##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K (Mark One) /X/
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996]
 For the fiscal year ended December 31, 2003 OR /   /
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
 For the transition period from
    
    to
 Commission File Number 33-85014 FIRST SUNAMERICA LIFE INSURANCE COMPANY Incorporated in New York
    
    06-0992729IRS employerIdentification No.
 733 Third Avenue, 4th Floor, New York, New York 10017
Registrants telephone number, including area code (800) 272-3007 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None 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            Yes [X] No [   ] INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANTS KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO
THIS FORM 10-K. [X] INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE SECURITIES EXCHANGE ACT OF 1934). Yes [   ] No [X] AS THE REGISTRANT IS AN INDIRECT WHOLLY OWNED SUBSIDIARY OF AMERICAN
INTERNATIONAL GROUP, INC., NONE OF THE REGISTRANTS COMMON STOCK IS HELD BY
NON-AFFILIATES OF THE REGISTRANT. THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANTS COMMON STOCK ON March 26,
2004 WAS AS FOLLOWS: Common Stock (par value $10,000 per share)
    
    300 shares outstanding
 REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.




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TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERSPART IIITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERSITEM 6. SELECTED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 9A. DISCLOSURE CONTROLS AND PROCEDURESPART IIIItem 14. PRINCIPAL ACCOUNTING FEES AND SERVICESPART IVITEM 15. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-KSIGNATURESReport of Independent AuditorsBALANCE SHEETSTATEMENT OF INCOME AND COMPREHENSIVE INCOMESTATEMENT OF CASH FLOWSNOTES TO FINANCIAL STATEMENTSEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32    Table of Contents  
 PART I 
 ITEM 1. BUSINESS GENERAL DESCRIPTION First SunAmerica Life Insurance Company (the Company) was incorporated
under the laws of the State of New York on December 5,1978. The Company is a
direct wholly owned subsidiary of SunAmerica Life Insurance Company (the
Parent), which is a wholly owned subsidiary of AIG Retirement Services, Inc.
(AIGRS) (formerly AIG SunAmerica Inc.), a wholly owned subsidiary of American
International Group, Inc. (AIG). AIG is a holding company, which through its
subsidiaries is engaged in a broad range of insurance and insurance-related
activities, financial services and retirement services and asset management. The Company maintains its principal offices at 733 Third Avenue, 4th
Floor, New York, New York 10017, telephone (800) 996-9786. The Company has one
employee; however, employees of AIGRS and other affiliates of the Company
perform various services for the Company. AIGRs had approximately 1,800
employees at December 31, 2003, approximately 700 of whom perform services for
the Company as well as for certain of its affiliates. The Company is a life insurance company principally engaged in the
business of writing fixed and variable annuities for retirement savings. The
Company believes that demographic trends have produced strong consumer demand
for long-term, investment-oriented products. According to U.S. Census Bureau
projections, the number of individuals between the ages of 45 to 64 grew from
48 million to 67 million from 1992 to 2002, making this age group the
fastest-growing segment of the U.S. population. Between 1992 and 2002, annual
industry premiums from fixed and variable annuities and fund deposits increased
from $130.7 billion to $268.4 billion. Benefiting from continued strong growth of the retirement services market,
industry sales of tax-deferred savings products have represented, for a number
of years, a significantly larger source of new premiums for the U.S. life
insurance industry than have traditional life insurance products. Recognizing
the growth potential of this market, the Company focuses its operations on the
sale of annuities. Substantially all of the Companys revenues are derived from the State of
New York. Products are marketed through affiliated and independent
broker-dealers, full-service securities firms and financial institutions. One
financial institution represented approximately 15.9% and one independent
broker-dealer represented 15.3% of sales in the year ended December 31, 2003.
One financial institution represented approximately 19.3% of sales in the year
ended December 31, 2002. One financial institution represented approximately
35.7% of sales in the year ended December 31, 2001. No other independent
selling organization was responsible for more than 10% of sales for any such
periods. For the year ended December 31, 2003, the Companys investment income and
net realized investment losses and fee income by primary product line or
service are as follows: 1




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INVESTMENT AND FEE INCOME Amount
    
    Percent
    
    Primary Product orService(In thousands)Fee income:Variable annuity policy
fees
    
    $
    8,077
    
    
    
    5.9
    %
    
    Variable annuitiesUniversal life insurance
fees, net of
reinsurance
    
    
    5,289
    
    
    
    3.8
    
    
    Fixed-rate universal life productsSurrender charges
    
    
    1,744
    
    
    
    1.3
    
    
    Fixed and variable annuity productsTotal fee income
    
    
    15,110
    
    
    
    11.0
    
    
    Fixed-rate and variable annuity productsInvestment income
    
    
    119,730
    
    
    
    87.2
    
    
    Fixed-rate products and fixed options of variable annuitiesNet realized investment
gains
    
    
    2,417
    
    
    
    1.8
    
    
    Fixed-rate products and fixed options of variable annuitiesTotal
    
    $
    137,257
    
    
    
    100.0
    %
 ANNUITY OPERATIONS Founded in 1978, the Company is licensed in the States of New York, New
Mexico and Nebraska and issues a portfolio of single-premium fixed and
flexible-premium variable annuities. The Company distributes its products through a vast network of financial
institutions, independent broker-dealers and full-service securities firms as
well as independent general insurance agents. In total, approximately 10,400
independent sales representatives are licensed to sell the Companys annuity
products in three states. ANNUITY OPERATIONS  GENERAL ACCOUNT Approximately, $1.15 billion of the Companys premiums were for fixed
annuities in 2003 representing 88.3% of all deposits. The Companys general
account obligations are fixed-rate products, including fixed annuities as well
as universal life contracts issued in prior years and fixed-rate options of its
variable annuity contracts. The Company offers single-premium and
flexible-premium deferred annuities that provide one, three, five, seven, or
ten-year fixed interest rate guarantees. The Company also offers fixed-rate
account options on its variable annuity contracts with similar guarantees.
Although the Companys annuity contracts remain in force an average of seven to
ten years, a majority (approximately 85% at December 31, 2003) of the annuity
contracts, as well as the universal life contracts, reprice annually at
discretionary rates determined by the Company subject to 1.5% to 5.5% minimum
rate guarantees, depending on the contract. In repricing, the Company takes
into account yield characteristics of its investment portfolio, surrender
assumptions and competitive industry pricing, among other factors. Its fixed
annuity products offer many of the same features as conventional certificates
of deposit from financial institutions, giving investors a
choice of interest period and yield as well as additional advantages 2




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particularly applicable to retirement planning, such as tax-deferred
accumulation and flexible payout options (including the option of payout over
the life of the annuitant). The average size of a new single-premium fixed
annuity contract sold by the Company in 2003 was approximately $36,000. The Company has had the ability, limited by minimum interest rate
guarantees, to respond to the generally declining interest rate environment in
the last five years by lowering crediting rates in response to lower investment
returns. See Managements Discussion and Analysis of Financial Condition and
Results of Operations for additional information on the calculation of
investment yield and net investment spread used by the Companys management as
a key component in evaluating the profitability of its annuity business. The
trends experienced during the three years ended December 31, 2003 in the
Companys average yield on its portfolio of bonds, notes, and redeemable
preferred stocks (the Bond Portfolio) and rate of interest credited on
average interest-bearing liabilities, compared to the market trend in long-term
interest rates as illustrated by the average ten-year U.S. Treasury bond rate,
are presented in the following table: 2003
    
    2002
    
    200110-year U.S. Treasury bond rate:
    
    
    4.01
    %
    
    
    4.61
    %
    
    
    5.02
    %First SunAmerica Life Insurance Company:Average yield on Bond Portfolio
    
    
    5.77
    
    
    
    6.98
    
    
    
    7.01Rate paid on average interest-bearing
Liabilities
    
    
    3.84
    
    
    
    4.39
    
    
    
    4.70
 The Company designs its fixed-rate annuity products and conducts its
investment operations in order to closely match the duration of the assets in
its investment portfolio to its fixed annuity and universal life obligations.
The Company seeks to achieve a predictable spread between what it earns on its
assets and what it pays on its liabilities by investing principally in
fixed-rate securities. The Companys fixed annuity and universal life products
incorporate surrender charges or other restrictions in order to encourage
persistency. Approximately 79% of the Companys fixed annuity and universal
life reserves had surrender penalties or other restrictions at December 31,
2003. Beginning in July 2002, the Company began marketing fixed annuities
through an affiliated company, AIG Annuity Insurance Company. The Companys
fixed annuities sales increased significantly in 2003 and the latter half of
2002 due to the enhanced marketing and distribution efforts. The increase in
sales growth in 2003 and the second half of 2002 principally reflects the sales
of the Companys three new products: Dime Bank Proprietary, AIG Future Freedom
and AIG 5 SPDA, introduced in July 2002. ANNUITY OPERATIONS - VARIABLE ANNUITIES  SEPARATE ACCOUNT The variable annuity products of the Company offer investors a broad
spectrum of fund alternatives, with a choice of investment managers, as well as
guaranteed fixed-rate account options. The Company earns fee income through
the sale, administration and management of the variable account options of its
variable annuity products. The Company also earns investment income on monies
allocated to the fixed-rate account options of these products. Variable
annuities offer retirement planning features similar to those offered by fixed
annuities, but differ in that the contractholders rate of return is generally
dependent upon the investment performance of the particular equity,
fixed-income, money market or asset allocation fund selected by the
contractholder. Because the investment risk is borne by the customer in all
but the fixed-rate account options, these products require significantly less
capital support than fixed annuities. The Companys flagship Polaris variable annuity products are 3




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multimanager
variable annuities that offer investors a choice of several variable funds, 5
fixed account options and 2 dollar-cost averaging fixed account options for
different time periods. Variable annuity product sales have increased in
recent years due to enhanced distribution efforts and growing consumer demand
for flexible retirement savings products that offer a variety of equity,
fixed-income and guaranteed fixed account investment choices. The increase in
sales growth in 2003 reflects the sales of the Companys new products; WM
Diversfied Strategies III and Polaris II, introduced at the beginning of 2003
and late 2002, respectively. The increase in sales growth in 2002 is primarily
due to the marketing of annuities through new distribution relationships. The
increase in sales growth in 2001 is principally due to both new and enhanced
relationships with New York based investment firms as well as the addition of
four new funds offered by Polaris in December 2000. At December 31, 2003, total variable product liabilities were $739.5
million, of which $438.2 million were held in separate accounts and $301.3
million were the liabilities of the fixed-rate account options, which are held
in the general accounts. The Companys variable annuity products incorporate
surrender charges to encourage persistency. At December 31, 2003, 88% of the
Companys variable annuity liabilities held in the separate accounts were
subject to surrender penalties or other restrictions. The Companys variable
annuity products also generally limit the number of transfers made in a
specified period between account options without the assessment of a fee. The
average size of a new variable annuity contract sold by the Company in 2003 was
approximately $68,000. INVESTMENT OPERATIONS The Company believes that its fixed-rate liabilities should be backed by a
portfolio principally composed of fixed-rate investments that generate
predictable rates of return. The Company does not have a specific target rate
of return. Instead, its rates of return vary over time depending on the
current interest rate environment, the slope of the yield curve, the spread at
which fixed-rate investments are priced over the yield curve, default rates and
general economic conditions. The majority of the Companys invested assets are
managed by a subsidiary of AIG. Its portfolio strategy is constructed with a
view to achieve adequate risk-adjusted returns consistent with its investment
objectives of effective asset-liability matching, liquidity and safety. For more information concerning the Companys investments, including the
risks inherent in such investments, see Item 7, Managements Discussion and
Analysis of Financial Condition and Results of Operations  Capital Resources
and Liquidity. REGULATION The Company, in common with other insurers, is subject to regulation and
supervision by the states and jurisdictions in which it does business. Within
the United States, the method of such regulation varies but generally has its
source in statutes that delegate regulatory and supervisory powers to a state
insurance official. The regulation and supervision relate primarily to
approval of policy forms and rates, the standards of solvency that must be met
and maintained, including risk based capital measurements, the licensing of
insurers and their agents, the nature of and limitations on investments,
restrictions on the size of risks which may be insured under a single policy,
deposits of securities for the benefit of policyholders, methods of accounting,
periodic examinations of the affairs of insurance companies, the form and
content of reports of financial condition required to be filed, and reserves
for unearned premiums, losses and other purposes. In general, such regulation
is for the protection of policyholders rather than security holders. 4




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Risk based capital (RBC) standards are designed to measure the adequacy
of an insurers statutory capital and surplus in relation to the risks inherent
in its business. The standards are intended to help identify inadequately
capitalized companies and require specific regulatory actions in the event an
insurers RBC is deficient. The RBC formula develops a risk-adjusted target
level of adjusted statutory capital and surplus by applying certain factors to
various asset, premium and reserve items. Higher factors are applied to more
risky items and lower factors are applied to less risky items. Thus, the
target level of statutory surplus varies not only as a result of the insurers
size, but also on the risk profile of the insurers operations. The RBC Model
Law provides four incremental levels of regulatory attention for insurers whose
surplus is below the calculated RBC target. These levels of attention range
in severity from requiring the insurer to submit a plan for corrective action
to actually placing the insurer under regulatory control. The statutory
capital and surplus of the Company exceeded its RBC requirements as of December
31, 2003. In 1998, the NAIC adopted the codification of statutory accounting
principles (Codification) which replaced the NAICs previous primary guidance
on statutory accounting, which became effective January 1, 2001. Codification
changes prescribed statutory accounting practices and has resulted in changes
to the accounting practices that the Company uses to prepare its statutory
basis financial statements. Codification has been adopted by all fifty states
as the prescribed basis of accounting. New York, however, has made certain
modifications (e.g., no deferred taxes will be recorded prior to January 1,
2002 for companies domiciled in the State of New York). The adoption of
Codification resulted in a decrease to the Companys statutory surplus of
approximately $14.2 million and was recorded as a cumulative effect of changes
in accounting principles in 2001. For periods beginning as of January 1, 2002,
the State of New York conformed to NAIC codification relating to deferred
income taxes. Accordingly, the Company recorded a charge to surplus of $4.9
million during 2002 relating to a change in accounting principle. The federal government does not directly regulate the business of
insurance, however, the Company and its products are governed by federal
agencies, including the Securities and Exchange Commission and the Internal
Revenue Service. Federal legislation and administrative policies in several
areas, including financial services regulation, pension regulation and federal
taxation, can significantly and adversely affect the insurance industry. The
federal government has from time to time considered legislation relating to the
deferral of taxation on the accretion of value within certain annuities and
life insurance products, changes in ERISA regulations, the alteration of the
federal income tax structure and the availability of Section 401(k) and
individual retirement accounts. Although the ultimate effect of any such
changes, if implemented, is uncertain, both the persistency of our existing
products and our ability to sell products may be materially impacted in the
future. Recently there has been a significant increase in federal and state
regulatory activity relating to financial services companies, particularly
mutual fund companies and life insurers issuing variable annuity products.
These inquiries have focused on a number of issues including after-hours
trading, short-term trading (sometimes referred to as market timing), revenue
sharing arrangements and greater transparency regarding compensation
arrangements. There are several rule proposals pending at the SEC and on a
federal level which, if passed, could have an impact on the business of the
Company. COMPETITION The businesses conducted by the Company are highly competitive. The
Company competes with other life insurers, and also competes for customers 5




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funds with a variety of investment products offered by financial services
companies other than life insurance companies, such as banks, investment
advisors, mutual fund companies and other financial institutions. In 2002,
net annuity premiums written among the top 100 companies ranged from
approximately $73 million to approximately $21 billion annually. In 2002, the
Company together with its affiliates was the largest of this group. The
Company believes the primary competitive factors among life insurance
companies for investment-oriented insurance products, such as annuities,
include product flexibility, net return after fees, innovation in product
design, the insurer financial strength rating and the name recognition of the
issuing company, the availability of distribution channels and service
rendered to the customer before and after a contract is issued. Other factors
affecting the annuity business include the benefits (including before-tax and
after-tax investment returns) and guarantees provided to the customer and the
commissions paid. 
 ITEM 2. PROPERTIES The Companys executive offices and its principal office are in leased
premises at 733 Third Avenue, New York, New York 10017. The Company, through
an affiliate, also leases office space in Los Angeles and Woodland Hills,
California. The Company believes that such properties, including the equipment
located therein, are suitable and adequate to meet the requirements of its
business. 
 ITEM 3. LEGAL PROCEEDINGS Various lawsuits against the Company have arisen in the ordinary course of
business. Contingent liabilities arising from litigation, income taxes and
other matters are not considered material in relation to the financial position
of the Company. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS No matters were submitted during the quarter ended December 31, 2003 to a
vote of security holders, through the solicitation of proxies or otherwise. 
 PART II 
  ITEM 5.
    MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Not applicable. 6




