<PAGE>
 
                                                                    EXHIBIT 10.9

                              EMPLOYMENT AGREEMENT

     This EMPLOYMENT AGREEMENT ("Agreement"), which is dated as of August 24,
1998, is made by and between VARIFLEX, INC., a Delaware corporation, located at
5152 North Commerce Avenue, Moorpark, California, 93021 and hereinafter referred
to as "Company", and STEVEN MUELLNER, whose address is 10056 Toluca Lake Avenue,
Toluca Lake, California 91602, hereinafter referred to as "Executive", based
upon the following:

                                    RECITALS
                                    --------

     WHEREAS, Company wishes to retain the services of Executive as its
President and to set forth in this Agreement the duties and responsbilities
Executive has agreeed to undertake on behalf of Company; and

     WHEREAS, Executive wishes to render services to Company as its President
and to have set forth in this Agreement the duties and responsibilities he has
agreed to undertake on behalf of Company; and

     THEREFORE, in consideration of the foregoing and of the mutual promises
contained in this Agreement, Company and Executive (who are sometimes
individually referred to as a "party" and collectively referred to as the
"parties") agree as follows:

                                   AGREEMENT
                                   ---------

     1.  "COMPANY" DEFINED.
         ----------------- 

     The term "Company" as used in this Agreement shall mean Variflex, Inc.

     2.  SPECIFIED PERIOD.
         ---------------- 

     (a)  INITIAL TERM.  Subject to paragraphs 9, 10 and 11, Company hereby
          ------------                                                     
employs Executive pursuant to the terms of this Agreement and Executive hereby
accepts employment with Company pursuant to the terms of this Agreement for the
period beginning on August 24, 1998 ("Commencement Date") and ending on February
23, 2001 (the "Initial Expiration Date"), the day before the two and one-half
(2.5) year anniversary of the Commencement Date.

     (b)  RENEWAL OF TERM.  Subject to paragraphs 9, 10 and 11, this Agreement
          ---------------                                                     
will be automatically renewed for an additional one (1) year term on the Initial
Expiration Date and on each anniversary date of the Initial Expiration Date
occurring thereafter, unless either party gives written notice to the other, at
least ninety (90) days prior to the Initial Expiration Date or prior to the date
of expiration of the then applicable renewal term of this Agreement (the
"Renewal Expiration Date"), as applicable, that the party desires to terminate
this Agreement.

     (c) TERM.  For purposes of this Agreement, "Term" shall mean the period
         ----                                                               
beginning on the Commencement Date and ending on the earlier of (i) the date on
which Executive's employment is terminated pursuant to paragraphs 9, 10 or 11 of
this Agreement, (ii)
<PAGE>
 
the Initial Expiration Date if this Agreement is not automatically renewed
pursuant to paragraph 2(b) above, or (iii) the then applicable Renewal
Expiration Date if the then renewal term is not automatically renewed for an
additional one (1) year period pursuant to paragraph 2(b) above.

     3.  GENERAL DUTIES.
         -------------- 

     Executive shall report only to the Company's Chief Executive Officer and
the Company's Board of Directors (the "Board").  Executive shall devote his
entire productive time, ability, and attention to Company's business during the
term of this Agreement.  Unless otherwise modified by the Board with the consent
of the Executive, the Executive shall serve as the President of the Company.  In
this capacity, Executive shall be responsible for the general supervision,
direction and control of the day-to-day business and affairs of Company.
Executive shall perform such other duties as are commonly performed by the
President of a publicly traded corporation (who is not also the Chief Executive
Officer) or which may from time to time be prescribed by the Board or the Chief
Executive Officer consistent with such duties.  Executive shall not work for any
other person, firm or entity during the Term of this Agreement.

     4.  NONCOMPETITION, NONSOLICITATION AND NONINTERFERENCE AND PROPRIETARY
         -------------------------------------------------------------------
          PROPERTY AND CONFIDENTIAL INFORMATION PROVISIONS.
          ------------------------------------------------ 

     (a)  NONCOMPETITION.
          -------------- 

         (1) "Applicable Definitions" - For purposes of this paragraph 4, the
              ----------------------                                         
following capitalized terms shall have the definitions set forth below:

              i. "Business Segments" - The term "Business Segment" is defined as
                  -----------------
each portion of the Company's (or Company's affiliates') business, including,
without limitation, the production, distribution, marketing, and sales of the
Company's (or Company's affiliates') products or product lines, and the
purchasing of raw materials and supplies in connection therewith.

              ii. "Competitive Business" - The term "Competitive Business" is
                   --------------------
defined as any business that is or may be competitive with or similar to or
adverse to any of Company's (or Company's affiliates') Business Segments,
whether such business is conducted by a proprietorship, partnership, corporation
or other entity or venture.

              iii. "Territory" - The term "Territory" is defined as the
                    ---------
geographic area (both within the United States and internationally) in which any
Business Segment is carried on including, by way of example and not limitation,
the entire geographic area in which Company conducts various phases of any such
Business Segment, including purchasing, production, distribution, promotional
and marketing activities, sales, and location of plants and warehouses.

