon available  information,  we believe the recorded  reserves for  discontinued  operations at June 30, 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 six months ended June 30, 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,  certain state income taxes not impacted by our deferred tax asset valuations
and  changes  to our  deferred  tax  balances  related  to our  available-for-sale  investment  securities  that are  reflected  in our
consolidated financial statements at fair value.

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 (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

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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 into a $30 million  revolving  credit  arrangement  with First  Commercial  Bank of Birmingham,
Alabama ("First  Commercial"),  collateralized by a pledge of 4.7 million shares of our holding company's ownership in the common stock
of Affirmative  Insurance  Holdings,  Inc. The facility bears interest at First Commercial's prime rate and will mature no earlier than
June 30, 2005.  As of June 30, 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 June 30, 2004, the Company was in
non-compliance  with its  consolidated  debt to capital ratio and GAAP net worth  covenants.  First  Commercial has waived its right to
declare an Event of  Default  under the credit  agreement  due to our  failure  to comply  with  these  covenants  at any time prior to
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 June
30, 2004, Vesta Fire was  contingently  liable for $38.5 million under the terms of letters of credit obtained in connection with these
reinsurance  disputes.  Letters of credit of $29.8 million were  cancelled in  conjunction  with our  settlement of the NRMA portion of
the 1997 20% whole  account  quota  share  agreement  under which we agreed to pay NRMA $25  million.  Such  cancellations  and payment
occurred in  July of 2004.

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 June 30, 2004, we had pledged  securities  with a market
value of approximately $8.2 million pursuant to these reinsurance contracts.

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 June 30,
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  $3.4
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.

20

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Cash Flows

On a  consolidated  basis,  net cash  provided by (used in)  operations  for the six months  ended June 30, 2004 and 2003 was $7.2
million and $(25.3)  million,  respectively.  Cash flow from operations for the current period improved from the prior period primarily
due to increased net income,  decreased cash outflows related to the policy  acquisition costs and the timing of payments  associated with
reinsurers,  offset lower levels of unearned premium  reflecting the Company's  increased use of reinsurance during the current period.
Net cash  used in  investing  activities  was $6.2  million  and  $46.3  million  for the six  months  ended  June 30,  2004 and  2003,
respectively  as the level of investment  security  purchases  decreased  during the current  quarter,  offset by decreases in security
sales, and the level of acquisitions  decreased.  Net cash used in financing  activities was $1.8 million and $13.1 million for the six
months ending June 30, 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  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 June 30, 2004 is  reflected as a component of total
liabilities from the previous "mezzanine" debt classification.  Furthermore,  Deferrable Capital Security distributions of $0.4 million
and $0.9  million  for the three and six months  ended June 30,  2004,  respectively,  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, in the
first  quarter  of fiscal  year 2004.  The  charge 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 six months ended June 30, 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.

21

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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 June 30, 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.

##### PART II
Item 1. Legal Proceedings

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 was 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.  During the second  quarter of 2004,  this matter was settled by the parties for a
payment  of $25  million by Vesta to NRMA.  As a result of the  settlement,  the  Company  recorded  a gain of $3.8  million in the 2nd
quarter.  Vesta  made  such  payment  in July of 2004 and  cancelled  the  letters  of  credit  of $29.8  million  related  to the NRMA
arbitration.

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 is currently 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 October 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.

22

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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. Document discovery has 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.

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 six  months  ended  June  30,  2004,  funding  of  such  expenses  was
approximately $10 thousand.

Other

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's 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 for any adverse  results from this lawsuit  regardless of the outcome of the pending  divestiture
of American Founders.

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.

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.

23

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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

At the annual  meeting of  stockholders  held June 1, 2004,  the following  matters were  submitted to a vote of  stockholders  (shares
eligible to vote: 36,067,740).

1. Election of DirectorsMessrs.
Robert
B.D. Batlivala, Kevin J. Tierney and T. Owen Vickers were elected to additional
 three-year terms on the               Board of Directors.For
     WithheldBatlivala
     
     
     33,696,948
        
     879,989Tierney
     33,990,998
        
     585,939Vickers
     33,986,664
        
     590,273
2. Ratification of Amendment to Long Term Incentive PlanThe

Company's
Long Term Incentive Plan is extended until December 31, 2008.For
     Against
     Abstain
     Non-Vote21,490,027
        
     2,477,732
        
     79,238
        
     10,529,940
3. Ratification of Independent Registered Public Accounting FirmPricewaterhouseCoopers

LLP
was appointed as the Independent Registered Public Accounting Firm of the Company and its  subsidiaries
for the year ending December 31, 2004.For
     Against
     AbstainPricewaterhouseCoopers LLP
     
     
     33,913,525
        
     506,575
        
     156,837

Item 5.  Other Information

None.

24

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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 May 10 and June 1, 2004 in connection with press releases.

25

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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:  August 9, 2004

26

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