---

## 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, 2001

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 10, 2001
33,075,560

---

# Vesta
Insurance Group, Inc.

Index

|Part I  | Financial Information                                                                              | Page
|------- | -------------------------------------------------------------------------------------------------- | ----
|Item 1. | Financial Statements:                                                                              |     
|        | Consolidated Balance Sheets at June 30, 2001 and December 31, 2000                                 | 1   
|        | Consolidated Statements of Income and Comprehensive Income for the                                 |     
|        | Three Months and Six Months ended June 30, 2001 and 2000                                           | 2   
|        | Consolidated Statements of Cash Flows for three months and six months ended June 30, 2000 and 2001 | 3   
|        | Notes to Consolidated Financial Statements                                                         | 4   
|Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations              | 11  
|        |                                                                                                    |     
|
|Item 1. | Legal Proceedings                                                                                  | 15  
|Item 2. | Changes in Securities                                                                              | 17  
|Item 3. | Defaults Upon Senior Securities                                                                    | 17  
|Item 4. | Submission of Matters to a Vote of Securities                                                      | 17  
|Item 5. | Other Information                                                                                  | 17  
|Item 6. | Exhibits and Reports on Form 8-K                                                                   | 18  

---

# Part I
Item 1. Financial Statements

Vesta Insurance Group, Inc.

Consolidated Balance Sheets

(amounts in thousands except share and per share data)

`June 30,      December 31,
                                                                                   2001            2000
                                                                               -------------  ---------------
                                                                               (unaudited)
Assets:
  Investments:
  Fixed maturities available for sale - at fair value
      (cost:  2001 - $776,331;  2000 - $795,118)                                $ 789,952        $ 798,205
  Equity securities--at fair value:(cost: 2001-$24,507; 2000- $30,221)             24,965           31,285
  Mortgage and collateral loans                                                    56,901           63,060
  Policy loans                                                                     62,996           61,413
  Short-term investments                                                           43,632           22,586
  Other invested assets                                                            37,791           29,343
                                                                               -------------  ---------------
            Total investments                                                   1,016,237        1,005,892
  Cash                                                                             76,328           13,374
  Accrued investment income                                                        18,668           17,017
  Premiums in course of collection (net of allowances for losses
       of $4,106 in 2001 and $3,937 in 2000)                                       42,224           23,882
  Reinsurance balances receivable                                                 350,294          353,949
  Reinsurance recoverable on paid losses                                           68,680           57,325
  Deferred policy acquisition costs                                                50,952           45,954
  Deferred income taxes                                                            17,902           22,457
  Other assets                                                                    143,232           82,149
                                                                               -------------  ---------------
            Total assets                                                      $ 1,784,517      $ 1,621,999
                                                                               =============  ===============

Liabilities:
  Policy liabilities                                                            $ 664,137        $ 660,284
  Losses and loss adjustment expenses                                             250,614          263,689
  Unearned premiums                                                               138,804          104,755
  Federal Home Loan Bank advances                                                 167,780          150,691
  Short term debt                                                                   5,000            5,000
  Long term debt                                                                   86,428           86,419
  Other liabilities                                                               164,214          102,825
                                                                               -------------  ---------------
            Total liabilities                                                   1,476,977        1,373,663

Commitments and contingencies: See Note B

Deferrable Capital Securities                                                      29,750           33,225

Stockholders' equity:
  Preferred stock, $.01 par value, 5,000,000 shares authorized, issued:
       2001 - 0 and 2000 - 2,950,000                                                                    30
  Common stock, $.01 par value, 100,000,000 shares authorized,  issued:
       2001 - 33,489,322 and 2000 - 18,964,322                                        306              190
  Additional paid-in capital                                                      214,423          167,382
  Accumulated other comprehensive income, net of  tax expense
       of $4,019 and $1,453  in 2001 and 2000, respectively                         7,464            2,698
  Retained earnings                                                                66,938           57,643
  Treasury stock (413,762 shares and 166,294 shares at cost
       at June 30, 2001 and December 31, 2000, respectively)                       (3,346)          (5,865)
  Unearned stock                                                                   (7,995)          (6,967)
                                                                               -------------  ---------------
            Total stockholders' equity                                            277,790          215,111
                                                                               -------------  ---------------
            Total liabilities, deferrable capital securities
              and stockholders' equity                                        $ 1,784,517      $ 1,621,999
                                                                               =============  ===============`

See accompanying Notes to Consolidated Financial Statements

---

# Vesta
Insurance Group, Inc.

Consolidated Statements of Income and Comprehensive Income
Statements of Income
(amounts in thousands except per share data)

`Three months ended            Six months ended
                                                                             June 30,                     June 30,
                                                                             2001           2000          2001           2000
                                                                          ------------   ------------  ------------   ------------
                                                                          (unaudited)                  (unaudited)
Revenues:
  Net premiums written                                                     $ 74,255       $ 55,896      $135,467       $105,023
  Change in unearned premiums                                                   (64)        (3,758)        4,119          3,680
                                                                          ------------   ------------  ------------   ------------
  Net premiums earned                                                        74,191         52,138       139,586        108,703
  Policy fees                                                                 1,728            239         2,981            239
  Net investment income                                                      17,110          5,258        32,713         12,261
  Realized gains                                                              2,522             --         4,228             --
  Other                                                                       2,596          1,085         4,742          1,412
                                                                          ------------   ------------  ------------   ------------
     Total revenues                                                          98,147         58,720       184,250        122,615
Expenses:
  Policyholder benefits                                                       8,938             --        16,995             --
  Losses and loss adjustment expenses incurred                               39,071         25,815        77,772         65,594
  Policy acquisition expenses                                                16,975         11,994        31,377         24,437
  Operating expenses                                                         15,236          8,941        29,889         18,926
  Interest on debt                                                            4,487          2,763         9,145          6,166
  Goodwill and other intangible amortization                                    969            603         1,495            754
                                                                          ------------   ------------  ------------   ------------
     Total expenses                                                          85,676         50,116       166,673        115,877
Income from continuing operations before taxes, minority interest,
   and deferrable capital securities                                         12,471          8,604        17,577          6,738
Income tax expense                                                            4,341          2,961         6,186          2,184
Minority interest, net of tax                                                   532             --           780             --
Deferrable capital security distributions, net of tax                           383            571           766          1,142
                                                                          ------------   ------------  ------------   ------------
Net Income from continuing operations                                         7,215          5,072         9,845          3,412
Income (loss) from discontinued operations, net of tax                         (163)        (2,833)         (158)         1,080
Extraordinary gain on debt extinguishments, net of tax                           --            683            --          5,250
                                                                          ------------   ------------  ------------   ------------
      Net income                                                              7,052          2,922         9,687          9,742
Preferred stock dividend                                                         --           (563)         (163)        (1,126)
Gain on redemption of preferred securities, net of tax                           --             --           565             --
                                                                          ------------   ------------  ------------   ------------
Net income available to common shareholders                                 $ 7,052        $ 2,359      $ 10,089        $ 8,616
                                                                          ============   ============  ============   ============
Net income from continuing operations per share - Basic                      $ 0.30         $ 0.28        $ 0.46         $ 0.19
                                                                          ============   ============  ============   ============
Net income available to common shareholders per share - Basic                $ 0.30         $ 0.13        $ 0.47         $ 0.47
                                                                          ============   ============  ============   ============
Net income from continuing operations per share - Diluted                    $ 0.30         $ 0.21        $ 0.43         $ 0.14
                                                                          ============   ============  ============   ============
Net income available to common shareholders per share - Diluted              $ 0.29         $ 0.12        $ 0.45         $ 0.40
                                                                          ============   ============  ============   ============

