-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LpT6N0I52DibEyXjuYApjQCkw0vQZBHnyTHVjIBxTsCcEyEL0LZmbqQ3tGir0Kfo ACcC7l+ygDSmVs+XhSfiAw== 0000950129-05-004201.txt : 20050428 0000950129-05-004201.hdr.sgml : 20050428 20050428070419 ACCESSION NUMBER: 0000950129-05-004201 CONFORMED SUBMISSION TYPE: POS AM PUBLIC DOCUMENT COUNT: 2 FILED AS OF DATE: 20050428 DATE AS OF CHANGE: 20050428 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AIG SUNAMERICA LIFE ASSURANCE CO CENTRAL INDEX KEY: 0000006342 IRS NUMBER: 860198983 STATE OF INCORPORATION: AZ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: POS AM SEC ACT: 1933 Act SEC FILE NUMBER: 333-103504 FILM NUMBER: 05778127 BUSINESS ADDRESS: STREET 1: 1 SUNAMERICA CENTER STREET 2: C/O LUCIA WILLIAMS CITY: LOS ANGELES STATE: CA ZIP: 90067-6022 BUSINESS PHONE: 3107726000 MAIL ADDRESS: STREET 1: 1 SUN AMERICA CENTER CITY: LOS ANGELES STATE: CA ZIP: 90067-6022 FORMER COMPANY: FORMER CONFORMED NAME: ANCHOR NATIONAL LIFE INSURANCE CO DATE OF NAME CHANGE: 19920929 FORMER COMPANY: FORMER CONFORMED NAME: ANCHOR LIFE INSURANCE CO DATE OF NAME CHANGE: 19600201 POS AM 1 v08019p1posam.txt AIG SUNAMERICA LIFE ASSURANCE CO. AS FILED WITH SECURITIES AND EXCHANGE COMMISSION ON APRIL 27, 2005. FILE NO. 333-103504 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ POST-EFFECTIVE AMENDMENT NO. 7 ON FORM S-1 TO FORM S-3 UNDER THE SECURITIES ACT OF 1933 -------------------------------- AIG SUNAMERICA LIFE ASSURANCE COMPANY ("AIG SunAmerica Life") (Exact Name of Registrant as specified in its Charter) California 6311 86-0198983 (State or other (Primary Standard I.R.S. Employer jurisdiction of incorporation or Industrial Classification Identification No. organization) Number)
1 SUNAMERICA CENTER LOS ANGELES, CALIFORNIA 90067-6022 (800) 871-2000 (Address, including zip code, and telephone number, including area code, or registrant's principal executive offices) CHRISTINE A. NIXON, ESQ. AIG SUNAMERICA LIFE ASSURANCE COMPANY 1 SUNAMERICA CENTER LOS ANGELES, CALIFORNIA 90067-6022 (800) 871-2000 (Name, address, including zip code, and telephone number, including area code of agent for service) -------------------------------- Approximate date of commencement of proposed sale to the public: As soon after the effective date of this Registration Statement as is practicable. If the only securities being registered on this form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. [ ] If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [X] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] _____________ If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] _____________ -------------------------------- The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), shall determine. AIG SUNAMERICA LIFE ASSURANCE COMPANY ================================================================================ VARIABLE ANNUITY ACCOUNT TWO SUPPLEMENT TO THE VISTA CAPITAL ADVANTAGE PROSPECTUS (A-3394-PRO) DATED DECEMBER 28, 2004 ================================================================================ THE DATE OF THE PROSPECTUS IS HEREBY CHANGED TO MAY 2, 2005. ALL REFERENCES IN THE PROSPECTUS TO THE DATE OF THE STATEMENT OF ADDITIONAL INFORMATION ARE HEREBY CHANGED TO MAY 2, 2005. THE FOLLOWING REPLACES THE INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE SECTION ON PAGE 3 OF THE PROSPECTUS: AIG SunAmerica Life Assurance Company's (the "Company") Annual Report on Form 10-K for the year ended December 31, 2004, File No. 811-21039, and its quarterly reports on Form 10-Q are incorporated herein by reference. The Company files its Exchange Act documents and reports, including its annual and quarterly reports on Form 10K and Form 10-Q, electronically pursuant to EDGAR under CIK No. 0000006342. All documents or reports filed by the Company under Section 13(a), 13(c), 14, or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") after the effective date of this prospectus are also incorporated by reference. Statements contained in this prospectus and subsequently filed documents which are incorporated by reference or deemed to be incorporate by reference are deemed to modify or supersede documents incorporated here by reference. The Company is subject to the informational requirements of the Exchange Act. We file reports and other information with the SEC to meet those requirements. You can inspect and copy this information at SEC public facilities at the following locations: WASHINGTON, DISTRICT OF COLUMBIA 450 Fifth Street, N.W., Room 1024 Washington, DC 20549 CHICAGO, ILLINOIS 500 West Madison Street Chicago, IL 60661 NEW YORK, NEW YORK 233 Broadway New York, NY 10029 To obtain copies by mail contact the Washington, D.C. location. After you pay the fees as prescribed by the rules and regulations of the SEC, the required documents are mailed. The Company will provide without charge to each person to whom this prospectus is delivered, upon written or oral request, a copy of the above documents incorporated by reference. Requests for these documents should be directed to the Company's Annuity Service Center, as follows: AIG SunAmerica Life Assurance Company Annuity Service Center P.O. Box 54299 Los Angeles, California 90054-9299 Telephone Number: (800) 445-SUN2 THE FOLLOWING IS ADDED TO THE GLOSSARY ON PAGE 6 OF THE PROSPECTUS: Fixed Account - An account, if available, that we may offer in which you may invest money and earn a fixed rate of return. Page 1 of 6 Market Close - The close of the New York Stock Exchange, usually 1:00 p.m. Pacific Time. NYSE - New York Stock Exchange. Owner - The person or entity (if a non-natural owner) with an interest or title to this contract. The term "you" or "your" are also used to identify the Owner. Separate Account - A segregated asset account maintained separately from the Company's regular portfolio of investments and general accounts. The Separate Account is established by the Company to purchase and hold the Variable Portfolios. Trust - Collectively refers to the Anchor Series Trust and SunAmerica Series Trust. Underlying Funds - The underlying investment portfolios of the Trusts in which the Variable Portfolios invest. THE FOLLOWING REPLACES THE PORTFOLIO EXPENSES IN THE FEE TABLES ON PAGE 8 OF THE PROSPECTUS: PORTFOLIO EXPENSES
TOTAL ANNUAL TRUST OPERATING EXPENSES MINIMUM MAXIMUM (expenses that are deducted from the underlying portfolios of the Trusts, including management fees, other expenses and service (12b-1) fees, if applicable).................................. 0.56% 1.24%
THE FOLLOWING REPLACES THE EXPENSE EXAMPLES ON PAGE 9 OF THE PROSPECTUS: MAXIMUM AND MINIMUM EXPENSE EXAMPLES MAXIMUM EXPENSE EXAMPLES (assuming maximum separate account annual expenses of 1.40% and investment in an underlying portfolio with total expenses of 1.24%.).
(1) If you surrender your contract at the end of the applicable time period: 1 YEAR 3 YEARS 5 YEARS 10 YEARS $872 $1,334 $1,823 $3,018 (2) If you annuitize your contract at the end of the applicable time period: 1 YEAR 3 YEARS 5 YEARS 10 YEARS $267 $820 $1,400 $2,973 (3) If you do not surrender your contract: 1 YEAR 3 YEARS 5 YEARS 10 YEARS $272 $834 $1,423 $3,018
MINIMUM EXPENSE EXAMPLES (assuming minimum separate account annual expenses of 1.40% and investment in an underlying portfolio with total expenses of 0.56%.)
(1) If you surrender your contract at the end of the applicable time period and you do not elect any optional features: 1 YEAR 3 YEARS 5 YEARS 10 YEARS $804 $1,129 $1,481 $2,334 (2) If you annuitize your contract at the end of the applicable time period: 1 YEAR 3 YEARS 5 YEARS 10 YEARS $199 $615 $1,057 $2,285 (3) If you do not surrender your contract and you do not elect any optional features: 1 YEAR 3 YEARS 5 YEARS 10 YEARS $204 $629 $1,081 $2,334
Page 2 of 6 THE FOLLOWING REPLACES THE SECTION ENTITLED TRANSFERS DURING THE ACCUMULATION PHASE ON PAGE 19 OF THE PROSPECTUS: TRANSFERS DURING THE ACCUMULATION PHASE Subject to our rules, restrictions and policies, during the Accumulation Phase you may transfer funds between the Variable Portfolios and/or any Fixed Accounts by telephone or through the Company's website (http://www.aigsunamerica.com) or in writing by mail or facsimile. All transfer instructions submitted via facsimile must be sent to (818) 615-1543, otherwise they will not be considered received by us. We may accept transfers by telephone or the Internet unless you tell us not to on your contract application. When receiving instructions over the telephone or the Internet, we follow procedures we have adopted to provide reasonable assurance that the transactions executed are genuine. Thus, we are not responsible for any claim, loss or expense from any error resulting from instructions received over the telephone or the Internet. If we fail to follow our procedures, we may be liable for any losses due to unauthorized or fraudulent instructions. Any transfer request will be priced as of the day it is confirmed in good order by us if the request is processed before Market Close. If the transfer request is processed after Market Close, the request will be priced as of the next business day. Funds already in your contract cannot be transferred into the DCA Fixed Accounts. You must transfer at least $100 per transfer. If less than $100 remains in any Variable Portfolio after a transfer, that amount must be transferred as well. TRANSFER POLICIES We do not want to issue this variable annuity contract to contract owners engaged in trading strategies that seek to benefit from short-term price fluctuations or price inefficiencies in the Variable Portfolios of this product ("Short-Term Trading") and we discourage Short-Term Trading as more fully described below. However, we cannot always anticipate if a potential contract owner intends to engage in Short-Term Trading. Short-Term Trading may create risks that may result in adverse effects on investment return of an Underlying Fund. Such risks may include, but are not limited to: (1) interference with the management and planned investment strategies of an Underlying Fund and/or (2) increased brokerage and administrative costs due to forced and unplanned fund turnover; both of which may dilute the value of the shares in the Underlying Fund and reduce value for all investors in the Variable Portfolio. In addition to negatively impacting the contract owner, a reduction in contract value may also be harmful to annuitants and/or beneficiaries. We have adopted the following administrative procedures to discourage Short-Term Trading. We charge for transfers in excess of 15 in any contract year. Currently, the fee is $25 for each transfer exceeding this limit. Transfers resulting from your participation in the DCA or Asset Rebalancing programs are not counted towards the number of free transfers per contract year. In addition to charging a fee when you exceed 15 transfers as described in the preceding paragraph, all transfer request in excess of 15 transfers per contract year must be submitted in writing by United States Postal Service first-class mail ("U.S. Mail") until your next contract anniversary ("Standard U. S. Mail Policy"). We will not accept transfer requests sent by any other medium except U.S. Mail until your next contract anniversary. Transfer requests required to be submitted by U.S. Mail can only be cancelled by a written request sent by U.S. Mail with the appropriate paperwork received prior to the execution of the transfer. All transfers made on the same day prior to Market Close are considered one transfer request. Transfers resulting from your participation in the DCA or Asset Page 3 of 6 Rebalancing programs are not included for the purposes of determining the number of transfers before applying the Standard U.S. Mail Policy. We apply the Standard U.S. Mail Policy uniformly and consistently to all contract owners except for omnibus group contracts and contracts utilizing third party asset allocation services as described below. We believe that the Standard U. S. Mail Policy is a sufficient deterrent to Short-Term Trading and we do not conduct any additional routine monitoring. However, we may become aware of transfer patterns among the Variable Portfolios and/or Fixed Accounts which reflect what we consider to be Short-Term Trading or otherwise detrimental to the Variable Portfolios but have not yet triggered the limitations of the Standard U.S. Mail Policy described above. If such transfer activity cannot be controlled by the Standard U.S. Mail Policy, we may require you to adhere to our Standard U.S. Mail Policy prior to reaching the specified number of transfers ("Accelerated U.S. Mail Policy"). To the extent we become aware of Short-Term Trading activities which cannot be reasonably controlled by the Standard U.S. Mail Policy or the Accelerated U.S. Mail Policy, we also reserve the right to evaluate, in our sole discretion, whether to impose further limits on the number and frequency of transfers you can make, impose minimum holding periods and/or reject any transfer request or terminate your transfer privileges. We will notify you in writing if your transfer privileges are terminated. In addition, we reserve the right to not accept transfers from a third party acting for you and not to accept preauthorized transfer forms. Some of the factors we may consider when determining whether to accelerate the Standard U.S. Mail Policy, reject or impose other conditions on transfer privileges include: (1) the number of transfers made in a defined period; (2) the dollar amount of the transfer; (3) the total assets of the Variable Portfolio involved in the transfer and/or transfer requests that represent a significant portion of the total assets of the Variable Portfolio; (4) the investment objectives and/or asset classes of the particular Variable Portfolio involved in your transfers; (5) whether the transfer appears to be part of a pattern of transfers to take advantage of short-term market fluctuations or market inefficiencies; and/or (6) other activity, as determined by us, that creates an appearance, real or perceived, of Short-Term Trading.*** Notwithstanding the administrative procedures above, there are limitations on the effectiveness of these procedures. Our ability to detect and/or deter Short-Term Trading is limited by operational systems and technological limitations. We cannot guarantee that we will detect and/or deter all Short-Term Trading. To the extent that we are unable to detect and/or deter Short-Term Trading, the Variable Portfolios may be negatively impacted as described above. Additionally, the Variable Portfolios may be harmed by transfer activity related to other insurance companies and/or retirement plans or other investors that invest in shares of the Underlying Fund. You should be aware that the design of our administrative procedures involves inherently subjective decisions, which we attempt to make in a fair and reasonable manner consistent with the interests of all owners of this contract. We do not enter into agreements with contract owners whereby we permit or intentionally disregard Short-Term Trading. The Standard and Accelerated U.S. Mail Policies are applied uniformly and consistently to contract owners utilizing third party trading services/ strategies performing asset allocation services for a number of contract owners at the same time except for purposes of calculating the number of transfers for the Standard U.S. Mail Policy. A calendar year will be used (instead of a contract year) for these contracts. You should be aware that such third party trading services may engage in transfer activities that can also be detrimental to the Variable Portfolios. These transfer activities may not be intended to take advantage of short-term price fluctuations or price inefficiencies. However, such activities can create the same or similar risks to Short-Term Trading and negatively impact the Variable Portfolios as described above. Omnibus group contracts may invest in the same Underlying Funds available in your contract but on an aggregate, not individual basis. Thus, we have limited ability to detect Short-Term Trading in omnibus group contracts and the Page 4 of 6 Standard U.S. Mail Policy does not apply to these contracts. Our inability to detect Short-Term Trading may negatively impact the Variable Portfolios as described above. WE RESERVE THE RIGHT TO MODIFY THE POLICIES AND PROCEDURES DESCRIBED IN THIS SECTION AT ANY TIME. To the extent that we exercise this reservation of rights, we will do so uniformly and consistently unless we disclose otherwise. For information regarding transfers during the Income Phase, SEE INCOME OPTIONS BELOW. THE FOLLOWING IS ADDED AS THE LAST PARAGRAPH OF THE GENERAL ACCOUNT SECTION ON PAGE 11 OF THE PROSPECTUS: The Company has a support agreement in effect between the Company and its ultimate parent company, American International Group, Inc. ("AIG"), and the Company's insurance policy obligations are guaranteed by American Home Assurance Company, a subsidiary of AIG. See the Statement of Additional Information for more information regarding these arrangements. THE FOLLOWING REPLACES THE SECTION ENTITLED DISTRIBUTION OF CONTRACTS ON PAGE 30 OF THE PROSPECTUS: PAYMENTS IN CONNECTION WITH DISTRIBUTION OF THE CONTRACT PAYMENTS TO BROKER-DEALERS Registered representatives of broker-dealers sell the contract. We pay commissions to the broker-dealers for the sale of your contract ("Contract Commissions"). There are different structures by which a broker-dealer can choose to have their Contract Commissions paid. For example, as one option, we may pay upfront Contract Commission only, that may be up to a maximum 6.5% of each Purchase Payment you invest (which may include promotional amounts). Another option may be a lower upfront Contract Commission on each Purchase Payment, with a trail commission of up to a maximum percentage of contract value annually. Generally, the higher the upfront commissions, the lower the trail and vice versa. We pay Contract Commissions directly to the broker-dealer with whom your registered representative is affiliated. Registered representatives may receive a portion of these amounts we pay in accordance with any agreement in place between the registered representative and his/her broker-dealer firm. We may pay broker-dealers support fees in the form of additional cash or non-cash compensation. These payments may be intended to reimburse for specific expenses incurred or may be based on sales, certain assets under management, longevity of assets invested with us or a flat fee. These payments may be consideration for, among other things, product placement/preference, greater access to train and educate the firm's registered representatives about our products, our participation in sales conferences and educational seminars and allowing broker-dealers to perform due diligence on our products. The amount of these fees may be tied to the anticipated level of our access in that firm. We enter into such arrangements in our discretion and we may negotiate customized arrangements with firms, including affiliated and non-affiliated broker-dealers based on various factors. We do not deduct these amounts directly from your Purchase Payments. We anticipate recovering these amounts from the fees and charges collected under the contract. Contract commissions and other support fees may influence the way that a broker-dealer and its registered representatives market the contracts and service customers who purchase the contracts and may influence the broker- dealer and its registered representatives to present this contract over others available in the market place. You should discuss with your broker-dealer and/or registered representative how they are compensated for sales of a contract and/or any resulting real or perceived conflicts of interest. AIG SunAmerica Capital Services, Inc., Harborside Financial Center, 3200 Plaza 5, Jersey City, NJ 07311-4992, distributes the contracts. AIG SunAmerica Capital Services, an affiliate of AIG SunAmerica Life, is a registered broker-dealer under the Exchange Act of 1934 and is a member of the National Association of Securities Dealers, Inc. No underwriting fees are paid in connection with the distribution of the contracts. Page 5 of 6 PAYMENTS WE RECEIVE In addition to amounts received pursuant to established 12b-1 Plans from the Underlying Funds, we receive compensation of up to 0.50% annually based on assets under management from certain Trusts' investment advisers or their affiliates for services related to the availability of the Underlying Funds in the contract. We receive such payments in connection with each of the Trusts available in this Contract. Such amounts received from our affiliate, AIG SAAMCo, are paid pursuant to a profit sharing agreement and are not expected to exceed 0.50%. Furthermore, certain investment advisers and/or subadvisers may help offset the costs we incur for training to support sales of the Underlying Funds in the contract. THE FOLLOWING REPLACES THE LEGAL PROCEEDINGS SECTION IN ITS ENTIRETY ON PAGE 30 OF PROSPECTUS: There are no pending legal proceedings affecting the Separate Account. The Company and its subsidiaries are parties to various kinds of litigation incidental to their respective business operations. In management's opinion, these matters are not material in relation to the financial position of the Company with the exception of the matter disclosed below. A purported class action captioned Nitika Mehta, as Trustee of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case 04L0199, was filed on April 5, 2004 in the Circuit Court, Twentieth Judicial District in St. Clair County, Illinois. The action has been transferred to and is currently pending in the United States District Court for the District of Maryland, Case No. 04-md-15863, as part of a Multi-District Litigation proceeding. The lawsuit alleges certain improprieties in conjunction with alleged market timing activities. The probability of any particular outcome cannot be reasonably estimated at this time. AIG has announced that it has delayed filing its Annual Report on Form 10-K for the year ended December 31, 2004 to allow AIG's Board of Directors and new management adequate time to complete an extensive review of AIG's books and records. The review includes issues arising from pending investigations into non-traditional insurance products and certain assumed reinsurance transactions by the Office of the Attorney General for the State of New York and the Securities and Exchange Commission and from AIG's decision to review the accounting treatment of certain additional items. Circumstances affecting AIG can have an impact on the Company. For example, the recent downgrades and ratings actions taken by the major rating agencies with respect to AIG resulted in corresponding downgrades and ratings actions being taken with respect to the Company's ratings. Accordingly, we can give no assurance that any further changes in circumstances for AIG will not impact us. Date: May 2, 2005 Please keep this Supplement with your Prospectus. Page 6 of 6 VISTA CAPITAL ADVANTAGE PROSPECTUS DECEMBER 28, 2004 FLEXIBLE PAYMENT GROUP DEFERRED ANNUITY CONTRACTS ISSUED BY AIG SUNAMERICA LIFE ASSURANCE COMPANY IN CONNECTION WITH VARIABLE ANNUITY ACCOUNT TWO The annuity has several investment choices - Variable Portfolios listed below and available fixed account options. The Variable Portfolios are part of the Anchor Series Trust ("AST") and the SunAmerica Series Trust ("SAST"): STOCKS: MANAGED BY DAVIS ADVISORS - DAVIS VENTURE VALUE PORTFOLIO SAST MANAGED BY MARSICO CAPITAL MANAGEMENT, LLC - MARSICO GROWTH PORTFOLIO SAST MANAGED BY MASSACHUSETTS FINANCIAL SERVICES COMPANY - MFS TOTAL RETURN PORTFOLIO SAST MANAGED BY PUTNAM INVESTMENT MANAGEMENT, LLC - INTERNATIONAL GROWTH AND INCOME PORTFOLIO SAST BONDS: MANAGED BY WELLINGTON MANAGEMENT COMPANY, LLC - GOVERNMENT AND QUALITY BOND PORTFOLIO AST CASH: MANAGED BY BANC OF AMERICA CAPITAL MANAGEMENT, LLC - CASH MANAGEMENT PORTFOLIO SAST Please read this prospectus carefully before investing and keep it for future reference. It contains important information about the Vista Capital Advantage Variable Annuity. To learn more about the annuity offered by this prospectus, you can obtain a copy of the Statement of Additional Information ("SAI") dated December 28, 2004. The SAI has been filed with the Securities and Exchange Commission ("SEC") and is incorporated by reference into this prospectus. The Table of Contents of the SAI appears in this prospectus. For a free copy of the SAI, call us at (800) 445-SUN2 or write to us at our Annuity Service Center, P.O. Box 54299, Los Angeles, California 90054-0299. In addition, the SEC maintains a website (http://www.sec.gov) that contains the SAI, materials incorporated by reference and other information filed electronically with the SEC by AIG SunAmerica Life Assurance Company. ANNUITIES INVOLVE RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AND ARE NOT A DEPOSIT OR OBLIGATION OF, OR GUARANTEED OR ENDORSED BY, ANY BANK. THEY ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER AGENCY. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION, NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF CONTENTS