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ITEM 6. SELECTED FINANCIAL DATA The following selected financial data of the Company should be read in
conjunction with the financial statements and notes thereto and Managements
Discussion and Analysis of Financial Condition and Results of Operations, both
of which are included elsewhere herein. Years Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(in thousands)RESULTS OF OPERATIONSFee income, net of
reinsurance
    
    $
    15,110
    
    
    $
    17,133
    
    
    $
    15,997
    
    
    $
    19,979
    
    
    $
    15,859Investment income
    
    
    119,730
    
    
    
    97,327
    
    
    
    100,952
    
    
    
    119,729
    
    
    
    125,681Net realized investment
gains (losses)
    
    
    2,417
    
    
    
    (10,025
    )
    
    
    (19,266
    )
    
    
    (20,779
    )
    
    
    (11,178
    )Total revenues
    
    
    137,257
    
    
    
    104,435
    
    
    
    97,683
    
    
    
    118,929
    
    
    
    130,362Interest expense
    
    
    76,707
    
    
    
    58,675
    
    
    
    63,135
    
    
    
    77,460
    
    
    
    82,589General and administrative expenses
    
    
    6,036
    
    
    
    8,112
    
    
    
    4,341
    
    
    
    4,945
    
    
    
    5,505Amortization of deferred
acquisition costs
    
    
    20,564
    
    
    
    16,367
    
    
    
    11,629
    
    
    
    19,399
    
    
    
    22,664Annual commissions
    
    
    1,038
    
    
    
    771
    
    
    
    724
    
    
    
    619
    
    
    
    450Claims on universal life
contracts, net of
reinsurance recoveries
    
    
    3,098
    
    
    
    2,985
    
    
    
    2,415
    
    
    
    4,897
    
    
    
    4,848Guaranteed minimum death
benefits
    
    
    816
    
    
    
    1,735
    
    
    
    546
    
    
    
    4
    
    
    
    13Total benefits and
expenses
    
    
    108,259
    
    
    
    88,645
    
    
    
    82,790
    
    
    
    107,324
    
    
    
    116,069Pretax income before
accounting change
    
    
    28,998
    
    
    
    15,790
    
    
    
    14,893
    
    
    
    11,605
    
    
    
    14,293Income tax expense
    
    
    12,081
    
    
    
    9,032
    
    
    
    6,180
    
    
    
    4,325
    
    
    
    6,621Income before cumulative
effect of accounting
change
    
    
    16,917
    
    
    
    6,758
    
    
    
    8,713
    
    
    
    7,280
    
    
    
    7,672Cumulative effect of
accounting change,
net of tax
    
    
    
    
    
    
    
    
    
    
    (520
    )
    
    
    
    
    
    
    NET INCOME
    
    $
    16,917
    
    
    $
    6,758
    
    
    $
    8,193
    
    
    $
    7,280
    
    
    $
    7,672
 In 2001, the Company adopted EITF 99-20, the effect of which was recorded as a
cumulative effect of accounting change (See Note 2 of the accompanying
financial statements). The results of operations for 2003 and 2002 are affected by the profit sharing
agreement with AIG SunAmerica Asset Management Corp. (See Notes 2 and 9 of the
accompanying financial statements). 7




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December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(in thousands)FINANCIAL POSITIONInvestments and cash
    
    $
    3,167,646
    
    
    $
    1,707,804
    
    
    $
    1,367,698
    
    
    $
    1,486,247
    
    
    $
    1,806,742Variable annuity assets
held in separate
accounts
    
    
    438,224
    
    
    
    399,017
    
    
    
    514,203
    
    
    
    565,547
    
    
    
    558,605Deferred acquisition
costs
    
    
    177,926
    
    
    
    104,459
    
    
    
    100,182
    
    
    
    124,451
    
    
    
    137,637Deferred income taxes
    
    
    
    
    
    
    
    
    
    
    1,947
    
    
    
    7,914
    
    
    
    18,275Other assets
    
    
    30,686
    
    
    
    28,106
    
    
    
    14,573
    
    
    
    30,214
    
    
    
    34,253TOTAL ASSETS
    
    $
    3,814,482
    
    
    $
    2,239,386
    
    
    $
    1,998,603
    
    
    $
    2,214,373
    
    
    $
    2,555,512Reserves for fixed
annuity contracts
    
    $
    2,490,145
    
    
    $
    1,290,702
    
    
    $
    1,024,830
    
    
    $
    1,186,996
    
    
    $
    1,523,641Reserves for universal
life insurance
contracts
    
    
    232,271
    
    
    
    237,862
    
    
    
    248,161
    
    
    
    249,987
    
    
    
    277,250Variable annuity
liabilities related
to separate accounts
    
    
    438,224
    
    
    
    399,017
    
    
    
    514,203
    
    
    
    565,547
    
    
    
    558,605Other payables and
accrued liabilities
    
    
    262,422
    
    
    
    68,373
    
    
    
    17,830
    
    
    
    24,215
    
    
    
    34,776Deferred income taxes
    
    
    41,895
    
    
    
    30,394
    
    
    
    
    
    
    
    
    
    
    
    Shareholders equity
    
    
    349,525
    
    
    
    213,038
    
    
    
    193,579
    
    
    
    187,628
    
    
    
    161,240TOTAL LIABILITIES AND
SHAREHOLDERS EQUITY
    
    $
    3,814,482
    
    
    $
    2,239,386
    
    
    $
    1,998,603
    
    
    $
    2,214,373
    
    
    $
    2,555,512
 
  ITEM 7.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Managements discussion and analysis of financial condition and results of
operations of First SunAmerica Life Insurance Company (the Company) for the
three years ended December 31, 2003 (2003), 2002 (2002) and 2001 (2001)
follows. Certain prior period amounts have been reclassified to conform to the
current periods presentation. In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions readers regarding certain
forward-looking statements contained in this report and in any other statements
made by, or on behalf of, the Company, whether or not in future filings with
the Securities and Exchange Commission (the SEC). Forward-looking statements
are statements not based on historical information and which relate to future
operations, strategies, financial results, or other developments. Statements
using verbs such as expect, anticipate, believe or words of similar
import generally involve forward-looking statements. Without limiting the
foregoing, forward-looking statements include statements which represent the
Companys beliefs concerning future levels of sales and redemptions of the
Companys products, investment spreads and yields, or the earnings or
profitability of the Companys activities. 8




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##### Table of Contents



Forward-looking statements are necessarily based on estimates and
assumptions that are inherently subject to significant business, economic and
competitive uncertainties and contingencies, many of which are beyond the
Companys control and many of which are subject to change. These uncertainties
and contingencies could cause actual results to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company. Whether or not actual results differ materially from forward-looking
statements may depend on numerous foreseeable and unforeseeable developments.
Some may be national in scope, such as general economic conditions, changes in
tax law and changes in interest rates. Some may be related to the insurance
industry generally, such as pricing competition, regulatory developments and
industry consolidation. Others may relate to the Company specifically, such as
credit, volatility and other risks associated with the Companys investment
portfolio. Investors are also directed to consider other risks and
uncertainties discussed in documents filed by the Company with the SEC. The
Company disclaims any obligation to update forward-looking information. The Company has one business segment, annuity operations, which consists
of the sale and administration of deposit-type insurance contracts, such as
fixed and variable annuities and universal life insurance contracts. The
Company focuses primarily on the marketing of fixed annuity products. CRITICAL ACCOUNTING POLICIES The Company considers among its most critical accounting policies those
policies with respect to valuation of certain financial instruments and
amortization of deferred acquisition costs. In the implementation of each of
the aforementioned policies, management is required to exercise its judgment on
both a quantitative and qualitative basis. Further explanation of how
management exercises that judgment follows: VALUATION OF CERTAIN FINANCIAL INSTRUMENTS: Gross unrealized losses on
the debt and equity securities available for sale amounted to $24.0 million at
December 31, 2003. In determining if and when a decline in fair value below
amortized cost is other-than-temporary, the Company evaluates at each reporting
period the market conditions, offering prices, trends of earnings, price
multiples, and other key measures for our investments in debt and marketable
equity securities. In particular, for debt securities, the Company assesses the
probability that all amounts due are collectible according to the contractual
terms of the obligation. When such a decline in value is deemed to be
other-than-temporary, the Company recognizes an impairment loss in the current
period operating results to the extent of the decline (See also discussion
within Capital Resources and Liquidity herein). Securities in the Companys portfolio with a carrying value of
approximately $558.0 million at December 31, 2003 do not have readily
determinable market prices. For these securities, the Company estimates the
fair value with internally prepared valuations (including those based on
estimates of future profitability).Otherwise, the Company uses its most
recent purchases and sales of similar unquoted securities, independent broker
quotes or comparison to similar securities with quoted prices when possible to
estimate the fair value of those securities. All such securities are classified
as available for sale. The Companys ability to liquidate its positions in
these securities will be impacted to a significant degree by the lack of an
actively traded market, and may not be able to dispose of these investments in
a timely manner. Although the Company believes its estimates reasonably reflect
the fair value of those securities, the key assumptions about the risk-free
interest rates, risk premiums, performance of underlying collateral, if any,
and other factors may not reflect those of an active market. AMORTIZATION OF DEFERRED ACQUISITION COSTS: The Company amortizes 9




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##### Table of Contents



deferred acquisition costs (DAC) based on a percentage of expected gross
profits (EGPs) over the life of the underlying policies. EGPs are computed
based on assumptions related to the underlying policies written, including
their anticipated duration, net spreads earned during the life of the
contracts, costs of providing policy guarantees and the level of expenses
necessary to maintain the policies. The Company revises future DAC
assumptions, referred to herein as a DAC unlocking, when estimates of future
gross profits to be realized on its annuity policies are revised. Increases in
future EGPs may result from higher interest spread and/or lower surrender rate
assumptions, while decreases in future EGPs may result from lower interest
spread and /or higher surrender rate assumptions. DAC amortization for the
current period is reduced when future EGPs are increased and increased when
future EGPs are decreased. On December 9, 2002, the Company entered into a profit sharing agreement
with AIG SunAmerica Asset Management Corp. (SAAMCO), whereby SAAMCO will pay
its profits earned through servicing the Companys variable annuity contracts
to the Company (SAAMCO Agreement). SAAMCO is the investment adviser or
business manager for certain trusts that hold deposits from the Companys
variable annuity products. Pursuant to the SAAMCO Agreement, SAAMCO will pay
to the Company variable annuity fee income earned from acting as the investment
adviser or business manager for certain trusts that hold deposits from the
Companys variable annuity products. The SAAMCO Agreement was retroactive to
January 1, 2002. Amounts paid or accrued to the Company under this agreement
totaled $1.6 million in 2003 and $1.8 million in 2002. RESULTS OF OPERATIONS NET INCOME totaled $16.9 million in 2003, compared with $6.8 million in
2002 and $8.2 million in 2001. CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflected the adoption
of EITF 99-20 in 2001. The Company recorded a loss of $0.5 million, net of
tax, which is recognized in the statement of income and comprehensive income as
a cumulative effect of accounting change for the year ended December 31, 2001
(see Note 2 of Notes to Financial Statements). PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $29.0
million in 2003, compared with $15.8 million in 2002 and $14.9 million in 2001.
The increase in 2003 compared to 2002 was primarily due to growth in average
invested assets from the sales of annuity products, effective management of
interest credited rates in response to the lower investment yields available
in a declining interest rate environment, increased net realized investment
gains, decreased general and administrative expenses, and decreased guaranteed
minimum death benefits on variable annuities, partially offset by increased
amortization of deferred acquisition costs and decreased fees on variable
annuity and universal life contracts. The improvement in 2002 over 2001
primarily resulted from decreased net realized investment losses, increased
variable annuity fees and increased net investment income partially offset by
increased amortization of deferred acquisition costs, increased general and
administrative expenses and increased guaranteed minimum death benefits on
variable annuities. NET INVESTMENT SPREAD, a non-GAAP measure which represents investment
income earned on invested assets less interest credited to fixed annuity
contracts, is a key measurement used by the Company in evaluating the
profitability of its fixed annuity business. Accordingly, the Company presents
an analysis of net investment spread because the Company has determined this
measure to be useful and meaningful. In evaluating its investment yield and net investment spread, the Company
calculates average invested assets using the amortized cost of bonds, notes and
redeemable preferred stocks. This basis does not include unrealized gains and
losses, which are reflected in the carrying value (i.e., fair value) of those
investment pursuant to Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity 10




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##### Table of Contents



Securities. In the calculation of average invested assets, the Company
excludes cash collateral received from the securities lending program, which is
offset by a securities lending payable in the same amount. As discussed in
Notes 2 and 9 of Notes to Financial Statements, the Company participates in a
securities lending program with an affiliated agent, pursuant to which it lends
its securities and primarily takes cash as collateral with respect to the
securities lent. Participation in securities lending agreements provides
additional net investment income for the Company, resulting from investment
income earned on the collateral, less interest paid on the securities lending
agreements and the related management fees paid to administer the program. An analysis of net investment spread and a reconciliation to net income is
presented in the following table: Years ended December 31,2003
    
    2002
    
    2001(in thousands)Investment income
    
    $
    119,730
    
    
    $
    97,327
    
    
    $
    100,952Interest credited to fixed annuity
contracts
    
    
    (65,631
    )
    
    
    (47,186
    )
    
    
    (51,320
    )Interest credited to universal life
insurance contracts
    
    
    (11,076
    )
    
    
    (11,489
    )
    
    
    (11,815
    )Net investment spread
    
    
    43,023
    
    
    
    38,652
    
    
    
    37,817Net realized investment gains (losses)
    
    
    2,417
    
    
    
    (10,025
    )
    
    
    (19,266
    )Fee income
    
    
    15,110
    
    
    
    17,133
    
    
    
    15,997General and administrative expenses,
net of deferrals
    
    
    (6,036
    )
    
    
    (8,112
    )
    
    
    (4,341
    )Amortization of DAC
    
    
    (20,564
    )
    
    
    (16,367
    )
    
    
    (11,629
    )Annual commissions
    
    
    (1,038
    )
    
    
    (771
    )
    
    
    (724
    )Claims on universal life contracts,
net of reinsurance recoveries
    
    
    (3,098
    )
    
    
    (2,985
    )
    
    
    (2,415
    )Guaranteed minimum death benefits
    
    
    (816
    )
    
    
    (1,735
    )
    
    
    (546
    )Income tax expense
    
    
    (12,081
    )
    
    
    (9,032
    )
    
    
    (6,180
    )Cumulative effect of accounting change,
net of tax
    
    
    
    
    
    
    
    
    
    
    (520
    )Net income
    
    $
    16,917
    
    
    $
    6,758
    
    
    $
    8,193
 Net investment spread totaled $43.0 million in 2003, $38.7 million in 2002
and $37.8 million in 2001. These amounts equal 2.04% on average invested
assets (computed on a daily basis) of $2.11 billion in 2003, 2.68% on average
invested assets of $1.44 billion in 2002 and 2.65% on average invested assets
of $1.43 billion in 2001. The decrease in the net investment spread rate was
primarily due to the investment of new deposits into invested assets with
shorter durations than the Companys fixed rate liabilities. The components of
net investment spread were as follows: 11




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##### Table of Contents



Years ended December 31,2003
    
    2002
    
    2001(in thousands)Net investment spread
    
    $
    43,023
    
    
    $
    38,652
    
    
    $
    37,817Average invested assets
    
    
    2,112,881
    
    
    
    1,443,812
    
    
    
    1,427,447Average interest-bearing liabilities
    
    
    1,999,701
    
    
    
    1,335,113
    
    
    
    1,341,892Yield on average invested assets
    
    
    5.67
    %
    
    
    6.74
    %
    
    
    7.07
    %Rate paid on average interest-
bearing liabilities
    
    
    3.84
    
    
    