         (2) Covenant Not to Compete. Executive hereby covenants and agrees that
             -----------------------  
during the term of this Agreement, and (A) if and so long as Executive is being
paid

                                      -2-
<PAGE>
 
severance of $93,750.00 pursuant to paragraph 10 of this Agreement, for a
period of four and one-half (4.5) months following the date this Agreement is
terminated or (B) if and so long as Executive is being paid severance of
$125,000.00 pursuant to paragraph 10 of this Agreement, for a period of six (6)
months following the date this Agreement is terminated, Executive shall not,
with respect to any Business Segment and within the boundaries of the Territory
applicable to such Business Segment, without the prior written consent of
Company (which consent may be withheld in the sole and absolute discretion of
Company), directly or indirectly, either alone or in association or in
connection with or on behalf of any person, firm, partnership, corporation or
other entity or venture now existing or hereafter created:  (i) be or become
interested or engaged in, directly or indirectly, with any Competitive Business
including, without limitation, being or becoming an organizer, investor, lender,
partner, joint venturer, stockholder, officer, director, employee, manager,
independent sales representative , associate, consultant, agent, supplier,
vendor, vendee, lessor, or lessee to any Competitive Business, or (ii) in any
manner associate with, or aid or abet or give information or financial
assistance to any Competitive Business, or (iii) use or permit the use of
Executive's name or any part thereof to be used or employed in connection with
any Competitive Business (collectively and severally, the "Noncompetition
                                                          ---------------
Covenants").  Notwithstanding the foregoing, the provisions of this paragraph
---------                                                                    
4(a)(2) shall not be deemed to prevent the purchase or ownership by Executive as
a passive investment of no more than 5% of the outstanding capital shares of any
publicly held corporation, so long as any other obligation or duty under the
Noncompetition Covenants are not breached.  Executive shall have the right to
waive his entitlement to all of the severance benefits otherwise required to be
paid to him pursuant to paragraph 10 of this Agreement, in which event
paragraphs (a)(2)(A) and (a)(2)(B) of this paragraph 6(a)(2) shall not apply.

         (3) Separate Covenants. The Noncompetition Covenants shall be construed
             ------------------
to be divided into separate and distinct Noncompetition Covenants with respect
to (i) each Business Segment and (ii) each matter or type of conduct described
therein. Each of such divided Noncompetition Covenants shall be separate and
distinct from all such other Noncompetition Covenants with respect to the same
or any other Business Segment.

         (4) Acknowledgments. Executive acknowledges that: (i) the covenants and
             --------------- 
the restrictions contained in the Noncompetition Covenants are necessary,
fundamental, and required for the protection of Company's business; (ii) the
Noncompetition Covenants relate to matters which are of a special, unique and
extraordinary value; and (iii) a breach of any of the Noncompetition Covenants
will result in irreparable harm and damages which cannot be adequately
compensated by a monetary award.

         (5) Judicial Limitation. Notwithstanding the foregoing, if at any time
             -------------------
a court of competent jurisdiction holds that any portion of any Noncompetition
Covenant is unenforceable by reason of its extending for too great a period of
time or over too great a geographical area or by reason of its being too
extensive in any other respect, such Noncompetition Covenant shall be
interpreted to extend only over the maximum period of time, maximum geographical
area, or maximum extent in all other respects, as the case may be, as to which
it may be enforceable, all as determined by such court in such action.

                                      -3-
<PAGE>
 
     (b) NONSOLICITATION AND NONINTERFERENCE.
         ----------------------------------- 

         (1) Covenants. Executive hereby covenants and agrees that during the
             ---------
term of this Agreement, and for a period of one (1) year from the date this
Agreement terminates or expires, Executive shall not, either for Executive's own
account or directly or indirectly in conjunction with or on behalf of any
person, partnership, corporation or other entity or venture:

             i.  Solicit or employ or attempt to solicit or employ any person
who is then or has, within twelve (12) months prior thereto, been an officer,
partner, manager, agent or employee of Company or any affiliate of Company
whether or not such a person would commit a breach of that person's contract of
employment with Company or any affiliate of Company, if any, by reason of
leaving the service of Company or any affiliate of Company (the "Nonsolicitation
                                                                 ---------------
Covenant"); or
--------

             ii. On behalf of, directly or indirectly, any Competitive Business
(as such term is defined in paragraph 4(a)(1)ii., or for the purpose of or with
the reasonably foreseeable effect of harming the business of Company, solicit
the business of any person, firm or company which is then, or has been at any
time during the preceding twelve (12) months prior to such solicitation, a
customer, client, contractor, supplier or vendor of Company or any affiliate of
Company (the "Noninterference Covenant").
              ------------------------   

     (2) Acknowledgments.  Each of the parties acknowledges that:  (i) the
         ---------------                                                  
covenants and the restrictions contained in the Nonsolicitation and
Noninterference Covenants are necessary, fundamental, and required for the
protection of the business of Company; (ii) such Covenants relate to matters
which are of a special, unique and extraordinary value; and (iii) a breach of
either of such Covenants will result in irreparable harm and damages which
cannot be adequately compensated by a monetary award.