PAGE ITEM ---- GLOSSARY.................................................... 4 HIGHLIGHTS.................................................. 5 FEE TABLES.................................................. 6 MAXIMUM AND MINIMUM EXPENSE EXAMPLES........................ 7 PERFORMANCE................................................. 8 DESCRIPTION OF THE SEPARATE ACCOUNT AND THE GENERAL ACCOUNT................................................... 8 Separate Account....................................... 8 General Account........................................ 8 VARIABLE PORTFOLIO OPTIONS.................................. 9 Voting Rights.......................................... 10 Substitution........................................... 10 FIXED ACCOUNT OPTIONS....................................... 10 Fixed Accounts......................................... 10 Dollar Cost Averaging Fixed Accounts................... 11 EXPENSES.................................................... 11 Separate Account Charges............................... 11 Withdrawal Charges..................................... 12 Investment Charges..................................... 12 Contract Maintenance Fee............................... 12 Transfer Fee........................................... 12 Premium Tax............................................ 12 Income Taxes........................................... 13 Reduction or Elimination of Charges and Expenses, and Additional Amounts Credited........................... 13 Free Withdrawal Amount................................. 13 Nursing Home Waiver.................................... 13 DESCRIPTION OF THE CONTRACTS................................ 14 Summary................................................ 14 Ownership.............................................. 14 Annuitant.............................................. 14 Modification of the Contract........................... 14 Assignment............................................. 14 Death Benefit.......................................... 14 PURCHASES, WITHDRAWALS AND CONTRACT VALUE................... 16 Purchase Payments...................................... 16 Allocation of Purchase Payments........................ 16 Accumulation Units..................................... 16 Free Look.............................................. 17 Transfers During the Accumulation Phase................ 17 Dollar Cost Averaging Program.......................... 19 Automatic Asset Allocation Rebalancing Program......... 20 Return Plus Program.................................... 21 Withdrawals............................................ 21 Systematic Withdrawal Program.......................... 21 Minimum Contract Value................................. 22 INCOME PHASE................................................ 22 Annuity Date........................................... 22 Income Options......................................... 22 Transfers During the Income Phase...................... 24 Deferment of Payments.................................. 24 TAXES....................................................... 24 Annuity Contracts in General........................... 24 Tax Treatment of Distributions -- Non-Qualified Contracts............................................. 24 Tax Treatment of Distributions -- Qualified Contracts............................................. 25 Minimum Distributions.................................. 25 Tax Treatment of Death Benefits........................ 26 Contracts Owned by a Trust or Corporation.............. 26 Gifts, Pledges and/or Assignments of a Non-Qualified Contract.............................................. 26 Diversification and Investor Control................... 27 ADMINISTRATION.............................................. 27 Distribution of Contracts.............................. 28 LEGAL PROCEEDINGS........................................... 28
3
PAGE ITEM ---- REGISTRATION STATEMENT...................................... 29 TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION.... F-56 APPENDIX A -- MARKET VALUE ADJUSTMENT ("MVA")............... A-1 APPENDIX B -- WITHDRAWALS AND WITHDRAWAL CHARGES............ B-1 APPENDIX C -- CONDENSED FINANCIAL INFORMATION............... C-1
All financial representatives or agents that sell the contracts offered by this prospectus are required to deliver a prospectus. - -------------------------------------------------------------------------------- GLOSSARY - -------------------------------------------------------------------------------- The following terms, as used in this prospectus, have the indicated meanings: ACCUMULATION PHASE -- The period during which you invest money in your contract. ACCUMULATION UNIT -- A unit of measurement which we use to calculate the value of the variable portion of your contract during the Accumulation Phase. ANNUITANT(S) -- The person(s) on whose life (lives) we base income payments. ANNUITY DATE -- The date on which income payments begin, as selected by you. ANNUITY UNIT(S) -- A measurement we use to calculate the amount of income payments you receive from the variable portion of your contract during the Income Phase. BENEFICIARY -- The person designated to receive any benefits under the contract if you or the Annuitant dies. COMPANY -- AIG SunAmerica Life Assurance Company, We, Us, the insurer that issues this contract. INCOME PHASE -- The period during which we make income payments to you. IRS -- The Internal Revenue Service. LATEST ANNUITY DATE -- Your 90(th) birthday or 10(th) contract anniversary, whichever is later. NON-QUALIFIED (CONTRACT) -- A contract purchased with after-tax dollars. In general, these contracts are not under any pension plan, specially sponsored program or individual retirement account ("IRA"). PURCHASE PAYMENTS -- The money you give us to buy the contract, as well as any additional money you give us to invest in the contract after you own it. QUALIFIED (CONTRACT) -- A contract purchased with pre-tax dollars. These contracts are generally purchased under a pension plan, specially sponsored program or IRA. TRUSTS -- Refers to the Anchor Series Trust and the SunAmerica Series Trust collectively. UNDERLYING FUND(S) -- The underlying series of the Trust in which the Variable Portfolios invest. VARIABLE PORTFOLIO(S) -- The variable investment options available under the contract. Each Variable Portfolio has its own investment objective and is invested in the underlying investments of the Trust. 4 - ------------------------------------------------------ - ------------------------------------------------------ HIGHLIGHTS - ------------------------------------------------------ - ------------------------------------------------------ The Vista Capital Advantage Variable Annuity is a contract between you and AIG SunAmerica Life Assurance Company ("AIG SunAmerica Life"). It is designed to help you invest on a tax-deferred basis and meet long-term financial goals. There are minimum Purchase Payment amounts required to purchase a contract. Purchase Payments may be invested in a variety of variable and fixed account options. Like all deferred annuities, the contract has an Accumulation Phase and an Income Phase. During the Accumulation Phase, you invest money in your contract. The Income Phase begins when you start receiving income payments from your annuity to provide for your retirement. FREE LOOK: You may cancel your contract within 10 days after receiving it (or whatever period is required in your state). You will receive whatever your contract is worth on the day that we receive your request. The amount refunded may be more or less than your original Purchase Payment. We will return your original Purchase Payment if required by law. Please see PURCHASING A VISTA CAPITAL ADVANTAGE VARIABLE ANNUITY in the prospectus. EXPENSES: There are fees and charges associated with the contract. Each year, we deduct a $30 contract maintenance fee from your contract. We also deduct Separate Account charges which equal 1.40% annually of the average daily value of your contract allocated to the Variable Portfolios. There are investment charges on amounts invested in the Variable Portfolios. If you elect optional features available under the contract we may charge additional fees for those features. A separate withdrawal charge schedule applies to each Purchase Payment. The amount of the withdrawal charge declines over time. After a Purchase Payment has been in the contract for seven complete years, withdrawal charges no longer apply to that portion of the Purchase Payment. Please see the FEE TABLE, PURCHASING A VISTA CAPITAL ADVANTAGE VARIABLE ANNUITY and EXPENSES IN THE PROSPECTUS. ACCESS TO YOUR MONEY: You may withdraw money from your contract during the Accumulation Phase. If you do so, earnings are deemed to be withdrawn first. You will pay income taxes on earnings and untaxed contributions when you withdraw them. Payments received during the Income Phase are considered partly a return of your original investment. A federal tax penalty may apply if you make withdrawals before age 59 1/2. As noted above, a withdrawal charge may apply. Please see ACCESS TO YOUR MONEY and TAXES in the prospectus. DEATH BENEFIT: A death benefit feature is available under the contract to protect your Beneficiaries in the event of your death during the Accumulation Phase. Please see DEATH BENEFITS in the prospectus. INCOME OPTIONS: When you are ready to begin taking income, you can choose to receive income payments on a variable basis, fixed basis or a combination of both. You may also chose from five different income options, including an option for income that you cannot outlive. Please see INCOME OPTIONS in the prospectus. INQUIRIES: If you have questions about your contract call your financial advisor or contact us at AIG SunAmerica Life Assurance Company Annuity Service Center P.O. Box 54299 Los Angeles, California 90054-0299. Telephone Number: (800) 445-SUN2. AIG SUNAMERICA LIFE OFFERS SEVERAL DIFFERENT VARIABLE ANNUITY PRODUCTS TO MEET THE DIVERSE NEEDS OF OUR INVESTORS. EACH PRODUCT MAY PROVIDE DIFFERENT FEATURES AND BENEFITS OFFERED AT DIFFERENT FEES, CHARGES AND EXPENSES. WHEN WORKING WITH YOUR FINANCIAL ADVISOR TO DETERMINE THE BEST PRODUCT TO MEET YOUR NEEDS YOU SHOULD CONSIDER, AMONG OTHER THINGS, WHETHER THE FEATURES OF THIS CONTRACT AND THE RELATED FEES PROVIDE THE MOST APPROPRIATE PACKAGE TO HELP YOU MEET YOUR LONG-TERM RETIREMENT SAVINGS GOALS. PLEASE READ THE PROSPECTUS CAREFULLY FOR MORE DETAILED INFORMATION REGARDING THESE AND OTHER FEATURES AND BENEFITS OF THE CONTRACT, AS WELL AS THE RISKS OF INVESTING. 5 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FEE TABLES - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU WILL PAY AT THE TIME THAT YOU TRANSFER CASH VALUE BETWEEN INVESTMENT OPTIONS OR SURRENDER THE CONTRACT. IF APPLICABLE, YOU MAY ALSO BE SUBJECT TO STATE PREMIUM TAXES. MAXIMUM OWNER TRANSACTION EXPENSES MAXIMUM WITHDRAWAL CHARGES (AS A PERCENTAGE OF EACH PURCHASE PAYMENT)(1)......6% TRANSFER FEE.......... No charge for the first 15 transfers each contract year; thereafter, the fee is $25 per transfer
FOOTNOTE TO THE FEE TABLES: (1) Withdrawal Charge Schedule (as a percentage of each Purchase Payment) declines over 7 years as follows YEARS:............................ 1 2 3 4 5 6 7 8 6% 6% 5% 5% 4% 3% 2% 0%
THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU MAY PAY PERIODICALLY DURING THE TIME THAT YOU OWN THE CONTRACT, NOT INCLUDING UNDERLYING PORTFOLIO FEES AND EXPENSES WHICH ARE OUTLINED IN THE NEXT SECTION. CONTRACT MAINTENANCE FEE $30 SEPARATE ACCOUNT ANNUAL EXPENSES (DEDUCTED DAILY AS A PERCENTAGE OF YOUR AVERAGE DAILY NET ASSET VALUE) Mortality and Expense Risk Fees...................... 1.25% Distribution Expense Fee............................. 0.15% ----- TOTAL SEPARATE ACCOUNT ANNUAL EXPENSES............. 1.40% =====
THE FOLLOWING SHOWS THE MINIMUM AND MAXIMUM TOTAL OPERATING EXPENSES CHARGED BY THE UNDERLYING PORTFOLIOS OF THE TRUSTS BEFORE ANY WAIVERS OR REIMBURSEMENTS. MORE DETAIL CONCERNING THE TRUSTS' FEES AND EXPENSES IS CONTAINED IN THE PROSPECTUS FOR THE TRUSTS. PLEASE READ IT CAREFULLY BEFORE INVESTING. PORTFOLIO EXPENSES
TOTAL ANNUAL UNDERLYING PORTFOLIO EXPENSES MINIMUM MAXIMUM ------------------------------------------ ------- ------- (expenses that are deducted from underlying portfolios of the Trusts, including management fees, other expenses and 12b-1 fees, if applicable).................................. 0.54% 1.25%
6 - -------------------------------------------------------------------------------- MAXIMUM AND MINIMUM EXPENSE EXAMPLES - -------------------------------------------------------------------------------- These Examples are intended to help you compare the cost of investing in the contract with the cost of investing in other variable annuity contracts. These costs include owner transaction expenses, contract maintenance fee, separate account annual expenses and fees and expenses of the underlying portfolios of the Trusts. The Examples assume that you invest $10,000 in the contract for the time periods indicated; that your investment has a 5% return each year; and that the maximum and minimum fees and expenses of the underlying variable portfolios of the Trusts are reflected. Although your actual costs may be higher or lower, based on these assumptions, your costs at the end of the stated period would be: MAXIMUM EXPENSE EXAMPLES (ASSUMING MAXIMUM SEPARATE ACCOUNT ANNUAL EXPENSES OF 1.40% AND INVESTMENT IN AN UNDERLYING VARIABLE PORTFOLIO WITH TOTAL EXPENSES OF 1.25%) (1) If you surrender your contract at the end of the applicable time period:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------ ------- ------- -------- $873 $1,337 $1,828 $3,028
(2) If you annuitize your contract at the end of the applicable time period:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------ ------- ------- -------- $268 $ 823 $1,405 $2,983
(3) If you do not surrender your contract:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------ ------- ------- -------- $273 $ 837 $1,428 $3,028
MINIMUM EXPENSE EXAMPLES (ASSUMING MINIMUM SEPARATE ACCOUNT ANNUAL CHARGES OF 1.40% AND INVESTMENT IN AN UNDERLYING VARIABLE PORTFOLIO WITH TOTAL EXPENSES OF 0.54%) (1) If you surrender your contract at the end of the applicable time period:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------ ------- ------- -------- $802 $1,123 $1,471 $2,313
(2) If you annuitize your contract at the end of the applicable time period:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------ ------- ------- -------- $197 $ 609 $1,047 $2,264
(3) If you do not surrender your contract:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------ ------- ------- -------- $202 $ 623 $1,071 $2,313
EXPLANATION OF FEE TABLES AND EXAMPLES 1. The purpose of the Fee Tables is to show you the various expenses you would incur directly and indirectly by investing in the contract. The tables represent both fees at the separate account (contract level) as well as total annual underlying variable account operating expenses. We converted the contract maintenance fee to a percentage (0.05%). The actual impact of the contract maintenance fee may differ from this percentage. Additional information on the portfolio company fees can be found in the accompanying Trust prospectuses. 2. In addition to the stated assumptions, the Examples also assume Separate Account charges as indicated and that no transfer fees were imposed. Although premium taxes may apply in certain states, they are not reflected in the Examples. 3. THESE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. THE HISTORICAL ACCUMULATION UNIT VALUES ARE CONTAINED IN APPENDIX C -- CONDENSED FINANCIAL INFORMATION. 7 - -------------------------------------------------------------------------------- PERFORMANCE - -------------------------------------------------------------------------------- We advertise the Cash Management Portfolio's yield and effective yield. In addition, the other Variable Portfolios advertise total return, gross yield and yield-to-maturity. These figures represent past performance of the Variable Portfolios. These performance numbers do not indicate future results. When we advertise performance for periods prior to the date the contracts were first issued, we derive the figures from the performance of the corresponding portfolios for the Trusts, if available. We modify these numbers to reflect charges and expenses as if the Variable Portfolio was in existence during the period stated in the advertisement. Figures calculated in this manner do not represent actual historic performance of the particular Variable Portfolio. Consult the Statement of Additional Information for more detailed information regarding the calculation of performance data. The performance of each Variable Portfolio may also be measured against unmanaged market indices. The indices we use include but are not limited to the Dow Jones Industrial Average, the Standard & Poor's 500, the Russell 1000 Growth Index, the Morgan Stanley Capital International Europe, Australasia and Far East Index ("EAFE") and the Morgan Stanley Capital International World Index. We may compare the Variable Portfolios' performance to that of other variable annuities with similar objectives and policies as reported by independent ranking agencies such as Morningstar, Inc., Lipper Analytical Services, Inc. or Variable Annuity Research & Data Service ("VARDS"). AIG SunAmerica Life may also advertise the rating and other information assigned to it by independent industry ratings organizations. Some of those organizations are A.M. Best Company ("A.M. Best"), Moody's Investor's Service ("Moody's"), Standard & Poor's Insurance Rating Services ("S&P"), and Fitch Ratings ("Fitch's"). Best's and Moody's ratings reflect their current opinion of our financial strength and performance in comparison to others in the life and health insurance industry. S&P's and Fitch's ratings measure the ability of an insurance company to meet its obligations under insurance policies it issues. These two ratings do not measure the insurer's ability to meet non-policy obligations. Ratings in general do not relate to the performance of the Variable Portfolios. - -------------------------------------------------------------------------------- DESCRIPTION OF THE SEPARATE ACCOUNT AND THE GENERAL ACCOUNT - -------------------------------------------------------------------------------- SEPARATE ACCOUNT AIG SunAmerica Life originally established Variable Annuity Account Two (the "separate account") on May 24, 1994. The separate account is registered with the SEC as a unit investment trust under the Investment Company Act of 1940, as amended. AIG SunAmerica Life owns the assets of the separate account. However, the assets in the separate account are not chargeable with liabilities arising out of any other business conducted by AIG SunAmerica Life. Income gains and losses (realized and unrealized), resulting from assets in the separate account are credited to or charged against the separate account without regard to other income, gains, or losses of AIG SunAmerica Life. Assets in the separate account are not guaranteed by AIG SunAmerica Life. GENERAL ACCOUNT Money allocated to the fixed account options goes into AIG SunAmerica Life's general account. The general account consists of all of AIG SunAmerica Life's assets other than assets attributable to a separate account. All of the assets in the general account are chargeable with the claims of any AIG SunAmerica Life contract holders as well as all of its creditors. The general account funds are invested as permitted under state insurance laws. 8 - -------------------------------------------------------------------------------- VARIABLE PORTFOLIO OPTIONS - -------------------------------------------------------------------------------- VARIABLE PORTFOLIOS The Variable Portfolios invest in shares of the Trusts listed below. The Variable Portfolios are only available through the purchase of certain insurance contracts. The Trusts serve as the underlying investment vehicles for other variable annuity contracts issued by AIG SunAmerica Life, and other affiliated/unaffiliated insurance companies. Neither AIG SunAmerica Life nor the Trusts believe that offering shares of the Trusts in this manner disadvantages you. Each Trust's advisers monitor for potential conflicts. The Variable Portfolios along with their respective subadvisers are listed below: ANCHOR SERIES TRUST -- CLASS 1 Wellington Management Company, LLP serves as subadviser to the Anchor Series Trust Portfolios. Anchor Series Trust ("AST") contains investment portfolios in addition to those listed here which are not available for investment under this contract. SUNAMERICA SERIES TRUST -- CLASS 1 Various subadvisers provide investment advice for the SunAmerica Series Trust Portfolios. SunAmerica Series Trust ("SAST") contains investment portfolios in addition to those listed here which are not available for investment under this contract. STOCKS: MANAGED BY DAVIS ADVISORS - Davis Venture Value Portfolio SAST MANAGED BY MARSICO CAPITAL MANAGEMENT, LLC - Marsico Growth Portfolio SAST MANAGED BY MASSACHUSETTS FINANCIAL SERVICES COMPANY - MFS Total Return Portfolio SAST MANAGED BY PUTNAM INVESTMENT MANAGEMENT, LLC - International Growth and Income Portfolio SAST BONDS: MANAGED BY WELLINGTON MANAGEMENT COMPANY, LLC - Government & Quality Bond Portfolio AST CASH: MANAGED BY BANC OF AMERICA CAPITAL MANAGEMENT, LLC - Cash Management Portfolio SAST You should read the accompanying prospectuses for the Trusts carefully. These prospectuses contains detailed information about the Variable Portfolios, including each Variable Portfolio's investment objective and risk factors. 