                     Statements of Comprehensive Income
Net income                                                                  $ 7,052        $ 2,922       $ 9,687        $ 9,742
Other comprehensive income, net of tax:
    Unrealized holding gains on available-for-sale securities
      net of tax expense of $2,380, $294, $4,046 and $1,050, respectively.    4,420            547         7,514          1,951
    Less realized gains on available-for-sale securities net of
      tax expense of $883 and $1,480, respectively.                           1,639             --         2,748             --
                                                                          ------------   ------------  ------------   ------------
                                                                              2,781            547         4,766          1,951
Gain on extinuishment of preferred securities, net of tax expense of $305                                    565
                                                                          ------------   ------------  ------------   ------------
Comprehensive income                                                        $ 9,833        $ 3,469      $ 15,018       $ 11,693
                                                                          ============   ============  ============   ============`

See accompanying Notes to Consolidated Financial Statements

---

# Vesta
Insurance Group, Inc.

Consolidated Statements of Cash Flows

(amounts in thousands)

`Six months ended June 30,
                                                                                2001            2000
                                                                             ------------   --------------
                                                                             (unaudited)
Operating Activities:
  Net income                                                                   $ 9,687          $ 9,742
  Adjustments to reconcile net income to cash used in operations
     Changes in:
     Loss and LAE reserves, and future policy liabilities                      (36,700)         (78,380)
     Unearned premium reserves                                                  (1,766)         (17,883)
     Reinsurance balances receivable                                            17,795           26,391
     Premiums in course of collection                                          (15,368)          18,997
     Reinsurance recoverable on paid losses                                    (11,355)           6,639
     Other assets and liabilities                                               16,779          (12,284)
  Policy acquisition costs deferred                                             31,478          (10,967)
  Policy acquisition costs amortized                                           (31,377)          17,799
  Realized gains                                                                (4,228)              --
  Amortization and depreciation                                                  4,347            2,753
  Extraordinary gain                                                                --           (5,250)
                                                                             ------------   --------------
         Net cash used in operations                                           (20,708)         (42,443)

Investing Activities:
  Investments sold, matured, and called:
     Fixed maturities available for sale                                       221,900           61,439
  Investments acquired:
     Fixed maturities available for sale                                      (159,860)         (18,178)
     Equity securities                                                         (10,376)              --
     Other invested assets                                                      (8,448)              --
  Net cash paid for acquisition                                                     --           (4,634)
  Net (increase) decrease in short-term investments                            (14,178)          72,839
  Additions to property and equipment                                           (3,554)          (1,591)
                                                                             ------------   --------------
         Net cash provided from investing activities                            25,484          109,875

Financing Activities:
  Net change in FHLB borrowings                                                 16,336               --
  Net deposits and withdrawals to (from) insurance liabilities                  (2,732)              --
  Retirement of long term debt and  preferred securities                            --          (47,967)
  Issuance of common stock                                                      96,381           21,263
  Acquisition of common stock                                                  (50,788)         (23,625)
  Dividends paid                                                                (1,019)          (1,021)
                                                                             ------------   --------------
         Net cash provided by (used in) financing activities                    58,178          (51,350)
Increase in cash                                                                62,954           16,082
Cash at beginning of period                                                     13,374           17,677
                                                                             ------------   --------------
Cash at end of period                                                         $ 76,328         $ 33,759
                                                                             ============   ==============`

See accompanying Notes to Consolidated Financial Statements

---

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

## Note
ASignificant Accounting Policies

Basis
of Presentation:The accompanying unaudited interim financial statements
have been prepared in conformity with accounting principles generally accepted
in the United States and, in the opinion of management, reflect all adjustments
(consisting of normal recurring accruals) necessary for a fair presentation of
results for such periods. The results of operations and cash flows for any
interim period are not necessarily indicative of results for the full year.
These financial statements should be read in conjunction with the financial
statements and related notes which have been issued by the Company and filed
with the Securities and Exchange Commission.

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

New
Accounting Standards:In June 2001, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets (Statement 142). Statement 142 supercedes
Accounting Principles Board Opinion 17, Intangible Assets, and addresses
how intangible assets acquired individually or within a group of other assets
are accounted for in financial statements upon their acquisition. Statement 142
is effective for fiscal years beginning after December 15, 2001.

In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, Business Combinations (Statement 141).
Statement 141 requires the use of the purchase method for all business combinations.  Statement 141 is effective for all business
combinations occurring after June 30, 2001.

The
Company is currently evaluating the impact of these statements on our operating
results and financial condition.

In
June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS
No. 133 and subsequent amendments standardize the accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, by requiring that an entity recognize those items as assets or
liabilities in the financial statements and measure them at fair value.
Management has evaluated our activities and has determined that Vesta does not
currently have any material derivative exposures and that the adoption of the
SFAS No. 133 on January 1, 2001 did not have a material impact on the financial
statements.

Change
in compensation plan: Effective June 30, the Board of Directors approved a
change to the Executive Officer Incentive Compensation Plan such that Messrs.
Gayle, Tait, and Thornton agreed to accept 1.25 million shares of restricted
stock and a $5.0 million loan as satisfaction of Vestas obligations under
the terms of the plan. The restrictions on the stock award and the loan
repayments are lifted over a 10 year vesting period in accordance with the terms
of the plan.

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.