    4.39
    
    
    
    4.70Difference between yield and
interest rate paid
    
    
    1.83
    
    
    
    2.35
    
    
    
    2.37Net investment spread as a
percentage of average invested
assets
    
    
    2.04
    %
    
    
    2.68
    %
    
    
    2.65
    %
 Growth in average invested assets resulted primarily from increased sales
in the latter half of 2002 and in 2003 relating to the marketing of fixed
annuities through an affiliate, AIG Annuity. Contributing to the increased
sales in 2002 was higher demand for guaranteed fixed-return products, as
investors sought security in an uncertain market environment. Changes in
average invested assets also reflect sales of fixed account options of the
Companys variable annuity products, and renewal deposits on its universal life
products (UL Deposits). Sales of fixed annuities and fixed account options
(Fixed Annuity Deposits) and UL Deposits totaled $1.29 billion in 2003,
$400.0 million in 2002 and $76.9 million in 2001, and are primarily fixed
annuity deposits. On an annualized basis, these deposits represent 84%, 31%
and 5% respectively, of the related reserve balances at the beginning of the
respective periods. The increase in Fixed Annuity Deposits in 2003 is due
primarily to increased sales relating to the marketing of fixed annuities
through AIG Annuity. Investment income (and the related yields on average invested assets)
totaled $119.7 million (5.67%) in 2003, compared with $97.3 million (6.74%) in
2002 and $101.0 million (7.07%) in 2001. The decrease in the investment yield
in 2003 compared to 2002 primarily reflects a lower prevailing interest rate
environment. Investment income has been reduced by expenses incurred to manage
the investment portfolio of $0.7 million in 2003, $0.6 million in 2002 and $1.2
million in 2001. These expenses are included as a reduction of investment
income in the statement of income and comprehensive income. Interest expense totaled $76.7 million in 2003, $58.7 million in 2002 and
$63.1 million in 2001. The average rate paid on all interest-bearing
liabilities was 3.84% in 2003, compared with 4.39% in 2002 and 4.70% in 2001.
Interest-bearing liabilities averaged $2.00 billion during 2003, $1.34 billion
during 2002 and $1.34 billion during 2001. The decline in overall rates paid in
2003 compared to 2002 resulted primarily from the impact of a declining
interest rate environment, as the Company issued new fixed annuities at rates
substantially below the prior year average rates. The decline in overall rates
paid in 2002 compared to 2001 resulted primarily from the impact of a declining
interest rate environment and the continued reduction of crediting rates on
certain closed blocks of business. NET REALIZED INVESTMENT GAINS totaled $2.4 million in 2003 compared with
net realized investment losses of $10.0 million in 2002 and $19.3 million in
2001 and include impairment writedowns of $3.1 million, $9.5 12




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##### Table of Contents



million and $17.3 million, respectively. Thus, net realized gains from sales
and redemptions of investments totaled $5.5 million in 2003, compared with net
realized losses from sales and redemptions of investments of $0.5 million in
2002 and $2.0 million in 2001. The Company sold or redeemed invested assets, principally bonds and notes,
aggregating $715.0 million in 2003, $370.9 million in 2002 and $427.5 million
in 2001. Sales of investments result from the active management of the
Companys investment portfolio. Because redemptions of investments are
generally involuntary and sales of investments are made in both rising and
falling interest rate environments, net gains and losses from sales and
redemptions of investments fluctuate from period to period, and represent
0.26%, 0.04% and 0.14% of average invested assets for 2003, 2002 and 2001,
respectively. Active portfolio management involves the ongoing evaluation of
asset sectors, individual securities within the investment portfolio and the
reallocation of investments from sectors that are perceived to be relatively
overvalued to sectors that are perceived to be relatively undervalued. The
intent of the Companys active portfolio management is to maximize total
returns on the investment portfolio, taking into account credit, option,
liquidity and interest-rate risk. Impairment writedowns include $3.1 million, $9.5 million and $17.3 million
of provisions applied to bonds in 2003, 2002 and 2001, respectively. Impairment
writedowns represent 0.15%, 0.66% and 1.21% of average invested assets for
2003, 2002 and 2001, respectively. For the five years ended December 31, 2003,
impairment writedowns as a percentage of average invested assets have ranged
from 0.15% to 1.23% and have averaged 0.74%. Such writedowns are based upon
estimates of the fair value of invested assets and recorded when declines in
the value of such assets are considered to be other than temporary. Actual
realization will be dependent upon future events. The Company recorded $0.8
million ($0.5 million, net of tax) of additional impairments in 2001 pursuant
to the implementation of EITF 99-20. This adjustment was recorded as a
cumulative effect of accounting change in the accompanying statement of income
and comprehensive income for 2001. VARIABLE ANNUITY POLICY FEES are based on the market value of assets in
separate accounts supporting variable annuity contracts. Such fees totaled
$8.1 million in 2003, $9.0 million in 2002, and $8.0 million in 2001 and
include fees related to the SAAMCO Agreement of $1.6 million and $1.8 million
in 2003 and 2002, respectively. The decreased fees in 2003 as compared to 2002
and 2001 primarily reflects the unfavorable equity market conditions in 2002
and the early part of 2003, and the resulting unfavorable impact on market
values of assets in the separate accounts. Excluding the impact of the
SAAMCO Agreement, the decreased fees in 2002 reflected the unfavorable equity
market conditions in 2002. Variable annuity fees represent 2.0%, 1.9%, and
1.6% of average variable annuity assets in 2003, 2002 and 2001, respectively.
The increase in fees as a percentage of average variable assets in 2003 and
2002 is due primarily to the fees related to the SAAMCO Agreement. Excluding
the impact of the SAAMCO Agreement, variable annuity fees would have
represented 1.6% of average variable annuity assets in all periods. Variable
annuity assets averaged $410.1 million, $462.3 million and $517.1 million
during the respective periods. Variable annuity deposits, which exclude
deposits allocated to the fixed accounts of variable annuity products,
totaled $25.5 million in 2003, $65.0 million in 2002 and $34.6 million in 2001.
These amounts represent 6%, 13% and 6% of variable annuity reserves at the
beginning of the respective periods. The increase in variable annuity deposits
in 2002 reflected increased demand for a new product, FSA Advisor, initially
marketed in January 2001. Transfers from the fixed accounts of the Companys
variable annuity products to the separate accounts (see Change in Average
Invested Assets) are not classified as variable annuity deposits. Accordingly,
changes in variable annuity deposits are not necessarily indicative of the
ultimate allocation by customers among fixed and variable account options of
the Companys variable annuity products. Sales of variable annuity products (which include deposits allocated to 13




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##### Table of Contents



the fixed accounts) (Variable Annuity Product Sales) amounted to $142.6
million, $101.3 million and $90.5 million in 2003, 2002 and 2001, respectively.
The increase in Variable Annuity Product Sales during 2003 reflect the sales of
the Companys new products, WM Diversfied Strategies III and Polaris II.
Introduced at the beginning of 2003, WM Diversified Strategies III, product
sales totaled $56.5 million in 2003. Polaris II product sales totaled $63.2
million 2003 with no sales occurring in 2002. The increase in Variable Annuity
Product Sales during 2002 primarily reflects those of FSA Advisor, originally
marketed in 2001. FSA Advisor product sales were approximately $51.3 million
in 2002 as compared to $15.9 million in 2001. The Company has encountered increased competition in the variable annuity
marketplace during recent years and anticipates that the market will remain
highly competitive for the foreseeable future. Also, from time to time,
Federal initiatives are proposed that could affect the taxation of annuities.
(See Regulation in Item 1). UNIVERSAL LIFE INSURANCE FEES, NET OF REINSURANCE amounted to $5.3 million
in 2003, $6.3 million in 2002 and $5.8 million in 2001 and are net of
reinsurance premiums of $7.1 million, $6.1 million and $6.3 million,
respectively . Universal life insurance fees consist of mortality charges,
up-front fees earned on deposits received and administrative fees, net of
reinsurance premiums. The administrative fees are assessed based on the number
of policies in force as of the end of each month. The Company acquired its
universal life contracts as part of the acquisition of business from MBL Life
Assurance Corporation on July 1, 1999 and does not actively market such
contracts. Such fees represent 2.26%, 2.59% and 2.32% of average reserves for
universal life insurance contracts in the respective periods. The decrease in
fees in 2003 resulted primarily from increased reinsurance premiums ceded. SURRENDER CHARGES on fixed annuity, variable annuity and universal life
contracts totaled $1.7 million in 2003, $1.9 million in 2002 and $2.1 million
in 2001. Surrender charge periods range from zero to nine years from the date a
deposit is received. Surrender charges generally are assessed on withdrawals
at declining rates. Withdrawal payments, which exclude claims and annuitization
payments, totaled $185.9 million in 2003 compared with $212.9 million in 2002
and $257.3 million in 2001. These payments, when expressed as a percentage of
average related reserves, represent 7.9%, 12.1% and 14.2% for 2003, 2002 and
2001, respectively. GENERAL AND ADMINISTRATIVE EXPENSES totaled $6.0 million in 2003, $8.1
million in 2002 and $4.3 million in 2001. General and administrative costs
were unusually low in 2001 due to certain guaranty fund credits, which reduced
overall expenses. Excluding the impact of this item, general and
administrative expenses increased approximately 20% in 2002, representing the
additional costs of selling and servicing a growing fixed annuity block of
business. General and administrative expenses remain closely controlled through
a company-wide cost containment program and continue to represent less than 1%
of average total assets. AMORTIZATION OF DEFERRED ACQUISITION COSTS totaled $20.6 million in 2003
compared with $16.4 million in 2002 and $11.6 million in 2001. The increase in
amortization in 2003 was primarily related to the substantial increase in fixed
annuity deposits, as well as the impact of increased net investment gains,
partially offset by a DAC unlocking. The increase in amortization in 2002 was
primarily related to the impact of decreased net investment losses. ANNUAL COMMISSIONS totaled $1.0 million in 2003, compared with $0.8
million in 2002 and $0.7 million in 2001. Annual commissions represent renewal
commissions paid quarterly in arrears to maintain the persistency of certain of
the Companys variable annuity contracts. Substantially all of the Companys
currently available variable annuity products allow for an annual commission
payment option in return for a lower immediate commission. 14




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##### Table of Contents



CLAIMS ON UNIVERSAL LIFE INSURANCE CONTRACTS, NET OF REINSURANCE
RECOVERIES totaled $3.1 million in 2003, compared to $3.0 million in 2002 and
$2.4 million in 2001 (net of reinsurance recoveries of $3.6 million in 2003,
$4.2 million in 2002 and $3.9 million in 2001). GUARANTEED MINIMUM DEATH BENEFITS on variable annuity contracts totaled
$0.8 million in 2003 compared with $1.7 million in 2002 and $0.5 million in
2001. The decrease in 2003 in such benefits reflects the upturn in the equity
markets in 2003. The increase in 2002 in such benefits reflects the downturn
in the equity markets since 2000. Further downturns in the equity markets
could increase these expenses. A majority of the Companys variable annuity products are issued with a
death benefit feature, which provides that, upon the death of a contractholder,
the contractholders beneficiary will receive the greater of (1) the
contractholders account value, or (2) a guaranteed minimum death benefit that
varies by product (the GMDB). The Company bears the risk that death claims
following a decline in the financial markets may exceed contractholder account
balances, and that the fees collected under the contract are insufficient to
cover the costs of the benefit to be provided. In accordance with Generally
Accepted Accounting Principles, the Company expenses such benefits in the
period incurred, and therefore does not provide reserves for future benefits.
However, effective January 1, 2004, the Company will be required to record a
liability for GMDBs (see Note 2 of notes to financial statements). INCOME TAX EXPENSE totaled $12.1 million in 2003, $9.0 million in 2002 and
$6.2 million in 2001, representing effective tax rates of 42%, 57%, and 41%,
respectively. The higher rate in 2002 was principally due to the impact of a
deferred tax liability adjustment. See Note 8 of the accompanying financial
statements for a reconciliation of income tax expense to the federal statutory
rate. CAPITAL RESOURCES AND LIQUIDITY SHAREHOLDERS EQUITY increased to $349.5 million at December 31, 2003 from
$213.0 million at December 31, 2002. The increase reflected a capital
contribution of $115.0 million, net income of $16.9 million and other
comprehensive income of $4.6 million. INVESTMENTS AND CASH at December 31, 2003 totaled $3.17 billion, compared
with $1.71 billion at December 31, 2002. The Companys invested assets are
managed by a subsidiary of AIG. The following table summarizes the Companys
portfolio of bonds and notes (the Bond Portfolio) and other investments and
cash at December 31, 2003 and December 31, 2002: 15




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##### Table of Contents



December 31, 2003
    
    December 31, 2002Carrying
    
    Percent of
    
    Carrying
    
    Percent ofValue
    
    Portfolio
    
    Value
    
    Portfolio(in thousands, except for percentages)Bond Portfolio:U.S. government securities
    
    $
    18,054
    
    
    
    0.6
    %
    
    $
    3,208
    
    
    
    0.2
    %Mortgage-backed securities
    
    
    634,640
    
    
    
    20.0
    
    
    
    471,065
    
    
    
    27.6Securities of public
utilities
    
    
    131,158
    
    
    
    4.1
    
    
    
    75,470
    
    
    
    4.4Corporate bonds and notes
    
    
    1,248,590
    
    
    
    39.4
    
    
    
    638,266
    
    
    
    37.4Other debt securities
    
    
    625,370
    
    
    
    19.8
    
    
    
    222,044
    
    
    
    13.0Total Bond Portfolio
    
    
    2,657,812
    
    
    
    83.9
    
    
    
    1,410,053
    
    
    
    82.6Mortgage loans
    
    
    215,521
    
    
    
    6.8
    
    
    
    193,035
    
    
    
    11.3Common stocks
    
    
    295
    
    
    
    0.0
    
    
    
    1,140
    
    
    
    0.1Cash and short-term
investments
    
    
    104,011
    
    
    
    3.3
    
    
    
    37,955
    
    
    
    2.2Other
    
    
    190,007
    
    
    
    6.0
    
    
    
    65,621
    
    
    
    3.8Total investments and cash
    
    $
    3,167,646
    
    
    
    100.0
    %
    
    $
    1,707,804
    
    
    
    100.0
    %
 The Companys general investment philosophy is to hold fixed-rate assets
for long-term investment. Thus, it does not have a trading portfolio. However,
the Company has determined that all of the Bond Portfolio is available to be
sold in response to changes in market interest rates, changes in relative value
of asset sectors and individual securities, changes in prepayment risk, changes
in the credit quality outlook for certain securities, the Companys need for
liquidity and other similar factors. THE BOND PORTFOLIO, which constituted 84% of the Companys total
investment portfolio at December 31, 2003, had an aggregate fair value that was
$40.2 million greater than its amortized cost at December 31, 2003, compared
with an aggregate fair value that was $35.0 million greater than its amortized
cost at December 31, 2002. The increase in net unrealized gains on the Bond
Portfolio during 2003 principally reflects the decline in prevailing interest
rates and the corresponding effect on the fair value of the Bond Portfolio at
December 31, 2003. At December 31, 2003, the Bond Portfolio had an aggregate carrying value
(i.e. fair value) of $2.66 billion and an aggregate amortized cost of $2.62
billion. At December 31, 2003, the Bond Portfolio included $2.40 billion of
bonds rated by Standard & Poors (S&P), Moodys Investors Services
(Moodys), Fitch (Fitch) or the National Association of Insurance
Commissioners (NAIC), and $261.5 million of bonds rated by the Company
pursuant to statutory ratings guidelines established by the NAIC. At
December 31, 2003, approximately $2.50 billion of the Bond Portfolio was
investment grade, including $652.7 million of U.S. government/agency securities
and mortgage-backed securities (MBS). At December 31, 2003, the Bond Portfolio included $153.2 million of bonds
that were not investment grade. These non-investment-grade bonds accounted for
approximately 4.0% of the Companys total assets and approximately 4.8% of its
invested assets. Non-investment-grade securities generally provide higher
yields and involve greater risks than investment-grade securities because their
issuers typically are more highly leveraged and more vulnerable to adverse
economic conditions than investment-grade issuers. In addition, the trading
market for these securities is usually more limited than for investment-grade
securities. An economic downturn could produce higher than average issuer
defaults on the non-investment-grade securities, which could cause the
Companys investment returns and net income 16