9 VOTING RIGHTS AIG SunAmerica Life is the legal owner of the Trusts' shares. However, when a Variable Portfolio solicits proxies in conjunction with a vote of shareholders, we must obtain your instructions on how to vote those shares. We vote all of the shares we own in proportion to your instructions. This includes any shares we own on our own behalf. Should we determine that we are no longer required to comply with these rules, we will vote the shares in our own right. SUBSTITUTION We may amend your contract due to changes to the Variable Portfolios offered under your contract. For example, we may offer new Variable Portfolios, delete Variable Portfolios, or stop accepting allocations and/or investments in a particular Variable Portfolio. We may move assets and re-direct future premium allocations from one Variable Portfolio to another if we receive investor approval through a proxy vote or SEC approval for a fund substitution. This would occur if a Variable Portfolio is no longer an appropriate investment for the contract, for reasons such as continuing substandard performance, or for changes to the portfolio manager, investment objectives, risks and strategies, or federal or state laws. The new Variable Portfolio offered may have different fees and expenses. You will be notified of any upcoming proxies or substitutions that affect your Variable Portfolio choices. - -------------------------------------------------------------------------------- FIXED ACCOUNT OPTIONS - -------------------------------------------------------------------------------- FIXED ACCOUNTS Your contract may offer Fixed Account Guarantee Periods ("FAGP") to which you may allocate certain Purchase Payments or contract value. Available guarantee periods may be for different lengths of time (such as 1, 3 or 5 years) and may have different guaranteed interest rates, as noted below. We guarantee the interest rate credited to amounts allocated to any available FAGP and that the rate will never be less than the minimum guaranteed interest rate as specified in your contract. Once established, the rates for specified payments do not change during the guarantee period. We determine the FAGPs offered at any time in Our sole discretion and We reserve the right to change the FAGPs that We make available at any time, unless state law requires Us to do otherwise. Please check with your financial representative to learn if any FAGPs are currently offered. There are three interest rate scenarios for money allocated to the FAGPs. Each of these rates may differ from one another. Once declared, the applicable rate is guaranteed until the corresponding guarantee period expires. Under each scenario your money may be credited a different rate of interest as follows: - Initial Rate: The rate credited to any portion of the initial Purchase Payment allocated to a FAGP. - Current Rate: The rate credited to any portion of the subsequent Purchase Payments allocated to a FAGP. - Renewal Rate: The rate credited to money transferred from a FAGP or a Variable Portfolio into a FAGP and to money remaining in a FAGP after expiration of a guarantee period. When a FAGP ends, you may leave your money in the same FAGP or you may reallocate your money to another FAGP or to the Variable Portfolios. If you want to reallocate your money, you must contact Us within 30 days after the end of the current interest guarantee period and instruct Us as to where you would like the money invested. We do not contact you. If We do not hear from you, your money will remain in the same FAGP where it will earn interest at the renewal rate then in effect for that FAGP. If you take money out of any available multi-year FAGP, before the end of the guarantee period, We make an adjustment to your contract. We refer to the adjustment as a market value adjustment ("MVA"). The MVA reflects any difference in the interest rate environment between the time you place 10 your money in the FAGP and the time when you withdraw or transfer that money. This adjustment can increase or decrease your contract value. Generally, if interest rates drop between the time you put your money into a FAGP and the time you take it out, We credit a positive adjustment to your contract. Conversely, if interest rates increase during the same period, We post a negative adjustment to your contract. You have 30 days after the end of each guarantee period to reallocate your funds without incurring any MVA. APPENDIX A SHOWS HOW WE CALCULATE AND APPLY THE MVA. All FAGPs may not be available in all states. We reserve the right to refuse any Purchase Payment to available FAGPs if we are crediting a rate equal to the minimum guaranteed interest rate specified in your contract. We may also offer the specific Dollar Cost Averaging Fixed Accounts ("DCAFA"). The rules, restrictions and operation of the DCAFAs may differ from the standard FAGPs described above, please see DOLLAR COST AVERAGING PROGRAM below for more details. DOLLAR COST AVERAGING FIXED ACCOUNTS You may invest initial and/or subsequent Purchase Payments in the DCA fixed accounts ("DCAFA"), if available. DCAFAs also credit a fixed rate of interest but are specifically designed to facilitate a dollar cost averaging program. Interest is credited to amounts allocated to the DCAFAs while your investment is transferred to the Variable Portfolios over certain specified time frames. The interest rates applicable to the DCAFA may differ from those applicable to any available FAGPs but will never be less than the minimum annual guaranteed interest rate as specified in your contract. However, when using a DCAFA the annual interest rate is paid on a declining balance as you systematically transfer your investment to the Variable Portfolios. Therefore, the actual effective yield will be less than the annual crediting rate. We determine the DCAFAs offered at any time in Our sole discretion and We reserve the right to change to DCAFAs that we make available at any time, unless state law requires us to do otherwise. See DOLLAR COST AVERAGING PROGRAM below for more information. - -------------------------------------------------------------------------------- EXPENSES - -------------------------------------------------------------------------------- There are charges and expenses associated with your contract. These charges and expenses reduce your investment return. We will not increase the contract maintenance fee or the insurance and withdrawal charges under your contract. However, the investment charges under your contract may increase or decrease. Some states may require that we charge less than the amounts described below. SEPARATE ACCOUNT CHARGES The Company deducts a mortality and expense risk charge in the amount of 1.40%, annually of the value of your contract invested in the Variable Portfolios. We deduct the charge daily. This charge compensates the Company for the mortality and expense risk and the costs of contract distribution assumed by the Company. Generally, the mortality risks assumed by the Company arise from its contractual obligations to make income payments after the Annuity Date and to provide a death benefit. The expense risk assumed by the Company is that the costs of administering the contracts and the Separate Account will exceed the amount received from the administrative fees and charges assessed under the contract. If these charges do not cover all of our expenses, we will pay the difference. Likewise, if these charges exceed our expenses, we will keep the difference. The insurance charge is expected to result in a profit. Profit may be used for any legitimate cost/expense including distribution, depending upon market conditions. 11 WITHDRAWAL CHARGES The contract provides a free withdrawal amount every year. (SEE CONTRACT CHARGES, FREE WITHDRAWAL AMOUNT BELOW.) Additionally, earnings in your contract may be withdrawn free of withdrawal charges. If you take money out in excess of the free withdrawal amount, you may incur a withdrawal charge. We apply a withdrawal charge against each Purchase Payment you put into the contract. After a Purchase Payment has been in the contract for seven complete years, no withdrawal charge applies to that Purchase Payment. The withdrawal charge equals a percentage of the Purchase Payment you take out of the contract. The withdrawal charge percentage declines each year a Purchase Payment is in the contract, as follows:
- ------------------------------------------------------------------------------------------------------ YEAR 1 2 3 4 5 6 7 8 - ------------------------------------------------------------------------------------------------------ WITHDRAWAL CHARGE 6% 6% 5% 5% 4% 3% 2% 0% - ------------------------------------------------------------------------------------------------------
When calculating the withdrawal charge, we treat withdrawals as coming first from the Purchase Payments that have been in your contract the longest. However, for tax purposes, your withdrawals are considered earnings first, then Purchase Payments. Whenever possible, we deduct the withdrawal charge from the money remaining in your contract. If you withdraw all of your contract value, applicable withdrawal charges are deducted from the amount withdrawn. We do not assess a withdrawal charge for money withdrawn to pay a death benefit or to begin the Income Phase of your contract. Withdrawals made prior to age 59 1/2 may result in a 10% IRS penalty tax. SEE TAXES BELOW. APPENDIX B provides more information on withdrawals and the withdrawal charge. INVESTMENT CHARGES Charges are deducted from your Variable Portfolios for the advisory and other expenses of the Underlying Funds. THE FEE TABLES ABOVE illustrate these charges and expenses. For more detailed information on these investment charges, refer to the attached prospectuses for the Trusts. CONTRACT MAINTENANCE FEE During the Accumulation Phase, we subtract a contract maintenance fee from your account once per contract year. This charge compensates us for the cost of contract administration. We deduct the $30 contract maintenance fee on a pro-rata basis from your account value on your contract anniversary. If you withdraw your entire contract value, the fee is deducted from that withdrawal. TRANSFER FEE Generally, We currently permit 15 free transfers between investment options each contract year. After that, a charge of $25 applies to each additional transfer in any one contract year ($10 in Pennsylvania and Texas). SEE TRANSFERS DURING THE ACCUMULATION PHASE BELOW. PREMIUM TAX Certain states charge the Company a tax on the premiums you pay into the contract ranging from 0% to 3.5%. We deduct from your contract these premium tax charges where applicable. Currently, we deduct the charge for premium taxes when you take a full withdrawal or begin the Income Phase of the contract. In the future, we may assess this deduction at the time you put Purchase Payment(s) into the contract or upon payment of a death benefit. 12 INCOME TAXES We do not currently deduct income taxes from your contract. We reserve the right to do so in the future. REDUCTION OR ELIMINATION OF CHARGES AND EXPENSES, AND ADDITIONAL AMOUNTS CREDITED Sometimes sales of the contracts to groups of similarly situated individuals may lower our administrative and/or sales expenses. We reserve the right to reduce or waive certain charges and expenses when this type of sale occurs. In addition, we may also credit additional interest to policies sold to such groups. We determine which groups are eligible for such treatment. Some of the criteria used to make a determination are: size of the group; amount of expected Purchase Payments; relationship existing between us and prospective purchaser; nature of the purchase; length of time a group of contracts is expected to remain active; purpose of the purchase and whether that purpose increases the likelihood that our expenses will be reduced; and/or any other factors that we believe indicate that administrative and/or sales expenses may be reduced. We may make such a determination regarding sales to our employees, our affiliates' employees and employees of currently contracted broker-dealers, our registered representatives and immediate family members of all of those described. We reserve the right to change or modify any such determination or the treatment applied to a particular group, at any time. FREE WITHDRAWAL AMOUNT Your contract provides for a free withdrawal amount each year. Purchase Payments that are no longer subject to a withdrawal charge and not previously withdrawn, plus earnings, may be withdrawn without penalty. After the first full contract year, the contract provides for a free withdrawal amount on your first withdrawal of the contract year. The free withdrawal amount is the greater (1) 10% of your total Purchase Payments invested for at least one year and not yet withdrawn; only available for first withdrawal of contract year or (2) earnings in your contract. Total Purchase Payments are equal to your total Purchase Payments invested in the contract less any Purchase Payments withdrawn upon which a surrender charge was paid and the amount of the surrender charge. Additionally, once a Purchase Payment is no longer subject to withdrawal charges, it is no longer included when determining total Purchase Payments. Upon a full surrender of your contract, to the extent you previously withdraw Purchase Payments free of a withdrawal charge under the free withdrawal provision, we will recoup the full withdrawal charge on such amounts, as if that money was still invested in the contract on the date of surrender. We will waive the withdrawal charge upon payment of a death benefit. Where legally permitted, the withdrawal charge may be eliminated when a contract is issued to an officer, director or employee of the Company or its affiliates. NURSING HOME WAIVER If your contract was issued with the appropriate rider and you are confined to a nursing home for 60 days or longer, we may waive the withdrawal charge and/or the MVA on certain withdrawals prior to the Annuity Date (not available in Texas). The waiver applies only to withdrawals made while you are in a nursing home or within 90 days after you leave the nursing home. Your rider prohibits use of this waiver during the first 90 days after purchase. In addition, the confinement period for which you seek the waiver must begin after you purchase your contract. In order to use this waiver, you must submit with your withdrawal request, the following documents: (1) a doctor's note recommending admittance to a nursing home; (2) an admittance form which shows the type of facility you entered; and (3) a bill from the nursing home which shows that you met the 60 day confinement requirement. 13 - -------------------------------------------------------------------------------- DESCRIPTION OF THE CONTRACTS - -------------------------------------------------------------------------------- SUMMARY This contract works in two stages, the Accumulation Phase and the Income Phase. Your contract is in the Accumulation Phase while you make payments into the contract. The Income Phase begins when you request that we begin making payments to you out of the money accumulated in your contract. OWNERSHIP The Vista Capital Advantage Variable Annuity is a Flexible Payment Group Deferred Annuity Contract. AIG SunAmerica Life issues a group contract to a contract holder for the benefit of the participants in the group. As a participant in the group, you will receive a certificate which evidences your ownership. As used in this prospectus, the term contract refers to your certificate. In some states, a Flexible Payment Individual Modified Guaranteed and Variable Deferred Annuity Contract is available instead. Such a contract is identical to the contract described in this prospectus, with the exception that we issue it directly to the owner. ANNUITANT The annuitant is the person on whose life we base income payments. You may change the Annuitant at any time before the Annuity Date. You may also designate a second person on whose life, together with the annuitant, income payments depend. If the annuitant dies before the Annuity Date, you must notify us and select a new annuitant. MODIFICATION OF THE CONTRACT Only the Company's President, a Vice President or Secretary may approve a change or waive a provision of the contract. Any change or waiver must be in writing. We reserve the right to modify the terms of the contract as necessary to comply with changes in applicable law. ASSIGNMENT Contracts issued pursuant to Non-qualified plans that are not subject to Title 1 of the Employee Retirement Income Security Act of 1974 ("ERISA") may be assigned by the owner at any time during the lifetime of the Annuitant prior to the Annuity Date. We will not be bound by any assignment until written notice is received by us at our Annuity Service Center. We are not responsible for the validity, tax or other legal consequences of any assignment. An assignment will not affect any payments we may make or actions we may take before we receive notice of the assignment. If the contract is issued pursuant to a Qualified plan (or a Non-qualified plan that is subject to Title 1 of ERISA), it may not be assigned, pledged or otherwise transferred except under such conditions as may be allowed under applicable law. BECAUSE AN ASSIGNMENT MAY BE A TAXABLE EVENT, YOU SHOULD CONSULT A COMPETENT TAX ADVISER SHOULD YOU WISH TO ASSIGN YOUR CONTRACT. DEATH BENEFIT If you die during the Accumulation Phase of your contract, we pay a death benefit to your Beneficiary. 14 If you were less than age 70 when your contract was issued, the death benefit is equal to the greater of: 1. the value of your contract at the time we receive satisfactory proof of death; or 2. total Purchase Payments less any withdrawals (and any fees or charges applicable to such withdrawals); or 3. the maximum anniversary value on any contract anniversary preceding your death. The anniversary value equals the value of your contract on a contract anniversary plus any Purchase Payments and less any withdrawals (and any fees or charges applicable to such withdrawals) since that contract anniversary. If you were age 70 or older when your contract was issued, the death benefit will equal the value of your contract at the time we receive satisfactory proof of death. We do not pay the death benefit if you die after you switch to the Income Phase. However, if you die during the Income Phase, your Beneficiary receives any remaining guaranteed income payments in accordance with the income option you selected. (SEE INCOME PHASE, INCOME OPTIONS BELOW.) You name your Beneficiary. You may change the Beneficiary at any time, unless you previously made an irrevocable Beneficiary designation. We pay the death benefit when we receive satisfactory proof of death. We consider the following satisfactory proof of death: 1. a certified copy of the death certificate; or 2. a certified copy of a decree of a court of competent jurisdiction as to the finding of death; or 3. a written statement by a medical doctor who attended the deceased at the time of death; or 4. any other proof satisfactory to us. We may require additional proof before we pay the death benefit. The death benefit must be paid within 5 years of the date of death unless the Beneficiary elects to have it payable in the form of an income option. If the Beneficiary elects an income option, it must be paid over the Beneficiary's lifetime or for a period not extending beyond the Beneficiary's life expectancy. Payments must begin within one year of the date of your death. If a Beneficiary does not elect a specific form of pay out within 60 days of our receipt of proof of death, we pay a lump sum death benefit to the Beneficiary. If the Beneficiary is the spouse of a deceased owner, he or she can elect to continue the contract at the then current value. If the spouse continues the contract, we do not pay a death benefit to him or her. 15 - -------------------------------------------------------------------------------- PURCHASES, WITHDRAWALS AND CONTRACT VALUE - -------------------------------------------------------------------------------- PURCHASE PAYMENTS A Purchase Payment is the money you give us to buy a contract. Any additional money you give us to invest in the contract after purchase is a subsequent Purchase Payment. AIG SunAmerica Life discontinued new sales of the contract as of the close of business on October 11, 2000. AIG SunAmerica Life will continue to accept subsequent payments on existing contracts. This chart shows the minimum initial and subsequent Purchase Payments permitted under your contract. These amounts depend upon whether your contract is Qualified or Non-qualified for tax purposes. SEE TAXES BELOW.