Reconciliation
of income available to common shareholders and average shares outstanding for
the six months ending June 30, 2001 and 2000 and the three months ending June
30, 2001 and 2000 are as follows:

`Six months ended June 30,
                                                                 2001             2000
                                                            ----------------  --------------
Net income available to common shareholders                        $ 10,089         $ 8,616
Preferred stock dividends on convertible preferred stock                163           1,126
                                                            ----------------  --------------
Adjusted net income available to common shareholders               $ 10,252         $ 9,742
                                                            ================  ==============

Weighted average shares outstanding-basic (1)                        21,334          18,387
Stock options and restricted stock                                      452             234
Weighted average convertible preferred stock (1)                        945           5,900
                                                            ----------------  --------------
Weighted average shares outstanding-diluted (1)                      22,731          24,521
                                                            ================  ==============`

4

---

`Three months ended June 30,
                                                                 2001             2000
                                                            ---------------- ---------------
Net income available to common shareholders                         $ 7,052         $ 2,359
Preferred stock dividends on convertible preferred stock                 --             563
                                                            ---------------- ---------------
Adjusted net income available to common shareholders                $ 7,052         $ 2,922
                                                            ================ ===============

Weighted average shares outstanding-basic (1)                        23,784          18,099
Stock options and restricted stock                                      498             250
Weighted average convertible preferred stock (1)                         --           5,900
                                                            ---------------- ---------------
Weighted average shares outstanding-diluted (1)                      24,282          24,249
                                                            ================ ===============`

| | (1)    Reflects weighted averages. At June 30, 2001, Vesta had 33.1 million shares
outstanding and zero shares of convertible preferred stock outstanding. Weighted
average shares outstanding for earnings per share purposes do not include shares
held by the Agents Stock Incentive Plan Trust that have not been allocated
to participants, and shares issued as restricted stock that represent unearned
amounts.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Earnings per share for discontinued  operations and  extraordinary  gains for the three and six months ended June 30,
2001 and 2000 are as follows:

`2001                            2000
                                     3 month        6 month         3 month        6 month
                                   ------------  -------------    -------------  ------------
Basic Earnings per share:
    Discontinued Operations            $ (0.01)       $ (0.01)         $ (0.02)       $ 0.06
    Extraordinary Gain                      --             --           $ 0.04        $ 0.29
Diluted Earnings per share:
    Discontinued Operations            $ (0.01)       $ (0.01)          $ 0.01        $ 0.04
    Extraordinary Gain                      --             --           $ 0.03        $ 0.21`

## Note
BCommitments and Contingencies

Securities Litigation

Subsequent
to the filing of our quarterly report on Form 10-Q for the period ended March
31, 1998 with the U.S. Securities and Exchange Commission (SEC or
Commission), we commenced an internal investigation to determine the
exact scope and amount of certain reductions of reserves and overstatement of
premium income in our reinsurance assumed business that had been recorded in the
fourth quarter of 1997 and the first quarter of 1998. This investigation
concluded that inappropriate amounts had, in fact, been recorded and we
determined that we should restate our previously issued 1997 financial
statements and first quarter 1998 Form 10-Q. Additionally, during our internal
investigation we were advised by our then outside auditors that there was an
error in the accounting methodology used to recognize earned premium income in
our reinsurance business. We had historically reported certain assumed
reinsurance premiums as earned in the year in which the related reinsurance
contracts were entered even though the terms of those contracts frequently
bridged two years. We determined that reinsurance premiums should be recognized
as earned over the contract period and corrected the error in our accounting
methodology by restating previously issued financial statements. On June 1, 1998
and June 29, 1998, we issued press releases, which were filed with the
Commission, regarding the matters addressed in this section.

We
restated our previously-issued financial statements for 1995, 1996, and 1997 and
our first quarter 1998 Form 10-Q for the above items by issuance of a current
report on Form 8-K dated August 19, 1998. These restatements resulted in a
cumulative decrease to stockholders equity of approximately $75.2 million
through March 31, 1998. Commencing in June 1998, we and several of our current
and former officers and directors were named as defendants in several purported
class action lawsuits filed in the United States District Court for the Northern
District of Alabama. Several of our officers and directors also have been named
in a derivative action lawsuit in the Circuit Court of Jefferson County,
Alabama, in which Vesta is a nominal defendant. In addition, we received various
inquiries and requests for information from various state departments of
insurance and other regulatory authorities, including a subpoena issued to Vesta
on August 24, 1998 by the Commission as part of a formal, non-public order of
investigation. We fully responded to such requests in 1998, and no further
requests for information from Vesta have been made by the Commission.

5

---

In
March 1999, the actions filed in the United States District Court for the
Northern District of Alabama were consolidated into a single action in that
district and certified as a class action. Torchmark Corporation and KPMG Peat
Marwick LLP, our outside auditor at the time, were added as additional
defendants in the consolidated class action. The consolidated amended complaint
alleges violations of certain federal securities laws and seeks unspecified but
potentially substantial damages. The court has denied all motions to dismiss and
the class action is presently in discovery, with a trial date set for November
5, 2001. We are vigorously defending this litigation but there is no assurance
of its outcome. The parties have conducted settlement discussions, but have not
been successful in reaching any resolution to date. The derivative case has been
stayed and placed on the administrative docket.

We
have several layers of directors and officers liability insurance
coverage (D&O insurance), the terms of which may cover all or a
portion of the damages or settlement costs of the class action. These policies
provide up to $100 million in D&O insurance to cover damages or settlement
costs and an additional policy provides another layer of $10 million D&O
insurance to cover any damages awarded by a court in these actions. Cincinnati
Insurance Company (Cincinnati) issued the primary policy that
provides the first $25 million of D&O insurance. Federal Insurance Company
(The Chubb Group of Insurance Companies) issued an excess D&O insurance
policy which provides coverage for the second $25 million in losses, if
necessary. The balance of the coverage is provided by a group of insurers and
was purchased after the class actions comprising the consolidated class action
were filed. In September 1998, after these actions were filed, Cincinnati, which
provides the primary insurance policy, filed a lawsuit in the United States
District Court for the Northern District of Alabama seeking to rescind the
policy and avoid the coverage. That action was dismissed for lack of subject
matter jurisdiction, and we then filed an action against Cincinnati in the
Circuit Court of Jefferson County, Alabama, to enforce the policy and to recover
damages arising out of Cincinnatis actions. Cincinnati filed an answer and
counterclaim in that action, seeking to rescind the policy and avoid the
coverage. This action is in the discovery stage and the outcome is uncertain.
There is no assurance that the primary insurance coverage will ultimately be
available for any damages or settlement costs incurred. The outcome of this
litigation may also materially affect the availability of the excess policy
issued by The Chubb Group. The damages sought by stockholder plaintiffs in the
consolidated class action, either at trial or through settlement, may be
substantial. If the damages or settlement costs incurred in connection with the
consolidated class action and derivative action are ultimately determined not to
be covered by our D&O insurance policies for any reason, we may incur a
significant and material loss which could have a material and adverse impact on
our financial condition and results of operation.

The
consolidated class action is in the discovery stage with a current trial date of
November 5, 2001 and the derivative action has been placed on the administrative
docket. The ultimate outcome of these matters is uncertain. Accordingly, we have
not currently set aside any financial reserves relating to any of the
above-referenced actions.

Indemnification Agreements and Liability Insurance

Pursuant
to Delaware law and our Bylaws, 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 agreed to advance
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.

Arbitration

As
discussed above, 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 by 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% whole
account quota share treaty which was terminated on June 30, 1998 on a run-off
basis. We believe such treatment is appropriate under the terms of this treaty
and have calculated the quarterly reinsurance billings presented to the three
treaty participants accordingly. The aggregate amount included herein as
recoverable from such reinsurers totaled approximately $55.2 million as of June
30, 2001. We have collected approximately $48.5 million from the drawdown of
collateral on hand.

