<PAGE>
 
                           INDEMNIFICATION AGREEMENT
                           -------------------------

     THIS AGREEMENT is entered into as of September 17, 1998 between Variflex,
Inc. a Delaware corporation (the "Company"), and Steven Muellner ("Indemnitee").

                                    RECITALS
                                    --------

     WHEREAS, it is essential to the best interests of the Company to attract
and retain highly capable persons to serve as directors and/or officers of the
Company;

     WHEREAS, Indemnitee is or has been appointed or elected to be a director
and/or officer of the Company;

     WHEREAS, the Company and Indemnitee recognize the increased risk of
litigation and other claims being asserted against directors and officers of
corporations; and

     WHEREAS, in recognition of Indemnitee's need for substantial protection
against personal liability, in order to enhance Indemnitee's continued service
to the Company, and in order to induce Indemnitee to continue to provide
services to the Company as a director and/or officer, the Company wishes to
provide in this Agreement for the indemnification of and the advancement of
expenses to Indemnitee to the fullest extent permitted by law and as set forth
in this Agreement, and to the extent applicable insurance is maintained, for the
coverage of Indemnitee under the Company's policies of directors' and officers'
liability insurance.

     NOW THEREFORE, IN CONSIDERATION of the foregoing, the mutual covenants and
promises contained herein and of Indemnitee's continuing to provide services to
the Company the parties agree as follows:

SECTION 1.  DEFINITIONS.
            ----------- 

     a.  BOARD:  the board of directors of the Company.

     b.  CHANGE IN CONTROL:  a state of affairs that shall be deemed to have
occurred if:

          (i) any person's or entity's beneficial ownership of the total voting
power of the Company's then outstanding voting securities increases, either
directly or indirectly, by twenty percent (20%); or

         (ii) during any period of three (3) consecutive years, individuals
who, at the beginning of such period, constituted the Board, together with any
new director whose election by the Board or nomination for election by the
Company's shareholders was approved by a vote of at least two-thirds (2/3) of
the directors then in office who either were directors at the beginning of the
three (3) year period, or whose election or nomination was previously so
approved, cease for any reason to constitute a majority of the Board; or

       (iii)  the shareholders of the Company approve a merger or
consolidation of the Company with any other corporation, other than a merger or
consolidation that would result in the outstanding voting securities of the
Company immediately prior to such merger or consolidation continuing to
represent (either by remaining outstanding or by being converted into voting
securities of the surviving entity) at least eighty percent (80%) of the total
outstanding 

                                       1

<PAGE>
 
voting power represented by the voting securities of the Company or such
surviving entity outstanding immediately after such merger or consolidation.

      c.  EXPENSES:

          (i) any costs, expenses, fees or losses actually and reasonable
incurred, including, but not limited to, attorneys' fees, judgements, fines,
damages, penalties and amounts paid or to be paid in settlement;

         (ii) any interest, assessments, or other charges imposed on any of the
items in part (i) of this subsection (c); and

        (iii) any federal, state, local or foreign taxes imposed as a result
of the actual or deemed receipt of any payments under this Agreement that are
paid or incurred in connection with investigating, defending, being a witness
in, or participating in (including on appeal) or preparing for any of the
foregoing in any Proceeding relating to an Indemnifiable Event, as defined
hereinbelow.

     d.   INDEMNIFIABLE EVENT:  any Proceeding that takes place either before or
after the execution of this Agreement and that is related to or arises out of:

          (i) the fact that Indemnitee is or was a director and/or officer of
the Company or is or was serving at the request of the Company as a director,
officer, employee or agent of another corporation, partnership, joint venture,
trust or other enterprise; or

         (ii) actions taken or not taken by Indemnitee in his capacity as a
director and/or officer (subject to Section 2b. hereof).

     e.  INDEPENDENT COUNSEL:  the person or body described in Section 4.

     f.  POTENTIAL CHANGE IN CONTROL:  a state of affairs that shall be deemed
to exist if:

         (i) the Company enters into an agreement or arrangement, the
consummation of which would result in the occurrence of a Change in Control; or

        (ii) any person or entity announces an intention to take or to
consider taking actions that, if consummated, would constitute a Change in
Control; or

       (iii) the Board adopts a resolution to the effect that, for purposes
of this Agreement, a Potential Change in Control has occurred.

     g.  PROCEEDING:  any threatened, pending, or completed action, suit, or
proceeding, or any injury, hearing, or investigation, whether conducted by the
Company or any other party, that an Indemnitee in good faith believes might lead
to the institution of any such action, suit, or proceeding, whether civil,
criminal, administrative, investigative or other.

     h.  REVIEWING PARTY:  the person or body appointed in accordance with
Section 4.

     i.  VOTING SECURITIES:  any securities of the Company that have the right
to vote generally in the election of directors.