- -------------------------------------------------------------------- MINIMUM MINIMUM INITIAL SUBSEQUENT PURCHASE PAYMENT PURCHASE PAYMENT - -------------------------------------------------------------------- Qualified $2,000 $250 - -------------------------------------------------------------------- Non-Qualified $5,000 $250 - --------------------------------------------------------------------
Prior Company approval is required to accept Purchase Payments greater than $1,000,000. The Company reserves the right to refuse any Purchase Payment including one which would cause Total Purchase Payments to exceed $1,000,000 at the time of the Purchase Payment. Further, we reserve the right to aggregate all contracts having the same owners' and/or annuitants' social security or federal tax identification number for purposes of determining which contracts and/or purchase payments require Company pre-approval. Also, the optional automatic payment plan allows you to make subsequent Purchase Payments of as little as $100. We may refuse any Purchase Payment. In general, AIG SunAmerica Life will not issue a Qualified contract to anyone who is age 70 1/2 or older, unless it is shown that the minimum distribution required by the IRS is being made. In addition, we may not issue a contract to anyone over age 85. ALLOCATION OF PURCHASE PAYMENTS We invest your Purchase Payments in the fixed and variable investment options according to your instructions. If we receive a Purchase Payment without allocation instructions, we invest the money according to your last allocation instructions. SEE VARIABLE PORTFOLIO OPTIONS, AND FIXED ACCOUNT OPTIONS BELOW. In order to issue your contract, we must receive your completed application, Purchase Payment allocation instructions and any other required paperwork at our principal place of business. We allocate your initial purchase payment within two days of receiving it. If we do not have complete information necessary to issue your contract, we will contact you. If we do not have the information necessary to issue your contract within 5 business days we will: - Send your money back to you, or; - Ask your permission to keep your money until we get the information necessary to issue the contract. ACCUMULATION UNITS When you allocate a Purchase Payment to the Variable Portfolios, we credit your contract with Accumulation Units of the separate account. We base the number of Accumulation Units you receive on the unit value of the Variable Portfolio as of the day we receive your money if we receive it before 1 p.m. Pacific Standard Time, or on the next business day's unit value if we receive your money after 16 1 p.m. Pacific Standard Time. The value of an Accumulation Unit will go up and down based on the performance of the Variable Portfolios. We calculate the value of an Accumulation Unit each day that the New York Stock Exchange ("NYSE") is open as follows: 1. We determine the total value of money invested in a particular Variable Portfolio; 2. We subtract from that amount all applicable contract charges; and 3. We divide this amount by the number of outstanding Accumulation Units. We determine the number of Accumulation Units credited to your contract by dividing the Purchase Payment by the Accumulation Unit value for the specific Variable Portfolio. EXAMPLE: We receive a $25,000 Purchase Payment from you on Wednesday. You allocate the money to the MFS Total Return Portfolio. The value of an Accumulation Unit for the MFS Total Return Portfolio is $11.10 when the NYSE closes on Wednesday. Your Purchase Payment of $25,000 is then divided by $11.10 and we credit your contract on Wednesday night with 2252.52 Accumulation Units of the MFS Total Return Portfolio. Performance of the Variable Portfolios and the charges and expenses under your contract affect Accumulation Unit values. These factors cause the value of your contract to go up and down. FREE LOOK You may cancel your contract within ten days after receiving it (or longer if required by state law). AIG SunAmerica Life calls this a "free look." To cancel, you must mail the contract along with your free look request to the Annuity Service Center at P.O. Box 54299, Los Angeles, California 90054-0299. We will refund the value of your contract on the day we receive your request. The amount refunded to you may be more or less than the amount you originally invested. Certain states require us to return your Purchase Payments upon a free look request. Additionally, all contracts issued as an IRA require the full return of Purchase Payments upon a free look. TRANSFERS DURING THE ACCUMULATION PHASE Subject to our rules, restrictions and policies, during the Accumulation Phase you may transfer funds between the Variable Portfolios and/or any available fixed account options by telephone or through the Company's website (http://www.aigsunamerica.com) or in writing by mail or facsimile. All transfer instructions submitted via facsimile must be sent to (818) 615-1543, otherwise they will not be considered received by us. We may accept transfers by telephone or the Internet unless you tell us not to on your contract application. When receiving instructions over the telephone or the Internet, we follow procedures we have adopted to provide reasonable assurance that the transactions executed are genuine. Thus, we are not responsible for any claim, loss or expense from any error resulting from instructions received over the telephone or the Internet. If we fail to follow our procedures, we may be liable for any losses due to unauthorized or fraudulent instructions. Any transfer request will be priced as of the day it is received in good order by us if the request is processed before the close of the New York Stock Exchange ("NYSE"), usually at 1:00 p.m. Pacific Time. If the transfer request is processed after the NYSE closes, the request will be priced as of the next business day. Funds already in your contract cannot be transferred into the DCA fixed accounts. You must transfer at least $100 per transfer. If less than $100 remains in any Variable Portfolio after a transfer, that amount must be transferred as well. 17 TRANSFER POLICIES This product is not designed for contract owners engaged in trading strategies that seek to benefit from short-term price fluctuations or price inefficiencies in the Variable Portfolios of this product ("Short-Term Trading"). Such Short-Term Trading may create risks that may result in adverse effects on investment return of an underlying fund. Such risks may include, but are not limited to: (1) interference with the management and planned investment strategies of an underlying fund and/or (2) increased brokerage and administrative costs due to forced and unplanned fund turnover; both of which may dilute the value of the shares in the underlying fund and reduce value for all investors in the Variable Portfolio. In addition to negatively impacting the contract owner, a reduction in contract value may also be harmful to annuitants and/or beneficiaries. We have adopted administrative procedures to discourage Short-Term Trading. We charge for transfers in excess of 15 in any contract year. Currently, the fee is $25 ($10 in Pennsylvania and Texas) for each transfer exceeding this limit. Transfers resulting from your participation in the DCA or Asset Rebalancing programs are not counted towards the number of free transfers per contract year. In addition to charging a fee when you exceed 15 transfers as described in the preceding paragraph, all transfer requests in excess of 15 transfers per contract year must be submitted in writing by United States Postal Service first-class mail ("U.S. Mail") until your next contract anniversary. We will not accept transfer requests sent by any other medium except U.S. Mail until your next contract anniversary. For purposes of determining the number of transfers for the U.S. Mail requirement, contracts subject to certain asset allocation services will be calculated on a calendar year instead of a contract year. Transfer requests required to be submitted by U.S. Mail can only be cancelled by a written request sent by U.S. Mail. Transfers resulting from your participation in the DCA or Asset Rebalancing programs are not included for the purposes of determining the number of transfers for the U.S. Mail requirement. We try to ensure that the U.S. Mail Policy is uniformly and consistently applied to all contract owners. However, as discussed below, our ability to detect and deter Short-Term Trading may be limited. Therefore, Short-Term Trading may occur and the Variable Portfolios may be negatively impacted. In connection with our efforts to deter Short-Term Trading, we may become aware of trading activity that appears detrimental to the Variable Portfolios. If we determine that your transfer patterns among the Variable Portfolios and/or available fixed accounts reflect what we consider to be Short-Term Trading, we may require you to adhere to our U.S. Mail policy described above prior to reaching the specified number of transfers within the defined period for a period that we determine. To the extent we become aware of Short-Term Trading activities which cannot be reasonably controlled by the U.S. Mail Policy, we also reserve the right to impose further limits on the number and frequency of transfers you can make, impose minimum holding periods, pass through to you redemption fees imposed by the underlying funds and/or reject any transfer request or terminate your transfer privileges. We will notify you in writing if your transfer privileges are terminated. In addition, we reserve the right to not accept transfers from a financial representative acting for you and not to accept preauthorized transfer forms. We try to ensure that the restrictions and policies applicable to Short-Term Trading are uniformly and consistently applied to all contract owners. However, as discussed below, our ability to detect and deter Short-Term Trading may be limited. Therefore, Short-Term Trading may occur and the Variable Portfolios may be negatively impacted. Some of the factors we may consider when determining whether to accelerate the U.S. Mail policy, reject or impose other conditions on transfer privileges include: (1) the number of transfers made in a defined period; (2) the dollar amount of the transfer; (3) the total assets of the Variable Portfolio involved in the transfer and/or transfer requests that represent a significant portion of the total assets of the Variable Portfolio; 18 (4) the investment objectives and/or asset classes of the particular Variable Portfolio involved in your transfers; (5) whether the transfer appears to be part of a pattern of transfers to take advantage of short-term market fluctuations or market inefficiencies; and/or (6) other activity, as determined by us, that creates an appearance, real or perceived, of Short-Term Trading. Notwithstanding the administrative procedures above, there may be limitations on the effectiveness of these procedures. Our ability to detect and deter Short-Term Trading may be limited by operational systems and technological limitations. Despite our efforts, we cannot guarantee that we will detect all Short-Term Trading. To the extent that we are unable to detect and deter Short-Term Trading, the Variable Portfolios may be negatively impacted as described above. Additionally, the Variable Portfolios may be harmed by transfer activity related to other insurance companies and/or retirement plans or other investors that invest in shares of the underlying fund. You should be aware that the design of our administrative procedures involves inherently subjective decisions, which we attempt to make in a fair and reasonable manner consistent with the interests of all owners of this contract. We try to ensure that the restrictions and policies applicable to Short-Term Trading are uniformly and consistently applied to all contract owners. However, as discussed above, our ability to detect and deter Short-Term Trading may be limited. Therefore, Short-Term Trading may occur and the Variable Portfolios may be negatively impacted. We do not enter into agreements with contract owners whereby we permit Short-Term Trading in exchange for other investments in our products. As stated above, we try to ensure that the Short-Term Trading restrictions and policies apply uniformly and consistently to all contract owners with the exception of transfers that occur through omnibus group contracts . The Short-Term Trading policies and procedures, which include the U.S. Mail policy are not applied to such contracts. Omnibus group contracts may invest in the same underlying funds available in your contract but on an aggregate, not individual basis. Thus, we have limited ability to detect Short-Term Trading in omnibus group contracts and our inability to detect Short-Term Trading may negatively impact the Variable Portfolios as described above. WE RESERVE THE RIGHT TO MODIFY THE POLICIES AND PROCEDURES DESCRIBED IN THIS SECTION AT ANY TIME. To the extent that we exercise this reservation of rights, we will do so uniformly and consistently unless we disclose otherwise. For information regarding transfers during the Income Phase, see INCOME OPTIONS below. DOLLAR COST AVERAGING PROGRAM The Dollar Cost Averaging ("DCA") program allows you to invest gradually in the Variable Portfolios. Under the program you systematically transfer a set dollar amount or percentage of portfolio value from one Variable Portfolio or DCAFAs (source account) to any other Variable Portfolio (target account). Transfers may occur on certain periodic schedules such as monthly or weekly and do not count against your 15 free transfers per contract year. You may change the frequency to other available options at any time by notifying us in writing. The minimum transfer amount under the DCA program is $100 per transaction, regardless of the source account. Currently, there is no fee for participating in the DCA program. We may offer DCAFAs exclusively to facilitate the DCA program for a specified time period. The DCAFAs only accept new Purchase Payments. You cannot transfer money already in your contract into the DCAFAs. If you allocate new Purchase Payments into a DCAFA, we transfer all your money into the Variable Portfolios over the selected time period. You cannot change the option once selected. You may terminate the DCA program at any time. If money remains in the DCAFAs, we transfer the remaining money according to your instructions or to your current allocation on file. Upon termination of the DCA program, if money remains in the DCA fixed accounts, we transfer the remaining money to the same target account(s) as previously designated, unless we receive different 19 instructions from you. Transfers resulting from a termination of this program do not count towards your 15 free transfers. The DCA program is designed to lessen the impact of market fluctuations on your investment. However, we cannot ensure that you will make a profit. When you elect the DCA program, you are continuously investing in securities regardless of fluctuating price levels. You should consider your tolerance for investing through periods of fluctuating price levels. We reserve the right to modify, suspend or terminate this program at any time. EXAMPLE: Assume that you want to gradually move $750 each quarter from the Cash Management Portfolio to the Marsico Growth Portfolio over six months. You set up dollar cost averaging and purchase Accumulation Units at the following values:
- ----------------------------------------------------------- ACCUMULATION UNITS MONTH UNIT PURCHASED - ----------------------------------------------------------- 1 $ 7.50 100 2 $ 5.00 150 3 $10.00 75 4 $ 7.50 100 5 $ 5.00 150 6 $ 7.50 100 - -----------------------------------------------------------
You paid an average price of only $6.67 per Accumulation Unit over six months, while the average market price actually was $7.08. By investing an equal amount of money each month, you automatically buy more Accumulation Units when the market price is low and fewer Accumulation Units when the market price is high. This example is for illustrative purposes only. AUTOMATIC ASSET ALLOCATION REBALANCING PROGRAM Earnings in your contract may cause the percentage of your investment in each investment option to differ from your original allocations. The Automatic Asset Rebalancing Program addresses this situation. At your election, we periodically rebalance your investments to return your allocations to their original percentages. Asset rebalancing typically involves shifting a portion of your money out of an investment option with a higher return into an investment option with a lower return. At your request, rebalancing occurs on a quarterly, semiannual or annual basis. Transfers made as a result of rebalancing do not count against your 15 free transfers for the contract year. We reserve the right to modify, suspend or terminate this program at any time. EXAMPLE: Assume that you want your initial Purchase Payment split between two Variable Portfolios. You want 50% in the Government & Quality Bond Portfolio and 50% in the Marsico Growth Portfolio. Over the next calendar quarter, the Government & Quality Bond Portfolio outperforms the Marsico Growth Portfolio. At the end of the calendar quarter, the Government & Quality Bond Portfolio now represents 60% of your holdings because it has increased in value and the Marsico Growth Portfolio represents 40% of your holdings. If you had chosen quarterly rebalancing, on the last day of that quarter, we would sell some of your units in the Government & Quality Bond Portfolio to bring its holdings back to 50% and use the money to buy more units in the Marsico Growth Portfolio to increase those holdings to 50%. 20 RETURN PLUS PROGRAM The Return Plus Program allows you to invest in one or more Variable Portfolios without putting your principal at direct risk. The program accomplishes this by allocating your investment strategically between the fixed investment options and Variable Portfolios. You decide how much you want to invest and approximately when you want a return of principal. We calculate how much of your Purchase Payment to allocate to the particular fixed account option to ensure that it grows to an amount equal to your total principal invested under this program. The remaining principal is invested in the Variable Portfolio(s) of your choice. We reserve the right to modify, suspend or terminate this program at any time. EXAMPLE: Assume that you want to allocate a portion of your initial Purchase Payment of $100,000 to the fixed investment option. You want the amount allocated to the fixed investment option to grow to $100,000 in 7 years. If the 7-year fixed investment option is offering a 5% interest rate, we will allocate $71,069 to the 7-year fixed investment option to ensure that this amount will grow to $100,000 at the end of the 7-year period. The remaining $28,931 may be allocated among the Variable Portfolios, as determined by you, to provide opportunity for greater growth. WITHDRAWALS You can access money in your contract in two ways: - by making a partial or total withdrawal, and/or; - by receiving income payments during the Income Phase. (SEE INCOME PHASE BELOW.) Generally, we deduct a withdrawal charge applicable to any total or partial withdrawal and a MVA against withdrawals from the 3, 5, 7 or 10 year fixed account options. If you withdraw your entire contract value, a deduction for premium taxes and the contract maintenance fee also occurs. (SEE CONTRACT CHARGES, WITHDRAWAL CHARGE ABOVE.) Under certain Qualified plans, access to the money in your contract may be restricted. Additionally, withdrawals made prior to age 59 1/2 may result in a 10% IRS penalty tax. (SEE TAXES BELOW.) Under most circumstances, the partial withdrawal minimum is $1,000. We require that the value left in any investment option be at least $100 after the withdrawal. You must send a written withdrawal request. Unless you provide different instructions, partial withdrawals will be made pro rata from each Variable Portfolio and the fixed account option in which your contract is invested. We may be required to suspend or postpone the payment of a withdrawal for any period of time when: (1) the NYSE is closed (other than customary weekend and holiday closings); (2) trading with the NYSE is restricted; (3) an emergency exists such that disposal of or determination of the value of shares of the Variable Portfolios is not reasonably practicable; (4) the SEC, by order, so permits for the protection of contract owners. Additionally, we reserve the right to defer payments for a withdrawal from a fixed account option. Such deferrals are limited to no longer than six months. SYSTEMATIC WITHDRAWAL PROGRAM During the Accumulation Phase, you may elect to receive periodic income payments under the systematic withdrawal program. Under the program, you may choose to take monthly, quarterly, semiannual or annual payments from your contract. Electronic transfer of these funds to your bank account is available. The minimum amount of each withdrawal is $250. There must be at least $100 remaining in each Variable Portfolio after a withdrawal from your contract at all times. Withdrawals 21 may be subject to a withdrawal charge, a MVA and taxation, and a 10% IRS penalty tax may apply if you are under age 59 1/2. There is no additional charge for participating in this program. The program is not available to everyone. Please check with our Annuity Service Center, which can provide the necessary enrollment forms. AIG SunAmerica Life reserves the right to modify, suspend or terminate this program at any time. MINIMUM CONTRACT VALUE Where permitted by state law, we may terminate your contract if both of the following occur: (1) your contract is less than $500 as a result of withdrawals; and (2) you have not made any Purchase Payments during the past three years. We will provide you with sixty days written notice. At the end of the notice period, we will distribute the contract value to you. - -------------------------------------------------------------------------------- INCOME PHASE - -------------------------------------------------------------------------------- ANNUITY DATE During