     (3) Judicial Limitation.  Notwithstanding the foregoing, if at any time,
         -------------------                                                 
despite the express agreement of Company and Executive, a court of competent
jurisdiction holds that any portion of any Nonsolicitation or Noninterference
Covenant is unenforceable by reason of its extending for too great a period of
time or by reason of its being too extensive in any other respect, such Covenant
shall be interpreted to extend only over the maximum period of time or to the
maximum extent in all other respects, as the case may be, as to which it may be
enforceable, all as determined by such court in such action.

     (c)  PROPRIETARY PROPERTY; CONFIDENTIAL INFORMATION.
          ---------------------------------------------- 

          (1) "Applicable Definitions"  For purposes of this paragraph 4(c), the
               ----------------------                                           
following capitalized terms shall have the definitions set forth below:

             i.  "Confidential Information" - The term "Confidential
                  ------------------------
Information" is collectively and severally defined as any information, matter or
thing of a secret, confidential or private nature, whether or not so labeled,
which is connected with Company's business, Business Segments, or methods of
operation or concerning any of Company's suppliers, customers, licensors,
licensees or others with whom Company has a business

                                      -4-
<PAGE>
 
relationship, and which has current or potential value to Company or the
unauthorized disclosure of which could be detrimental to Company. Confidential
Information shall be broadly defined and shall include, by way of example and
not limitation: (i) matters of a business nature available only to management
and owners of Company of which Executive may become aware (such as information
concerning customers, vendors and suppliers, including their names, addresses,
credit or financial status, buying or selling habits, practices, requirements,
and any arrangements or contracts that Company may have with such parties,
Company's marketing methods, plans and strategies, the costs of materials, the
prices Company obtains or has obtained or at which Company sells or has sold its
products or services, Company's manufacturing and sales costs, the amount of
compensation paid to employees of Company and other terms of their employment,
financial information such as financial statements, budgets and projections, and
the terms of any contracts or agreements Company has entered into) and (ii)
matters of a technical nature (such as product information, trade secrets, know-
how, formulae, innovations, inventions, devices, discoveries, techniques,
formats, processes, methods, specifications, designs, patterns, schematics,
data, compilation of information, test results, and research and development
projects). For purposes of the foregoing, the term "trade secrets" shall mean
the broadest and most inclusive interpretation of trade secrets as defined by
Section 3426.1(d) of the California Civil Code (the Uniform Trade Secrets Act)
                         ---------------------
and cases interpreting the scope of said Section. "Confidential Information"
does not include information which (i) is or becomes generally available to the
public through no wrongful act of Executive, or (ii) was available to or
otherwise in the possession of Executive prior to the date of this Agreement,
provided Executive acquired such information through lawful means and from a
source who or which was not under a duty of non-disclosure.

             ii.  "Proprietary Property" - The term "Proprietary Property" is
                   --------------------                                      
collectively and severally defined as any written or tangible property owned or
used by Company in connection with Company's business, whether or not such
property also qualifies as Confidential Information.  Proprietary Property shall
be broadly defined and shall include, by way of example and not limitation,
products, samples, equipment, files, lists, books, notebooks, records,
documents, memoranda, reports, patterns, schematics, compilations, designs,
drawings, data, test results, contracts, agreements, literature, correspondence,
spread sheets, computer programs and software, computer print outs, other
written and graphic records, and the like, whether originals, copies, duplicates
or summaries thereof, affecting or relating to the business of Company,
financial statements, budgets, projections, invoices.

     (2) Ownership of Proprietary Property.  Executive acknowledges that all
         ---------------------------------                                  
Proprietary Property which Executive may prepare, use, observe, come into
possession of and/or control shall, at all times, remain the sole and exclusive
property of Company.  Executive shall, upon demand by Company at any time, or
upon the cessation of Executive's employment, irrespective of the time, manner,
cause or lack of cause of such cessation, immediately deliver to Company or its
designated agent, in good condition, ordinary wear and tear and damage by any
cause beyond the reasonable control of Executive excepted, all items of the
Proprietary Property which are or have been in Executive's

                                      -5-
<PAGE>
 
possession or under his control, as well as a statement describing the
disposition of all items of the Proprietary Property previously in Executive's
possession in the event Executive has not previously returned such items of the
Proprietary Property to Company.

     (3) Agreement Not to Use or Divulge Confidential Information.  Executive
         --------------------------------------------------------            
agrees that he will not, at any time, in any fashion, form or manner, unless
specifically consented to in writing by Company, either directly or indirectly
use, divulge, transmit or otherwise disclose or cause to be used, divulged,
transmitted or otherwise disclosed to any person, firm or corporation, in any
manner whatsoever (other than in Executive's performance of duties for Company
or except as required by law) any Confidential Information of any kind, nature
or description.  The foregoing provisions shall not be construed to prevent
Executive from making use of or disclosing information which is in the public
domain through no fault of Executive, provided, however, specific information
shall not be deemed to be in the public domain merely because it is encompassed
by some general information that is published or in the public domain or in
Executive's possession prior to Executive's employment with Company.