NRMA
Insurance, Ltd. (NRMA), one of the participants in the 20% 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 fund any
amounts NRMA may recover as a result of the arbitration. We filed for
arbitration against the other two participants in the treaty and all of these
arbitrations are in their discovery stages. While management believes its
interpretation of the treatys terms and computations based thereon are
correct, the ultimate outcome of these arbitrations is uncertain and their
ultimate outcome cannot be determined at this time.

During
1999, F&G Re (on behalf of USF&G), filed for arbitration under two
aggregate stop loss reinsurance treaties whereby F&G Re assumed certain risk
from us. F&G Re is seeking to rescind the treaties and avoid its obligation.
Under the terms of the two treaties, we believe we will be entitled to
recoveries of approximately $28.2 million as losses mature from prior accident
years. Vesta has recorded a reinsurance

6

---

recoverable of approximately $28.2
million as of June 30, 2001 and December 31, 2000 related to these two treaties.
This arbitration is in its early stage and the ultimate outcome cannot be
determined at this time.

We
are in arbitration with CIGNA Property and Casualty Insurance Company
(CIGNA) (now ACE USA) under a personal lines insurance quota share
reinsurance agreement, whereby we assumed certain risks from CIGNA. During
September 2000, CIGNA filed for arbitration under the reinsurance agreement,
seeking payment of the balances that CIGNA claims are due under the terms of the
treaty. In addition, during the fourth quarter, the treaty was terminated on a
cut-off basis. Vesta is seeking recoupment of all improper claims payments and
excessive expense allocations and charges from CIGNA. This arbitration is in the
discovery stage and the ultimate outcome cannot be determined at this time.

If
the amounts recoverable under the relevant treaties are ultimately determined to
be materially less than the amounts that we have reported as recoverable, we may
incur a significant, material, and adverse impact on our financial condition and
results of operations.

Other Litigation

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 us and our  subsidiaries,  management  does not consider  liability  from any  threatened or pending  litigation
regarding routine matters to be material.

## Note CSegment Information

In
2000, we changed our segments to reflect our entering new lines of business, and
exiting old lines of business. We operate several segments, which are
distinguishable by their product offerings. The accounting policies of the
operating segments are the same as used in preparing the consolidated financial
statements. Segment pre-tax income is generally income before income tax, and
minority interest, if any. Premiums, policy fees, other income, loss and benefit
expenses, and amortization of deferred acquisition costs are attributed directly
to each operating segment. Operating expenses are allocated to the segments in a
manner which most appropriately reflects the operations of that segment. Net
investment income and interest expense are allocated only to those segments for
which such amounts are considered an integral part of the financial results for
that segment.

A brief description of each segment is as follows:

## Standard Property-Casualty

The
standard property-casualty segment primarily consists of the marketing and
distribution of personal lines products including Homeowners and Personal Auto
coverages. Vestas products are distributed through approximately 1,900
independent agencies in 24 states. Our personal auto line targets drivers over
age thirty-five with above average driving records and our homeowners products
cover the full range of homes.

## Life and Health Insurance

On
June 30, 2000, we entered the life and annuity business through a 71% investment
in American Founders Financial Corporation, a holding company for two life
insurance companies domiciled in Texas and we entered the health insurance
business through the acquisition of Aegis Financial Corporation in December
2000. American Founders and Aegis have approximately $2.2 billion (face value)
of life and annuity products in force and $22.5 million of health insurance
premiums in force at June 30, 2001. American Founders markets traditional life
products, universal life products, fixed-rate annuities, pension contracts and
related products through independent agents throughout the majority of the
United States. Aegis Financial markets health insurance through captive agents
throughout the United States.

## Specialty Lines

In
2000, we began utilizing our licences to write business for the benefit of
certain reinsurance companies. In this segment, we enter into arrangements
whereby we write targeted property-casualty insurance coverages and reinsure
substantially all of the risks to reinsurers in exchange for fees. This business
takes advantage of our certificates of authority granting us license to write
insurance in many states. Income in this segment is primarily generated on a
fee-for-service basis.

7

---

## Non-Standard

In
December 2000, we acquired a 52% economic interest in Instant Auto Insurance
Holdings, Inc. Instant Auto operates as a non-standard insurance agency. Its
principal revenue stream is agents fees and commissions.

## Corporate and Other

Our
corporate and other segment primarily consists of unallocated net investment
income, unallocated interest expense, and certain overhead expenses not directly
associated with a particular segment.

A summary of segment results for the six months ended June 30, 2001 and 2000 is as follows:

`2001
                                                    Standard      Life and
                                                    Property       Health        Specialty                        Corporate
                                                    Casualty      Insurance        Lines        Non-Standard      and Other
                                                   ------------   ------------   -----------    ------------   ------------
                                                                                (in thousands)
Revenues:
    Premiums earned                                   $121,553        $ 14,947       $ 3,086
    Net investment income                                   --          21,790            --           $ 260       $ 10,663
    Policy fees                                          1,031           1,950            --              --             --
    Realized gains                                          --           1,398            --              --          2,830
    Other                                                  420             235         1,804             798          1,485
                                                   ------------   -------------  ------------   -------------   ------------
           Total revenues                              123,004          40,320         4,890           1,058         14,978
Expenses:
    Loss, LAE and policyholder benefits                 75,475          16,995         2,297              --             --
    Policy acquisition costs                            26,577           4,157           643              --             --
    Operating expenses                                  14,405           6,567           157           2,827          5,933
    Interest on debt                                        --           4,628            --              --          4,517
    Goodwill and other intangible amortization              --              --            --              --          1,495
                                                   ------------   -------------  ------------   -------------   ------------
           Total expenses                              116,457          32,347         3,097           2,827         11,945

Pre-tax income (loss) from continuing operations       $ 6,547         $ 7,973       $ 1,793        $ (1,769)       $ 3,033
                                                   ============   =============  ============   =============   ============
Operating segment assets:
    Investments and other assets                      $333,458       $ 925,653      $ 11,493        $ 24,135      $ 353,719
    Deferred acquisition costs                          32,140           1,573           253              --             --
                                                   ------------   -------------  ------------   -------------   ------------
                                                      $365,598       $ 927,226      $ 11,746        $ 24,135      $ 353,719
                                                   ============   =============  ============   =============   ============`

8

---

`2000
                                                    Standard       Life and
                                                    Property        Health        Specialty                          Corporate
                                                    Casualty       Insurance        Lines         Non-Standard       and Other
                                                   ------------  -------------   -------------    ------------       ----------
                                                                        (in thousands)
Revenues:
    Premiums earned                                 $108,703              --             --            --
    Net investment income                                 --              --             --            --            $ 12,261
    Policy fees                                          239              --             --            --                 --
    Realized losses                                       --              --             --            --                 --
    Other                                                 --              --             --            --               1,412
                                                 ------------    ------------   ------------     ------------      ----------
                Total revenues                       108,942              --             --            --              13,673
Expenses:
    Loss, LAE and policyholder benefits               65,594              --             --            --                 --
    Policy acquisition costs                          24,437              --             --            --                 --
    Operating expenses                                13,127              --             --            --               5,799
    Interest on debt                                      --              --             --            --               6,166
    Goodwill and other intangible amortization            --              --             --            --                 754
                                                 ------------    -------------   ------------    ------------       ----------
                Total expenses                       103,158              --             --            --              12,719