the Income Phase, we use the money accumulated in your contract to make regular income payments to you. You may switch to the Income Phase any time after your 2nd contract anniversary. You select the month and year in which you want income payments to begin. The first day of that month is the Annuity Date. You may change your Annuity Date, so long as you do so at least seven days before the income payments are scheduled to begin. Once you begin receiving income payments, you cannot change your income option. Except as indicated under Option 5 below, once you begin receiving income payments, you cannot otherwise access your money through a withdrawal or surrender. Income payments must begin on or before your 90th birthday or on your tenth contract anniversary, whichever occurs later. If you do not choose an Annuity Date, your income payments will automatically begin on this date. Certain states may require your income payments to start earlier. If the Annuity Date is past your 85th birthday, your contract could lose its status as an annuity under Federal tax laws. This may cause you to incur adverse tax consequences. In addition, most Qualified contracts require you to take minimum distributions after you reach age 70 1/2. (SEE TAXES BELOW.) INCOME OPTIONS Currently, this contract offers five income options. If you elect to receive income payments but do not select an option, your income payments will be made in accordance with option 4 for a period of 10 years. For income payments based on joint lives, we pay according to option 3. We base our calculation of income payments on the life of the Annuitant and the annuity rates set forth in your contract. As the contract owner, you may change the Annuitant at any time prior to the Annuity Date. You must notify us if the Annuitant dies before the Annuity Date and designate a new Annuitant. OPTION 1 -- LIFE INCOME ANNUITY This option provides income payments for the life of the Annuitant. Income payments stop when the Annuitant dies. 22 OPTION 2 -- JOINT AND SURVIVOR LIFE ANNUITY This option provides income payments for the life of the Annuitant and for the life of another designated person. Upon the death of either person, we will continue to make income payments during the lifetime of the survivor. Income payments stop whenever the survivor dies. OPTION 3 -- JOINT AND SURVIVOR LIFE ANNUITY WITH 10 YEARS GUARANTEED This option is similar to option 2 above, with an additional guarantee of payments for at least 10 years. If the Annuitant and the survivor die before all of the guaranteed income payments have been made, the remaining payments are made to the Beneficiary under your contract. OPTION 4 -- LIFE ANNUITY WITH 10 OR 20 YEARS GUARANTEED This option is similar to option 1 above. In addition, this option provides a guarantee that income payments will be made for at least 10 or 20 years. You select the number of years. If the Annuitant dies before all guaranteed income payments are made, the remaining income payments go to the Beneficiary under your contract. OPTION 5 -- INCOME FOR A SPECIFIED PERIOD This option provides income payments for a guaranteed period ranging from 3 to 30 years. If the Annuitant dies before all of the guaranteed income payments are made, the remaining income payments will be made to the Beneficiary under your contract. Additionally, if variable payments are elected under this option, you (or the Beneficiary under the contract if the Annuitant dies prior to all guaranteed payments being made) may redeem the contract value after the Annuity Date. The amount available upon such redemption would be the discounted present value of any remaining guaranteed payments. Please read the SAI for a more detailed discussion of the income options. You can choose income payments that are fixed, variable or both. If at the date when income payments begin you are invested in the Variable Portfolios only, your income payments will be variable. If your money is only in fixed accounts at that time, your income payments will be fixed in amount. Further, if you are invested in both the fixed and variable investment options when payments begin your payments will be fixed and variable. If income payments are fixed, AIG SunAmerica Life guarantees the amount of each payment. If the income payments are variable, the amount is not guaranteed. We make income payments on a monthly, quarterly, semiannual or annual basis. You instruct us to send you a check or to have the payments directly deposited into your bank account. If state law allows, we distribute annuities with a contract value of $5,000 or less in a lump sum. Also, if the selected income option results in income payments of less than $50 per payment, the frequency of your payments may be decreased, state law allowing. If you are invested in the Variable Portfolios after the Annuity Date your income payments vary depending on four things: - for life options, your age when payments begin, and; - the value of your contract in the Variable Portfolios on the Annuity Date, and; - the 3.5% assumed investment rate used in the annuity table for the contract, and; - the performance of the Variable Portfolios in which you are invested during the time you receive income payments. If you are invested in both the fixed account options and the Variable Portfolios after the Annuity Date, the allocation of funds between the fixed and variable options also impacts the amount of your income payments. 23 TRANSFERS DURING THE INCOME PHASE During the Income Phase, one transfer per month is permitted from the Variable Portfolios to another Variable Portfolio or fixed account option. No other transfers are allowed during the Income Phase. DEFERMENT OF PAYMENTS We may defer making fixed income payments for up to six months, or less if required by law. Interest is credited to you during the deferral period. - -------------------------------------------------------------------------------- TAXES - -------------------------------------------------------------------------------- NOTE: WE PREPARED THE FOLLOWING INFORMATION ON TAXES AS A GENERAL DISCUSSION OF THE SUBJECT. THE BASIC SUMMARY BELOW ADDRESSES BROAD FEDERAL TAXATION MATTERS, AND GENERALLY DOES NOT ADDRESS STATE TAXATION ISSUES OR QUESTIONS. IT IS NOT TAX ADVICE. WE CAUTION YOU TO SEEK COMPETENT TAX ADVICE ABOUT YOUR OWN CIRCUMSTANCES. WE DO NOT GUARANTEE THE TAX STATUS OF YOUR ANNUITY. TAX LAWS CONSTANTLY CHANGE, THEREFORE, WE CANNOT GUARANTEE THAT THE INFORMATION CONTAINED HEREIN IS COMPLETE AND/OR ACCURATE. WE HAVE INCLUDED AN ADDITIONAL DISCUSSION REGARDING TAXES IN THE SAI. ANNUITY CONTRACTS IN GENERAL The Internal Revenue Code ("IRC") provides for special rules regarding the tax treatment of annuity contracts. Generally, taxes on the earnings in your annuity contract are deferred until you take the money out. Qualified retirement investments that satisfy specific tax and ERISA requirements automatically provide tax deferral regardless of whether the underlying contract is an annuity, a trust, or a custodial account. Different rules apply depending on how you take the money out and whether your contract is Qualified or Non-Qualified. If you do not purchase your contract under a pension plan, a specially sponsored employer program or an individual retirement account, your contract is referred to as a Non-Qualified contract. A Non-Qualified contract receives different tax treatment than a Qualified contract. In general, your cost basis in a Non-Qualified contract is equal to the Purchase Payments you put into the contract. You have already been taxed on the cost basis in your contract. If you purchase your contract under a pension plan, a specially sponsored employer program or as an individual retirement account, your contract is referred to as a Qualified contract. Examples of qualified plans are: Individual Retirement Accounts ("IRAs"), Roth IRAs, Tax-Sheltered Annuities (referred to as 403(b) contracts), plans of self-employed individuals (often referred to as H.R. 10 Plans or Keogh Plans) and pension and profit sharing plans, including 401(k) plans. Typically you have not paid any tax on the Purchase Payments used to buy your contract and therefore, you have no cost basis in your contract. However, you normally will have cost basis in a Roth IRA, and you may have cost basis in a traditional IRA or in another Qualified Contract. TAX TREATMENT OF DISTRIBUTIONS -- NON-QUALIFIED CONTRACTS If you make a partial or total withdrawal from a Non-Qualified contract, the IRC treats such a withdrawal as first coming from the earnings and then as coming from your Purchase Payments. Purchase payments made prior to August 14, 1982, however, are an important exception to this general rule, and for tax purposes are treated as being distributed before the earnings on those contributions. If you annuitize your contract, a portion of each income payment will be considered, for tax purposes, to be a return of a portion of your Purchase Payment(s). Any portion of each income payment that is considered a return of your Purchase Payment will not be taxed. Withdrawn earnings are treated as income to you and are taxable. The IRC provides for a 10% penalty tax on any earnings 24 that are withdrawn other than in conjunction with the following circumstances: (1) after reaching age 59 1/2; (2) when paid to your Beneficiary after you die; (3) after you become disabled (as defined in the IRC); (4) when paid in a series of substantially equal installments made for your life or for the joint lives of you and your Beneficiary; (5) under an immediate annuity; or (6) which are attributable to Purchase Payments made prior to August 14, 1982. TAX TREATMENT OF DISTRIBUTIONS -- QUALIFIED CONTRACTS (INCLUDING GOVERNMENTAL 457(B) ELIGIBLE DEFERRED COMPENSATION PLANS) Generally, you have not paid any taxes on the Purchase Payments used to buy a Qualified contract. As a result, with certain limited exceptions, any amount of money you take out as a withdrawal or as income payments is taxable income. In the case of certain Qualified contracts, the IRC further provides for a 10% penalty tax on any taxable withdrawal or income payment paid to you other than in conjunction with the following circumstances: (1) after reaching age 59 1/2; (2) when paid to your Beneficiary after you die; (3) after you become disabled (as defined in the IRC); (4) in a series of substantially equal installments, made for your life or for the joint lives of you and your Beneficiary, that begins after separation from service with the employer sponsoring the plan; (5) to the extent such withdrawals do not exceed limitations set by the IRC for deductible amounts paid during the taxable year for medical care; (6) to fund higher education expenses (as defined in IRC; only from an IRA); (7) to fund certain first-time home purchase expenses (only from an IRA); and, except in the case of an IRA; (8) when you separate from service after attaining age 55; (9) when paid for health insurance if you are unemployed and meet certain requirements; and (10) when paid to an alternate payee pursuant to a qualified domestic relations order. This 10% penalty tax does not apply to withdrawals or income payments from governmental 457(b) eligible deferred compensation plans, except to the extent that such withdrawals or income payments are attributable to a prior rollover to the plan (or earnings thereon) from another plan or arrangement that was subject to the 10% penalty tax. The IRC limits the withdrawal of an employee's voluntary Purchase Payments to a Tax-Sheltered Annuity (TSA). Withdrawals can only be made when an owner: (1) reaches age 59 1/2; (2) severs employment with the employer; (3) dies; (4) becomes disabled (as defined in the IRC); or (5) experiences a hardship (as defined in the IRC). In the case of hardship, the owner can only withdraw Purchase Payments. Additional plan limitations may also apply. Amounts held in a TSA annuity contract as of December 31, 1988 are not subject to these restrictions. Qualifying transfers of amounts from one TSA contract to another TSA contract under section 403(b) or to a custodial account under section 403(b)(7), and qualifying transfers to a state defined benefit plan to purchase service credits, are not considered distributions, and thus are not subject to these withdrawal limitations. If amounts are transferred from a custodial account described in Code section 403(b)(7) to this contract the transferred amount will retain the custodial account withdrawal restrictions. Withdrawals from other Qualified Contracts are often limited by the IRC and by the employer's plan. MINIMUM DISTRIBUTIONS Generally, the IRS requires that you begin taking annual distributions from qualified annuity contracts by April 1 of the calendar year following the later of (1) the calendar year in which you attain age 70 1/2 or (2) the calendar year in which you retire. If you own an IRA, you must begin taking distributions when you attain age 70 1/2, regardless of when you retire. If you own more than one TSA, you may be permitted to take your annual distributions in any combination from your TSAs. A similar rule applies if you own more than one IRA. However, you cannot satisfy this distribution requirement for your TSA contract by taking a distribution from an IRA, and you cannot satisfy the requirement for your IRA by taking a distribution from a TSA. You may be subject to a surrender charge on withdrawals taken to meet minimum distribution requirements, if the withdrawals exceed the contract's maximum penalty free amount. 25 Failure to satisfy the minimum distribution requirements may result in a tax penalty. You should consult your tax advisor for more information. You may elect to have the required minimum distribution amount on your contract calculated and withdrawn each year under the automatic withdrawal option. You may select either monthly, quarterly, semiannual or annual withdrawals for this purpose. This service is provided as a courtesy and we do not guarantee the accuracy of our calculations. Accordingly, we recommend you consult your tax advisor concerning your required minimum distribution. You may terminate your election for automated minimum distribution at any time by sending a written request to our Annuity Service Center. We reserve the right to change or discontinue this service at any time. The IRS issued new regulations, effective January 1, 2003, regarding required minimum distributions from qualified annuity contracts. One of the regulations requires that the annuity contract value used to determine required minimum distributions include the actuarial value of other benefits under the contract, such as optional death benefits. This regulation does not apply to required minimum distributions made under an irrevocable annuity income option. We are currently awaiting further clarification from the IRS on this regulation, including how the value of such benefits is determined. You should discuss the effect of these new regulations with your tax advisor. TAX TREATMENT OF DEATH BENEFITS Any death benefits paid under the contract are taxable to the Beneficiary. The rules governing the taxation of payments from an annuity contract, as discussed above, generally apply whether the death benefits are paid as lump sum or annuity payments. Estate taxes may also apply. Certain enhanced death benefits may be purchased under your contract. Although these types of benefits are used as investment protection and should not give rise to any adverse tax effects, the IRS could take the position that some or all of the charges for these death benefits should be treated as a partial withdrawal from the contract. In such case, the amount of the partial withdrawal may be includible in taxable income and subject to the 10% penalty if the owner is under 59 1/2. If you own a Qualified contract and purchase these enhanced death benefits, the IRS may consider these benefits "incidental death benefits." The IRC imposes limits on the amount of the incidental death benefits allowable for Qualified contracts. If the death benefit(s) selected by you are considered to exceed these limits, the benefit(s) could result in taxable income to the owner of the Qualified contract. Furthermore, the IRC provides that the assets of an IRA (including a Roth IRA) may not be invested in life insurance, but may provide, in the case of death during the Accumulation Phase, for a death benefit payment equal to the greater of Purchase Payments or Contract Value. This Contract offers death benefits, which may exceed the greater of Purchase Payments or Contract Value. If the IRS determines that these benefits are providing life insurance, the contract may not qualify as an IRA (including Roth IRAs). You should consult your tax adviser regarding these features and benefits prior to purchasing a contract. CONTRACTS OWNED BY A TRUST OR CORPORATION A Trust or Corporation ("Non-Natural Owner") that is considering purchasing this contract should consult a tax advisor. Generally, the IRC does not treat a Non-Qualified contract owned by a non-natural owner as an annuity contract for Federal income tax purposes. The non-natural owner pays tax currently on the contract's value in excess of the owner's cost basis. However, this treatment is not applied to a Contract held by a trust or other entity as an agent for a natural person nor to Contracts held by Qualified Plans. See the SAI for a more detailed discussion of the potential adverse tax consequences associated with non-natural ownership of a non-qualified annuity contract. GIFTS, PLEDGES AND/OR ASSIGNMENTS OF A NON-QUALIFIED CONTRACT If you transfer ownership of your Non-Qualified contract to a person other than your spouse (or former spouse incident to divorce) as a gift you will pay federal income tax on the contract's cash 26 value to the extent it exceeds your cost basis. The recipient's cost basis will be increased by the amount on which you will pay federal taxes. In addition, the IRC treats any assignment or pledge (or agreement to assign or pledge) of any portion of a Non-Qualified contract as a withdrawal. See the SAI for a more detailed discussion regarding potential tax consequences of gifting, assigning or pledging a non-qualified contract. The IRC prohibits Qualified annuity contracts including IRAs from being transferred, assigned or pledged as security for a loan. This prohibition, however, generally does not apply to loans under an employer-sponsored plan (including loans from the annuity contract) that satisfy certain requirements, provided that: (a) the plan is not an unfunded deferred compensation plan; and (b) the plan funding vehicle is not an IRA. DIVERSIFICATION AND INVESTOR CONTROL The IRC imposes certain diversification requirements on the underlying investments for a variable annuity. We believe that the management of the Underlying Funds monitors the Funds so as to comply with these requirements. To be treated as a variable annuity for tax purposes, the underlying investments must meet these requirements. The diversification regulations do not provide guidance as to the circumstances under which you, and not the Company, would be considered the owner of the shares of the Variable Portfolios under your Nonqualified Contract, because of the degree of control you exercise over the underlying investments. This diversification requirement is sometimes referred to as "investor control." It is unknown to what extent owners are permitted to select investments, to make transfers among Variable Portfolios or the number and type of Variable Portfolios owners may select from. If any guidance is provided which is considered a new position, then the guidance would generally be applied prospectively. However, if such guidance is considered not to be a new position, it may be applied retroactively. This would mean you, as the owner of the Nonqualified Contract, could be treated as the owner of the underlying Variable Portfolios. Due to the uncertainty in this area, we reserve the right to modify the contract in an attempt to maintain favorable tax treatment. These investor control limitations generally do not apply to Qualified Contracts, which are referred to as "Pension Plan Contracts" for purposes of this rule, although the limitations could be applied to Qualified Contracts in the future. - -------------------------------------------------------------------------------- ADMINISTRATION - -------------------------------------------------------------------------------- We are responsible for the administrative servicing of your contract. Please contact our Annuity Service Center at 1-800-445-SUN2, if you have any comment, question or service request. We send out transaction confirmations and quarterly statements. During the accumulation phase, you will receive confirmation of transactions within your contract. Transactions made pursuant to contractual or systematic agreements, such as the annual maintenance fee and dollar cost averaging, may be confirmed quarterly. Purchase payments received through the automatic payment plan or a salary reduction arrangement, may also be confirmed quarterly. For all other transactions, we send confirmations immediately. During the accumulation and income phases, you will receive a statement of your transactions over the past quarter and a summary of your account values. It is your responsibility to review these documents carefully and notify us of any inaccuracies immediately. We investigate all inquiries. To the extent that we believe we made an error, we retroactively adjust your contract, provided you notify us within 30 days of receiving the transaction 27 confirmation or quarterly statement. Any other adjustments we deem warranted are made as of the time we receive notice of the error. DISTRIBUTION OF CONTRACTS Registered representatives of broker-dealers sell the contract. AIG SunAmerica Life pays commissions to these representatives for the sale of the contracts. We do not expect the total commissions to exceed 6.5% of your Purchase Payments. We may also pay a bonus to representatives for contracts which stay active for a particular period of time, in addition to standard commissions. We do not deduct commissions paid to registered representatives directly from your Purchase Payments. From time