                                       2
<PAGE>
 
SECTION 2.  GENERAL AGREEMENT; PROHIBITED INDEMNIFICATION.
            --------------------------------------------- 

     a.  GENERAL AGREEMENT.  In the event Indemnitee was, is, or is threatened
to be made a participant in, an Indemnifiable Event, the Company shall indemnify
Indemnitee from and against any and all Expenses to the fullest extent permitted
by law, including but not limited to Section 145 of the Delaware General
Corporation Law, as the same exists or may hereafter be amended or interpreted
(but in the case of any such amendment or interpretation, only to the extent
that such amendment or interpretation permits the Company to provide broader
indemnification rights than were permitted prior to that amendment or
interpretation).  The parties to this Agreement intend that this Agreement shall
provide for indemnification in excess of that expressly permitted by statute,
including, without limitation, any indemnification provided by the Company's
Articles of Incorporation, its Bylaws, a vote of its shareholders or
disinterested directors or applicable law.  The indemnification provided under
this Agreement shall continue for Indemnitee even though Indemnitee may have
ceased to serve in such capacity at the time of any Proceeding. Notwithstanding
anything in this Agreement to the contrary, Indemnitee shall not be entitled to
indemnification under this Agreement in connection with any Proceeding initiated
by Indemnitee against the Company or any director or officer of the Company
unless:

          (i)  the Company has joined in or the Board has consented to the
initiation of the Proceeding; or

          (ii) the Proceeding is one to enforce indemnification rights or any
other terms under this Agreement.

     b.  PROHIBITED INDEMNIFICATION.  The following shall not be Indemnifiable
by the Company:

          (i)  A Proceeding in which judgement is rendered against Indemnitee
for an accounting or profits made from the purchase or sale by Indemnitee of
securities of the Company under the provisions of Section 16(b) of the
Securities Exchange Act, or similar provision of any federal, state or local
laws;

         (ii)  Any breach of the director's duty of loyalty to the Company or
its shareholders;

        (iii)  Acts or omissions not in good faith or which involve
intentional misconduct or a knowing and violation of law;

         (iv)  Unlawful payment of dividends or unlawful stock purchase or
redemption pursuant to Section 174 of the Delaware General Corporation Law; and

         (v)   Any transaction from which the director derived an improper
personal benefit.

SECTION 3.  INDEMNIFICATION PROCESS.
            ------------------------

     a.  DEFENSE OF ACTION.  Indemnitee shall notify the Company in writing
within a reasonable amount of time of becoming aware of the commencement of an
Indemnifiable Event (the "Event Notice").  The Event Notice shall also set forth
whether Indemnitee desires to be indemnified by the Company and whether
Indemnitee desires the Company to defend the Indemnifiable Event.  The Company
shall defend the Indemnifiable Event with counsel reasonably satisfactory to
Indemnitee, provided, however, Indemnitee reserves the right to appoint separate
counsel in the event of a conflict of interest with the interests of Indemnitee
or 

                                       3
<PAGE>
 
in the event the Company fails to timely and adequately defend the Indemnifiable
Event. In the event Indemnitee elects to defend the Indemnifiable Event, such
election shall not constitute a waiver by Indemnitee of his rights against the
Company for Expenses or to later demand that the Company assume the defense of
Indemnitee. Counsel defending the Indemnifiable Event on behalf of either party
shall diligently defend the matter and shall keep the other parties fully
informed of its status including all pertinent facts and information pertaining
to the Indemnifiable Event and the strategy to be followed. The Company shall
not settle any Proceeding in any manner without Indemnitee's written consent.

     b.  ADVANCE OF EXPENSES.  If requested by Indemnitee, the Company shall, in
accordance with this Agreement and within ten (10) business days of a written
request by Indemnitee, advance to Indemnitee the Expenses that are reasonably
anticipated to be incurred by Indemnitee and reimburse Indemnitee for the
Expenses that are actually incurred by Indemnitee in connection with any claim
asserted against or action brought by Indemnitee for:

          (i) indemnification by the Company under this Agreement, or any other
agreement, or under applicable law, or the Company's Articles of Incorporation
or Bylaws now or hereafter in effect relating to indemnification for
Indemnifiable Events, and/or

          (ii) recovery under directors' and officers' liability insurance
policies maintained by the Company.

     c.  PROHIBITED INDEMNIFICATION;  REIMBURSEMENT TO THE COMPANY.