     (4) Acknowledgment of Secrecy.  Executive acknowledges that the
         -------------------------                                  
Confidential Information is not generally known to the public or to other
persons who can obtain economic value from its disclosure or use and that the
Confidential Information derives independent economic value thereby, and
Executive agrees that he shall take all efforts reasonably necessary to maintain
the secrecy and confidentiality of the Confidential Information and to otherwise
comply with the terms of this Agreement.

     (5) Inventions, Discoveries.  Executive acknowledges that any inventions,
         -----------------------                                              
discoveries or trade secrets, whether patentable or not, made or found by
Executive in the scope of his employment with Company constitute property of
Company and that any rights therein now held or hereafter acquired by Executive
individually or in any capacity are hereby transferred and assigned to Company,
and agrees to execute and deliver any confirmatory assignments, documents or
instruments of any nature necessary to carry out the intent of this paragraph
when requested by Company without further compensation therefor, whether or not
Executive is at the time employed by Company.  Provided, however,
notwithstanding the foregoing, Executive shall not be required to assign his
rights in any invention which qualifies fully under the provisions of Section
2870(a) of the California Labor Code, which provides, in pertinent part, that
               ---------------------                                         
the requirement to assign "shall not apply to any invention that the employee
developed entirely on his or her own time without using employer's equipment,
supplies, facilities or trade secret information except for those inventions
that either:

             (i) Relate at the time of conception or reduction to practice of
the invention to the employer's business, or actual or demonstrably anticipated
research or development of the employer; or

             (ii) Result from any work performed by the employee for the
employer."

     Executive understands that he bears the full burden of proving to Company
that an invention qualifies fully under Section 2870(a).  By signing this
Agreement,

                                      -6-
<PAGE>
 
Executive acknowledges receipt of a copy of this Agreement and of written
notification of the provisions of Section 2870.

     5.  COMPLIANCE WITH SECURITIES LAWS.
         ------------------------------- 

     Executive acknowledges that, the Company is a publicly reporting company,
and that Company and Executive are subject to the provisions of Sections 10(b),
16(a) and 16(b) of the Securities Exchange Act of 1934 (the "Exchange Act").
Executive acknowledges that Section 16(a) of the Exchange Act requires Executive
to report the ownership or transfer of his stock or other securities in Company
to the Securities and Exchange Commission and that Sections 10(b) and 16(b) can
prohibit Executive from selling or transferring his stock or securities in
Company.  Executive agrees that he will comply with Company's policies, as
stated from time to time in writing, relating to selling or transferring his
stock or securities in Company.

     6.  COMPENSATION.
         ------------ 

          (a)  SALARY.  During the term of this Agreement, Company shall pay to 
               ------                                                          
Executive a base salary of Two Hundred Fifty Thousand Dollars ($250,000) per
year.  Executive's annual salary shall be reviewed periodically by Company for
the purpose of determining whether Executive's salary shall be increased.  In no
event shall this review take place less frequently than annually.  Executive
shall be entitled to receive such bonuses as the Company may, in its discretion,
award of up to fifty percent (50%) of Executive's base salary.

          (b)  EMPLOYEE BENEFIT PLANS.  Except as otherwise herein provided,
               ----------------------                                       
Executive shall be entitled, during the specified period of this Agreement, to
participate in any retirement, pension, profit-sharing, insurance, or other
plans which may now be in effect or which may be adopted by Company, including,
without limitation, all such benefits generally available to Company's other
senior executive employees.

          (c)  STOCK OPTIONS.  Within thirty (30) days after the date of this
               -------------                                                 
Agreement, the Company will prepare and deliver to Executive, a stock option
agreement which shall provide the following:  (i) Executive shall be granted
incentive options, pursuant to the 1994 Variflex Stock Plan, to purchase an
aggregate of one hundred twenty-five thousand (125,000) shares of Company's
common stock at a price per share equal to the closing price of the Company's
common stock as listed by NASDAQ as of the end of the first business day
immediately preceding the option grant date; (ii) the option grant date shall be
the Commencement Date; (iii) options to purchase shall vest over a five year
period according to the vesting schedule in the stock option agreement, so long
as Executive continues his employment with Company; (iv) options shall expire
five years following the grant date, except that vested options shall terminate
earlier in certain circumstances and unvested options shall terminate upon
termination of Executive's employment; (v) Executive shall be entitled to pay
for the stock in cash, in stock of Company with a fair market value equal to the
exercise price, and (vi) stock issued pursuant to this plan shall be restricted
stock, although Company shall reserve the right to issue registered shares if it
so decides.  Executive agrees to be bound by the terms of the stock option
agreement as adopted, and the provisions of this paragraph shall be limited by
and subject to the terms of that agreement.

                                      -7-
<PAGE>
 
          (d) OTHER BENEFITS.  The Executive shall be entitled to a car
              --------------                                           
allowance of up to $1,000 per month for so long as Executive's employment under
this Agreement has not been terminated by the Company or by Executive.

     7.  REIMBURSEMENT OF BUSINESS EXPENSES.  Company shall promptly reimburse
         ----------------------------------                                   
Executive for all reasonable business expenses incurred by Executive in
connection with the business of Company.  However, each such expenditure shall
be reimbursable only if Executive furnishes to Company such records and other
documentary evidence as are required by the policies adopted from time to time
by the Company for reimbursement of expenses.