to time, we may pay or allow additional promotional incentives in the form of cash or other compensation. We reserve the right to offer these additional incentives only to certain broker-dealers that sell or are expected to sell, certain minimum amounts of the contract, or other contracts offered by us. Promotional incentives may change at any time. AIG SunAmerica Capital Services, Inc., Harborside Financial Center, 3200 Plaza 5, Jersey City, NJ 07311-4992, distributes the contracts. AIG SunAmerica Capital Services, an affiliate of AIG SunAmerica Life, is registered as a broker-dealer under the Exchange Act of 1934 and is a member of the National Association of Securities Dealers, Inc. No underwriting fees are paid in connection with the distribution of the contracts. - -------------------------------------------------------------------------------- LEGAL PROCEEDINGS - -------------------------------------------------------------------------------- The Company engages in various kinds of routine litigation. In management's opinion, these matters are not material in relation to the financial position of the Company with the exception of the matters disclosed below. A purported class action captioned NIKITA Mehta, as Trustee of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case 04L0199, filed on April 5, 2004 in the Circuit Court, Twentieth Judicial District in St. Clair County, Illinois. The lawsuit alleges certain improprieties in conjunction with alleged market timing activities. The probability of any particular outcome cannot be reasonably estimated at this time. On November 23, 2004, American International Group, Inc. (AIG), the parent company and affiliated person of the Company ("Depositor") and AIG SunAmerica Capital Services, Inc. ("Distributor"), consented to the settlement of an injunctive action instituted by the SEC. In its complaint, the Securities and Exchange Commission (SEC) alleged that AIG violated Section 10(b) of the Securities Exchange Act of 1934, as amended (Exchange Act) and Rule 10b-5 promulgated thereunder and Section 17(a) of the Securities Act of 1933 (Securities Act) and aided and abetted violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 promulgated thereunder, in connection with certain structured transactions between subsidiaries of The PNC Financial Services Group, Inc. and certain subsidiaries of AIG, and similar transactions marketed by certain subsidiaries of AIG to other publicly traded companies. The conduct described in the complaint did not involve any conduct of AIG or its affiliates related to their investment advisory, depository or distribution activities. Pursuant to a final judgment entered on December 7, 2004, AIG, without admitting or denying the allegations in the complaint (except as to jurisdiction), was ordered to pay approximately $46 million in disgorgement, penalties and prejudgment interest. In addition, the final judgment enjoins AIG from future violation of the above-referenced provisions of the federal securities laws. Absent exemptive relief granted by the SEC, the entry of the injunction would prohibit AIG and, its affiliated persons, from, among other things, serving as an investment advisor or depositor of any registered investment management company or principal underwriter for any registered open-end investment company pursuant to Section 9(a) of the 28 Investment Company Act of 1940, as amended (the "1940 Act"). Certain affiliated persons of AIG, including the Depositor and Distributor, received a temporary exemptive order from the SEC pursuant to Section 9(c) of the 1940 Act on December 8, 2004 with respect to the entry of the injunction, granting exemptive relief from the provisions of Section 9(a) of the 1940 Act. The temporary order permits AIG and its affiliated persons to serve as investment adviser, subadviser, depositor, principal underwriter or sponsor of the separate accounts through which your variable annuity is funded ("Separate Accounts"). The Depositor and Distributor expect that a permanent exemptive order will be granted, although there is no assurance the SEC will issue the permanent order. Additionally, AIG and AIG Financial Products Corp. (AIG-FP), a subsidiary of AIG, reached a similar settlement with the Fraud Section of the United States Department of Justice (DOJ). The settlement with the DOJ consists of an agreement with respect to AIG and AIG-FP and a complaint and deferred prosecution agreement with AIG-FP PAGIC Equity Holding Corp. (a special purpose entity) that will foreclose future prosecutions, provided that the companies comply with the agreements. As part of the settlement, AIG-FP will pay a penalty of $80 million to the DOJ. The Depositor believes that the disgorgement and penalties are not likely to have a material adverse effect on the Separate Accounts. Nor does the Distributor believe that the disgorgement and penalties will materially affect its ability to perform distribution services relating to the Separate Accounts. - -------------------------------------------------------------------------------- REGISTRATION STATEMENT - -------------------------------------------------------------------------------- A registration statement has been filed with the SEC under the Securities Act of 1933 relating to the contract. This prospectus does not contain all the information in the registration statement as permitted by SEC regulations. The omitted information can be obtained from the SEC's principal office in Washington, D.C., upon payment of a prescribed fee. 29 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AIG SUNAMERICA LIFE ASSURANCE COMPANY - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AIG SunAmerica Life Assurance Company (the "Company") was incorporated as Anchor National Life Insurance Company under the laws of the State of Arizona on April 12, 1965 while the Company changed its name to AIG SunAmerica Life Assurance Company on January 24, 2002. The Company continued to do business as Anchor National Life Insurance Company until February 28, 2003, after which time it began doing business under its new name, AIG SunAmerica Life Assurance Company. 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 has no employees; however, employees of AIGRS and other affiliates of the Company perform various services for the Company. AIGRS had approximately 1,900 employees at December 31, 2004, approximately 1,100 of whom perform services for the Company as well as for certain of its affiliates. The Company's primary activities are retirement services, herein discussed as annuity operations and asset management operations. The annuity operations consist of the sale and administration of deposit-type insurance contracts, such as variable and fixed annuity contracts, universal life insurance contracts and guaranteed investment contracts ("GICs"). The asset management operations are conducted by the Company's registered investment advisor subsidiary, AIG SunAmerica Asset Management Corp ("SAAMCo"), and its wholly owned distributor, AIG SunAmerica Capital Services, Inc. ("SACS"), and its wholly owned servicing administrator, AIG SunAmerica Fund Services, Inc. ("SFS"). See Note 13 of Notes to the Consolidated Financial Statements for operating results by segment. The Company ranks among the largest U.S. issuers of variable annuity contracts. The Company distributes its products and services through an extensive network of independent broker-dealers, full-service securities firms and financial institutions. In prior years, GICs were marketed directly to banks, municipalities, asset management firms and direct plan sponsors and through intermediaries, such as managers or consultants servicing these groups. In addition to distributing its variable annuity products through its nine affiliated broker-dealers, the Company distributes its products through a vast network of independent broker-dealers, full-service securities firms and financial institutions. In total, more than 84,000 independent sales representatives are appointed to sell the Company's annuity products. The Company's nine affiliated broker-dealers are among the largest networks of registered representatives in the nation. Sales through affiliated broker-dealers accounted for approximately a quarter of the Company's total annuity sales in 2004. 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 51 million to 69 million from 1994 to 2003, making this age group the fastest-growing segment of the U.S. population. Between 1994 and 2003, annual industry premiums from fixed and variable annuities increased from $155 billion to $267 billion. Benefiting from continued strong growth of the retirement savings 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 life operations on the sale of variable annuity contracts. In recent years, the Company has enhanced its marketing efforts and expanded its offerings of fee-based variable annuity contracts. Variable accounts within the Company's variable annuity business entail no portfolio credit risk and requires significantly less capital support than the fixed accounts of variable annuity contracts ("Fixed Options"), which generate net investment income. F-1 The following table shows the Company's investment income, net realized investment losses and fee income for the year ended December 31, 2004 by primary product line or service: NET INVESTMENT AND FEE INCOME
AMOUNT PERCENT PRIMARY PRODUCT OR SERVICE --------- -------- ----------------------------------------- (IN THOUSANDS, EXCEPT FOR PERCENTAGES) Fee income: Variable annuity policy fees, net of reinsurance.......... $369,141 42.2% Variable annuity contracts Asset management fees..................................... 89,569 10.2 Asset management Universal life policy fees, net of reinsurance............ 33,899 3.9 Universal life products Surrender charges......................................... 26,219 3.0 Fixed and variable annuity contracts Other fees................................................ 15,753 1.8 Asset management -------- ----- Total fee income.......................................... 534,581 61.1 Investment income........................................... 363,594 41.6 Fixed annuity contracts and Fixed Options Net realized investment losses.............................. (23,807) (2.7) Fixed annuity contracts and Fixed Options -------- ----- Total net investment and fee income......................... $874,368 100.0% ======== =====
ANNUITY OPERATIONS - SEPARATE ACCOUNT The annuity operations principally engaged in the business of issuing variable annuity contracts directed to the market for tax-deferred, long-term savings products. It also administers closed blocks of fixed annuity contracts, universal life insurance contracts and GICs directed to the institutional marketplace. The Company's variable annuity products offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as Fixed Options. The Company earns fees on the amounts earned in variable account options of its variable annuity products held in separate accounts and net investment income on the Fixed Options held in the general account. Variable annuity contracts offer retirement planning features similar to those offered by fixed annuity contracts, but differ in that the contract holder'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 contract holder. Because the investment risk is generally borne by the customer in all but the Fixed Options, these products require significantly less capital support than fixed annuity contracts. At December 31, 2004, variable product liabilities were $26.04 billion, of which $22.61 billion were held in separate accounts and $3.43 billion were the liabilities of the Fixed Options, held in the Company's general account. The Company's variable annuity products incorporate incentives, surrender charges and/or other restrictions to encourage persistency. At December 31, 2004, 71% of the Company's variable annuity liabilities held in 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 2004 was approximately $74,000. ANNUITY OPERATIONS - GENERAL ACCOUNT The Company's general account obligations are fixed-rate products, principally Fixed Options, but also including fixed annuity contracts, GICs and universal life insurance contracts ("Fixed-Rate Products") issued in prior years. The Fixed Options provide interest rate guarantees of certain periods ranging up to ten years. Although the Company's annuity contracts remain in force an average of seven to ten years, approximately 77% of the reserves for fixed annuity contracts and Fixed Options, as well as the universal life insurance contracts, reprice annually at discretionary rates determined by the Company subject to a minimum rate guarantee ranging from 1.5% to 4.0%, 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. In prior years, the Company augmented its retail annuity business with the sale of institutional products. At December 31, 2004, the Company had $211.4 million of fixed-maturity, variable-rate GIC obligations that reprice periodically based upon certain defined indices and $3.9 million of fixed-maturity, fixed-rate GICs. The Company designs its Fixed-Rate Products and conducts its investment operations in order to closely match the duration and cash flows of the assets in its investment portfolio to its fixed-rate 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-Rate Products incorporate incentives, surrender charges and other restrictions in order to encourage F-2 persistency. Approximately 77% of the Company's reserves for Fixed-Rate Products had incentives, surrender penalties and/or other restrictions at December 31, 2004. INVESTMENT OPERATIONS The Company believes a portfolio principally composed of fixed-rate investments that generate predictable rates of return should back its liabilities for Fixed-Rate Products. 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 an affiliate 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." ASSET MANAGEMENT OPERATIONS Effective January 1, 2004, the Parent contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, SAAMCo, which in turn has two wholly owned subsidiaries: SACS and SFS. Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary of the Company. This contribution increased the Company's shareholder's equity by $150,653,000. Assets, liabilities and shareholder's equity at December 31, 2003 were restated to include $190,605,000, $39,952,000 and $150,653,000, respectively, of SAAMCo balances. Similarly, the results of operations and cash flows have been restated for the years ended December 31, 2003 and 2002 for the addition and subtraction to pretax income of $16,345,000 and $4,464,000, respectively, to reflect the SAAMCo activity. The asset management operations are conducted by the Company's registered investment advisor subsidiary, SAAMCo, and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS. These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, serving as investment advisor to certain variable investment portfolios offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. 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 an 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 contract, deposits of securities for the benefit of contract holders, 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 contract holders rather than security holders. 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, 2004. The federal government does not directly regulate the business of insurance, however, the Company, its subsidiaries and its products are governed by federal agencies, including the Securities and Exchange Commission ("SEC"), the Internal Revenue Service and the self-regulatory organization, National Association of Securities Dealers, Inc. ("NASD"). 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 the F-3 Employee Retirement Income Security Act 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, among other items, after-hours trading, short-term trading (sometimes referred to as market timing), suitability, revenue sharing arrangements and greater transparency regarding compensation arrangements. There are several rule proposals pending at the SEC, the NASD and on a federal level, which, if passed, could have an impact on the business of the Company and/or its subsidiaries. COMPETITION The businesses conducted by the Company are highly competitive. The Company competes with other life insurers, and also competes for customers' 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 2003, net annuity premiums written among the top 100 companies ranged from approximately $79 million to approximately $20 billion annually. The Company together with its affiliates ranked third 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. AVAILABLE INFORMATION AIG SunAmerica Life Assurance Company (the "Company") files annual, quarterly, and current reports and other information with the Securities and Exchange Commission (the "SEC"). The SEC maintains a website that contains annual, quarterly, and current reports and other information that issuers (including the Company) file electronically with the SEC. The SEC's website is http://www.sec.gov. Additionally, any materials the Company files with the SEC may be read and copied at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company does not maintain a website. The Company makes available free of charge, Annual Reports on Form 10-K, Quarterly Reports of Form 10-Q and Current Reports of Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such materials are electronically filed with, or furnished to the SEC. SECURITIES AND EXCHANGE COMMISSION POSITION ON INDEMNIFICATION Indemnification for liabilities arising under the 1933 Act is provided to the Company's officers, directors and controlling persons. The SEC has advised that it believes such indemnification is against public policy under the Securities Act and unenforceable. If a claim for indemnification against such liabilities (other than for payment of expenses incurred or paid by its directors, officers or controlling persons in the successful defense of any legal action) is asserted by a director, officer or controlling person of the Company in connection with the securities registered under this prospectus, the Company will submit to a court with jurisdiction to determine whether the indemnification is against public policy under the Act. The Company will be governed by final judgment of the issue. However, if in the opinion of the Company's counsel this issue has been determined by controlling precedent, the Company will not submit the issue to a court for determination. DESCRIPTION OF PROPERTY The Company's executive offices and its principal office are in leased premises at 1 SunAmerica Center, Los Angeles, California 90067. The Company, through an affiliate, also leases office space in Woodland Hills, California and Jersey City, New Jersey. The Company believes that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of its businesses. F-4 SELECTED FINANCIAL DATA The following selected financial data of the Company should be read in conjunction with the consolidated 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. The following selected financial date of the Company for years prior to December 31, 2004 have been restated as if the contribution of SAAMCo and its related subsidiaries were effective as of the earliest period reported below. The following amounts include only the subsidiaries of SAAMCo as of December 31, 2004.
YEARS ENDED DECEMBER 31, ---------------------------------------------------- 2004 2003 2002 2001 2000 -------- -------- -------- -------- -------- (IN THOUSANDS) Results of Operations Revenues: Fee income, net of reinsurance.............................. $534,581 $427,091 $444,002 $481,945 $549,970 Investment income........................................... 363,594 402,923 387,355 370,198 398,168 Net realized investment losses.............................. (23,807) (30,354) (65,811) (59,784) (15,177) -------- -------- -------- -------- -------- Total revenues............................................ 874,368 799,660 765,546 792,359 932,961 Benefits and Expenses: Interest expense............................................ 222,749 240,213 238,129 244,614 264,493 Amortization of bonus interest.............................. 10,357 19,776 16,277 11,938 3,824 General and administrative expenses......................... 131,612 119,093 115,210 99,232 138,955 Amortization of deferred acquisition costs and other deferred expenses......................................... 157,650 160,106 222,484 208,378 154,183 Annual commissions.......................................... 64,323 55,661 58,389 58,278 56,473 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 17,766 15,716 17,566 19,914 Guaranteed minimum death benefits, net of reinsurance recoveries................................................ 58,756 63,268 67,492 17,839 614 -------- -------- -------- -------- -------- Total benefits & expenses................................. 662,867 675,883 733,697 657,845 638,456 -------- -------- -------- -------- -------- Pretax income before cumulative effect of accounting change.................................................... 211,501 123,777 31,849 134,514 294,505 Income tax expense.......................................... 6,410 30,247 160 21,824 94,400 -------- -------- -------- -------- -------- Net income before cumulative effect of accounting change.... 205,091 93,530 31,689 112,690 200,105 -------- -------- -------- -------- -------- Cumulative effect of accounting change, net of tax.......... (62,589) -- -- (10,342) -- -------- -------- -------- -------- -------- Net Income.................................................. $142,502 $ 93,530 $ 31,689 $102,348 $200,105 ======== ======== ======== ======== ========
In 2004, the Company adopted AICPA Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"), which was recorded as a cumulative effect of accounting change. (See Note 2 of Notes to Consolidated Financial Statements). F-5 In 2001, the Company adopted EITF 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" and Statement of Financial Accounting Standard 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), which were recorded as a cumulative effect of accounting change.