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##### Table of Contents



to decline. At December 31, 2003,
the Companys non-investment-grade portfolio consisted of 57 issues with no
single issuer representing more than 10% of the total non-investment grade bond
portfolio. These non-investment-grade securities are comprised of bonds
spanning 11 industries with 20% of these assets concentrated in
telecommunications, 20% concentrated in cyclical consumer products and 14%
concentrated in noncyclical consumer products. No other industry
concentration constituted more than 10% of these assets. The table on the following page summarizes the Companys rated bonds by
rating classification as of December 31, 2003. 17




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##### Table of Contents



RATED BONDS BY RATING CLASSIFICATION
(Dollars in thousands) Issues not rated by S&P/Moodys/Issues rated by S&P/Moodys/ Fitch
    
    Fitch, by NAIC category
    
    TotalPercentEstimated
    
    NAIC
    
    
    
    
    
    Estimated
    
    
    
    
    
    Estimated
    
    of totalS&P/Moodys/ Fitch
    
    Amortized
    
    fair
    
    category
    
    Amortized
    
    fair
    
    Amortized
    
    fair
    
    investedCategory (1)
    
    Cost
    
    value
    
    (2)
    
    cost
    
    value
    
    cost
    
    value
    
    assetsAAA+ to A-
(Aaa to A3)
[AAA to A-]
    
    $
    1,595,064
    
    
    $
    1,617,255
    
    
    
    1
    
    
    $
    230,958
    
    
    $
    236,883
    
    
    $
    1,826,022
    
    
    $
    1,854,138
    
    
    
    58.53
    %BBB+ to BBB-
(Baa1 to Baa3)
[BBB+ to BBB-]
    
    
    523,511
    
    
    
    534,331
    
    
    
    2
    
    
    
    113,987
    
    
    
    116,177
    
    
    
    637,498
    
    
    
    650,508
    
    
    
    20.54
    %BB+ to BB-
(Ba1 to Ba3)
[BB+ to BB-]
    
    
    63,169
    
    
    
    61,490
    
    
    
    3
    
    
    
    16,313
    
    
    
    16,812
    
    
    
    79,482
    
    
    
    78,302
    
    
    
    2.47
    %B+ to B-
(B1 to B3)
[B+ to B-]
    
    
    16,999
    
    
    
    17,497
    
    
    
    4
    
    
    
    7,993
    
    
    
    8,042
    
    
    
    24,992
    
    
    
    25,539
    
    
    
    0.81
    %CCC+ to C
(Caa to C)
[CCC]
    
    
    7,901
    
    
    
    7,008
    
    
    
    5
    
    
    
    1,726
    
    
    
    2,026
    
    
    
    9,627
    
    
    
    9,034
    
    
    
    0.29
    %CI to D
[DD]
{D}
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    40,026
    
    
    
    40,291
    
    
    
    40,026
    
    
    
    40,291
    
    
    
    1.27
    %TOTAL RATED
ISSUES
    
    $
    2,206,644
    
    
    $
    2,237,581
    
    
    
    
    
    
    $
    411,003
    
    
    $
    420,231
    
    
    $
    2,617,647
    
    
    $
    2,657,812
 Footnotes appear on the following page. 18




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##### Table of Contents



Footnotes to the table of Rated Bonds by Rating Classification(1)
    
    S&P and Fitch rate debt securities in rating categories ranging from AAA
(the highest) to D (in payment default). A plus (+) or minus (-)
indicates the debts relative standing within the rating category. A
security rated BBB- or higher is considered investment grade. Moodys
rates debt securities in rating categories ranging from Aaa (the highest)
to C (extremely poor prospects of ever attaining any real investment
standing). The number 1,2 or 3 (with 1 the highest and 3 the lowest)
indicates the debts relative standing within the rating category. A
security rated Baa3 or higher is considered investment grade. Issues are
categorized based on the highest of the S&P, Moodys, and Fitch ratings if
rated by multiple agencies.(2)
    
    Bonds and short-term promissory instruments are divided into six quality
categories for NAIC rating purposes, ranging from 1 (highest) to 5
(lowest) for non-defaulted bonds plus one category, 6, for bonds in or
near default. These six categories correspond with the S&P/Moodys/Fitch
rating groups listed above, with categories 1 and 2 considered investment
grade. The NAIC categories include $261.5 million of assets that were
rated by the Company pursuant to applicable NAIC rating guidelines. The valuation of invested assets involves obtaining a fair value for each
security. The source for the fair value is generally from market exchanges,
with the exception of non-traded securities. Another aspect of valuation pertains to impairment. As a matter of
policy, the determination that a security has incurred an other-than-temporary
decline in value and the amount of any loss recognition requires the judgment
of the Companys management and a continual review of its investments. In general, a security is considered a candidate for impairment if it
meets any of the following criteria:  
    
    Trading at a significant discount to par, amortized cost (if lower)
or cost for an extended period of time;
    
    The occurrence of a discrete credit event resulting in; (i) the
issuer defaulting on a material outstanding obligation; or (ii) the
issuer seeking protection from creditors under the bankruptcy laws or
similar laws intended for the court supervised reorganization of
insolvent enterprises; or (iii) the issuer proposing a voluntary
reorganization pursuant to which creditors are asked to exchange their
claims for cash or securities having a fair value substantially lower
than the par value of their claims; or
    
    In the opinion of the Companys management, it is unlikely the
Company will realize a full recovery on its investment, irrespective of
the occurrence of one of the foregoing events. Once a security has been identified as potentially impaired, the amount of
such impairment is determined by reference to that securitys contemporaneous
market price. The Company has the ability to hold any security to its stated maturity.
Therefore, the decision to sell reflects the judgment of the Companys
management that the security sold is unlikely to provide, on a relative value
basis, as attractive a return in the future as alternative securities entailing
comparable risks. With respect to distressed securities, the sale decision
reflects managements judgment that the risk-discounted anticipated ultimate
recovery is less than the value achieved on 19




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##### Table of Contents



sale. As a result of these policies, the Company recorded pretax impairment
writedowns of $3.1 million in the 2003, $9.5 million in 2002 and $17.3 million
in 2001. No impairment charge with respect to any one single credit was significant
to the Companys financial condition or results of operations and no individual
impairment loss exceeded 10% of the Companys net income for the year ended
December 31, 2003. Excluding the impairments noted above, the changes in fair value for the
Companys Bond Portfolio, which constitutes the vast majority of the Companys
investments, were recorded as a component of other comprehensive income in
shareholders equity as unrealized gains or losses. At December 31, 2003, the Companys Bond Portfolio had gross unrealized
gains of $64.2 million and gross unrealized losses of $24.0 million. No
single issuer accounted for more than 10% of unrealized losses. At December 31, 2003, the fair value of the Companys Bond Portfolio
aggregated $2.66 billion. Of this aggregate fair value, approximately 0.3%
represented securities trading at or below 75% of amortized cost. The impact
of unrealized losses on net income will be further mitigated upon realization,
because realization will result in current decreases in the amortization of
certain deferred acquisition costs and decreases in income taxes. At December 31, 2003, approximately $834.0 million, at amortized cost, of
the Bond Portfolio had a fair value of $810.0 million resulting in an aggregate
unrealized loss of $24.0 million. The gross unrealized losses in the bond
portfolio included the following concentrations: GrossConcentration
    
    Unrealized Losses(in thousands)Investment Grade:Finance companies
    
    $
    6,784Non-corporate
    
    
    6,472Transportation
    
    
    1,797Utility
    
    
    1,249Consumer products
    
    
    1,009Not rated and Below Investment Grade:Finance companies
    
    
    3,134Communications
    
    
    754Non-corporate
    
    
    518Consumer products
    
    
    299Utility
    
    
    106
 The amortized cost of the Bond Portfolio in an unrealized loss position at
December 31, 2003, by contractual maturity, is shown below. 20




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##### Table of Contents



AmortizedCost(in thousands)Due in one year or less
    
    $
    29Due after one year through five years
    
    
    160,490Due after five years through ten years
    
    
    350,459Due after ten years
    
    
    322,980Total
    
    $
    833,958
 The aging of the Bond Portfolio in an unrealized loss position at December
31, 2003 is shown below: Less than or Equal to 20%
    
    Greater than 20% to 50%
    
    Greater than 50%of Amortized Cost
    
    of Amortized Cost
    
    of Amortized Cost
    
    Total(dollars in thousands)
    
    Amortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    Unrealized
    
    
    
    
    
    Amortized
    
    UnrealizedMonths
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    Items
    
    Cost
    
    Loss
    
    ItemsInvestment Grade Bonds0-6
    
$
    761,049
    
    
$

    (16,271
    )
    
    
    134
    
    

$
    
    
    
   $
    
    
    

 
    
    
    
$
    
    
    
$

    
    
    
    
    
    
    
$

    761,049
    
    
$
    (16,271
    )
    
    
    1347-12
    
    

    45,740
    
    
    
    (1,412
    )
    
    
    7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,740
    
    
    
    (1,412
    )
    
    
    7>12
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,000
    
    
    
    (1,480
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,000
    
    
    
    (1,480
    )
    
    
    1Total
    

$
    806,789
    
    
$

    (17,683
    )
    
    
    141
    
    
$
    5,000
    
    
    $
    (1,480
    )
    
    
    1
    
    
$

    
    
    
$

    
    
    


   
    
    
$


    811,789
    
    
$
    (19,163
    )
    
    
    142Below Investment Grade
Bonds0-6
    
    $
   13,743
    
    
    $
    (1,887
    )
    
    
    7
    
    
   $

   8,318
    
    

$

    (2,926
    )
    
    
    5
    
    
$
    39
    
    
$
    (37
    )
    
    
    3
    
    
$
        22,100
    
    
    $
    (4,850
    )
    
    
    157-12
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    >12
    
    
    69
    
    
    
    (13
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    69
    
    
    
    (13
    )
    
    
    1Total
    
    $
    13,812
    
    
    $
    (1,900
    )
    
    
    8
    
    

$
    8,318
    
    
    $
    (2,926
    )
    
    
    5
    
    
    $
    39
    
    
    $
    (37
    )
    
    
    3
    
    
    $
    22,169
    
    
    $
    (4,863
    )
    
    
    16Total Bonds0-6
    
    $
    774,792
    
    
    $
    (18,158
    )
    
    
    141
    
    
    $
    8,318
    
    
    $
    (2,926
    )
    
    
    5
    
    

$
    39
    
    
    $
    (37
    )
    
    
    3
    
    

$
    783,149
    
    
    $
    (21,121
    )
    
    
    1497-12
    
    
    45,740
    
    
    
    (1,412
    )
    
    
    7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,740
    
    
    
    (1,412
    )
    
    
    7>12
    
    
    69
    
    
    
    (13
    )
    
    
    1
    
    
    
    5,000
    
    
    
    (1,480
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,069
    
    
    
    (1,493
    )
    
    
    2Total
    

$
    820,601
    
    
    $
    (19,583
    )
    
    
    149
    
    

$
    13,318
    
    
    $
    (4,406
    )
    
    
    6
    
    

$
    39
    
    
    $
    (37
    )
    
    
    3
    
    

$
    833,958
    
    
    $
    (24,026
    )
    
    
    158
 In 2003, the pretax realized losses incurred with respect to the sale of
fixed securities in the Bond Portfolio were $3.3 million. The aggregate fair
value of securities sold was $140.8 million, which was approximately 98% of
amortized cost. The average period of time that securities sold at a loss
during 2003 were trading continuously at a price below amortized cost was
approximately 10 months. The valuation for the Companys Bond Portfolio comes from market exchanges
or dealer quotations, with the exception of non-traded securities. The Company
considers non-traded securities to mean certain fixed income investments and
certain structured securities. The aggregate carrying value of these
securities at December 31, 2003 was approximately $509.8 million. The methodology used to estimate fair value of non-traded fixed income
investments is by reference to traded securities with similar attributes and
using a matrix pricing methodology. This technique takes into account such
factors as the industry, the securitys rating and tenor, its coupon rate, its
position in the capital structure of the issuer and other relevant factors.
The change in fair value is recognized as a component of other comprehensive
income. For certain structured securities, the carrying value is based on an
estimate of the securitys future cash flows pursuant to the requirements of
Emerging Issues Task Force Issue No. 99-20 Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets. The change in carrying value is recognized in
income. 21




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##### Table of Contents



Each of these investment categories is regularly tested to determine if
impairment in value exists. Various valuation techniques are used with respect
to each category in this determination. Senior secured loans (Secured Loans) are included in the Bond Portfolio
and aggregated $70.5 million at December 31, 2003. Secured Loans are senior to
subordinated debt and equity and are secured by assets of the issuer. At
December 31, 2003, Secured Loans consisted of $41.0 million of privately traded
securities and $29.5 million of publicly traded securities. These Secured Loans
are composed of loans to borrowers spanning 13 industries, with 26% of these
assets concentrated in the electric industry, 21% concentrated in the food
industry and 14% concentrated in each of financial institutions and
transportation. No other industry concentration constituted more than 10% of
these assets. While the trading market for the Companys privately traded Secured Loans
is more limited than for publicly traded issues, participation in these
transactions has enabled the Company to improve its investment yield. As a
result of restrictive financial covenants, these Secured Loans involve greater
risk of technical default than do publicly traded investment-grade securities.
However, management believes that the risk of loss upon default for these
Secured Loans is mitigated by such financial covenants and the collateral
values underlying the Secured Loans. The Companys Secured Loans are rated by
S&P, Moodys, Fitch, the NAIC or by the Company, pursuant to comparable
statutory ratings guidelines established by the NAIC. MORTGAGE LOANS aggregated $215.5 million at December 31, 2003 and
consisted of 81 commercial first mortgage loans with an average loan balance of
approximately $2.7 million, collateralized by properties located in 26 states.
Approximately 45% of this portfolio was office, 21% was multifamily
residential, 13% was retail, 12% was industrial, and 9% was other types. At
December 31, 2003, approximately 27% of this portfolio was secured by
properties located in California, approximately 12% by properties located in
Texas, approximately 10% by properties located in both Michigan and New York
and no more than 10% of this portfolio was secured by properties located in any
other single state. At December 31, 2003, four mortgage loans had an
outstanding balance of $10.0 million or more, which collectively aggregated
approximately 22% of this portfolio. At December 31, 2003, approximately
20% of the mortgage loan portfolio consisted of loans with balloon payments due
before January 1, 2007. During 2003, 2002 and 2001, loans delinquent by more
than 90 days, foreclosed loans and restructured loans have not been significant
in relation to the total mortgage loan portfolio. At December 31, 2003, approximately 20% of the mortgage loans were
seasoned loans underwritten to the Companys standards and purchased at or near
par from other financial institutions. Such loans generally have higher
average interest rates than loans that could be originated today. The balance
of the mortgage loan portfolio has been originated by the Company under strict
underwriting standards. Commercial mortgage loans on properties such as
offices, hotels and shopping centers generally represent a higher level of risk
than do mortgage loans secured by multifamily residences. This greater risk is
due to several factors, including the larger size of such loans and the more
immediate effects of general economic conditions on these commercial property
types. However, due to the seasoned nature of the Companys mortgage loan
portfolio and its strict underwriting standards, the Company believes that it
has prudently managed the risk attributable to its mortgage loan portfolio
while maintaining attractive yields. POLICY LOANS totaled $35.3 million at December 31, 2003, compared to $36.1
million at December 31, 2002 and primarily represent loans taken against
universal life insurance policies. SECURITIES LENDING COLLATERAL totaled $154.8 million at December 31, 2003,
compared to $29.6 million at December 31, 2002, and consisted of cash 22