Pre-tax income (loss) from continuing operations     $ 5,784              --             --            --               $ 954
                                                 ============   ==============   ============    ============      ==========
Operating segment assets:
    Investments and other assets                    $268,517       $ 697,223             --            --           $ 340,090
    Deferred acquisition costs                        27,784          32,713             --            --               --
                                                   ------------ ---------------  ------------    ------------     -----------
                                                    $296,301       $ 729,936                                        $ 340,090
                                                   ============ ===============  ============    ============     ===========`

## Note
DStock Transactions

In
the first quarter of 2001, we engaged in a number of stock transactions. On
January 20, 2001, we issued approximately 380,000 shares of common stock in
exchange for $3.475 million face amount of Deferrable Capital Securities. On
January 26, 2001, the holders of our Series A Convertible Preferred Stock
converted their shares into 5.9 million shares of common stock pursuant to their
original conversion terms. We repurchased that common stock for approximately
$47.2 million. In separate transactions, we sold 5.5 million shares of common
stock to a number of investors for approximately $32.3 million. These
transactions and other transactions resulted in Vesta repurchasing 6.4 million
shares of its common stock for approximately $50.8 million and issuing 5.9
million shares of its common stock for approximately $32.3 million of cash and
$3.475 million face amount of Deferrable Capital Securities.

In the second quarter of 2001, we engaged in a follow-on offering of our common stock.  We sold 8.625 million shares of common
stock for approximately $64.0 million after expenses.

## Note
EAcquisition of Florida Select Insurance Holdings, Inc.

Effective
April 1, 2001, we acquired Florida Select Insurance Holdings Inc, the parent
company of Florida Select Insurance Company. Florida Select is the
8th largest residential homeowners insurer in the State of Florida
with approximately $140.0 million of assets and $60.0 of annual gross written
premium. The transaction has been accounted for as a purchase. Summarized below
is a preliminary allocation of assets and liabilities acquired and the
consolidated results of operations for the six-month periods ended June 30, 2001
and 2000 on an unaudited pro forma basis as if the acquisition had occurred as
of January 1, 2000. The pro forma information is based on our consolidated
results of operations for the six-months ended June 30, 2001 and 2000 and on
data provided by the acquired company, after giving effect to certain pro-forma
adjustments, including the issuance of 8.625 million shares of common stock. The
pro forma financial information does not purport to be indicative of results of
operations that would have occurred had the transactions occurred on the basis
assumed above nor are they indicative of results of the future operations of the
combined enterprises.

9

---

Assets and liabilities acquired (in thousands except per share amounts and unaudited):

`Assets acquired:
     Invested assets                  $ 56,707
     Cash                               20,764
     Other assets                       27,107
     Goodwill                           35,288
                                  -------------
          Total assets                 139,866

Liabilities acquired:
     Loss and LAE reserves              22,019
     Unearned premiums                  35,100
     Other liabilities                  16,334
                                  -------------
                                        73,453`

Pro forma consolidated results of operations are as follows: (unaudited)

`Six months ended June 30,
                                                                     2001            2000
                                                               --------------  --------------
Total revenues                                                     $ 200,831       $ 149,199
Income available to common shareholders                               13,889          13,137
Income available to common shareholders per share - basic             $ 0.46          $ 0.49
Income available to common shareholders per share - diluted           $ 0.45          $ 0.43`

10

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

## Results of
Operations

Vesta
writes insurance on selected personal lines risks only. Our Standard-Property
Casualty writings are balanced between risks of property damage (faster
determination of ultimate loss but highly unpredictable) and casualty exposure
(more predictable but takes longer to determine the ultimate loss). We also
write life, annuity, and health insurance business. Additionally, we are
actively involved in the writing of insurance on our policies for the benefit of
reinsurance companies, commonly referred to as servicing carrier or fronting,
which generates fee-for-service income.

Our
revenues from operations are derived primarily from net premiums earned on risks
written by our insurance subsidiaries, investment income and investment gains or
losses. Our expenses consist primarily of payments for claims and underwriting
expenses, including agents commissions and operating expenses.

Comparison of Second Quarter 2001 to Second Quarter 2000

Income  available to common  shareholders  increased by $4.7  million,  or 195.8% to $7.1 million for the quarter  ended June 30,
2001,  from $2.4 million for the quarter ended June 30, 2000.  On a diluted per share basis,  income  available to common  shareholders
for the second  quarter of 2001 was $0.29 per share versus net income of $0.12 per share for the second  quarter of 2000.  The increase
in  income  available  to  common  shareholders  is  primarily   attributable  to  improved  underwriting  results  from  our  standard
property-casualty  segments and the positive  contributions  to income of our new business  segments  entered into since the prior year
period, each of which is discussed below.

Standard Property-Casualty

Net
premiums written for standard property-casualty lines increased by $8.9 million,
or 16.0%, to $64.8 million for the quarter ended June 30, 2001, from $55.9
million for the quarter ended June 30, 2000. Net premiums earned for standard
property-casualty lines increased $12.6 million, or 24.2% to $64.7 million for
the quarter ended June 30, 2001, from $52.1million for the quarter ended June
30, 2000. The increase in net premiums written and net premiums earned are
primarily attributable to the acquisition of Florida Select, continued rollover
from other segments of certain policies acquired in prior years, and an increase
in new policy applications.

Loss
and loss adjustment expenses (LAE) for standard property-casualty
lines increased by $ 11.8 million, or 45.7%, to $37.6 million for the quarter
ended June 30, 2001, from $25.8 million for the quarter ended June 30, 2000. The
loss and LAE ratio for property-casualty lines for the quarter ended June 30,
2001 was 58.1% as compared to 49.5% at June 30, 2000. The increase in the loss
and LAE incurred and the loss and LAE ratio is primarily attributable to
estimated salvage and subrogation recoverables recorded in the prior period,
offset by improved underwriting results in the current period..

Policy
acquisition expenses remained flat for the quarter-to-quarter comparison,
consistent with earned premium. Operating expenses increased by $1.5 million, or
23.1% to $8.0 million for the quarter ended June 30, 2001, from $6.5 million for
the quarter ended June 30, 2000, due to the acquisition of Florida Select.