     8.  ANNUAL VACATION; PLACE OF PERFORMANCE; AND INSURANCE.

          (a) VACATION.  Executive shall be entitled to three (3) weeks vacation
              --------                                                          
time each year without loss of compensation.  The Executive shall be entitled to
such period of vacation immediately upon effectiveness of this Agreement, and
such vacation need not be taken in consecutive periods.  If Executive does not
take all such vacation time in any given calendar year, such unused time shall
carry over to the next year during the Term.  Executive shall also be entitled
to all paid holidays provided by the Company to its other senior executive
employees.

          (b) PLACE OF PERFORMANCE.  In connection with his employment by the
              --------------------                                           
Company pursuant to this Agreement, the Executive shall be based at the
principal executive office of the Company in Southern California, except for
travel reasonably required for Company business.

          (c) INSURANCE.  During the Term, and for twenty-four (24) months
              ---------                                                   
thereafter, Company shall maintain in effect a directors and officers liability
insurance policy with a minimum coverage amount of Five Million Dollars
($5,000,000.00) with related commercially reasonable deductibles or, if Company
cannot obtain such minimum coverage amount of Five Million Dollars
($5,000,000.00) without unreasonable cost or expense or deductibles, taking into
account the size of the Company, whatever minimum coverage is commercially
reasonably available.

     9.  TERMINATION BY COMPANY FOR CAUSE.
         -------------------------------- 

          Company reserves the right to terminate Executive and Executive's
employment hereunder for cause.  For purposes of this Agreement, the term
"cause" shall be deemed to exist if Executive (a) breaches or habitually
neglects the duties which he is required to perform under the terms of this
Agreement and such breach or neglect remains uncured after ten (10) days
following the delivery of written notice from the Company asserting such breach
or neglect; or (b) fails to adhere to any written Company policy if the
Executive has been given a reasonable opportunity to comply with such policy or
cure his failure to comply (which reasonable opportunity must be granted during
the ten-day period preceding the proposed termination of this Agreement for such
failure); or (c) appropriates (or attempts to appropriate) for himself or others
a material business opportunity of the Company, including attempting to secure
or securing any personal profit in connection with any transaction entered into
on behalf of the Company; or (d) appropriates (or attempts to misappropriate)
for himself or others any of the Company's funds or

                                      -8-
<PAGE>
 
property; or (e) is convicted of, indicted for (or its procedural equivalent),
or enters a guilty plea or plea of no contest with respect to, a felony, the
equivalent thereof, or any other crime involving moral turpitude; or (f) commits
such acts of dishonesty, fraud, or misrepresentation as would prevent the
effective performance of his duties or results in material harm to Company's
business, taken as a whole. Company may terminate this Agreement for cause by
giving written notice of termination to Executive. With the exception of the
covenants included in paragraphs 4 and 5 above, upon such termination the
obligations of Executive and Company under this Agreement shall immediately
cease. Such termination shall be without prejudice to any other remedy to which
Company may be entitled either at law, in equity, or under this Agreement. If
Executive's employment is terminated pursuant to this paragraph, Company shall
pay to Executive, within two (2) business days of such termination, any deferred
or unpaid compensation and benefits to which Executive has earned and vested and
is otherwise entitled at the time of such termination.

     10.  TERMINATION WITHOUT CAUSE.
          ------------------------- 

          (a) BY COMPANY.  Company shall have the right to terminate this
              ----------                                                 
Agreement and Executive's employment hereunder without cause at any time.  If
Company terminates Executive without cause before the first anniversary of the
Commencement Date, Executive shall be entitled to a severance benefit equal to
Ninety Three Thousand Seven Hundred and Fifty Dollars ($93,750.00).  If Company
terminates Executive without cause after the first anniversary of the
Commencement Date, Executive shall be entitled to a severance benefit equal to
One Hundred and Twenty Five Thousand Dollars ($125,000.00); provided, however,
that Executive shall not be entitled to any severance if (i) this Agreement is
terminated by Company pursuant to paragraph 2(b) above or the Company gives
written notice of non renewal pursuant to paragraph 2(b) above, or (ii) this
Agreement is terminated by Executive pursuant to paragraph 2(b) above or
paragraph 10(b) below or the Executive gives written notice of non-renewal
pursuant to paragraph 2(b) above, or (iii) this Agreement and Executive's
employment hereunder is terminated for cause pursuant to paragraph 9 above, or
(iv) Executive's employment is terminated by reason of the death or disability
of Executive as provided in paragraph 11 below.  In the event the Executive is
"constructively terminated" (as defined below) by the Company, such constructive
termination shall constitute termination without cause for purposes of the
severance payments under this paragraph 10(a).  The term "constructively
terminated" shall mean any action by the Company (other than actual termination
of Executive's employment) taken without "cause" (as this term is defined in
paragraph 9 above) which results in a material diminution in Executive's
position (including status, title and reporting requirements), authority, duties
or responsibilities from that which is consistent with the status, title,
reporting requirements, authority, duties or responsibilities of a President of
a similarly situated public company (who is not also the Chief Executive
Officer).  The severance payment shall be subject to applicable tax withholding
and shall be paid in a lump sum within ten (10) business days following the
effective date of the event giving rise to Executive's being terminated without
cause.