DECEMBER 31, ------------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS) Financial Position Investments and cash.................................. $ 7,125,986 $ 7,124,633 $ 7,248,324 $ 6,294,148 $ 5,249,827 Variable annuity assets held in separate accounts..... 22,612,451 19,178,796 14,758,642 18,526,413 20,393,820 Deferred acquisition costs and other deferred expenses............................................ 1,606,870 1,505,328 1,436,802 1,419,498 1,286,456 Other assets.......................................... 150,708 162,970 309,221 258,446 177,468 ----------- ----------- ----------- ----------- ----------- Total Assets.......................................... $31,496,015 $27,971,727 $23,752,989 $26,498,505 $27,107,571 =========== =========== =========== =========== =========== Reserves for fixed annuity and fixed accounts of variable annuity contracts.......................... $ 3,948,158 $ 4,274,329 $ 4,285,098 $ 3,498,917 $ 2,778,229 Reserves for universal life insurance contracts....... 1,535,905 1,609,233 1,676,073 1,738,493 1,832,667 Reserves for guaranteed investment contracts.......... 215,331 218,032 359,561 483,861 610,672 Variable annuity liabilities related to separate accounts............................................ 22,612,451 19,178,796 14,758,642 18,526,413 20,393,820 Other payables and accrued liabilities................ 1,172,594 794,031 831,138 839,032 268,201 Subordinated notes payable to affiliates.............. -- 40,960 40,960 47,960 55,119 Deferred income taxes................................. 257,532 242,556 341,935 211,242 81,989 Shareholder's equity.................................. 1,754,044 1,613,790 1,459,582 1,152,587 1,086,874 ----------- ----------- ----------- ----------- ----------- Total Liabilities and Shareholder's Equity............ $31,496,015 $27,971,727 $23,752,989 $26,498,505 $27,107,571 =========== =========== =========== =========== ===========
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 AIG SunAmerica Life Assurance Company (the "Company") for the years ended December 31, 2004 ("2004"), 2003 ("2003") and 2002 ("2002") 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 and profitability of the Company's activities. 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. CRITICAL ACCOUNTING POLICIES The Company considers its most critical accounting policies those policies with respect to valuation of certain financial instruments, amortization of deferred acquisition costs ("DAC") and other deferred expenses and the reserve for guaranteed benefits. 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. F-6 Valuation of Certain Financial Instruments: Gross unrealized losses on debt and equity securities available for sale amounted to $27.1 million at December 31, 2004. 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 investments in debt and 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 $813.0 million at December 31, 2004 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 the Company 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 and Other Deferred Expenses: Policy acquisition costs include commissions and other costs that vary with, and are primarily related to, the production or acquisition of new business. Such costs are deferred and amortized over the estimated lives of the annuity contracts. Approximately 81% of the amortization of DAC and other deferred expenses was attributed to policy acquisition costs deferred by the annuity operations and 19% was attributed to the distribution costs deferred by the asset management operations. For the annuity operations, the Company amortizes DAC and other deferred expenses 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, the growth rate of the separate account assets (with respect to variable options of the variable annuity contracts) or general account assets (with respect to fixed annuity contracts, Fixed Options and universal life insurance contracts) supporting these obligations, costs of providing contract guarantees and the level of expenses necessary to administer the policies. The Company adjusts amortization of DAC and other deferred expenses (a "DAC unlocking") when current or estimates of future gross profits to be realized from its annuity contracts are revised as more fully described below. Substantially all of the DAC balance attributed to annuity operations at December 31, 2004 related to variable annuity contracts. DAC amortization on annuities is impacted by surrender rates, claims costs, and the actual and assumed future growth rate of the assets supporting the Company's obligations under annuity policies. With respect to Fixed Options, the growth rate depends on the yield on the general account assets supporting those annuity contracts. With respect to the variable options of the variable annuity contracts, the growth rate depends on the performance of the investment options available under the annuity contract and the allocation of assets among these various investment options. The assumption the Company uses for the long-term annual net growth rate of the separate account assets in the determination of DAC amortization with respect to its variable annuity contracts is 10% (the "long-term growth rate assumption"). The Company uses a "reversion to the mean" methodology that allows it to maintain this 10% long-term growth rate assumption, while also giving consideration to the effect of short-term swings in the equity markets. For example, if performance was 15% during the first year following the introduction of a product, the DAC model would assume that market returns for the following five years (the "short-term growth rate assumption") would be approximately 9%, resulting in an average annual growth rate of 10% during the life of the product. Similarly, following periods of below 10% performance, the model will assume a short-term growth rate higher than 10%. A DAC unlocking will occur if management deems the short-term growth rate assumption (i.e., the growth rate required to revert to the mean 10% growth rate over a five-year period) to be unreasonable. The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. For the asset management operations, the Company defers distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or a contingent deferred sales charge feature (collectively, "Distribution Fee Revenue"). These costs are amortized on a straight-line basis, adjusted for redemptions, over a period ranging from one year to eight years depending on share class. The carrying value of the deferred asset is subject to continuous review based on projected Distribution Fee Revenue. Amortization of deferred distribution costs is increased if at any reporting period the value of the deferred amount exceeds the projected Distribution Fee Revenue. The projected Distribution Fee Revenue is impacted by estimated future withdrawal rates and the rates of market return. Management uses historical activity to estimate future withdrawal rates and average annual performance of the equity markets to estimate the rates of market return. F-7 Reserve for Guaranteed Benefits: Pursuant to the adoption of Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1") which was adopted on January 1, 2004, the Company is required to recognize a liability for guaranteed minimum death benefits and other guaranteed benefits. In calculating the projected liability, five thousand stochastically generated investment performance scenarios were developed using the Company's best estimates. These assumptions included, among others, mean equity return and volatility, mortality rates and lapse rates. The estimation of cash flow and the determination of the assumptions used require judgment, which can, at times, be subjective. Several of the guaranteed benefits are sensitive to equity market conditions. The Company uses the purchase of reinsurance and capital market hedging strategies to mitigate the risk of paying benefits in excess of account values as a result of significant downturns in equity markets. Risk mitigation may or may not reduce the volatility of net income resulting from equity market volatility. Reinsurance or hedges are secured when the cost is less than the risk reduction. The Company expects to use either additional reinsurance or capital market hedges for risk mitigation on an opportunistic basis. Despite the purchase of reinsurance or hedges, the reinsurance or hedge secured may be inadequate to completely offset the effects of changes in equity markets. BUSINESS SEGMENTS Effective January 1, 2004, SunAmerica Life Insurance Company (the "Parent"), the parent of the Company, contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo"), which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") and AIG SunAmerica Fund Services, Inc. ("SFS"). This contribution increased the Company's shareholder's equity by approximately $150.7 million (see Note 1 of Notes to Consolidated Financial Statements). Effective January 1, 2004, the Company's earnings include the asset management operations of SAAMCo, SACS and SFS. Prior year results have been restated to account for this contribution as if it had occurred at the beginning of the earliest period presented. The Company has two business segments: annuity operations and asset management operations. The annuity operations consist of the sale and administration of deposit-type insurance contracts, such as variable and fixed annuity contracts, universal life insurance contracts and guaranteed investment contracts. The Company focuses primarily on the marketing of variable annuity products. The variable annuity products offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as Fixed Options. The Company earns fee income on amounts invested in the variable account options and net investment spread on the Fixed Options. The asset management operations are conducted by the Company's registered investment advisor subsidiary, SAAMCo, and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS. These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, servicing as investment advisor to certain variable investment portfolios offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. RESULTS OF OPERATIONS NET INCOME totaled $142.5 million in 2004, compared with $93.5 million in 2003 and $31.7 million in 2002. CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflected the adoption of SOP 03-1 on January 1, 2004. The Company recorded a loss of $62.6 million, net of tax, which is recognized in the consolidated statement of income and comprehensive income as a cumulative effect of accounting change for the year ended December 31, 2004. PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $211.5 million in 2004, compared with $123.8 million in 2003 and $31.8 million in 2002. The increase in 2004 compared to 2003 was primarily due to higher variable annuity policy fee and asset management fee income, partially offset by lower investment income and higher general and administrative and other expenses. The increase in 2003 compared to 2002 was primarily due to reductions in net realized investment losses and amortization of DAC and other expenses. INCOME TAX EXPENSE totaled $6.4 million in 2004, $30.2 million in 2003 and $0.2 million in 2002 representing effective tax rates of 3%, 24% and 1%, respectively. The tax expense in 2004 included the benefit of $39.7 million resulting from the reduction of the prior year tax liability based on additional information becoming available. Excluding this benefit the effective tax rate is 22% in 2004. The unusually low effective tax rate for 2002 is due primarily to the lower relative pretax income without corresponding reductions in permanent tax differences. See Note 11 of the Notes to Consolidated Financial Statements for a reconciliation of income tax expense to the federal statutory rate. F-8 ANNUITY OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $176.9 million in 2004, compared with $98.7 million in 2003 and $27.7 million in 2002. The increase in 2004 compared to 2003 was primarily due to higher variable annuity policy fee income and lower amortization of deferred acquisition costs and other deferred expenses partially offset by higher general and administrative and other expenses. The increase in 2003 compared to 2002 was primarily due to lower net realized investment losses and improved net investment income as customers allocated more dollars to the fixed rate portion of variable annuity contracts. NET INVESTMENT SPREAD, a non-GAAP measure, represents investment income less interest credited to Fixed-Rate Products is a key measurement used by the Company in evaluating the profitability of its annuity business. Investment income includes income earned on invested assets, as well as the mark-to-market on both purchased derivatives and embedded derivatives inherent in certain product guarantees. 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 investments pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". In the calculation of average invested assets, the Company excludes collateral received from a securities lending program, which is offset by a securities lending payable in the same amount. 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 an affiliate to administer the program. An analysis of net investment spread and a reconciliation to pretax income before cumulative effect of accounting change is presented in the following table:
YEARS ENDED DECEMBER 31, --------------------------------- 2004 2003 2002 --------- --------- --------- (IN THOUSANDS) Investment income........................................... $ 362,631 $ 398,304 $ 377,556 Interest credited to fixed annuity contracts and Fixed Options................................................... (140,889) (153,636) (142,973) Interest credited to universal life insurance contracts..... (73,745) (76,415) (80,021) Interest credited to guaranteed investment contracts........ (6,034) (7,534) (11,267) --------- --------- --------- Net investment spread....................................... 141,963 160,719 143,295 Net realized investment losses.............................. (24,100) (30,354) (65,811) Fee income, net of reinsurance.............................. 429,259 344,908 358,983 Amortization of bonus interest.............................. (10,357) (19,776) (16,277) General and administrative expenses......................... (93,188) (83,013) (79,287) Amortization of DAC and other deferred expenses............. (126,142) (137,130) (171,583) Annual commissions.......................................... (64,323) (55,661) (58,389) Claims on UL contracts, net of reinsurance recoveries....... (17,420) (17,766) (15,716) Guaranteed benefits, net of reinsurance recoveries.......... (58,756) (63,268) (67,492) --------- --------- --------- Pretax income before cumulative effect of accounting change.................................................... $ 176,936 $ 98,659 $ 27,723 ========= ========= =========
Net investment spread totaled $142.0 million in 2004, compared to $160.7 million in 2003 and $143.3 million in 2002. These amounts equal 2.28% on average invested assets (computed on a daily basis) of $6.22 billion in 2004, 2.37% on average invested assets of $6.66 billion in 2003 and 2.41% on average invested assets of $6.09 billion in 2002. The decrease in net investment spread in 2004 from 2003 reflected results from lower average invested assets as discussed below and reinvesting in the historically low prevailing interest rate environment that has persisted throughout 2003 and 2004. The increase in net investment spread in 2003 from 2002 resulted from substantial growth in average invested assets and effective management of interest crediting rates to offset lower yields available on invested assets. F-9 The components of net investment spread were as follows:
YEARS ENDED DECEMBER 31, --------------------------------------- 2004 2003 2002 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Net investment spread....................................... $ 141,963 $ 160,719 $ 143,295 Average invested assets..................................... 6,216,792 6,656,360 6,086,517 Average interest-bearing liabilities........................ (5,942,627) (6,407,102) (5,962,521) Yield on average invested assets............................ 5.83% 5.98% 6.20% Rate paid on average interest-bearing liabilities........... 3.71 3.71 3.93 ----------- ----------- ----------- Difference between yield and interest rate paid............. 2.12% 2.27% 2.27% =========== =========== =========== Net investment spread as a percentage of average invested assets.................................................... 2.28% 2.41% 2.35% =========== =========== ===========
The decline in average invested assets resulted primarily from net exchanges from Fixed Options into the separate accounts of variable annuity contracts, partially offset by new deposits of Fixed Options. Deposits of Fixed Options and renewal deposits on its universal life insurance contracts totaled $1.41 billion 2004, $1.58 billion in 2003 and $1.78 billion in 2002, and are primarily deposits for the Fixed Options. Deposits of Fixed Options represent 24% in 2004, 27% in 2003 and 34% in 2002, of the related reserve balances at the beginning of the respective periods. Net investment spread includes the effect of income earned or interest paid on the difference between average invested assets and average interest-bearing liabilities. Average invested assets exceeded average interest-bearing liabilities by $274.2 million in 2004, compared with $249.3 million in 2003 and $124.0 million in 2002. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities was 2.12% in 2004 and 2.27% in 2003 and 2.27% in 2002. Investment income (and the related yields on average invested assets) totaled $362.6 million (5.83%) in 2004, compared with $398.3 million (5.98%) in 2003 and $377.6 million (6.20%) in 2002. The decrease in the investment yield primarily reflects the reinvesting in the historically low prevailing interest rate environment that has persisted throughout 2002, 2003 and 2004, as well as a $4.3 million reduction in income from the mark to market of the S&P 500 put options and the guaranteed minimum account value and guaranteed minimum withdrawal benefit embedded derivatives in 2004. Excluding the impact of the put options and embedded derivatives, investment income would have been $361.6 million (5.82%) and $393.0 million (5.90%) in 2004 and 2003, respectively. Expenses incurred to manage the investment portfolio amounted to $2.5 million in 2004, $2.3 million in 2003 and $2.4 million in 2002. These expenses are included as a reduction of investment income in the consolidated statement of income and comprehensive income. Interest expense (and the related rate paid on average interest-bearing liabilities) totaled $220.7 million (3.71%) in 2004, $237.6 million (3.71%) in 2003 and $234.3 million (3.93%) in 2002. Interest-bearing liabilities averaged $5.94 billion during 2004, $6.41 billion during 2003 and $5.96 billion during 2002. NET REALIZED INVESTMENT LOSSES totaled $24.1 million in 2004, $30.4 million in 2003 and $65.8 million in 2002 and include impairment writedowns of $21.1 million, $54.1 million and $57.3 million, respectively. Thus, net realized losses from sales and redemptions of investments totaled $3.0 million in 2004, compared with net realized gains of $23.7 million in 2003 and net realized losses of $8.5 million in 2002. The Company sold or redeemed invested assets, principally bonds and notes, aggregating $1.97 billion in 2004, $2.21 billion in 2003 and $1.60 billion in 2002. 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 0.05%, 0.36% and 0.14% of average invested assets for 2004, 2003 and 2002, 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 $21.1 million, $54.1 million and $57.3 million of provisions principally applied to bonds in 2004, 2003 and 2002, respectively. Impairment writedowns represent 0.34%, 0.81% and 0.96% of average invested assets in the respective periods. For the five years ended December 31, 2004, impairment writedowns as a percentage of average invested assets have ranged from 0.34% to 1.27% and have averaged 0.75%. 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. F-10 VARIABLE ANNUITY POLICY FEES, NET OF REINSURANCE are generally based on the market value of assets in the separate accounts supporting variable annuity contracts. Such fees totaled $369.1 million in 2004, $281.4 million in 2003 and $286.9 million in 2002 and are net of reinsurance premiums of $28.6 million, $30.8 million and $22.5 million, respectively. The increased fees in 2004 compared to 2003 primarily reflect the improved equity market conditions in 2004 and the latter part of 2003, and the resulting favorable impact on market values of the assets in the separate accounts. The decreased fees in 2003 as compared to 2002 reflected increased reinsurance premiums. Variable annuity policy fees represent 1.8%, 1.7% and 1.7% of average variable annuity assets in 2004, 2003 and 2002, respectively. Variable annuity assets averaged $20.41 billion, $16.32 billion and $16.45 billion during the respective periods. Variable annuity deposits, which exclude deposits allocated to the Fixed Options, totaled $2.65 billion in 2004, $1.73 billion in 2003 and $1.18 billion in 2002. These amounts represent 14%, 12% and 6% of variable annuity reserves at the beginning of the respective periods. The increase in variable annuity deposits in 2004 and 2003 reflected increased demand for variable annuity products due to the improved equity market conditions in 2004 and the latter part of 2003. Transfers from the Fixed Options to the separate accounts 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 the Fixed Options) ("Variable Annuity Product Sales") amounted to $4.01 billion, $3.27 billion and $2.92 billion in 2004, 2003 and 2002, respectively. Such sales primarily reflect those of the Company's Polaris and Seasons families of variable annuity products. The Company's variable annuity products are primarily multi-manager variable annuities that offer investors a choice of several variable funds as well as up to seven fixed funds, depending on the product. The increase in Variable Annuity Product Sales in 2004 and 2003 reflects the generally improved equity market conditions in 2004 and the latter part of 2003. 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"). With respect to all reinsurance agreements, 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. Due to the high credit ratings and periodic monitoring of these ratings of the reinsurers, such risks are considered to be minimal. UNIVERSAL LIFE INSURANCE POLICY FEES, NET OF REINSURANCE amounted to $33.9 million in 2004, $35.8 million in 2003 and $36.3 million in 2002 and are net of reinsurance premiums of $34.3 million, $33.7 million and $34.1 million, respectively. Universal life insurance policy 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 insurance contracts as part of the acquisition of business from MBL Life Assurance Corporation on December 31, 1998 and does not actively market such contracts. Such fees represent 2.20%, 2.23% and 2.17% of average reserves for universal life insurance contracts in the respective periods. SURRENDER CHARGES on variable annuity and universal life insurance contracts totaled $26.2 million in 2004, $27.7 million in 2003 and $32.5 million in 2002. 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. GENERAL AND ADMINISTRATIVE EXPENSES totaled $93.2 million in 2004, $83.0 million in 2003 and $79.3 million in 2002. The increase in 2004 results from higher information technology costs and payroll related expenses resulting from the servicing of a larger block of annuity contracts. 