Life and Health Insurance

In
June, 2000, we entered the life and annuity business through a 71% investment in
American Founders Financial Corporation, a holding company for two life
insurance companies domiciled in Texas and we entered the health insurance
business through the acquisition of Aegis Financial Corporation, a holding
company for two life and health insurance companies domiciled in Texas, in
December, 2000. American Founders and Aegis have approximately $2.2 billion
(face value) of life and annuity products in force and $22.5 million of health
insurance premiums in force at June 30, 2001. Life insurance premiums and policy
fees were $3.5 million for the quarter ended June 30, 2001 compared to zero for
the comparable prior period due to the acquisition of American Founders on June
30, 2000 and Aegis in December 2000. Health insurance premiums totaled $5.1
million for the quarter ended June 30, 2001 versus zero for the comparable prior
period. Health insurance benefits incurred totaled $2.7 million for the quarter
and health insurance commission expense was $1.3 million.

Specialty Lines

In
2000, we began utilizing our licenses to write business for the benefit of
reinsurance companies. In this segment, we enter into arrangements whereby we
write targeted property-casualty insurance coverages and reinsure substantially
all of the risks to reinsurers in exchange for fees. This business takes
advantage of our certificates of authority granting us license to write
insurance in many states. Income in this segment is primarily generated on a
fee-for-service basis. For the quarter ended June30, 2001, this segment reported
break even underwriting results on net premiums written of $2.0 million and net
premiums earned of $2.0 million. Additionally, we earned approximately $1.0
million of fees for the quarter ended June 30, 2001.

11

---

Non-Standard

In
December 2000, we acquired a 52% economic interest in Instant Auto Insurance
Holdings, Inc. Instant Auto operates as a non-standard insurance agency. Its
principal revenue stream is agents fees and commissions. Fees and
commissions totaled $.5 million for the three months ended June 30, 2001 as
Instant Auto began executing its strategy of building its agency business.

Net Investment Income

Net
investment income increased by $.7 million, or 13.2%, to $6.0 million for the
quarter ended June 30, 2001, from $5.3 million for the quarter ended June 30,
2000. The weighted average yield on invested assets (excluding realized and
unrealized gains) was 6.7% for the quarter ended June 30, 2001, compared with
6.0% for the quarter ended June 30, 2000. The increase in investment income is
primarily attributable to an increase in average invested assets resulting from
our acquisitions, particularly American Founders.

Federal Income Taxes

Federal
income taxes increased by $1.3 million to $4.3 million of expense for the
quarter ended June 30, 2001 as a result of more income in the current
period compared to the prior period.

Comparison of Six Months Ended June 30, 2001 with Six Months Ended June 30, 2000

Income available to common  shareholders  increased by $1.5 million,  or 17.4% to $10.1 million for the six months ended June 30,
2001,  from  $8.6  million  for the six  months  ended  June 30,  2000.  On a diluted  per  share  basis,  income  available  to common
shareholders  for the six months ended June 30, 2001 was $.45 per share versus income of available to common  shareholders  of $.40 per
share for the  corresponding  period of 2000. The increase in income  available to common  shareholders  is primarily  attributable  to
improved  underwriting  results from our standard  property-casualty  segments and the impact of acquisition  and new lines of business
entered into since the prior year period.

Standard Property-Casualty

Net
premiums written for standard property-casualty lines increased by $30.5
million, or 29.0%, to $135.5 million for the six months ended June 30, 2001,
from $105.0 million for the six months ended June 30, 2000. Net premiums earned
for standard property-casualty lines increased $30.9 million, or 29.4% to $139.6
million for the six months ended June 30, 2001, from $108.7 million for the six
months ended June 30, 2000. The increase in net premiums written and net
premiums earned are primarily attributable to the acquisition of Florida Select,
the continued rollover from other segments of certain policies acquired in prior
years, and an increase in new policy applications.

Loss
and loss adjustment expenses (LAE) for standard property-casualty
lines increased by $9.9 million, or 15.1%, to $75.5 million for the six months
ended June 30, 2001, from $65.6 million for the corresponding period ended June
30, 2000. The loss and LAE ratio for property-casualty lines for the six months
ended June 30, 2001 was 61.5% as compared to 60.2% at June 30, 2000. The
increase in the loss and LAE incurred and the loss and LAE ratio is primarily
attributable to an increased in earned premium, estimated salvage and
subrogation recoverable recorded in the prior year, partially offset by improved
underwriting results.

Policy
acquisition expenses increased for the period-to-period comparison, consistent
with earned premium. Operating expenses increased by $1.3 million, or 9.9% to
$14.4 million for the six months ended June 30, 2001, from $13.1 million for the
six months ended June 30, 2000, due to increased expenses related to Florida
Select.

Life and Health Insurance

In June, 2000, we entered the life and annuity business through a 71% investment in American Founders  Financial  Corporation,
a holding  company for two life  insurance  companies  domiciled  in Texas and we entered  the health  insurance  business  through the
acquisition of Aegis  Financial  Corporation,  a holding  company for two life and health  insurance  companies  domiciled in Texas, in
December,  2000.  American  Founders and Aegis have  approximately  $2.2 billion (face value) of life and annuity products in force and
$22.5 million of health  insurance  premiums in force at June 30, 2001.  Life insurance  premiums and policy fees were $6.6 million for
the six months ended June 30, 2001 compared to zero for the  comparable  prior period due to the  acquisition  of American  Founders on
June 30, 2000 and Aegis in December  2000.  Health  insurance  premiums  totaled  $10.3  million for the six months ended June 30, 2001
versus zero for the comparable  prior period.  Health  insurance  benefits  incurred totaled $5.8 million for the six months and Health
insurance commission expense was $2.5 million.

12

---

Specialty Lines

In
2000, we began utilizing our licenses to write business for the benefit of
reinsurance companies. In this segment, we enter into arrangements whereby we
write targeted property-casualty insurance coverages and reinsure substantially
all of the risks to reinsurers in exchange for fees. This business takes
advantage of our certificates of authority granting us license to write
insurance in many states. Income in this segment is primarily generated on a
fee-for-service basis. For the six months ended June 30, 2001, the segment
reported breakeven underwriting results on net premiums written of $3.5 million
and net premiums earned of $3.1 million. Additionally, we earned approximately
$1.8 million of fees for the six months ended June 30, 2001.

Non-Standard

In
December 2000, we acquired a 52% economic interest in Instant Auto Insurance
Holdings, Inc. Instant Auto operates as a non-standard insurance agency. Its
principal revenue stream is agents fees and commissions. Fees and
commissions totaled $.8 million for the six months ended June 30, 2001 as
Instant Auto began executing its strategy of building its agency business.

Net Investment Income

Net
investment income increased by $20.4 million, or 165.9%, to $32.7 million for
the six months ended June 30, 2001, from $12.3 million for the six months ended
June 30, 2000. The weighted average yield on invested assets (excluding realized
and unrealized gains) was 6.5% for the six months ended June 30, 2001, compared
with 5.9% for the six months ended June 30, 2000. The increase in investment
income is primarily attributable to an increase in average invested assets
resulting from our acquisitions, particularly American Founders.

Federal Income Taxes

Federal
income taxes increased by $4.0 million to $6.2 million of expense for the six
months ended June 30, 2001 as a result of more income in the current period
compared to the prior period.