     To the extent that a Reviewing Party determines that an Indemnitee is not
permitted to be indemnified under applicable law and Section 2b. hereinabove,
the Company shall be entitled to be reimbursed by Indemnitee for all Expenses
advanced and/or incurred, and Indemnitee hereby agrees to reimburse the Company
promptly for the same, provided, however, that if Indemnitee has commenced legal
proceedings in a court of competent jurisdiction to secure a determination that
Indemnitee should be indemnified under applicable law, as provided in Section
2d. hereinabove, any determination made by the Reviewing Party that Indemnitee
would not be permitted to be indemnified under applicable law shall not be
binding, and Indemnitee shall not be required to reimburse the Company for any
advance of Expenses until a final judicial determination is made with respect
thereto and all rights of appeal therefrom have been exhausted or have lapsed.
Indemnitee's obligation to reimburse the Company for Expenses advances shall be
unsecured and no interest shall be charged thereon.

     d.  INDEMNIFICATION ENFORCEMENT RIGHTS.  If Indemnitee has not received
full indemnification within thirty (30) days after making a demand for Expenses,
Indemnitee shall have the right to enforce its indemnification rights under this
Agreement by commencing litigation in any court in the State of California
seeking an initial determination by the court or challenging any determination
by the Reviewing Party or any aspect thereof.  The Company hereby consents to
service of process and to appear in any such proceeding.  Any determination by
the Reviewing Party not challenged by Indemnitee shall be binding on the Company
and Indemnitee.  The remedy provided for in this section 2(d) shall be in
addition to any other remedies available to Indemnitee in law or equity.

     e.  COMPANY DEFENSES.  It shall be a defense to any action brought by
Indemnitee against the Company to enforce this Agreement (other than an action
brought to enforce a claim for Expenses incurred in defending a Proceeding in
advance of its final disposition) that it is not permissible, under this
Agreement or applicable law, for the Company to indemnify Indemnitee for the
amount claimed.  In connection with any such action, the burden of proving such
a defense shall be on the Company.  The failure of a Reviewing Party to have
made an Indemnification Determination (as defined below) before the commencement
of such action by 

                                       4
<PAGE>
 
Indemnitee that indemnification is proper under the circumstances shall not be a
defense to the action. For purposes of this Agreement, the termination of any
Indemnifiable Event by judgment, order, settlement (whether with or without
court approval), conviction or upon a plea of nolo contendere or its equivalent
(a "Termination Event"), shall not, of itself, create a presumption that
Indemnitee did not meet any particular standard of conduct or have any
particular belief or that a court had determined that indemnification is not
permitted by applicable law.

SECTION 4.  INDEMNIFICATION REVIEW PROCEDURE; REVIEWING PARTY.
            ------------------------------------------------- 

        a.  INDEMNIFICATION REVIEW PROCEDURE.  Within five (5) days of the
occurrence of a Termination Event, Indemnitee shall provide written notice to
the Company of the Termination Event (the "Termination Event Notice").  In the
Event that Indemnitee has been successful on the merits or otherwise in defense
of the Indemnifiable Event, indemnification by the Company of Indemnitee shall
be mandatory.  In the event that Indemnitee loses a judgement on the merits or
otherwise in defense of the Indemnifiable Event, or where there is no judicial
determination of the actual merits of the defense raised, whether due to
settlement, dismissal of the Complaint before trial, or upon a plea of nolo
contendere or its equivalent, the Company shall submit the Termination Event
Notice to the applicable Reviewing Party (as set forth below).  The Reviewing
Party shall make a determination whether or not Indemnitee is entitled to be
indemnified pursuant to this Agreement and applicable law (the "Indemnification
Determination").  The Indemnification Determination shall be made within twenty-
five (25) days of the receipt of the Termination Event Notice.  In connection
with any Indemnification Determination, the burden of proof shall be on the
Company.

        b.  REVIEWING PARTY.  The Reviewing Party that shall make an
Indemnification Determination shall be, at Indemnitee's option, either:

            (i) A majority of a quorum of the board of directors of the Company
consisting of directors who are not parties to the Indemnifiable Event (a
"Quorum"); or

           (ii) An Independent Counsel.