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##### Table of Contents



collateral invested in highly rated short-term securities received in
connection with the Companys securities lending program. Although the cash
collateral is currently invested in highly rated short-term securities, the
applicable collateral agreements permit the cash collateral to be invested in
highly liquid short and long-term investment portfolios. At least 75% of the
portfolios short-term investments must have external issue ratings of A-1/P-1,
one of the highest ratings for short-term credit quality. Long-term
investments include corporate notes with maturities of five years or less and
a credit rating by at least two nationally recognized statistical rating
organizations (NRSRO), with no less than a S&P rating of A or equivalent by any
other NRSRO. ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks
of interest rate fluctuations and disintermediation. The Company believes that
its fixed-rate liabilities should be backed by a portfolio principally composed
of fixed-rate investments that generate predictable rates of return. The
Company does not have a specific target rate of return. Instead, its rates of
return vary over time depending on the current interest rate environment, the
slope of the yield curve, the spread at which fixed-rate investments are priced
over the yield curve, default rates, and general economic conditions. Its
portfolio strategy is constructed with a view to achieve adequate risk-adjusted
returns consistent with its investment objectives of effective asset-liability
matching, liquidity and safety. The Companys fixed-rate products incorporate
surrender charges or other restrictions in order to encourage persistency.
Approximately 79% of the Companys fixed annuity and universal life reserves
had surrender penalties or other restrictions at December 31, 2003. As part of its asset-liability matching discipline, the Company conducts
detailed computer simulations that model its fixed-rate assets and liabilities
under commonly used interest rate scenarios. With the results of these
computer simulations, the Company can measure the potential gain or loss in
fair value of its interest-rate sensitive instruments and seek to protect its
economic value and achieve a predictable spread between what it earns on its
invested assets and what it pays on its liabilities by designing its fixed-rate
products and conducting its investment operations to closely match the duration
of the fixed-rate assets to that of its fixed-rate liabilities. The Companys
fixed-rate assets in the Companys asset-liability modeling include: cash and
short-term investments; bonds, notes and redeemable preferred stocks; mortgage
loans; and policy loans. At December 31, 2003, these assets had an aggregate
fair value of $3.02 billion with an option-adjusted duration of 4.2 years. The
Companys fixed-rate liabilities include fixed annuity, fixed options of
variable annuity and universal life insurance contracts. At December 31, 2003,
these liabilities had an aggregate fair value (determined by discounting future
contractual cash flows by related market rates of interest) of $2.82 billion
with an option-adjusted duration of 4.9 years. The Companys potential exposure
due to a relative 10% decrease in prevailing interest rates from their December
31, 2003 levels is a loss of approximately $3.2 million, representing the
increase in fair value of its fixed rate liabilities that is not offset by an
increase in fair value of its fixed rate assets. Because the Company actively
manages its assets and liabilities and has strategies in place to minimize its
exposure to loss as interest rate changes occur, it expects that actual losses
would be less than the estimated potential loss. Option-adjusted duration is a common measure for the price sensitivity of
a fixed-maturity portfolio to changes in interest rates. For example, if
interest rates increase 1%, the fair value of an asset with a duration of 5.0
is expected to decrease in value by approximately 5%. The Company estimates
the option-adjusted duration of its assets and liabilities using a number of
different interest rate scenarios, assuming continuation of existing
investment and interest crediting strategies, including maintaining an
appropriate level of liquidity. Actual company and contract owner behaviors
may be different than was assumed in the estimate of option-adjusted duration 23




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##### Table of Contents



and these differences may be material. The overall interest-credited rate environment has continued to decline in
2003. A significant portion of the Companys fixed annuity contracts
(including the fixed option of variable contracts) has reached or is near the
minimum contractual guaranteed rate (generally 3%). Continual declines in
interest rates could cause the spread between the yield on the portfolio and
the interest rate credited to policyholders to deteriorate. In 2003, the State
of New York adopted legislation reducing the minimum contractual rate that can
be credited to policyholders on new contracts to 1.5%. As a result, certain
contracts issued in 2003 will have a 1.5% minimum contractual guaranteed rate.
This will not impact the previously issued contracts. The Company has had the ability, limited by minimum interest rate
guarantees, to respond to the generally declining interest rate environment in
the last five years by lowering crediting rates in response to lower investment
returns. The trends experienced during the three years ended December 31,
2003 in the Companys yield on average invested assets and rate of interest
credited on average interest-bearing liabilities, compared to the market trend
in long-term interest rates as illustrated by the average ten-year U.S.
Treasury bond rate, are presented in the following table: 2003
    
    2002
    
    200110-year U.S. Treasury bond rate:
    
    
    4.01
    %
    
    
    4.61
    %
    
    
    5.02
    %First SunAmerica Life Insurance Company:Average yield on bond portfolio
    
    
    5.77
    
    
    
    6.98
    
    
    
    7.01Rate paid on average interest-bearing
liabilities
    
    
    3.84
    
    
    
    4.39
    
    
    
    4.70
 The Company seeks to enhance its spread income with dollar roll repurchase
agreements (Dollar Roll Repos). Dollar Roll Repos involve a sale of MBS by
the Company and an agreement to repurchase substantially similar MBS at a later
date at an agreed upon price. The Company also seeks to provide liquidity by
investing in MBSs. MBSs are generally investment-grade securities
collateralized by large pools of mortgage loans. MBSs generally pay principal
and interest monthly. The amount of principal and interest payments may
fluctuate as a result of prepayments of the underlying mortgage loans. There are risks associated with some of the techniques the Company uses to
provide liquidity, enhance its spread income and match its assets and
liabilities. The primary risk associated with the Companys Dollar Roll Repos
is counterparty risk. The Company believes, however, that the counterparties
to its Dollar Roll Repos are financially responsible and that the counterparty
risk associated with those transactions is minimal. It is the Companys policy
that these agreements are entered into with counterparties who have a debt
rating of A/A2 or better from both S&P and Moodys. The Company continually
monitors its credit exposure with respect to these agreements. The primary
risk associated with MBSs is that a changing interest rate environment might
cause prepayment of the underlying obligations at speeds slower or faster than
anticipated at the time of their purchase. As part of its decision to purchase
such a security, the Company assesses the risk of prepayment by analyzing the
securitys projected performance over an array of interest-rate scenarios.
Once such a security is purchased, the Company monitors its actual prepayment
experience monthly to reassess the relative attractiveness of the security with
the intent to maximize total return. INVESTED ASSETS EVALUATION is routinely conducted by the Company.
Management identifies monthly those investments that require additional
monitoring and carefully reviews the carrying values of such investments at 24




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##### Table of Contents



least quarterly to determine whether specific investments should be placed on a
non-accrual basis and to determine declines in value that may be other than
temporary. In conducting these reviews for bonds, management principally
considers the adequacy of any collateral, compliance with contractual
covenants, the borrowers recent financial performance, news reports and other
externally generated information concerning the creditors affairs. In the case
of publicly traded bonds, management also considers market value quotations, if
available. For mortgage loans, management generally considers information
concerning the mortgaged property and, among other things, factors impacting
the current and expected payment status of the loan and, if available, the
current fair value of the underlying collateral. The carrying values of investments that are determined to have declines in
value that are other than temporary are reduced to fair value and, in the case
of bonds, no further accruals of interest are made. The provisions for
impairment on mortgage loans are based on losses expected by management to be
realized on transfers of mortgage loans to real estate, on the disposition and
settlement of mortgage loans and on mortgage loans that management believes may
not be collectible in full. Accrual of interest is suspended when principal and
interest payments on mortgage loans are past due more than 90 days. Impairment
losses on securitized assets are recognized if the fair value of the security
is less than its book value, and the net present value of expected future cash
flows is less than the net present value of expected future cash flows at the
most recent(prior) estimation date. DEFAULTED INVESTMENTS, comprising all investments that are in default as
to the payment of principal or interest, totaled $0.2 million of bonds at
December 31, 2003, and constituted less than 0.1% of total invested assets. At
December 31, 2002, defaulted investments totaled $5.7 million of bonds and
constituted less than 0.3% of total invested assets. SOURCES OF LIQUIDITY are readily available to the Company in the form of
the Companys existing portfolio of cash and short-term investments, Dollar
Roll Repo capacity on invested assets and if required, proceeds from invested
asset sales. The Companys liquidity is primarily derived from operating cash
flows. At December 31, 2003, approximately $1.85 billion of the Bond Portfolio
had an aggregate unrealized gain of $64.2 million while approximately $809.9
million of the Companys Bond Portfolio had an aggregate unrealized loss of
$24.0 million. In addition, the Companys investment portfolio currently
provides approximately $26.5 million of monthly cash flow from scheduled
principal and interest payments. Historically, cash flows from operations and
from the sale of the Companys annuity products have been more than sufficient
in amount to satisfy the Companys liquidity needs. Management is aware that prevailing market interest rates may shift
significantly and has strategies in place to manage either an increase or
decrease in prevailing rates. In a rising interest rate environment, the
Companys average cost of funds would increase over time as it prices its new
and renewing annuities to maintain a generally competitive market rate.
Management would seek to place new funds in investments that were matched in
duration to, and higher yielding than, the liabilities assumed. The Company
believes that liquidity to fund withdrawals would be available through incoming
cash flow, the sale of short-term or floating-rate instruments or Dollar Roll
Repos on the Companys substantial MBS segment of the Bond Portfolio, thereby
avoiding the sale of fixed-rate assets in an unfavorable bond market. In a declining rate environment, the Companys cost of funds would
decrease over time, reflecting lower interest crediting rates on its fixed
annuities. Should increased liquidity be required for withdrawals, the Company
believes that a significant portion of its investments could be sold
without adverse consequences in light of the general strengthening that
would be expected in the bond market. 25




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If a substantial portion of the Companys bond portfolio diminished
significantly in value and/or defaulted, the Company would need to liquidate
other portions of its investment portfolio and/or arrange financing. Such
events that may cause such a liquidity strain could be the result of economic
collapse or terrorist acts. Management believes that the Companys liquid assets and its net cash
provided by operations will enable the Company to meet any foreseeable cash
requirements for at least the next twelve months. GUARANTEES AND OTHER COMMITMENTS: At December 31, 2003, the Company has future
obligations to purchase approximately $9.0 million of asset backed securities
in the ordinary course of business. The expiration dates of these commitments
are as follows: $4.0 million in 2004 and $5.0 million in 2007. RECENTLY ISSUED ACCOUNTING STANDARDS In January 2001, the Emerging Issues Task Force (EITF) issued EITF
99-20, Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets (EITF 99-20). EITF
99-20 provides guidance on the calculation of interest income and the
recognition of impairments related to beneficial interests held in an
investment portfolio. The Companys beneficial interests are investments that
represent rights to receive specified cash flows from a pool of underlying
assets (i.e., collateralized debt obligations). In accordance with the
transition provisions of EITF 99-20, the Company recorded in its statement of
income and comprehensive income for 2001 a cumulative effect of an accounting
change adjustment loss of $520,000 ($800,000 before tax). In July 2003, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position 03-1, Accounting and Reporting by
Insurance Enterprises for Certain Non traditional Long-Duration Contracts and
for Separate Accounts (SOP 03-1). FASB did not object to the issuance of
SOP 03-1. This statement is effective for the Company as of January 1, 2004.
Under SOP 03-1, variable annuity assets held in separate accounts will continue
to be measured at fair value and reported in summary total on the Companys
financial statements, with an equivalent summary total reported for related
liabilities, if the separate account arrangement meets certain specified
conditions. The adoption of SOP 03-1 will not have a material impact on the
Companys separate accounts. In addition, SOP 03-1 will require the Company to recognize a liability
for guaranteed minimum death benefits and modify certain disclosures and
financial statement presentations for this product. The Companys estimate of
the liability, including the impact of DAC, will result in a one-time
cumulative accounting charge upon adoption of approximately $2 million ($4
million pre-tax) to be recorded in the first quarter of 2004. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The quantitative and qualitative disclosures about market risk are
contained in the Asset-Liability Matching section of Managements Discussion
and Analysis of Financial Condition and Results of Operations on pages 23 to 24
herein. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Companys financial statements begin on page F-3. Reference is made to
the Index to Financial Statements on page F-1 herein. 
 ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 26




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##### Table of Contents



None. 
 ITEM 9A. DISCLOSURE CONTROLS AND PROCEDURES The Companys disclosure and procedures are designed to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Securities Exchange Act of 1934, as amended (Exchange Act),
is recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange Commission.
Disclosure controls and procedures include controls and procedures designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the Companys management, including the Companys Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure. The Companys management, with the participation the
Companys Chief Executive Officer and Chief Financial Officer, have evaluated
the effectiveness of the Companys disclosure controls and procedures as of the
end of the period covered by this report. Based on the evaluation, the
Companys Chief Executive Officer and Chief Financial Officer concluded that
the disclosure controls and procedures provide reasonable assurance of
effectiveness as of the end of the period covered by this report. In addition,
there has been no change in the Companys internal control over financial
reporting that occurred during the fourth fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Companys internal
control over financial reporting. 
 PART III Information called for by Items 10 through 13 of this part is omitted
pursuant to General Instruction I. of Form 10-K. 
 Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES As an indirect wholly-owned subsidiary of AIG, oversight functions
regarding our independent accountants, PricewaterhouseCoopers LLP, are included
in the duties of AIGs Audit Committee. AIGs Audit Committee has adopted
pre-approval policies and procedures regarding audit and non-audit services
provided by PricewaterhouseCoopers LLP for AIG and its consolidated
subsidiaries, including the Company. In accordance with the SECs definitions and rules, audit fees of $229,000
and $84,000 were paid to PricewaterhouseCoopers LLP for professional services
for the audits of our financial statements included in Form 10-K, review of
financial statements included in Forms 10-Q, and for services that are normally
provided in connection with statutory and regulatory filings or engagements for
2003 and 2002, respectively. 27




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##### Table of Contents



PART IV 
  ITEM 15.
    EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K Financial Statements and Financial Statement Schedules Reference is made to the index set forth on page F-1 of this report. EXHIBITS ExhibitNo
    
    Description2(a)
    
    Purchase and Sale Agreement, dated as of July 15, 1998, by and
among the Company, SunAmerica Inc. (SAI), Anchor National Life
Insurance Company and MBL Life Assurance Corporation, is incorporated
herein by reference to Exhibit 2(e) to SAIs 1998 Annual Report on
Form 10-K, filed December 21, 1998.3(a)
    
    Agreement and Plan of Merger and Amended and Restated Certificate
of Incorporation are incorporated herein by reference to Exhibit 3(a)
of the Companys 1997 Annual Report on Form 10-K, filed September 22,
1997.3(b)
    
    Certificate of Amendment of the Amended and Restated Charter,
dated May 30, 2003, filed with the State of New York Department of
Insurance, effective as of June 13, 2003, is incorporated herein by
reference to Exhibit 3(a) to the Companys quarterly report on Form
10-Q for quarter ended June 30, 2003, filed August 14, 2003.3(c)
    
    Bylaws, as amended January 1, 1996, are incorporated herein by
reference to Exhibit 3(b) of the Companys annual report on Form 10-Q
for the quarter ended March 31, 1996, dated May 14, 1996.3(d)
    
    Bylaws, as amended May 9, 2003, are incorporated herein by
reference to Exhibit 3(b) to the Companys quarterly report on Form
10-Q for quarter ended June 30, 2003, filed August 14, 2003.4(a)
    
    Agreement and Plan of Merger and Amended and Restated Certificate
of Incorporation, filed with the State of New York, Insurance
Department, effective as of October 31, 1997. See Exhibit 3(a).4(b)
    
    Certificate of Amendment of the Amended and Restated Charter,
dated May 30, 2003, filed with the State of New York Department of
Insurance, effective as of June 13, 2003. See Exhibit 3(b).4(c)
    
    Bylaws, as amended May 9, 2003. See Exhibit 3(d).(31.1)
    
    Rule 13a-14(a)/15d-14(a) Certifications(31.2)
    
    Rule 13a-14(a)/15d-14(a) Certifications(32)
    
    Section 1350 CertificationsREPORTS ON FORM 8-KThere were no reports on Form 8-K filed during the three months ended December
31, 2003.
 28




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized. FIRST SUNAMERICA LIFE INSURANCE COMPANYBy /s/ N. SCOTT GILLISN. Scott GillisSenior Vice President,Chief Financial Officerand Director
 March 29, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated: Signature
    