## Liquidity and
Capital Resources

Vesta is a holding  company whose  principal  asset is its  investment in the capital stock of the companies  constituting  the
Vesta Insurance Group, a group of wholly owned insurance  companies  including Vesta Fire and a majority  ownership in a life insurance
holding company which includes  American Founders Life Insurance  Company.  The insurance  subsidiaries  comprising the Vesta Group are
individually  supervised  by various  state  insurance  regulators.  Vesta  Fire and  American  Founders  are our  principal  operating
subsidiaries.

Dividends and Management Fees

The
principal uses of funds at the holding company level are to pay operating
expenses, principal and interest on outstanding indebtedness and deferrable
capital securities and dividends to stockholders if declared by the Board of
Directors. During the last three years, our insurance subsidiaries have produced
operating results and paid management fees and dividends sufficient to fund our
needs. As a holding company with no other business operations, we rely primarily
on fees generated by our management agreement with our insurance subsidiaries
and dividend payments from Vesta Fire to meet our cash requirements (including
our debt service) and to pay dividends to our stockholders

Transactions
between Vesta and its insurance subsidiaries, including the payment of dividends
and management fees to Vesta by such subsidiaries, 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 in any year which, together with
other dividends or distributions made within the preceding 12 months, do not
exceed the greater of 10% of statutory surplus as of the end of the preceding
year or the net income for the preceding year, with larger dividends payable
only after receipt of prior regulatory approval. Except for the regulatory
restrictions described above, we are not aware of any demands or commitments of
the insurance subsidiaries that would prevent them from paying dividends
sufficient to meet our anticipated needs (including debt service) for at least
the next twelve months. See, BusinessRegulation.

13

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Credit Facilities

On
March 3, 2000, we established a revolving credit facility with First Commercial
Bank, Birmingham, Alabama (First Commercial). In May, 2001 we
increased the amounts available and increased the term of the credit facility to
the following:

- a $15 million unsecured line which bears interest at First Commercial's prime rate +1/4%;

- an additional $15 million line which bears interest at First  Commercial's  prime rate,  secured by a pledge of the management
          contract between our wholly owned management company, J. Gordon Gaines, Inc., and our operating insurance subsidiaries.

Each
of these credit facilities mature on December 31, 2002. In addition, the credit
agreements related to these facilities contain typical financial covenants which
require us to maintain certain financial standards. As of June 30, 2001, $25.0
million of credit line was available.

Long
Term Debt and Preferred Stock

Annual
distribution obligations for the Companys long-term debt and preferred
stock outstanding at June 30, 2001 are as follows:

|Security                                      | Principal     | Annual Interest Obligation
|--------------------------------------------- | ------------- | --------------------------
|8.75% Senior Debentures due 2025              | $87 million   | $7.6 million              
|8.525% Deferrable Capital Securities due 2027 | $29.8 million | $2.5 million              
|Subsidiary Preferred Stock                    | $7 million    | $.5 million               

Cash flows

The
principal sources of funds for our insurance subsidiaries are premiums,
investment income and proceeds from the sale or maturity of invested assets.
Such funds are used principally for the payment of claims, operating expenses,
commissions and the purchase of investments. As is typical in the insurance
industry, we collect cash in the form of premiums and invest that cash until
claims are paid. Cash collected from premiums and cash paid for claims is
included in cash flow from operations, while the cash impact from our investing
activities is included in cash flow from investing activities. In periods such
as 2001 and 2000, where we are exiting certain lines of business such as
commercial lines and reinsurance assumed lines we are funding the payout of
commercial and reinsurance assumed claims through the liquidation of invested
assets, consistent with the historical insurance business model. However, this
generates cash outflows from operations that can be misleading.

On
a consolidated basis, net cash used in operations for the six months ended June
30, 2001 and 2000, was $20.7 million and $42.4 million, respectively. Cash flow
from operations was negative for the current period due to the continued payout
of claims from our discontinued operations, the payout of standard-property
casualty claims incurred in prior periods, and the timing of payment of certain
payables and other operational items. Net cash provided by investing activities
was $25.5 million and $109.9 million for the six months ended June 30, 2001 and
2000, respectively as we funded the discontinuance of the reinsurance assumed
and commercial lines of business. Net cash provided by (used in) financing
activities was $ 58.2 million and $(51.4) million for the six month periods
ending June 30, 2001 and 2000, respectively as we engaged in a number of stock
transactions in the six month period ended June 30, 2001 including the issuance
of 8.625 million shares of stock in a follow on offering for approximately $64.0
million, net of underwriting discount and expenses and repurchased outstanding
debt in the six month period ending June 30, 2000.

## Market Risk of
Financial Instruments

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.

## 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.

14

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# PART II
Item 1. Legal Proceedings

Securities Litigation

Subsequent
to the filing of our quarterly report on Form 10-Q for the period ended March
31, 1998 with the U.S. Securities and Exchange Commission (SEC or
Commission), we commenced an internal investigation to determine the
exact scope and amount of certain reductions of reserves and overstatement of
premium income in our reinsurance assumed business that had been recorded in the
fourth quarter of 1997 and the first quarter of 1998. This investigation
concluded that inappropriate amounts had, in fact, been recorded and we
determined that we should restate our previously issued 1997 financial
statements and first quarter 1998 Form 10-Q. Additionally, during our internal
investigation we were advised by our then outside auditors that there was an
error in the accounting methodology used to recognize earned premium income in
our reinsurance business. We had historically reported certain assumed
reinsurance premiums as earned in the year in which the related reinsurance
contracts were entered even though the terms of those contracts frequently
bridged two years. We determined that reinsurance premiums should be recognized
as earned over the contract period and corrected the error in our accounting
methodology by restating previously issued financial statements. On June 1, 1998
and June 29, 1998, we issued press releases, which were filed with the
Commission, regarding the matters addressed in this section.

We
restated our previously-issued financial statements for 1995, 1996, and 1997 and
our first quarter 1998 Form 10-Q for the above items by issuance of a current
report on Form 8-K dated August 19, 1998. These restatements resulted in a
cumulative decrease to stockholders equity of approximately $75.2 million
through March 31, 1998. Commencing in June 1998, we and several of our current
and former officers and directors were named as defendants in several purported
class action lawsuits filed in the United States District Court for the Northern
District of Alabama. Several of our officers and directors also have been named
in a derivative action lawsuit in the Circuit Court of Jefferson County,
Alabama, in which Vesta is a nominal defendant. In addition, we received various
inquiries and requests for information from various state departments of
insurance and other regulatory authorities, including a subpoena issued to Vesta
on August 24, 1998 by the Commission as part of a formal, non-public order of
investigation. We fully responded to such requests in 1998, and no further
requests for information from Vesta have been made by the Commission.