          (b) BY EXECUTIVE.  Executive shall have the right to terminate this
              ------------                                                   
Agreement and Executive's employment hereunder without cause at any time upon
least sixty (60) days 

                                      -9-
<PAGE>
 
advance written notice to the Company. If Executive fails for any reason to give
the Company at least sixty (60) days advance written notice of termination of
his employment with the Company, such failure shall constitute a breach of this
Agreement by Executive .

     11.  TERMINATION UPON DEATH OR DISABILITY.
          ------------------------------------ 

          (a)  DEATH.  Executive's employment shall terminate upon the death of
               -----                                                           
Executive.  Upon such termination, the obligations of Executive and Company
under this Agreement shall immediately cease.

          (b)  DISABILITY.  Company reserves the right to terminate Executive's
               ----------                                                      
employment upon ten (10) days written notice ("Disability Termination Notice")
if, for a period of sixty (60) days, Executive is prevented from discharging his
duties under this Agreement due to any physical or mental disability.  With the
exception of the covenants included in paragraphs 4 and 5 above, upon such
termination the obligations of Executive and Company under this Agreement shall
immediately cease.  If the Executive shall not agree with a determination to
terminate his employment because of disability, he must send a written notice of
objection ("Disability Objection Notice") to the Company within ten (10) days
after the date of the Disability Termination Notice.  If for any reason
Executive fails or neglects to send a Disability Objection Notice within such
ten (10) day period, Executive shall be deemed to have waived his right to
object to his termination for disability.  If Executive does send a Disability
Objection Notice to the Company within said ten (10) day period, then the
question of the Executive's disability within the meaning of this Agreement
shall be subject to the certification of a qualified medical doctor agreed to by
the Company and the Executive.  If a qualified medical doctor cannot be mutually
agreed upon within ten (10) days following the date of the Disability Objection
Notice, each party shall nominate a medical doctor by written notice to each
other within fifteen (15) days after the date of the Disability Objection Notice
and those two doctors shall select a third doctor within twenty (20) days after
the date of the Disability Objection Notice, who shall make the final
determination as to disability and send a reasonably detailed written report of
such determination to the Company and Executive not later than the forty-fifth
(45th) day following the date of the Disability Objection Notice.  If Executive
sends a Disability Objection Notice within the time period specified herein,
then during the period from the date of such Notice until the earlier of the
date of the written report of the third medical doctor setting forth his
determination or the forty-fifth (45th) day following the date of the Disability
Objection Notice, Executive shall continue to receive full compensation and
other benefits called for hereunder.

     12.  MISCELLANEOUS.
          ------------- 

          (a)  PREPARATION OF AGREEMENT.  It is acknowledged by each party that
               ------------------------                                        
such party either had separate and independent advice of counsel or the
opportunity to avail itself or himself of same.  In light of these facts it is
acknowledged that no party shall be construed to be solely responsible for the
drafting hereof, and therefore any ambiguity shall not be construed against any
party as the alleged draftsman of this Agreement.

                                      -10-
<PAGE>
 
          (b)  COOPERATION.  Each party agrees, without further consideration,
               -----------                                                    
to cooperate and diligently perform any further acts, deeds and things and to
execute and deliver any documents that may from time to time be reasonably
necessary or otherwise reasonably required to consummate, evidence, confirm
and/or carry out the intent and provisions of this Agreement, all without undue
delay or expense.

          (c)  INTERPRETATION.
               -------------- 

              (i) Entire Agreement/No Collateral Representations.  Each party
                  ----------------------------------------------             
expressly acknowledges and agrees that this Agreement, including all exhibits
attached hereto:  (1) is the final, complete and exclusive statement of the
agreement of the parties with respect to the subject matter hereof; (2)
supersedes any prior to contemporaneous agreements, promises, assurances,
guarantees, representations, understandings, conduct, proposals, conditions,
commitments, acts, course of dealing, warranties, interpretations or terms of
any kind, oral or written (collectively and severally, the "Prior Agreements"),
and that any such Prior Agreements are of no force or effect except as expressly
set forth herein; and (3) may not be varied, supplemented or contradicted by
evidence of Prior Agreements, or by evidence of subsequent oral agreements.  Any
agreement hereafter made shall be ineffective to modify, supplement or discharge
the terms of this Agreement, in whole or in part, unless such agreement is in
writing and signed by the party against whom enforcement of the modification or
supplement is sought.

              (ii) Waiver.  No breach of any agreement or provision herein
                   ------                                                 
contained, or of any obligation under this Agreement, may be waived, nor shall
any extension of time for performance of any obligations or acts be deemed an
extension of time for performance of any other obligations or acts contained
herein, except by written instrument signed by the party to be charged or as
otherwise expressly authorized herein.  No waiver of any breach of any agreement
or provision herein contained shall be deemed a waiver of any preceding or
succeeding breach thereof, or a waiver or relinquishment of any other agreement
or provision or right or power herein contained.