    Title
    
    Date/s/
    
    JAY S. WINTROB
    
    Chief Executive Officer
    
    March 29, 2004and Director (PrincipalJay S. Wintrob
    
    Executive Officer)/s/
    
    N. SCOTT GILLIS
    
    Senior Vice President,
    
    March 29, 2004Chief Financial OfficerN. Scott Gillis
    
    and Director (Principal
Financial Officer)/s/
    
    STEWART POLAKOV
    
    Senior Vice President and
    
    March 29, 2004Controller (PrincipalStewart Polakov
    
    Accounting Officer)/s/
    
    JAMES R. BELARDI
    
    Senior Vice President
    
    March 29, 2004and DirectorJames R. Belardi/s/
    
    MARC H. GAMSIN
    
    Senior Vice President
    
    March 29, 2004and DirectorMarc H. Gamsin/s/
    
    JANA W. GREER
    
    President and Director
    
    March 29, 2004Jana W. Greer/s/
    
    DAVID L. HERZOG
    
    Director
    
    March 29, 2004David L. Herzog/s/
    
    ERNEST T. PATRIKIS
    
    Director
    
    March 29, 2004Ernest T. Patrikis/s/
    
    M. BERNARD AIDINOFF
    
    Director
    
    March 29, 2004M. Bernard Aidinoff/s/
    
    EDWIN R. RAQUEL
    
    Senior Vice President
    
    March 29, 2004and Chief ActuaryEdwin R. Raquel
 29




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY INDEX TO FINANCIAL STATEMENTS PageNumber(s)Report of Independent Auditors
    
    
    F-2Balance Sheet - December 31, 2003 and December 31, 2002
    
    
    F-3Statement of Income and Comprehensive Income - Years Ended
December 31, 2003, December 31, 2002, and
December 31, 2001
    
    F-4 to F-5Statement of Cash Flows - Years Ended December 31, 2003,
December 31, 2002, and December 31, 2001
    
    F-6 to F-7Notes to Financial Statements
    
    F-8 to F-22
 F-1




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##### Table of Contents



Report of Independent Auditors To the Board of Directors and Shareholder of
First SunAmerica Life Insurance Company: In our opinion, the accompanying balance sheet and the related statements of
income and comprehensive income and of cash flows present fairly, in all
material respects, the financial position of First SunAmerica Life Insurance
Company, an indirect wholly owned subsidiary of American International Group,
Inc., at December 31, 2003 and 2002, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 2003,
in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Companys management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion. As discussed in Note 2 to the financial statements, the Company changed its
method of accounting for interest income and impairment of certain beneficial
interests in securitized financial assets in 2001. PricewaterhouseCoopers LLP
Los Angeles, California
March 29, 2004 F-2




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
BALANCE SHEET December 31,2003
    
    2002(in thousands)ASSETSInvestments and cash:Cash and short-term investments
    
    $
    104,011
    
    
    $
    37,955Bonds, notes
and redeemable preferred stocks available for sale,
at market value (amortized cost: December 31, 2003, $2,617,647; December 31, 2002, $1,375,026)
    
    
    2,657,812
    
    
    
    1,410,053Mortgage loans
    
    
    215,521
    
    
    
    193,035Policy loans
    
    
    35,251
    
    
    
    36,052Common stocks available for sale, at
market value (cost: December 31, 2003,
$291; December 31, 2002, $1,629)
    
    
    295
    
    
    
    1,140Securities lending collateral
    
    
    154,756
    
    
    
    29,569Total investments and cash
    
    
    3,167,646
    
    
    
    1,707,804Variable annuity assets held in separate
accounts
    
    
    438,224
    
    
    
    399,017Accrued investment income
    
    
    27,577
    
    
    
    15,849Deferred acquisition costs
    
    
    177,926
    
    
    
    104,459Income taxes currently receivable from Parent
    
    
    1,360
    
    
    
    9,831Receivable from brokers
    
    
    
    
    
    
    1,025Other assets
    
    
    1,749
    
    
    
    1,401TOTAL ASSETS
    
    $
    3,814,482
    
    
    $
    2,239,386LIABILITIES AND SHAREHOLDERS EQUITYReserves, payables and accrued liabilities:Reserves for fixed annuity contracts
    
    $
    2,490,145
    
    
    $
    1,290,702Reserves for universal life insurance
contracts
    
    
    232,271
    
    
    
    237,862Securities lending payable
    
    
    154,756
    
    
    
    29,569Payable to brokers
    
    
    40,852
    
    
    
    Other liabilities
    
    
    66,814
    
    
    
    38,804Total reserves, payables and accrued liabilities
    
    
    2,984,838
    
    
    
    1,596,937Variable annuity liabilities related to
separate accounts
    
    
    438,224
    
    
    
    399,017Deferred income taxes
    
    
    41,895
    
    
    
    30,394Total liabilities
    
    
    3,464,957
    
    
    
    2,026,348Shareholders equity:Common stock
    
    
    3,000
    
    
    
    3,000Additional paid-in capital
    
    
    259,428
    
    
    
    144,428Retained earnings
    
    
    68,657
    
    
    
    51,740Accumulated other comprehensive income
    
    
    18,440
    
    
    
    13,870Total shareholders equity
    
    
    349,525
    
    
    
    213,038TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    3,814,482
    
    
    $
    2,239,386
 See accompanying notes to financial statements F-3




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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF INCOME AND COMPREHENSIVE INCOME Years Ended December 31,2003
    
    2002
    
    2001(in thousands)REVENUESFee income:Variable annuity policy fees
    
    $
    8,077
    
    
    $
    9,003
    
    
    $
    8,041Universal life insurance policy fees,
net of reinsurance
    
    
    5,289
    
    
    
    6,276
    
    
    
    5,815Surrender charges
    
    
    1,744
    
    
    
    1,854
    
    
    
    2,141Total fee income
    
    
    15,110
    
    
    
    17,133
    
    
    
    15,997Investment income
    
    
    119,730
    
    
    
    97,327
    
    
    
    100,952Net realized investment gains (losses)
    
    
    2,417
    
    
    
    (10,025
    )
    
    
    (19,266
    )Total revenues
    
    
    137,257
    
    
    
    104,435
    
    
    
    97,683BENEFITS AND EXPENSESInterest expense:Fixed annuity contracts
    
    
    65,631
    
    
    
    47,186
    
    
    
    51,320Universal life insurance contracts
    
    
    11,076
    
    
    
    11,489
    
    
    
    11,815Total interest expense
    
    
    76,707
    
    
    
    58,675
    
    
    
    63,135General and administrative expenses
    
    
    6,036
    
    
    
    8,112
    
    
    
    4,341Amortization of deferred acquisition costs
    
    
    20,564
    
    
    
    16,367
    
    
    
    11,629Annual commissions
    
    
    1,038
    
    
    
    771
    
    
    
    724Claims on universal life contracts,
net of reinsurance recoveries
    
    
    3,098
    
    
    
    2,985
    
    
    
    2,415Guaranteed minimum death benefits
    
    
    816
    
    
    
    1,735
    
    
    
    546Total benefits and expenses
    
    
    108,259
    
    
    
    88,645
    
    
    
    82,790PRETAX INCOME BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE
    
    
    28,998
    
    
    
    15,790
    
    
    
    14,893Income tax expense
    
    
    12,081
    
    
    
    9,032
    
    
    
    6,180INCOME BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE
    
    
    16,917
    
    
    
    6,758
    
    
    
    8,713Cumulative effect of accounting change,
net of tax
    
    
    
    
    
    
    
    
    
    
    (520
    )NET INCOME
    
    $
    16,917
    
    
    $
    6,758
    
    
    $
    8,193
 See accompanying notes to financial statements F-4




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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF INCOME AND COMPREHENSIVE INCOME (Continued) Years Ended December 31,2003
    
    2002
    
    2001(in thousands)OTHER COMPREHENSIVE INCOME,
NET OF TAXNet unrealized gains on fixed maturity and
equity securities available for sale
identified in the current period less
amortization of deferred acquisition costs
    
    $
    8,750
    
    
    $
    16,123
    
    
    $
    7,185Less reclassification adjustment for net
realized (gains) losses included in net
income
    
    
    (1,719
    )
    
    
    3,417
    
    
    
    9,212Income tax expense
    
    
    (2,461
    )
    
    
    (6,839
    )
    
    
    (5,739
    )OTHER COMPREHENSIVE INCOME
    
    
    4,570
    
    
    
    12,701
    
    
    
    10,658COMPREHENSIVE INCOME
    
    $
    21,487
    
    
    $
    19,459
    
    
    $
    18,851
 See accompanying notes to financial statements F-5




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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS Years Ended December 31,2003
    
    2002
    
    2001(in thousands)CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    16,917
    
    
    $
    6,758
    
    
    $
    8,193Adjustments to reconcile net income to
net cash provided by operating activities:Cumulative effect of accounting change,
net of tax
    
    
    
    
    
    
    
    
    
    
    520Interest credited to:Fixed annuity contracts
    
    
    65,631
    
    
    
    47,186
    
    
    
    51,320Universal life insurance contracts
    
    
    11,076
    
    
    
    11,489
    
    
    
    11,815Net realized investment (gains) losses
    
    
    (2,417
    )
    
    
    10,025
    
    
    
    19,266Amortization of discount on securities
    
    
    (2,493
    )
    
    
    (1,241
    )
    
    
    (2,999
    )Amortization of deferred acquisition costs
    
    
    20,564
    
    
    
    16,367
    
    
    
    11,629Acquisition costs deferred
    
    
    (92,631
    )
    
    
    (30,345
    )
    
    
    (8,160
    )Provision for deferred income taxes
    
    
    9,040
    
    
    
    25,503
    
    
    
    507Change in:Accrued investment income
    
    
    (11,728
    )
    
    
    (3,537
    )
    
    
    2,497Income taxes currently (receivable
from)/payable to Parent
    
    
    8,471
    
    
    
    (13,550
    )
    
    
    11,786Other liabilities
    
    
    17,209
    
    
    
    (5,609
    )
    
    
    (10,103
    )Other, net
    
    
    3,574
    
    
    
    510
    
    
    
    1,100NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    43,213
    
    
    
    63,556
    
    
    
    97,371CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of:Bonds and notes
    
    
    (1,883,889
    )
    
    
    (604,280
    )
    
    
    (266,757
    )Mortgage loans
    
    
    (53,070
    )
    
    
    (45,944
    )
    
    
    (31,540
    )Common stocks
    
    
    
    
    
    
    (845
    )
    
    
    (58
    )Other investments, excluding short-term
investments
    
    
    (771
    )
    
    
    (417
    )
    
    
    (229
    )Sales of:Bonds and notes
    
    
    403,973
    
    
    
    219,856
    
    
    
    246,769Other investments, excluding short-term
investments
    
    
    1,522
    
    
    
    49
    
    
    
    42Redemptions and maturities of:Bonds and notes
    
    
    283,637
    
    
    
    121,907
    
    
    
    149,150Mortgage loans
    
    
    30,846
    
    
    
    25,833
    
    
    
    26,813Other investments, excluding short-term
investments
    
    
    1,572
    
    
    
    1,709
    
    
    
    2,767NET CASH (USED IN) PROVIDED BY INVESTING
ACTIVITIES
    
    $
    (1,216,180
    )
    
    $
    (282,132
    )
    
    $
    126,957
 See accompanying notes to financial statements F-6




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FIRST SUNAMERICA LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS (Continued) Years Ended December 31,2003
    
    2002
    
    2001(in thousands)CASH FLOWS FROM FINANCING ACTIVITIES:Deposits received on:Fixed annuity contracts
    
    $
    1,280,979
    
    
    $
    390,318
    
    
    $
    66,463Universal life insurance contracts
    
    
    9,436
    
    
    
    9,712
    
    
    
    10,466Net exchanges from (to) the fixed accounts
of variable annuity contracts
    
    
    (2,712
    )
    
    
    23,542
    
    
    
    (33,539
    )Withdrawal payments on:Fixed annuity contracts
    
    
    (114,000
    )
    
    
    (137,007
    )
    
    
    (207,166
    )Universal life insurance contracts
    
    
    (7,522
    )
    
    
    (10,740
    )
    
    
    (11,565
    )Claims and annuity payments on:Fixed annuity contracts
    
    
    (29,888
    )
    
    
    (28,271
    )
    
    
    (30,242
    )Universal life insurance contracts
    
    
    (12,270
    )
    
    
    (20,005
    )
    
    
    (17,567
    )Capital contributions received from Parent
    
    
    115,000
    
    
    
    
    
    
    
    Dividend paid to Parent
    
    
    
    
    
    
    
    
    
    
    (12,900
    )NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES
    
    
    1,239,023
    
    
    
    227,549
    
    
    
    (236,050
    )NET INCREASE (DECREASE) IN CASH AND SHORT-
TERM INVESTMENTS
    
    
    66,056
    
    
    
    8,973
    
    
    
    (11,722
    )CASH AND SHORT-TERM INVESTMENTS
AT BEGINNING OF PERIOD
    
    
    37,955
    
    
    
    28,982
    
    
    
    40,704CASH AND SHORT-TERM INVESTMENTS AT END OF
PERIOD
    
    $
    104,011
    
    
    $
    37,955
    
    
    $
    28,982SUPPLEMENTAL CASH FLOW INFORMATION:Interest paid on indebtedness
    
    
    
    
    
    
    
    
    
    
    Net income taxes refunded by Parent
    
    $
    (5,430
    )
    
    $
    (2,922
    )
    
    $
    (6,113
    )
 See accompanying notes to financial statements F-7




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS  1.
    
    NATURE OF OPERATIONSFirst SunAmerica Life Insurance Company (the Company) is a New York-domiciled
life insurance company principally engaged in the business of writing fixed and
variable annuities for retirement savings in the State of New York. The
Company is a direct wholly owned subsidiary of SunAmerica Life Insurance
Company (the Parent), which is a wholly owned subsidiary of AIG Retirement
Services, Inc. (AIGRS)(formerly AIG SunAmerica Inc.), a subsidiary of
American International Group, Inc. (AIG). AIG is a holding company, which
through its subsidiaries is engaged in a broad range of insurance and
insurance-related activities, financial services, retirement services and
retirement services and asset management.Substantially all of the Companys revenues are derived from the State of New
York. Products are marketed through financial institutions, affiliated and
independent broker-dealers and full-service securities firms. One financial
institution represented approximately 15.9% and one independent broker-dealer
represented 15.3% of sales in the year ended December 31, 2003. One financial
institution represented approximately 19.3% of sales in the year ended December
31, 2002. One financial institution represented approximately 35.7% of sales
in the year ended December 31, 2001. No other independent selling organization
was responsible for more than 10% of sales for any such periods.The operations of the Company are influenced by many factors, including general
economic conditions, monetary and fiscal policies of the federal government,
and policies of state and other regulatory authorities. The level of sales of
the Companys financial products is influenced by many factors, including
general market rates of interest, the strength, weakness and volatility of
equity markets, and terms and conditions of competing financial products. The
Company is exposed to the typical risks normally associated with a portfolio of
fixed-income securities, namely interest rate, option, liquidity and credit
risk. The Company controls its exposure to these risks by, among other things,
closely monitoring and matching the duration of its assets and liabilities,
monitoring and limiting prepayment and extension risk in its portfolio,
maintaining a large percentage of its portfolio in highly liquid securities,
and engaging in a disciplined process of underwriting, reviewing and monitoring
credit risk. The Company also is exposed to market risk, as market volatility
may result in reduced fee income in the case of assets held in separate
accounts.2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBASIS OF PRESENTATION: The accompanying financial statements have been
prepared on the basis of U.S. generally accepted accounting principles
(GAAP). Certain prior period amounts have been reclassified to conform to the
current periods presentation.Under GAAP, deposits collected on non-traditional life and annuity insurance
products, such as those sold by the Company, are not reflected as revenues in
the Companys statement of income and comprehensive income, as they are
recorded directly to policyholder liabilities upon receipt.The preparation of financial statements in conformity with GAAP requires the
use of estimates and assumptions that affect the amounts reported in the
financial statements and the accompanying notes. Actual results could differ
from those estimates.INVESTMENTS: Cash and short-term investments primarily include cash,
commercial paper, money market investments and short-term bank F-8