        If the Reviewing Party is an Independent Counsel, such Independent
Counsel shall be selected by Indemnitee and approved by the Company (which
approval shall not be unreasonably withheld), and shall not have otherwise
performed services for the Company or Indemnitee within the previous five (5)
years. An Independent Counsel shall not include any person who, under the
applicable standards of professional conduct then prevailing, would have a
conflict of interest in representing either the Company or Indemnitee in an
action to determine Indemnitee's rights under this Agreement. An Independent
Counsel, among other things, shall render a written opinion to the Company and
Indemnitee on whether and to what extent Indemnitee should be permitted to be
indemnified under applicable law. The Company agrees to pay the reasonable fees
of an Independent Counsel and to fully indemnify an Independent Counsel against
any and all expenses, including attorneys' fees, claims, liabilities, losses and
damages arising out of or relating to this Agreement or the engagement of an
Independent Counsel under this Agreement.

SECTION 5.  ESTABLISHMENT OF TRUST.
            ---------------------- 

     In the event of a Change in Control or a Potential Change in Control, the
Company shall, on written request by Indemnitee, create a trust for the benefit
of Indemnitee (the "Trust") and from time to time on written request of
Indemnitee (a "Trust Request"), shall fund the Trust with an amount sufficient
to satisfy any and all Expenses reasonably anticipated to be incurred in
connection with investigating, preparing for, participating in, and/or defending
any Indemnifiable 

                                       5
<PAGE>
 
Event. The individual selected to be trustee shall be agreed upon by both
Indemnitee and the Company (the "Trustee"). The terms of the Trust shall provide
that upon a Change in Control:

     a.  The Trust shall not be revoked or the principal invaded without the
written consent of Indemnitee;

     b.  The Trust shall continue to be funded by the Company in accordance with
the funding obligation set forth in this Section 5;

     c.  The Trustee shall promptly pay to Indemnitee all amounts for which
Indemnitee shall be entitled under this Agreement or otherwise; and

     d.  All unexpended funds in the Trust shall revert to the Company on a
final determination by a Reviewing Party or a court of competent jurisdiction
that Indemnitee has been fully indemnified under the terms of this Agreement.`

     Nothing in this Section 5 shall relieve the Company of any of its
obligations under this Agreement.  The Company shall pay all costs of
establishing and maintaining the Trust and shall indemnify the Trustee against
any and all expenses, including attorneys' fees, claims, liabilities, losses and
damages arising out of or relating to this Agreement or the establishment and
maintenance of the Trust.

SECTION 6.  NONEXCLUSIVITY.
            -------------- 

     The rights of Indemnitee under this Agreement shall be in addition to any
other rights Indemnitee may have under the Company's Articles of Incorporation,
Bylaws, applicable law or otherwise.  To the extent that a change in applicable
law (whether by statute or judicial decision) permits greater indemnification by
agreement than would be afforded currently under the Company's Articles of
Incorporation, Bylaws, applicable law or this Agreement, it is the intent of the
parties that Indemnitee enjoy by this Agreement the greater benefits afforded by
such change.

SECTION 7.  LIABILITY INSURANCE.
            ------------------- 

     To the extent the Company maintains an insurance policy or policies
providing directors' and officers' liability insurance, Indemnitee shall be
covered by such policy or policies, in accordance with its or their terms, to
the maximum extent of the coverage available for any Company director and/or
officer.

SECTION 8.  PERIOD OF LIMITATIONS.
            --------------------- 

     No legal action shall be brought, and no cause of action shall be asserted,
by or on behalf of the Company or any affiliate of the Company against
Indemnitee, Indemnitee's spouse, heirs, executors or personal or legal
representatives, after the expiration of two (2) years from the date of accrual
of such cause of action, or such longer period as may be required by state law
under the circumstances.  Any claim or cause of action of the Company or its
affiliate shall be extinguished and deemed released unless asserted by the
timely filing of a legal action within such period; provided, however, that if
any shorter period of limitations is otherwise applicable to any such cause of
action, the shorter period shall govern.

SECTION 9.  AMENDMENT OF THIS AGREEMENT; WAIVER.
            ----------------------------------- 

     No supplement, modification, or amendment of this Agreement shall be
binding unless executed in writing by both of the parties hereto.  No waiver of
any of the provisions of this 

                                       6
<PAGE>
 
Agreement shall operate as a waiver of any other provisions of this Agreement
(whether or not similar), nor shall such waiver constitute a continuing waiver.
Except as specifically provided in this Agreement, no failure to exercise or
delay in exercising any right or remedy under it shall constitute a waiver of
the right or remedy.