              (iii)  Remedies Cumulative.  The remedies of each party under this
                     -------------------                                        
Agreement are cumulative and shall not exclude any other remedies to which such
party may be lawfully entitled.

              (iv) 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 and amount 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.

                                      -11-
<PAGE>
 
             (v) Time is of the Essence.  It is expressly understood and agreed
                 ----------------------                                        
that time of performance is strictly of the essence with respect to each and
every term, condition, obligation and provision hereof and that the failure to
timely perform any of the terms, conditions, obligations or provisions hereof by
any party shall constitute a material breach and a noncurable (but waivable)
default under this Agreement by the party so failing to perform.

             (vi) No Third Party Beneficiary.  Notwithstanding anything else 
                  --------------------------  
herein to the contrary, the parties specifically disavow any desire or intention
to create any third party beneficiary obligations, and specifically declare that
no person or entity, other than as set forth in this Agreement, shall have any
rights hereunder or any right of enforcement hereof.

             (vii)  No Reliance Upon Prior Representation.  The parties 
                    -------------------------------------                    
acknowledge that no other party has made any oral representation or promise
which would induce them prior to executing this Agreement to change their
position to their detriment, partially perform, or part with value in reliance
upon such representation or promise; the parties acknowledge that they have
taken such action at their own risk; and the parties represent that they have
not so changed their position, performed or parted with value prior to the time
of their execution of this Agreement.

             (viii)  Headings; References; Incorporation; Gender.  The headings
                     -------------------------------------------               
used in this Agreement are for convenience and reference purposes only, and
shall not be used in construing or interpreting the scope or intent of this
Agreement or any provision hereof.  References to this Agreement shall include
all amendments or renewals thereof.  All cross-references in this Agreement,
unless specifically directed to another agreement or document, shall be
construed only to refer to provisions within this Agreement, and shall not be
construed to be referenced to the overall transaction or to any other agreement
or document.  Any exhibit referenced in this Agreement shall be construed to be
incorporated in this Agreement.  As used in this Agreement, each gender shall be
deemed to include the other gender, including neutral genders or genders
appropriate for entities, if applicable, and the singular shall be deemed to
include the plural, and vice versa, as the context requires.

          (d) ENFORCEMENT.
              ----------- 

             (i) Applicable 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 laws (without regard to the
conflicts of law principles thereof) of the State of California, as if this
agreement were made, and as if its obligations are to be performed, wholly
within the State of California.

             (ii) Consent to Jurisdiction; Service of Process.  Any action or
                  -------------------------------------------                
proceeding arising out of or related 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 to venue therein, consents to the
service of process in any such action or proceeding by certified or registered
mailing of the summons and complaint in accordance with the notice provisions of
this

                                      -12-
<PAGE>
 
Agreement, 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 judgment rendered thereby in connection with this Agreement.

             (iii)  Consent to Specific Performance and Injunctive Relief and
                    ---------------------------------------------------------
Waiver of Bond or Security.  Each party acknowledges that Company may, as a
--------------------------                                                 
result of Executive's breach of the covenants and obligations included in
paragraph 4 of this Agreement, sustain immediate and long-term substantial and
irreparable injury and damage which cannot be reasonably or adequately
compensated by damages at law.  Each party agrees that in the event of
Executive's breach or threatened breach of the covenants and obligations
included in paragraph 4, Company shall be entitled to obtain from a court of
competent jurisdiction or arbitration, as the case may be under this Agreement,
equitable relief, including, without limitation, enforcement of all of the
provisions of this Agreement by specific performance and/or temporary,
preliminary and/or permanent injunctions enforcing any of Company's rights,
requiring performance by Executive, or enjoining any breach by Executive, all
without proof of any actual damages that have been or may be caused to Company
by such breach or threatened breach and without the posting of bond or other
security in connection therewith.  Executive waives the claim or defense that
Company has an adequate, remedy at law and Excessive shall not allege or
otherwise assert the legal position that any such remedy at law exists.  Each
party agrees and acknowledges:  (1) that the terms of this paragraph are fair,
reasonable and necessary to protect the legitimate interests of the other party;
(2) that this waiver is a material inducement to the other party to enter into
the transaction contemplated hereby; (3) that the other party has already relied
upon this waiver in entering into this agreement; and (4) that each party will
continue to rely on this wavier in their future dealings.  Each party warrants
and represents that such party has reviewed this provision with such party's
legal counsel or has been afforded an ample opportunity to do so, and that such
party has knowingly and voluntarily waived its rights.

             (iv) Attorneys' Fees and Costs.  If any party institutes or should 
                  -------------------------
the parties otherwise become a party to any Action Or Proceeding (as defined
below) based upon or arising out of this Agreement including, without
limitation, to enforce or interpret this Agreement or any provision hereof, or
for damages by reason of any alleged breach of this Agreement or any provision
hereof, or for a declaration of rights in connection herewith, or for any other
relief, including equitable relief, in connection herewith, the Prevailing Party
(as defined below) in any such Action Or Proceeding, whether or not such Action
Or Proceeding proceeds to final judgment or determination, shall be entitled to
receive from the non-Prevailing Party as a cost of suit, and not as damages, all
Costs And Expenses (as defined below) of prosecuting or defending the Action Or
Proceeding, as the case may be, including, without limitation, reasonable
Attorneys' And Other Fees.