In
March 1999, the actions filed in the United States District Court for the
Northern District of Alabama were consolidated into a single action in that
district and certified as a class action. Torchmark Corporation and KPMG Peat
Marwick LLP, our outside auditor at the time, were added as additional
defendants in the consolidated class action. The consolidated amended complaint
alleges violations of certain federal securities laws and seeks unspecified but
potentially substantial damages. The court has denied all motions to dismiss and
the class action is presently in discovery, with a trial date set for November
5, 2001. We are vigorously defending this litigation but there is no assurance
of its outcome. The parties have conducted settlement discussions, but have not
been successful in reaching any resolution to date. The derivative case has been
stayed and placed on the administrative docket.

We
have several layers of directors and officers liability insurance
coverage (D&O insurance), the terms of which may cover all or a
portion of the damages or settlement costs of the class action. These policies
provide up to $100 million in D&O insurance to cover damages or settlement
costs and an additional policy provides another layer of $10 million D&O
insurance to cover any damages awarded by a court in these actions. Cincinnati
Insurance Company (Cincinnati) issued the primary policy that
provides the first $25 million of D&O insurance. Federal Insurance Company
(The Chubb Group of Insurance Companies) issued an excess D&O insurance
policy which provides coverage for the second $25 million in losses, if
necessary. The balance of the coverage is provided by a group of insurers and
was purchased after the class actions comprising the consolidated class action
were filed. In September 1998, after these actions were filed, Cincinnati, which
provides the primary insurance policy, filed a lawsuit in the United States
District Court for the Northern District of Alabama seeking to rescind the
policy and avoid the coverage. That action was dismissed for lack of subject
matter jurisdiction, and we then filed an action against Cincinnati in the
Circuit Court of Jefferson County, Alabama, to enforce the policy and to recover
damages arising out of Cincinnatis actions. Cincinnati filed an answer and
counterclaim in that action, seeking to rescind the policy and avoid the
coverage. This action is in the discovery stage and the outcome is uncertain.
There is no assurance that the primary insurance coverage will ultimately be
available for any damages or settlement costs incurred. The outcome of this
litigation may also materially affect the availability of the excess policy
issued by The Chubb Group. The damages sought by stockholder plaintiffs in the
consolidated class action, either at trial or through settlement, may be
substantial. If the damages or settlement costs incurred in connection with the
consolidated class action and derivative action are ultimately determined not to
be covered by our D&O insurance policies for any reason, we may incur a
significant and material loss which could have a material and adverse impact on
our financial condition and results of operation.

The
consolidated class action is in the discovery stage with a current trial date of
November 5, 2001 and the derivative action has been placed on the administrative
docket. The ultimate outcome of these matters is uncertain. Accordingly, we have
not currently set aside any financial reserves relating to any of the
above-referenced actions.

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Indemnification Agreements and Liability Insurance

Pursuant
to Delaware law and our Bylaws, 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 agreed to advance
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.

Arbitration

As
discussed above, 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 by 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% whole
account quota share treaty which was terminated on June 30, 1998 on a run-off
basis. We believe such treatment is appropriate under the terms of this treaty
and have calculated the quarterly reinsurance billings presented to the three
treaty participants accordingly. The aggregate amount included herein as
recoverable from such reinsurers totaled approximately $55.2 million as of June
30, 2001. We have collected approximately $48.5 million from the drawdown of
collateral on hand.

NRMA
Insurance, Ltd. (NRMA), one of the participants in the 20% 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 fund any
amounts NRMA may recover as a result of the arbitration. We filed for
arbitration against the other two participants in the treaty and all of these
arbitrations are in their discovery stages. While management believes its
interpretation of the treatys terms and computations based thereon are
correct, the ultimate outcome of these arbitrations is uncertain and their
ultimate outcome cannot be determined at this time.

During
1999, F&G Re (on behalf of USF&G), filed for arbitration under two
aggregate stop loss reinsurance treaties whereby F&G Re assumed certain risk
from us. F&G Re is seeking to rescind the treaties and avoid its obligation.
Under the terms of the two treaties, we believe we will be entitled to
recoveries of approximately $28.2 million as losses mature from prior accident
years. Vesta has recorded a reinsurance recoverable of approximately $28.2
million as of June 30, 2001 and December 31, 2000 related to these two treaties.
This arbitration is in its early stage and the ultimate outcome cannot be
determined at this time.

We
are in arbitration with CIGNA Property and Casualty Insurance Company
(CIGNA) (now ACE USA) under a personal lines insurance quota share
reinsurance agreement, whereby we assumed certain risks from CIGNA. During
September 2000, CIGNA filed for arbitration under the reinsurance agreement,
seeking payment of the balances that CIGNA claims are due under the terms of the
treaty. In addition, during the fourth quarter, the treaty was terminated on a
cut-off basis. Vesta is seeking recoupment of all improper claims payments and
excessive expense allocations and charges from CIGNA. This arbitration is in the
discovery stage and the ultimate outcome cannot be determined at this time.

If
the amounts recoverable under the relevant treaties are ultimately determined to
be materially less than the amounts that we have reported as recoverable, we may
incur a significant, material, and adverse impact on our financial condition and
results of operations.

Other Litigation

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 us and our  subsidiaries,  management  does not consider  liability  from any  threatened or pending  litigation
regarding routine matters to be material.

16

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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 May 7, 2001, the following  matters were submitted to a vote of stockholders.
(Shares Eligible to Vote 24,427,946)

`1.       Election of Directors

     Messrs. Robert B. D. Batlivala and Ehney  A. Camp III were elected to additional three year terms on the Board of Directiors.

                                                                                        For             Withheld
                                                                                        ---             --------
Batlivala.......................................................................    20,757,725          2,194,129
Camp............................................................................    20,760,003          2,191,851


2.      Approval of 2001 Incentive Compensation Plan


     The Company's 2001 Incentive Compensation Plan was approved.

                                                                                For         Against       Abstain
                                                                                ---         -------       -------
Approval of 2001 Incentive Compensation Plan...............................  10,940,711    5,506,041      82,891


3. Election of Auditors

     PricewaterhouseCoopers  was  appointed  as the  principal  independent  auditor of the Company and its  subsidiaries  for the
year ending December 31, 2001.

                                                                                For        Against     Abstain
                                                                                ---        -------     -------
PricewaterhouseCoopers LLP.................................................. 22,566,817    306,428     78,609`

# Item 5. Other
information

None.

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## Item 6.
Exhibits and Reports on Form 8-K

## a) EXHIBITS

10.25     Employment agreement between the registrant and William P. Cronin, dated as of February 5, 2001.

__________

## b) Reports on
Form 8-K.

Current reports were filed on Form 8-K on April 10, 2001, April 23, 2001, May 9, 2001, May 16, 2001 and May 17, 2001 in
connection with press releases and a Form 8-K on June 19, 2001 attaching the form of Underwriting Agreement in connection with a stock offering.

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Signatures

Pursuant
to the requirements of the Securities Act of 1933, the registrant has duly
caused this report to be signed on its behalf by the undersigned hereunto
duly authorized.

Vesta Insurance Group, Inc.

Date:  August 13, 2001

Date: August 13, 2001

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