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)participations. All such investments are carried at cost plus accrued
interest, which approximates fair value, have maturities of three months or
less and are considered cash equivalents for purposes of reporting cash flows.Bonds, notes and redeemable preferred stocks available for sale and common
stocks are carried at aggregate fair value and changes in unrealized gains or
losses, net of tax, are credited or charged directly to the accumulated other
comprehensive income or loss component of shareholders equity. Bonds, notes
and redeemable preferred stocks are reduced to estimated net fair value when
declines in value are considered to be other than temporary. Estimates of net
fair value are subjective and actual realization will be dependent upon future
events.Mortgage loans are carried at amortized unpaid balances, net of provisions for
estimated losses. Policy loans are carried at unpaid balances.Securities lending collateral consist of securities provided as collateral with
respect to the Companys securities lending program. The Company has entered
into a securities lending agreement with an affiliated lending agent, which
authorizes the agent to lend securities held in the Companys portfolio to a
list of authorized borrowers. The Company receives primarily cash collateral
in an amount in excess of the market value of the securities loaned. The
Company monitors the daily market value of securities loaned with respect to
the collateral value and obtains additional collateral when necessary to ensure
that collateral is maintained at a minimum of 102% of the value of the loaned
securities. Such collateral is not available for the general use of the
Company. Income earned on the collateral, net of interest paid on the
securities lending agreements and the related management fees paid to
administer the program, is recorded as investment income in the statement of
income and comprehensive income.Realized gains and losses on the sale of investments are recognized in income
at the date of sale and are determined by using the specific cost
identification method. Premiums and discounts on investments are amortized to
investment income by using the interest method over the contractual lives of
the investments.The Company regularly reviews its investments for possible impairment based on
criteria including economic conditions, market prices, past experience and
other issuer-specific developments among other factors. If there is a decline
in a securitys net realizable value, a determination is made as to whether
that decline is temporary or other than temporary. If it is believed that a
decline in the value of a particular investment is temporary, the decline is
recorded as an unrealized loss in accumulated other comprehensive income. If it
is believed that the decline is other than temporary, the Company writes down
the carrying value of the investment and records a realized loss in the
statement of income and comprehensive income.DEFERRED ACQUISITION COSTS (DAC): Policy acquisition costs are deferred and
amortized, with interest, in relation to the incidence of estimated gross
profits (EGPs) to be realized over the estimated lives of the annuity
contracts. EGPs are composed of net investment income, net realized
investment gains and losses, variable annuity fees, universal life
insurance fees, guarantee costs, surrender charges and direct
administrative expenses. DAC consists of commissions and other costs that
vary with, and are primarily F-9




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)related to, the production or acquisition of new business. The Company
capitalized DAC of $92,631,000, $30,345,000 and $8,160,000 for the years ended
December 31, 2003, 2002 and 2001, respectively.As fixed maturity and equity securities available for sale are carried at
aggregate fair value, an adjustment is made to DAC equal to the change in
amortization that would have been recorded if such securities had been sold at
their stated aggregate fair value and the proceeds reinvested at current
yields. The change in this adjustment, net of tax, is included with the change
in net unrealized gains or losses on fixed maturity and equity securities
available for sale which is a component of accumulated other comprehensive
income and is credited or charged directly to shareholders equity. DAC has
been decreased by $11,800,000 and $13,200,000 at December 31, 2003 and 2002,
respectively, for this adjustment.AMORTIZATION OF DEFERRED ACQUISITION COSTS: DAC is amortized based on a
percentage of EGPs over the life of the underlying policies. EGPs are computed
based on assumptions related to the underlying policies written, including
their anticipated duration, net spreads earned during the life of the
contracts, costs of providing policy guarantees, and the level of expenses
necessary to maintain the policies. The Company revises future DAC
assumptions, referred to herein as a DAC unlocking, when estimates of future
gross profits to be realized on its annuity policies are revised. At December
31, 2003, DAC amortization was adjusted for a DAC unlocking that resulted in a
reduction of $2.0 million. Increases in future EGPs may result from higher
interest spread and/or lower surrender rate assumptions, while decreases in
future EGPs may result from lower interest spread and /or higher surrender rate
assumptions. DAC amortization for the current period is reduced when future
EGPs are increased and increased when future EGPs are decreased.The Company reviews the carrying value of DAC on at least an annual basis.
Management considers estimated future gross profit margins as well as expected
mortality, interest earned and credited rates, persistency and expenses in
determining whether the carrying amount is recoverable. Any amounts deemed
unrecoverable are charged to expense.VARIABLE ANNUITY ASSETS AND LIABILITIES RELATED TO SEPARATE ACCOUNTS: The
assets and liabilities resulting from the receipt of variable annuity deposits
are segregated in separate accounts. The Company receives administrative fees
for managing the funds and other fees for assuming mortality and certain
expense risks. Such fees are included in variable annuity fees in the
statement of income and comprehensive income.RESERVES FOR FIXED ANNUITY AND UNIVERSAL LIFE INSURANCE CONTRACTS: Reserves
for fixed annuity and universal life insurance contracts are accounted for in
accordance with Statement of Financial Accounting Standards No. 97, Accounting
and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and
for Realized Gains and Losses from the Sale of Investments, and are recorded
at accumulated value (deposits received, plus accrued interest, less
withdrawals and assessed fees).FEE INCOME: Variable annuity fees, universal life insurance fees and surrender
charges are recorded in income when earned. F-10




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)INCOME TAXES: The Company files as a life insurance company under the
provisions of the Internal Revenue Code of 1986. Its federal income tax return
is consolidated with those of the Parent and its affiliate, AIG SunAmerica Life
Assurance Company (AIG SALAC). Income taxes have been calculated as if the
Company filed a separate return. Deferred income tax assets and liabilities are
recognized based on the difference between financial statement carrying amounts
and income tax basis of assets and liabilities using enacted income tax rates
and laws.RECENTLY ISSUED ACCOUNTING STANDARDS: In January 2001, the Emerging Issues Task
Force (EITF) issued EITF 99-20, Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets (EITF 99-20). EITF 99-20 provides guidance on the
calculation of interest income and the recognition of impairments related to
beneficial interests held in an investment portfolio. The Companys beneficial
interests are investments that represent rights to receive specified cash flows
from a pool of underlying assets (i.e., collateralized debt obligations). In
accordance with the transition provisions of EITF 99-20, the Company recorded
in its statement of income and comprehensive income for 2001 a cumulative
effect of an accounting change adjustment loss of $520,000 ($800,000 before
tax).In July 2003, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position 03-1, Accounting and reporting by Insurance
Enterprises for Certain Non traditional Long-Duration Contracts and for
Separate Accounts (SOP 03-1). FASB did not object to the issuance of SOP
03-1. This statement is effective for the Company as of January 1, 2004. Under
SOP 03-1, variable annuity assets held in separate accounts will continue to be
measured at fair value and reported in summary total on the Companys financial
statements, with an equivalent summary total reported for related liabilities,
if the separate account arrangement meets certain specified conditions. The
adoption of SOP 03-1 will not have a material impact on the Companys separate
accounts.In addition, SOP 03-1 will require the Company to recognize a liability for
guaranteed minimum death benefits and modify certain disclosures and financial
statement presentations for this product. The Companys estimate of the
liability, including the impact of DAC, will result in a one-time cumulative
accounting charge upon adoption of approximately $2 million ($4 million
pre-tax) to be recorded in the first quarter of 2004.3.
    
    INVESTMENTSThe amortized cost and estimated fair value of bonds, notes and redeemable
preferred stocks by major category follow: F-11




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)  3.
    
    INVESTMENTS (Continued) Amortized
    
    EstimatedCost
    
    Fair Value(in thousands)AT DECEMBER 31, 2003:Securities of the United States
government
    
    $
    17,671
    
    
    $
    18,054Mortgage-backed securities
    
    
    619,800
    
    
    
    634,640Securities of public utilities
    
    
    126,229
    
    
    
    131,158Corporate bonds and notes
    
    
    1,226,035
    
    
    
    1,248,590Other debt securities
    
    
    627,912
    
    
    
    625,370Total
    
    $
    2,617,647
    
    
    $
    2,657,812AT DECEMBER 31, 2002:Securities of the United States
government
    
    $
    3,074
    
    
    $
    3,208Mortgage-backed securities
    
    
    442,675
    
    
    
    471,065Securities of public utilities
    
    
    74,205
    
    
    
    75,470Corporate bonds and notes
    
    
    619,304
    
    
    
    638,266Other debt securities
    
    
    235,768
    
    
    
    222,044Total
    
    $
    1,375,026
    
    
    $
    1,410,053
  The amortized cost and estimated fair value of bonds, notes and redeemable
preferred stocks by contractual maturity, as of December 31, 2003, follow: EstimatedAmortized
    
    FairCost
    
    Value(in thousands)Due in one year or less
    
    $
    35,767
    
    
    $
    36,178Due after one year through five years
    
    
    764,378
    
    
    
    784,755Due after five years through ten years
    
    
    888,517
    
    
    
    892,038Due after ten years
    
    
    309,185
    
    
    
    310,201Mortgage-backed securities
    
    
    619,800
    
    
    
    634,640Total
    
    $
    2,617,647
    
    
    $
    2,657,812
  Actual maturities of bonds, notes and redeemable preferred stocks may differ
from those shown above due to prepayments and redemptions.  Gross unrealized gains and losses on bonds, notes and redeemable preferred
stocks by major category follow: F-12




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  3.
    
    INVESTMENTS (Continued) Gross
    
    GrossUnrealized
    
    UnrealizedGains
    
    Losses(in thousands)AT DECEMBER 31, 2003:Securities of the United States
government
    
    $
    383
    
    
    $
    Mortgage-backed securities
    
    
    20,483
    
    
    
    (5,643
    )Securities of public utilities
    
    
    5,258
    
    
    
    (329
    )Corporate bonds and notes
    
    
    30,773
    
    
    
    (8,217
    )Other debt securities
    
    
    7,294
    
    
    
    (9,837
    )Total
    
    $
    64,191
    
    
    $
    (24,026
    )
 Gross
    
    GrossUnrealized
    
    UnrealizedGains
    
    Losses(in thousands)AT DECEMBER 31, 2002:Securities of the United States
government
    
    $
    133
    
    
    $
    Mortgage-backed securities
    
    
    28,484
    
    
    
    (94
    )Securities of public utilities
    
    
    2,632
    
    
    
    (1,366
    )Corporate bonds and notes
    
    
    30,261
    
    
    
    (11,299
    )Other debt securities
    
    
    1,421
    
    
    
    (15,145
    )Total
    
    $
    62,931
    
    
    $
    (27,904
    )
  Gross unrealized gains on equity securities aggregated $9,000 and $22,000 at
December 31, 2003 and 2002, respectively. Gross unrealized losses on equity
securities aggregated $5,000 and $511,000 at December 31, 2003 and 2002,
respectively.  The following table summarizes the Companys gross unrealized losses and
estimated fair values on investments, aggregated by investment category and
length of time that individual securities have been in a continuous unrealized
loss position at December 31, 2003. Less than 12 months
    
    12 Months or More
    
    Total(dollars in thousands)
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    
    
    
    UnrealizedDecember 31, 2003
    
    Fair Value
    
    Losses
    
    Items
    
    Fair Value
    
    Losses
    
    Items
    
    Fair Value
    
    Losses
    
    ItemsMortgaged-backed securities
    
    $
    183,577
    
    
    $
    (5,643
    )
    
    
    37
    
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    $
    183,577
    
    
    $
    (5,643
    )
    
    
    37Securities of public
utilities
    
    
    15,013
    
    
    
    (329
    )
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,013
    
    
    
    (329
    )
    
    
    6Corporate bonds and notes
    
    
    388,358
    
    
    
    (8,204
    )
    
    
    69
    
    
    
    56
    
    
    
    (13
    )
    
    
    1
    
    
    
    388,414
    
    
    
    (8,217
    )
    
    
    70Other debt securities
    
    
    219,407
    
    
    
    (8,357
    )
    
    
    44
    
    
    
    3,521
    
    
    
    (1,480
    )
    
    
    1
    
    
    
    222,928
    
    
    
    (9,837
    )
    
    
    45Total - debt securities
    
    
    806,355
    
    
    
    (22,533
    )
    
    
    156
    
    
    
    3,577
    
    
    
    (1,493
    )
    
    
    2
    
    
    
    809,932
    
    
    
    (24,026
    )
    
    
    158Equity securities
    
    
    291
    
    
    
    (5
    )
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    291
    
    
    
    (5
    )
    
    
    2Total
    
    $
    806,646
    
    
    $
    (22,538
    )
    
    
    158
    
    
    $
    3,577
    
    
    $
    (1,493
    )
    
    
    2
    
    
    $
    810,223
    
    
    $
    (24,031
    )
    
    
    160
 F-13




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  3.
    
    INVESTMENTS (Continued)Gross realized investment gains and losses on the sales of investments are as
follows: Years Ended December 31,2003
    
    2002
    
    2001(in thousands)BONDS, NOTES AND REDEEMABLE
PREFERRED STOCKS:Realized gains
    
    $
    8,954
    
    
    $
    8,522
    
    
    $
    8,220Realized losses
    
    
    (3,311
    )
    
    
    (8,677
    )
    
    
    (10,222
    )COMMON STOCKS:Realized gains
    
    
    202
    
    
    
    
    
    
    
    42Realized losses
    
    
    (20
    )
    
    
    (38
    )
    
    
    
  The sources and related amounts of investment income are as follows: Years Ended December 31,2003
    
    2002
    
    2001(in thousands)Short-term investments
    
    $
    848
    
    
    $
    1,441
    
    
    $
    1,661Bonds and notes and redeemable
preferred stocks
    
    
    103,197
    
    
    
    80,518
    
    
    
    83,449Mortgage loans
    
    
    13,552
    
    
    
    13,000
    
    
    
    14,068Policy loans
    
    
    2,819
    
    
    
    2,160
    
    
    
    Other invested assets
    
    
    55
    
    
    
    788
    
    
    
    3,022Gross investment income
    
    
    120,471
    
    
    
    97,907
    
    
    
    102,200Less: investment expenses
    
    
    (741
    )
    
    
    (580
    )
    
    
    (1,248
    )Total investment income
    
    $
    119,730
    
    
    $
    97,327
    
    
    $
    100,952
  The Company had no investments in any one entity or its affiliates exceeding
10% of the Companys shareholders equity at December 31, 2003. Investment
income was attributable to the following products: Years Ended December 31,2003
    
    2002
    
    2001(in thousands)Fixed annuities
    
    $
    91,169
    
    
    $
    65,606
    
    
    $
    70,006Variable annuities
    
    
    14,564
    
    
    
    14,062
    
    
    
    12,082Universal life insurance
    
    
    13,997
    
    
    
    17,659
    
    
    
    18,864$
    119,730
    
    
    $
    97,327
    
    
    $
    100,952
 F-14




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  3.
    
    INVESTMENTS (Continued)At December 31, 2003, bonds and notes included $153,165,000 of bonds and notes
not rated investment grade. These non-investment-grade securities are
comprised of bonds spanning 11 industries with 20% concentrated in
telecommunications, 20% concentrated in cyclical consumer products and 14%
concentrated in non-cyclical consumer products. No other industry
concentration constituted more than 10% of these assets.At December 31, 2003, mortgage loans were collateralized by properties located
in 26 states, with loans totaling approximately 27% of the aggregate carrying
value of the portfolio secured by properties located in California,
approximately 12% by properties located in Texas and approximately 10% by
properties located in both Michigan and New York. No more than 10% of the
portfolio was secured by properties located in any other single state.At December 31, 2003, the carrying value, which approximates its estimated fair
value, of all investments in default as to the payment of principal or interest
totaled $222,000.At December 31, 2003, $594,000 of bonds, at amortized cost, was on deposit with
regulatory authorities in accordance with statutory requirements.4.
    
    FAIR VALUE OF FINANCIAL INSTRUMENTSThe following estimated fair value disclosures are limited to reasonable
estimates of the fair value of only the Companys financial instruments. The
disclosures do not address the value of the Companys recognized and
unrecognized non-financial assets (including its other invested assets) and
liabilities or the value of anticipated future business. The Company does not
plan to sell most of its assets or settle most of its liabilities at these
estimated fair values.The fair value of a financial instrument is the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale. Selling expenses and potential taxes are not
included. The estimated fair value amounts were determined using available
market information, current pricing information and various valuation
methodologies. If quoted market prices were not readily available for a
financial instrument, management determined an estimated fair value.
Accordingly, the estimates may not be indicative of the amounts the financial
instruments could be exchanged for in a current or future market transaction.The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
that value:CASH AND SHORT-TERM INVESTMENTS: Carrying value is considered to be a
reasonable estimate of fair value.BONDS, NOTES AND REDEEMABLE PREFERRED STOCKS: Fair value is based principally
on independent pricing services, broker quotes and other independent
information. For securities which do not have readily determinable market
prices, the fair value is estimated with internally prepared valuations
(including those based on estimates of future profitability). Otherwise, the
most recent purchases and sales of similar unquoted securities, independent
broker quotes or comparison to similar securities with quoted prices when
possible is used to estimate the fair value of those securities.MORTGAGE LOANS: Fair values are primarily determined by discounting future
cash flows to the present at current market rates, using expected prepayment
rates. F-15




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  4.
    
    FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)POLICY LOANS: Carrying value is considered a reasonable estimate of fair
value.COMMON STOCKS: Fair value is based principally on independent pricing
services, broker quotes and other independent information.VARIABLE ANNUITY ASSETS HELD IN SEPARATE ACCOUNTS: Variable annuity assets are
carried at the market value of the underlying securities.RESERVES FOR FIXED ANNUITY CONTRACTS: Deferred annuity contracts are assigned
a fair value equal to current net surrender value. Annuitized contracts are
valued based on the present value of future cash flows at current pricing
rates.VARIABLE ANNUITY LIABILITIES RELATED TO SEPARATE ACCOUNTS: Variable annuity
liabilities are carried at the market value of the underlying securities of the
variable annuity assets held in separate accounts.SECURITIES HELD/LOANED UNDER COLLATERAL AGREEMENTS: Carrying value is
considered to be a reasonable estimate of fair value.The estimated fair values of the Companys financial instruments at December
31, 2003 and December 31, 2002, compared with their respective carrying values,
are as follows: Carrying
    
    FairValue
    
    Value(in thousands)DECEMBER 31, 2003:ASSETS:Cash and short-term investments
    
    $
    104,011
    
    
    $
    104,011Bonds and notes and redeemable
preferred stocks
    
    
    2,657,812
    
    
    
    2,657,812Mortgage loans
    
    
    215,521
    
    
    
    230,022Policy loans
    
    
    35,251
    
    
    
    35,251Common stock
    
    
    295
    
    
    
    295Securities lending collateral
    
    
    154,756
    
    
    
    154,756Variable annuity assets held in
separate accounts
    
    
    438,224
    
    
    
    438,224LIABILITIES:Reserves for fixed annuity contracts
    
    $
    2,490,145
    
    
    $
    2,419,705Securities lending payable
    
    
    154,756
    
    
    
    154,756Variable annuity liabilities related
to separate accounts
    
    
    438,224
    
    
    
    438,224
 F-16




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  4.
    
    FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) Carrying
    
    FairValue
    
    Value(in thousands)DECEMBER 31, 2002:ASSETS:Cash and short-term investments
    
    $
    37,955
    
    
    $
    37,955Bonds and notes and redeemable preferred
stocks
    
    
    1,410,053
    
    
    
    1,410,053Mortgage loans
    
    
    193,035
    
    
    
    213,212Policy loans
    
    
    36,052
    
    
    
    36,052Common stock
    
    
    1,140
    
    
    
    1,140Securities lending collateral
    
    
    29,569
    
    
    
    29,569Variable annuity assets held in
separate accounts
    
    
    399,017
    
    
    
    399,017LIABILITIES:Reserves for fixed annuity contracts
    
    $
    1,290,702
    
    
    $
    1,255,463Securities lending payable
    
    
    29,569
    
    
    
    29,569Variable annuity liabilities related
to separate accounts
    
    
    399,017
    
    
    
    399,017
  5.
    
    REINSURANCEThe universal life contracts are subject to existing reinsurance ceded
agreements. In order to limit the exposure to loss on any single insured, the
Company entered into a reinsurance treaty effective January 1, 2000 under which
the Company retains no more than $100,000 of risk on any one insured
life. Total reserve credits of $1,200,000 and $1,141,000 were taken
against the life insurance reserves at December 31, 2003 and 2002, respectively.Reinsurance premiums of $7.1 million, $6.1 million and $6.3 million were netted
against universal life insurance policy fees in 2003, 2002 and 2001,
respectively. Reinsurance recoveries were $3.6 million, $4.2 million and $3.9
million in 2003, 2002 and 2001, respectively and were offset against claims on
universal life contracts.With respect to the Companys reinsurance, the Company could become liable for
all obligations of the reinsured policies if the reinsurers were to become
unable to meet the obligations assumed under the respective reinsurance
agreements. The Company monitors its credit exposure with respect to these
agreements. However, due to the high credit ratings of the reinsurers, such
risks are considered to be minimal.6.
    
    COMMITMENTS AND CONTINGENT LIABILITIESVarious lawsuits against the Company have arisen in the ordinary course of
business. Contingent liabilities arising from litigation, income taxes and
other matters are not considered material in relation to the financial position
of the Company.The Companys current financial strength and counterparty credit ratings from
Standard & Poors are based in part on a guarantee (the Guarantee) of the
Companys insurance policy obligations by American Home Assurance Company
(American Home), a subsidiary of AIG, and a member of an AIG intercompany
pool, and the belief that the Company is viewed as a strategically important
member of AIG. The Guarantee is unconditional and irrevocable, and
policyholders have the right to enforce the Guarantee directly against American
Home. F-17




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  6.
    
    COMMITMENTS AND CONTINGENT LIABILITIES (Continued)The Companys current financial strength rating from Moodys is based in part
on a support agreement between the Company and AIG (the Support Agreement),
pursuant to which AIG has agreed that AIG will cause the Company to maintain a
policyholders surplus of not less than $1 million or such greater amount as
shall be sufficient to enable the Company to perform its obligations under any
policy issued by it. The Support Agreement also provides that if the Company
needs funds not otherwise available to it to make timely payment of its
obligations under policies issued by it, AIG will provide such funds at the
request of the Company. The Support Agreement is not a direct or indirect
guarantee by AIG to any person of any obligation of the Company. AIG may
terminate the Support Agreement with respect to outstanding obligations of the
Company only under circumstances where the Company attains, without the benefit
of the Support Agreement, a financial strength-rating equivalent to that held
by the Company with the benefit of the Support Agreement. Policyholders have
the right to cause the Company to enforce its rights against AIG and, if the
Company fails or refuses to take timely action to enforce the Support Agreement
or if the Company defaults in any claim or payment owed to such policyholder
when due, have the right to enforce the Support Agreement directly against AIG.American Home does not publish financial statements, although it files
statutory annual and annual reports with the New York State Insurance
Department, where such reports are available to the public. AIG is a reporting
company under the Securities Exchange Act of 1934, and publishes annual reports
on Form 10-K and annual reports on Form 10-Q, which are available from the
Securities and Exchange Commission.At December 31, 2003, the Company was obligated to purchase approximately
$9,000,000 of asset backed securities in the ordinary course of business. The
expiration dates of these commitments are as follows: $4,000,000 in 2004 and
$5,000,000 in 2007.The Company guarantees a minimum level of death benefits for the majority of
the Companys separate account contracts. If assets in these separate accounts
are insufficient to fund minimum policy benefits, the Company is obligated to
pay the difference.7.
    
    SHAREHOLDERS EQUITYThe Company is authorized to issue 300 shares of its $10,000 par value Common
Stock. At December 31, 2003 and December 31, 2002, 300 shares were
outstanding. F-18




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  7.
    
    SHAREHOLDERS EQUITY (continued)Changes in shareholders equity are as follows: Years ended December 31,2003
    
    2002
    
    2001(in thousands)ADDITIONAL PAID-IN CAPITAL:Beginning balances
    
    $
    144,428
    
    
    $
    144,428
    
    
    $
    144,428Capital contributions by Parent
    
    
    115,000
    
    
    
    
    
    
    
    Ending balances
    
    $
    259,428
    
    
    $
    144,428
    
    
    $
    144,428RETAINED EARNINGS:Beginning balances
    
    $
    51,740
    
    
    $
    44,982
    
    
    $
    49,689Net income
    
    
    16,917
    
    
    
    6,758
    
    
    
    8,193Dividends paid to Parent
    
    
    
    
    
    
    
    
    
    
    (12,900
    )Ending balances
    
    $
    68,657
    
    
    $
    51,740
    
    
    $
    44,982ACCUMULATED OTHER COMPREHENSIVE
INCOME (LOSS):Beginning balances
    
    $
    13,870
    
    
    $
    1,169
    
    
    $
    (9,489
    )Change in net unrealized gains (losses)
on debt securities available for sale
    
    
    5,138
    
    
    
    29,401
    
    
    
    37,497Change in net unrealized gains (losses)
on equity securities available for
sale
    
    
    493
    
    
    
    (161
    )
    
    
    (300
    )Change in adjustment to deferred
Acquisition costs
    
    
    1,400
    
    
    
    (9,700
    )
    
    
    (20,800
    )Tax effects of net changes
    
    
    (2,461
    )
    
    
    (6,839
    )
    
    
    (5,739
    )Ending balances
    
    $
    18,440
    
    
    $
    13,870
    
    
    $
    1,169
  Gross unrealized gains (losses) on fixed maturity and equity securities
included in accumulated other comprehensive income are as follows: December 31,
    
    December 31,2003
    
    2002(in thousands)Gross unrealized gains
    
    $
    64,200
    
    
    $
    62,953Gross unrealized losses
    
    
    (24,031
    )
    
    
    (28,415
    )Adjustment to DAC
    
    
    (11,800
    )
    
    
    (13,200
    )Deferred income taxes
    
    
    (9,929
    )
    
    
    (7,468
    )Accumulated other comprehensive
income
    
    $
    18,440
    
    
    $
    13,870
 F-19




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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  7.
    
    SHAREHOLDERS EQUITY (Continued)On September 30, 2003 and December 31, 2003, the Company received cash capital
contributions from the Parent of $40,000,000 and $75,000,000, respectively.Dividends that the Company may pay to its shareholder in any year without prior
approval of the New York Department of Insurance are limited by statute. The
maximum amount of dividends which can be paid to stockholders by a life
insurance company domiciled in the State of New York without obtaining the
prior approval of the Superintendent of Insurance is limited to the lesser of
the Companys net gain from operations of the preceding years statutory annual
statement or 10% of preceding years statutory surplus. Currently, no
dividends can be paid to stockholders during 2004 without prior approval of the
New York Superintendent of Insurance.Under statutory accounting principles utilized in filings with insurance
regulatory authorities, the Companys net loss for the years ended December 31,
2003 and December 31, 2002 were approximately $28,065,000 and $1,416,000, and
the net income for the year ended December 31, 2001 was approximately
$4,525,000, respectively. The Companys statutory capital and surplus totaled
approximately $213,084,000 at December 31, 2003 and $123,141,000 at December
31, 2002.8.
    
    INCOME TAXESThe components of the provisions for federal income taxes on pretax income
consist of the following: Years Ended December 31,2003
    
    2002
    
    2001(in thousands)Current
    
    $
    3,041
    
    
    $
    (16,471
    )
    
    $
    5,673Deferred
    
    
    9,040
    
    
    
    25,503
    
    
    
    507Total income tax expense
    
    $
    12,081
    
    
    $
    9,032
    
    
    $
    6,180
  Income taxes computed at the United States federal income tax rate of 35% and
income tax expenses reflected in the statement of income and comprehensive
income differ as follows: Years Ended December 31,2003
    
    2002
    
    2001(in thousands)Amount computed at statutory rate
    
    $
    10,149
    
    
    $
    5,527
    
    
    $
    5,213Increases (decreases) resulting
from:State income taxes, net of
federal tax benefit
    
    
    1,447
    
    
    
    2,103
    
    
    
    795Dividends received deduction
    
    
    (315
    )
    
    
    (144
    )
    
    
    (509
    )Other, net
    
    
    800
    
    
    
    1,546
    
    
    
    681Total income tax Expense
    
    $
    12,081
    
    
    $
    9,032
    
    
    $
    6,180
 F-20




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FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  8.
    
    INCOME TAXES (Continued)Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax reporting purposes. The
significant components of the (receivable) liability for deferred income taxes
are as follows: Years Ended December 31,2003
    
    2002(in thousands)DEFERRED TAX LIABILITIES:Investments
    
    $
    2,637
    
    
    $
    4,899Deferred acquisition costs
    
    
    52,448
    
    
    
    31,106Other liabilities
    
    
    3,383
    
    
    
    4,026Net unrealized gains on debt and
equity securities available for sale
    
    
    9,931
    
    
    
    7,468Total deferred tax liabilities
    
    
    68,399
    
    
    
    47,499DEFERRED TAX ASSETS:Contractholder reserves
    
    
    (14,994
    )
    
    
    (9,790
    )Other assets
    
    
    (11,510
    )
    
    
    (7,315
    )Total deferred tax assets
    
    
    (26,504
    )
    
    
    (17,105
    )Deferred income taxes
    
    $
    41,895
    
    
    $
    30,394
  In the Companys opinion, the deferred taxes will be fully realized and no
valuation allowance is necessary because the Company has the ability to
generate sufficient future taxable income to realize the tax benefits.9.
    
    RELATED-PARTY MATTERSThe Companys products may be sold by nine affiliated companies: SunAmerica
Securities, Inc.; Advantage Capital Corp.; Financial Services Corp.; Sentra
Securities Corp.; Spelman & Co. Inc.; Royal Alliance Associates, Inc.; VALIC
Financial Advisors; VALIC Financial Advisors, Inc.; and American General Equity
Services Corporation. Commissions paid to these broker-dealers totaled
$1,063,000 in the year ended December 31, 2003, $1,143,000 in the year ended
December 31, 2002 and $1,332,000 in the year ended December 31, 2001. These
affiliated broker-dealers represent a sequentially less significant portion of
the Companys business, amounting to 1.4%, 4.8% and 17.4% of premiums for each
of the respective periods.Pursuant to a cost allocation agreement, the Company purchases administrative,
investment management, accounting, marketing and data processing services from
its Parent and from certain AIG affiliates. Amounts paid for such services
totaled $5,250,000 for the year ended December 31, 2003, $8,399,000 for the
year ended December 31, 2002 and $6,469,000 for the year ended December 31,
2001. The component of such costs that relate to the production or acquisition
of new business during these periods amounted to $3,305,000 and $1,930,000, in
2002 and 2001 respectively, and is deferred and amortized as part of DAC. No
such deferral occurred in 2003. The other components of these costs are
included in general and administrative expenses in the statement of income and
comprehensive income.The majority of the Companys invested assets are managed by an affiliate of
the Company. The investment management fees incurred were $0.7 million, $0.6
million and $1.2 million for the years ended December 31, 2003, 2002 and 2001,
respectively. F-21




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##### Table of Contents



FIRST SUNAMERICA LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Continued)  9.
    
    RELATED-PARTY MATTERS (Continued)The Companys fixed annuities are administered by AIG Annuity Insurance
Company, an affiliate of the Company. Costs charged to the Company to
administer these policies were approximately $841,000 in 2003 and $107,000 in
2002. Additionally, costs charged to the Company for marketing such policies
amounted to $4,010,000 in 2003 and $1,021,000 in 2002 and are deferred and
amortized as part of Deferred Acquisition Costs. Effective November 2002, the
responsibility for administration of the remaining block of fixed annuities
was assumed by AIG Annuity Insurance Company, who the Company reimburses for
their cost of administration. The Company believes these costs are less than
the Company would have incurred to administer these policies internally.On December 9, 2002, the Company entered into a profit sharing agreement with
AIG SunAmerica Asset Management Corp. (SAAMCO), a registered investment
advisor and affiliate of the Company, whereby SAAMCO will contribute to the
Company on a quarterly basis its profits earned in connection with its role as
investment advisor and/or business manager to several open-end investment
management companies registered under the Investment Company Act of 1940, as
amended, that fund the variable investment options available to investors
through the Companys variable annuity contracts (the SAAMCO Agreement).
The SAAMCO Agreement was retroactive to January 1, 2002. Variable annuity
fees of $1,620,000 and $1,777,000 were included in the statement of income and
comprehensive income relating to the SAAMCO Agreement for the years ended
December 31, 2003 and 2002, respectively. Of this amount, $1,476,000 and
$1,639,000 has been paid to the Company in 2003 and 2002 and $144,000 and
$138,000 remains a receivable from SAAMCO at December 31, 2003 and 2002,
respectively.The Company paid $106,000 and $7,000 of management fees to an affiliate of the
Company to administer its securities lending program (see Note 2) for the year
ended December 31, 2003 and 2002, respectively. F-22