SECTION 10.  SUBROGATION.
             ----------- 

     In the event of payment under this Agreement, the Company shall be
subrogated to the extent of that payment to all of the rights of recovery of
Indemnitee, who shall execute all papers required and shall do everything that
may be necessary to secure such rights, including the execution of any documents
necessary to enable the Company effectively to bring suit to enforce such
rights.

SECTION 11.  NO DUPLICATION OF PAYMENTS.
             -------------------------- 

     The Company shall not be liable under this Agreement to make any payment in
connection with any claim made against Indemnitee to the extent Indemnitee has
otherwise obtained payment (under any insurance policy, bylaw or otherwise) of
the amounts otherwise indemnifiable under this Agreement.

SECTION 12.  BINDING EFFECT.
             -------------- 

     This Agreement shall be binding on and inure to the benefit of and be
enforceable by the parties to it and their respective successors (including any
direct or indirect successor by purchase, merger, consolidation, or otherwise to
all or substantially all of the Company's business or assets or both), assigns,
spouses, heirs, and personal and legal representatives.  The Company shall
require and cause any successor (whether direct or indirect, by purchase,
merger, consolidation, or otherwise) to all, substantially all, or a substantial
part, of the Company's business or assets or both, by written agreement in form
and substance satisfactory to Indemnitee, expressly to assume and agree to
perform this Agreement in the same manner and to the same extent that the
Company would be required to perform if no such succession had taken place.

SECTION 13.  SEVERABILITY.
             ------------ 

     If any term or provision of this Agreement or the application thereof to
any person or circumstance shall, to any extent, be determined to be invalid,
illegal or unenforceable under present or future laws effective during the term
of this Agreement, then and, in that event: (A) the performance of the offending
term or provision (but only to the extent its application is invalid, illegal or
unenforceable) shall be excused as if it had never been incorporated into this
Agreement, and, in lieu of such excused provision, there shall be added a
provision as similar in terms to such excused provision as may be possible and
be legal, valid and enforceable, and (B) the remaining part of this Agreement
(including the application of the offending term or provision to persons or
circumstances other than those as to which it is held invalid, illegal or
unenforceable) shall not be affected thereby and shall continue in full force
and effect to the fullest extent provided by law.

SECTION 14.  GOVERNING LAW.
             ------------- 

     This Agreement and the rights and remedies of each party arising out of or
relating to this Agreement (including, without limitation, equitable remedies)
shall be solely governed by, interpreted under, and construed and enforced in
accordance with the internal laws of the state of Delaware, without regard to
conflicts of laws principles as if this Agreement were made, and as if its
obligations are to be performed, wholly within the state of Delaware.

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<PAGE>
 
SECTION 15.  CONSENT TO JURISDICTION.
             ----------------------- 

     Any action or proceeding arising out of or relating to this Agreement shall
be filed in and heard and litigated solely before the state courts of California
located within the county of Ventura.  Each party generally and unconditionally
accepts the exclusive jurisdiction of such courts and waives any defense or
right to object to venue in said courts based upon the doctrine of "forum non
conveniens".  Each party irrevocably agrees to be bound by any judgement
rendered thereby in connection with this Agreement.

SECTION 16.  NOTICES.
             ------- 

     All notices, demands, and other communications required or permitted under
this Agreement shall be made in writing and shall be deemed to have been duly
given if delivered by hand, against receipt, or mailed, certified or registered
mail, return receipt requested, and addressed to the Company at:

                              Variflex, Inc.
                              5152 North Commerce Avenue
                              Moorpark, California 93021
                              Attn: Mr. Raymond "Jay" H. Losi, II
     and to counsel at:

                              Morrison & Foerster LLP
                              555 West Fifth Street
                              Los Angeles, California 90013
                              Attn: Michael C. Cohen

     and to Indemnitee at:
                              ------------------------------------- 
                              ------------------------------------- 
                              ------------------------------------- 

     Notice of change of address shall be effective only when given in
accordance with this Section.  All notices complying with this Section shall be
deemed to have been received on the date of delivery.

                                       8
<PAGE>
 
     IN WITNESS WHEREOF, the parties hereto have duly executed and delivered
this Agreement as of the date set forth above.

                              COMPANY:

                              Variflex, Inc., a Delaware corporation

                              /s/ Raymond (Jay) H. Losi II
                              ----------------------------
                              Raymond (Jay) H. Losi II
                              Chief Executive Officer and Chief Operating
                              Officer

                              Indemnitee:

                              /s/ Steven Muellner
                              -------------------
                              Steven Muellner

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