             (v) Definitions.  The term "Action Or Proceeding" is defined as any
                 -----------                                                    
and all claims, suits, actions, notices, inquiries, proceedings, hearings,
arbitrations or other similar proceedings, including appeals and petitions
therefrom, whether formal or informal, governmental or non-governmental, or
civil or criminal.  The term "Prevailing Party" is defined as the party who is
determined to prevail by the Court after its consideration of all damages and
equities in the Action Or Proceeding, whether or not the Action Or Proceeding
proceeds to final

                                      -13-
<PAGE>
 
judgment. The Court shall retain the discretion to determine that no party is
the Prevailing Party in which case no party shall be entitled to recover its
Costs And Expenses under this subparagraph 12(d). The term "Attorneys' And Other
Fees" is defined as attorneys' fees, accountants' fees, fees of other
professionals, witness fees (including experts engaged by the parties, but
excluding shareholders, officers, employees or partners of the parties), and any
and all other similar fees incurred in the prosecution or defense of the Action
Or Proceeding. The term "Costs And Expenses" is defined as the cost to take
depositions, the cost to arbitrate this dispute, if applicable, and the costs
and expenses of travel and lodging incurred with respect to the Action or
Proceeding, provided, however, the party incurring said travel and lodging
expense must ordinarily travel over one hundred (100) miles, one way, from his
or her residence in incurring such expense.

          (e)  NO ASSIGNMENT OF RIGHTS OR DELEGATION OF DUTIES BY EXECUTIVE.
               ------------------------------------------------------------  
Executive's rights and benefits under this Agreement are personal to him and
therefore (i) no such right or benefit shall be subject to voluntary or
involuntary alienation, assignment or transfer; and (ii) Executive may not
delegate his duties or obligations hereunder.  This Agreement will be binding
upon and inure to the benefit of the Company and any successor to the Company by
merger, consolidation, reorganization, sale of all or substantially all of the
assets or otherwise (and such successor shall thereafter be deemed the "Company"
for the purposes of this Agreement), but will not otherwise be assignable,
transferable or delegable by the Company.

          (f)  NOTICES.  Unless otherwise specifically provided in this
               -------                                                 
Agreement, all notices, demands, requests, consents, approvals or other
communications (collectively and severally called "Notices") required or
permitted to be given hereunder, or which are given with respect to this
Agreement, shall be in writing, and shall be given by:  (A) personal delivery
(which form of Notice shall be deemed to have been given upon delivery), (B) by
telegraph or by private airborne/overnight delivery service (which forms of
Notice shall be deemed to have been given upon confirmed delivery by the
delivery agency), (C) by facsimile transmission (which forms of Notice shall be
deemed delivered upon receipt by the sending party of a confirmation of
transmission issued by sender's facsimile machine), or (D) by mailing in the
United States mail by registered or certified mail, return receipt requested,
postage prepaid (which forms of Notice shall be deemed to have been given upon
the fifth (5th) business day following the date mailed).  Each party, and their
respective counsel, hereby agree that any such Notice may be given hereunder by
such party's Counsel and such counsel may communicate directly with all
principals, as required to comply with the foregoing notice provisions.  Notices
shall be addressed to the address hereinabove set forth in the introductory
paragraph of this Agreement, or to such other address as the receiving party
shall have specified most recently by like Notice, with a copy to the other
parties hereto.  Any Notice given to the estate of a party shall be sufficient
if addressed to the party as provided in this subparagraph.

          (g)  COUNTERPARTS.  This Agreement may be executed in counterparts,
               ------------                                                  
each of which shall be deemed an original, and all of which together shall
constitute one and the same instrument, binding on all parties hereto.  Any
signature page of this Agreement may be detached from any counterpart of this
Agreement and reattached to any other counterpart of this

                                      -14-
<PAGE>
 
Agreement identical in form hereto by having attached to it one or more
additional signature pages.

          (h)  EXECUTION BY ALL PARTIES REQUIRED TO BE BINDING:  ELECTRONICALLY
               ----------------------------------------------------------------
TRANSMITTED DOCUMENTS.  This Agreement shall not be construed to be an offer and
---------------------                                                           
shall have no force and effect until this Agreement is fully executed by all
parties hereto.  If a copy or counterpart of this Agreement is originally
executed and such copy or counterpart is thereafter transmitted electronically
by facsimile or similar device, such facsimile document shall for all purposes
be treated as if manually signed by the party whose facsimile signature appears.

          (i)  NO OBLIGATION TO MITIGATE.  Absent a breach of this Agreement by
               -------------------------                                       
Executive, the Executive is under no obligation to mitigate the amount of any
payment provided for hereunder by seeking other employment or otherwise.

     IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first written above.

                              COMPANY:

                              VARIFLEX, INC., a Delaware corporation


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



                              EXECUTIVE:



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

                                      -15-