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 AND OTHER DEFERRED EXPENSES totaled $126.1 million in 2004, compared with $137.1 million in 2003 and $171.6 million in 2002. DAC amortization in 2003 reflected a declining market which led to higher DAC amortization (i.e. impairments on specific products) during the first nine months of 2003 and is partially offset by an $18.0 million DAC unlocking. The higher amortization in 2002 was primarily related to lower estimates of future gross profits on variable annuity contracts compared to the prior years in light of the downturn in the equity markets in 2002, and additional variable annuity product sales over the last twelve months and the subsequent amortization of related deferred commissions and other direct selling costs. ANNUAL COMMISSIONS totaled $64.3 million in 2004, compared with $55.7 million in 2003 and $58.4 million in 2002. Annual commissions generally 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. The vast majority of the Company's average balances of its variable annuity products are currently subject to such annual commissions. F-11 CLAIMS ON UNIVERSAL LIFE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled $17.4 million in 2004, compared with $17.8 million in 2003 and $15.7 million in 2002 (net of reinsurance recoveries of $34.2 million in 2004, $34.0 million in 2003 and $29.2 million in 2002). The change in such claims resulted principally from changes in mortality experience and the reinsurance recoveries there on. GUARANTEED BENEFITS, NET OF REINSURANCE RECOVERIES on variable annuity contracts totaled $58.8 million in 2004, compared with $63.3 million in 2003 and $67.5 million in 2002 and are net of reinsurance recoveries of $2.7 million, $8.0 million and $8.4 million, respectively. These guaranteed benefits consist primarily of guaranteed minimum death benefits as well as immaterial amounts of earnings enhancement benefits and guaranteed minimum income benefits. These guarantees are described in more detail in the following paragraphs. The decrease during 2004 reflects the generally improved equity market conditions in 2004 and the latter part of 2003. Downturns in the equity markets could increase these expenses. Guaranteed minimum death benefits ("GMDB") are issued on a majority of the Company's variable annuity products. GMDB provides that, upon the death of a contract holder, the contract holder's beneficiary will receive the greater of (1) the contract holder's account value, or (2) a guaranteed minimum death benefit that varies by product and election by the contract holder. The Company bears the risk that death claims following a decline in the debt and equity markets may exceed contract holder account balances and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. On January 1, 2004, the Company recorded a liability for guaranteed benefits including GMDB (see Note 2 of Notes to Consolidated Financial Statements) pursuant to adoption of a new accounting standard, SOP 03-1. Earnings enhancement benefit ("EEB") is a feature the Company offers on certain variable annuity products. For contract holders who elect the feature, the EEB provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The Company bears the risk that account values following favorable performance of the financial markets will result in greater EEB death claims and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. Guaranteed minimum income benefit ("GMIB") is a feature the Company offers on certain variable annuity products. This feature provides a minimum fixed annuity payment guarantee for those contract holders who choose to receive fixed lifetime annuity payments after a seven, nine, or ten-year waiting period in their deferred annuity contracts. The Company bears the risk that the performance of the financial markets will not be sufficient for accumulated contract holder account balances to support GMIB benefits and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. As there is a waiting period to annuitize using the GMIB, there are no policies eligible to receive this benefit at December 31, 2004. The Company has eliminated offering a GMIB feature that guarantees a return in excess of the amount to be annuitized in order to mitigate its exposure. Guaranteed minimum account value ("GMAV") is a feature the Company offers on certain variable annuity products in the third quarter of 2002. If available and elected by the contract holder at the time of contract issuance, this feature guarantees that the account value under the contract will at least equal the amount of the deposits invested during the first ninety days of the contract, adjusted for any subsequent withdrawals, at the end of a ten-year waiting period. The Company bears the risk that protracted under-performance of the financial markets could result in GMAV benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The Company purchased put options on the S&P 500 index to partially offset this risk. Changes in the market value of both the GMAV benefit and the put options are recorded in investment income in the accompanying consolidated statement of income and comprehensive income. Guaranteed minimum withdrawal benefit ("GMWB") is a feature the Company began offering on certain variable annuity products in May of 2004. If available and elected by the contract holder at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days adjusted for any subsequent withdrawals ("Eligible Premium"). These guaranteed annual withdrawals of up to 10% of Eligible Premium are available after either a three-year or a five-year waiting period, as elected by the contract holder at the time of contract issuance, without reducing the future amounts guaranteed. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will realize an additional 10% or 20%, respectively, of Eligible Premium after all other amounts guaranteed under this benefit have been paid. The Company bears the risk that protracted under-performance of the financial markets could result in GMWB benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The Company purchased put options on the S&P 500 index to partially offset this risk. Changes in the market value of both the GMWB benefit and the put options are recorded in investment income in the accompanying consolidated statement of income and comprehensive income. F-12 Management expects substantially all of the Company's near-term exposure to guaranteed benefits will relate to GMDB and EEB. As sales of products with other guaranteed benefits increase, the Company expects these other guarantees to have an increasing impact on operating results, under current hedging strategies. ASSET MANAGEMENT OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $34.6 million in 2004, compared to $25.1 million in 2003 and $4.1 million in 2002. The increases in 2004 from 2003 resulted from the impact of higher average asset base and higher margin on account servicing fees, partially offset by increased amortization of DAC and other deferred expenses. The increase in 2003 from 2002 resulted from decreased amortization of DAC and other deferred expenses. ASSET MANAGEMENT FEES, which include investment advisory fees and 12b-1 distribution fees, are based on the market value of assets managed by SAAMCo in its mutual funds and certain variable annuity portfolios. Such fees totaled $89.6 million on average assets managed of $9.65 billion in 2004, $66.7 million on average assets managed of $8.15 billion in 2003 and $66.4 million on average assets managed of $7.64 billion in 2002. The increase in asset management fees is primarily the result of a higher average asset base and higher margin on account servicing fees. Mutual fund sales, excluding sales of money market accounts and private accounts, totaled $2.14 billion in 2004, compared to $2.23 billion in 2003 and $1.67 billion in 2002. Redemptions of mutual funds, excluding redemptions of money market accounts, amounted to $1.56 billion in 2004, $1.55 billion in 2003 and $1.55 billion in 2002, which represent 20%, 25% and 25%, respectively, of average related mutual fund assets. The 4% decrease in mutual fund sales in 2004 compared to 2003 primarily reflects generally difficult equity market conditions in the second and third quarters of 2004. The increase in sales in 2003 principally reflects increasing demand for equity products, due to generally improved equity market conditions in the latter part of 2003. GENERAL AND ADMINISTRATIVE EXPENSES totaled $38.4 million in 2004, $36.1 million in 2003 and $35.9 million in 2002. General and administrative expenses increased in 2004 due primarily to higher employee-related costs. AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES includes amortization of distribution costs that totaled $31.5 million in 2004, compared with $23.0 million in 2003 and $35.9 million in 2002. The increased amortization in 2004 was primarily due to additional mutual fund sales and amortization of the deferred commissions thereon. In 2002, amortization of deferred acquisition costs and other deferred expenses included additional amortization of $24.2 million, resulting from certain distribution costs whose carrying value exceeded projected revenue. CAPITAL RESOURCES AND LIQUIDITY SHAREHOLDER'S EQUITY increased to $1.75 billion at December 31, 2004 from $1.61 billion at December 31, 2003 due to $142.5 million of net income and $49.1 million of capital contribution from Parent partially offset by a $49.1 million tax effect on a distribution of investment and a $2.5 million dividend to the Parent. F-13 INVESTMENTS AND CASH at December 31, 2004 totaled $7.13 billion, compared with $7.14 billion at December 31, 2003. The Company's invested assets are managed by an affiliate. The following table summarizes the Company's portfolio of bonds, notes and redeemable preferred stocks (the "Bond Portfolio") and other investments and cash at December 31, 2004 and 2003:
DECEMBER 31, 2004 DECEMBER 31, 2003 ----------------------- ----------------------- FAIR PERCENT OF FAIR PERCENT OF VALUE PORTFOLIO VALUE PORTFOLIO ---------- ---------- ---------- ---------- BOND PORTFOLIO: (IN THOUSANDS, EXCEPT FOR PERCENTAGES) U.S. government securities.................................. $ 30,300 0.4% $ 24,292 0.3% Mortgage-backed securities.................................. 956,567 13.4 1,191,817 16.7 Securities of public utilities.............................. 332,038 4.7 365,150 5.1 Corporate bonds and notes................................... 2,902,829 40.8 2,697,142 37.9 Redeemable preferred stocks................................. 21,550 0.3 22,175 0.3 Other debt securities....................................... 917,743 12.9 1,205,224 16.9 ---------- ----- ---------- ----- Total Bond Portfolio........................................ 5,161,027 72.5 5,505,800 77.2 Mortgage loans.............................................. 624,179 8.7 716,846 10.1 Common stocks............................................... 4,902 0.1 727 0.0 Cash and short-term investments............................. 201,117 2.8 133,105 1.9 Securities lending collateral............................... 883,792 12.4 514,145 7.2 Other invested assets....................................... 250,969 3.5 254,010 3.6 ---------- ----- ---------- ----- Total investments and cash.................................. $7,125,986 100.0% $7,124,633 100.0% ========== ===== ========== =====
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 72% of the Company's total investment portfolio at December 31, 2004, had an aggregate fair value that was $153.2 million greater than its amortized cost at December 31, 2004, compared with $154.6 million at December 31, 2003. At December 31, 2004, the Bond Portfolio had an aggregate fair value of $5.16 billion and an aggregate amortized cost of $5.01 billion. At December 31, 2004, the Bond Portfolio (excluding $21.6 million of redeemable preferred stocks) included $4.50 billion of bonds rated by Standard & Poor's ("S&P"), Moody's Investors Service ("Moody's") or Fitch ("Fitch") and $638.1 million of bonds rated by the National Association of Insurance Commissioners ("NAIC") or the Company pursuant to statutory ratings guidelines established by the NAIC. At December 31, 2004, approximately $4.75 billion of the Bond Portfolio was investment grade, including $986.8 million of mortgage-backed securities ("MBS") and U.S. government/agency securities. At December 31, 2004, the Bond Portfolio included $386.4 million of bonds that were not investment grade. These non-investment-grade bonds accounted for approximately 1% of the Company's total assets and approximately 5% 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 to decline. At December 31, 2004, the Company's non-investment-grade bond portfolio consisted of 171 issues with no single issuer representing more than 10% of the total non-investment-grade portfolio. These non-investment-grade securities are comprised of bonds spanning 10 industries with 19%, 16%, 16% and 10% concentrated in telecommunications, utilities, financial services and noncyclical consumer products industries, respectively. No other industry concentration constituted more than 10% of these assets. F-14 The table below summarizes the Company's rated bonds by rating classification as of December 31, 2004. RATED BONDS BY RATING CLASSIFICATION
ISSUES RATED BY ISSUES NOT RATED BY S&P/MOODY'S/FITCH S&P/MOODY'S/FITCH, BY NAIC CATEGORY TOTAL - ------------------------------------------ ------------------------------------- ------------------------------------------ S&P/MOODY'S/FITCH AMORTIZED ESTIMATED NAIC AMORTIZED ESTIMATED AMORTIZED ESTIMATED PERCENT OF TOTAL CATEGORY(1) COST FAIR VALUE CATEGORY(2) COST FAIR VALUE COST FAIR VALUE INVESTED ASSETS - ----------------- ---------- ---------- ------------ --------- ---------- ---------- ---------- ---------------- (DOLLARS IN THOUSANDS) AAA+ to A- (Aaa to A3) [AAA to A-] $2,888,647 $2,964,803 1 $266,034 $270,334 $3,154,681 $3,235,137 45.40% BBB+ to BBB- (Baa to Baa3) [BBB+ to BBB-] 1,203,109 1,233,692 2 276,973 284,221 1,480,082 1,517,913 21.30% BB+ to BB- (Bal to Ba3) [BB+ to BB-] 133,070 138,091 3 36,371 36,462 169,441 174,553 2.45% B+ to B- (Bl to B3) [B+ to B-] 129,347 140,699 4 11,600 11,524 140,947 152,223 2.14% CCC+ to CCC- (Caal to Caa3) [CCC+ to CCC-] 18,954 19,353 5 7,305 6,695 26,259 26,048 0.37% CC to D (Ca to C) [CC to D] 1,842 4,722 6 14,476 28,880 16,318 33,602 0.47% ---------- ---------- -------- -------- ---------- ---------- TOTAL RATED ISSUES $4,374,969 $4,501,360 $612,759 $638,116 $4,987,728 $5,139,476 ========== ========== ======== ======== ========== ==========
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 $131.5 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; (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. F-15 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 sale. As a result of these policies, the Company recorded pretax impairment writedowns of $21.1 million, $54.1 million and $57.3 million in 2004, 2003 and 2002, respectively. No individual impairment loss, net of DAC and taxes, during the year exceeded 10% of the Company's net income for the year ended December 31, 2004. 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, 2004, the fair value of the Company's Bond Portfolio aggregated $5.16 billion. Of this aggregate fair value, approximately 0.03% 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 DAC and decreases in income taxes. At December 31, 2004, approximately $3.91 billion, at amortized cost, of the Bond Portfolio had a fair value of $4.09 billion resulting in an aggregate unrealized gain of $180.3 million. At December 31, 2004, approximately $1.10 billion, at amortized cost, of the Bond Portfolio had a fair value of $1.07 billion resulting in an aggregate unrealized loss of $27.1 million. No single issuer accounted for more than 10% of unrealized losses. Approximately 36%, 15% and 11% of unrealized losses were from the financial services, transportation and noncyclical consumer products industries, respectively. No other industry accounted for more than 10% of unrealized losses. The amortized cost of the Bond Portfolio in an unrealized loss position at December 31, 2004, by contractual maturity, is shown below.
AMORTIZED COST -------------- (IN THOUSANDS) Due in one year or less..................................... $ 46,250 Due after one year through five years....................... 422,237 Due after five years through ten years...................... 389,073 Due after ten years......................................... 243,973 ---------- Total....................................................... $1,101,533 ==========
F-16 The aging of the Bond Portfolio in an unrealized loss position at December 31, 2004 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 ------------------------------- ------------------------------ ------------------------------ AMORTIZED UNREALIZED AMORTIZED UNREALIZED AMORTIZED UNREALIZED MONTHS COST LOSS ITEMS COST LOSS ITEMS COST LOSS ITEMS - ------ ---------- ---------- ----- --------- ---------- ----- --------- ---------- ----- (DOLLARS IN THOUSANDS) Investment Grade Bonds 0-6 $ 455,818 $ (4,128) 73 $ -- $ -- -- $ -- $ -- -- 7-12 387,123 (6,808) 57 -- -- -- -- -- -- >12 171,695 (7,108) 22 17,477 (4,046) 3 -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $1,014,636 $(18,044) 152 $17,477 $(4,046) 3 $ -- $ -- -- ========== ======== === ======= ======= ==== ==== ===== ==== Below Investment Grade Bonds 0-6 $ 28,496 $ (1,806) 13 $ -- $ -- -- $452 $(292) 3 7-12 8,773 (489) 8 -- -- -- -- -- -- >12 31,699 (2,467) 11 -- -- -- -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $ 68,968 $ (4,762) 32 $ -- $ -- -- $452 $(292) 3 ========== ======== === ======= ======= ==== ==== ===== ==== Total Bonds 0-6 $ 484,314 $ (5,934) 86 $ -- $ -- -- $452 $(292) 3 7-12 395,896 (7,297) 65 -- -- -- -- -- -- >12 203,394 (9,575) 33 17,477 (4,046) 3 -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $1,083,604 $(22,806) 184 $17,477 $(4,046) 3 $452 $(292) 3 ========== ======== === ======= ======= ==== ==== ===== ==== TOTAL ------------------------------- AMORTIZED UNREALIZED MONTHS COST LOSS ITEMS - ------ ---------- ---------- ----- (DOLLARS IN THOUSANDS) Investment Grade Bonds 0-6 $ 455,818 $ (4,128) 73 7-12 387,123 (6,808) 57 >12 189,172 (11,154) 25 ---------- -------- --- Total $1,032,113 $(22,090) 155 ========== ======== === Below Investment Grade Bonds 0-6 $ 28,948 $ (2,098) 16 7-12 8,773 (489) 8 >12 31,699 (2,467) 11 ---------- -------- --- Total $ 69,420 $ (5,054) 35 ========== ======== === Total Bonds 0-6 $ 484,766 $ (6,226) 89 7-12 395,896 (7,297) 65 >12 220,871 (13,621) 36 ---------- -------- --- Total $1,101,533 $(27,144) 190 ========== ======== ===
In 2004, the pretax realized losses incurred with respect to the sale of fixed-rate securities in the Bond Portfolio was $12.6 million. The aggregate fair value of securities sold was $140.3 million, which was approximately 92% of amortized cost. The average period of time that securities sold at a loss during 2004 were trading continuously at a price below amortized cost was approximately 21 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 fair value of these securities at December 31, 2004 was approximately $813.0 million. 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. 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. 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 $277.2 million at December 31, 2004. Secured Loans are senior to subordinated debt and equity and are secured by assets of the issuer. At December 31, 2004, Secured Loans consisted of $190.1 million of privately traded securities and $87.1 million of publicly traded securities. These Secured Loans are composed of loans to 59 borrowers spanning 10 industries, with 26%, 18%, 15%, 12% and 11% from the utilities, telecommunications, transportation, noncyclical consumer products and cyclical consumer products industries, respectively. No other industry 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. F-17 MORTGAGE LOANS aggregated $624.2 million at December 31, 2004 and consisted of 100 commercial first mortgage loans with an average loan balance of approximately $6.2 million, collateralized by properties located in 30 states. Approximately 32% of this portfolio was office, 17% was manufactured housing, 17% was multifamily residential, 11% was industrial, 11% was hotels, and 12% was other types. At December 31, 2004, approximately 27%, 11% and 10% of this portfolio were secured by properties located in California, Michigan and Massachusetts, respectively. No more than 10% of this portfolio was secured by properties located in any other single state. At December 31, 2004, 13 mortgage loans have an outstanding balance of $10 million or more, which collectively aggregated approximately 45% of this portfolio. At December 31, 2004, approximately 42% of the mortgage loan portfolio consisted of loans with balloon payments due before January 1, 2008. During 2004 and 2003, loans delinquent by more than 90 days, foreclosed loans and structured loans have not been significant in relation to the total mortgage loan portfolio. Substantially all of the mortgage loan portfolio has been originated by the Company under its 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 Company's underwriting standards, the Company believes that it has prudently managed the risk attributable to its mortgage loan portfolio while maintaining attractive yields. SECURITIES LENDING COLLATERAL totaled $883.8 million at December 31, 2004, compared to $514.1 million at December 31, 2003, and consisted of cash collateral invested in highly rated short-term securities received in connection with the Company's securities lending program. The increase in securities lending collateral in 2004 results from increased demand for securities in the Company's portfolio. 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 in an effort to minimize the risks of interest rate fluctuations and disintermediation (i.e. the risk of being forced to sell investments during unfavorable market conditions). 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 incentives, surrender charges and/or other restrictions in order to encourage persistency. Approximately 77% of the Company's reserves for Fixed-Rate Products had surrender penalties or other restrictions at December 31, 2004. 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 and cash flows of the fixed-rate assets to that of its fixed-rate liabilities. The fixed-rate assets in the Company's asset-liability modeling include: cash and short-term investments; bonds, notes and redeemable preferred stocks; mortgage loans; policy loans; and investments in limited partnerships that invest primarily in fixed-rate securities. At December 31, 2004, these assets had an aggregate fair value of $6.17 billion with an option-adjusted duration of 3.2 years. The Company's fixed-rate liabilities include Fixed Options, as well as universal life insurance, fixed annuity and GIC contracts. At December 31, 2004, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $5.54 billion with an option-adjusted duration of 3.6 years. The Company's potential exposure due to a relative 10% decrease in prevailing interest rates from its December 31, 2004 levels is a loss of approximately $0.3 million, representing an 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 years 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 F-18 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 and these differences may be material. A significant portion of the Company's fixed annuity contracts (including the Fixed Options) 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. 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 the earlier discussion under "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 2004, 2003 and 2002 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:
2004 2003 2002 ---- ---- ---- AVERAGE 10-YEAR U.S. TREASURY BOND RATE:.................... 4.26% 4.01% 4.61% AIG SunAmerica Life Assurance Company: Average yield on Bond Portfolio........................... 5.66 5.75 6.23 Rate paid on average interest-bearing liabilities......... 3.71 3.71 3.93
Since the Company's investing strategy is to hold fixed-rate assets for long-term investment, the Company's average yield tends to trail movements in the average U.S. treasury yield. For further discussion on average yield on the bond portfolio and the rate paid on average interest-bearing liabilities, see discussion on "Investment Spread." As a component of its asset-liability management strategy, the Company may utilize interest rate swap agreements ("Swap Agreements") to match assets more closely to liabilities. Swap Agreements exchange interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) with a counterparty, based on an underlying principal balance (notional principal) to hedge against interest rate changes. 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. No Dollar Roll Repos were outstanding at December 31, 2004. The Company also seeks to provide liquidity by investing in MBS. MBS are generally investment-grade securities collateralized by large pools of mortgage loans. MBS 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 and Swap Agreements is counterparty risk. The Company believes, however, that the counterparties to its Dollar Roll Repos and Swap Agreements 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. In addition to counterparty risk, Swap Agreements also have interest rate risk. However, the Company's Swap Agreements are intended to hedge variable-rate assets or liabilities. The primary risk associated with MBS 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 least quarterly to determine whether specific investments should be placed on a nonaccrual 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 F-19 value of the underlying collateral. For investments in partnerships, management reviews the financial statements and other information provided by the general partners. The carrying values of investments that are determined to have declines in value that are other than temporary are reduced to net realizable 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 $40.1 million of bonds at December 31, 2004, and constituted approximately 0.6% of total invested assets. At December 31, 2003, defaulted investments totaled $49.6 million of bonds, which constituted approximately 0.7% 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, reverse repurchase agreement capacity on invested assets and, if required, proceeds from invested asset sales. The Company's liquidity is primarily derived from operating cash flows from annuity operations. At December 31, 2004, approximately $4.09 billion of the Bond Portfolio had an aggregate unrealized gain of $180.3 million, while approximately $1.07 billion of the Bond Portfolio had an aggregate unrealized loss of $27.1 million. In addition, the Company's investment portfolio currently provides approximately $44.0 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 Fixed-Rate Products 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 interest rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its Fixed-Rate Products. 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. 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 The Company has six agreements outstanding in which it has provided liquidity support for certain short-term securities of municipalities and non-profit organizations by agreeing to purchase such securities in the event there is no other buyer in the short-term marketplace. In return the Company receives a fee. In addition, the Company guarantees the payment of these securities upon redemption. The maximum liability under these guarantees at December 31, 2004 is $195.4 million. These commitments have contractual maturity dates in 2005. Related to each of these agreements are participation agreements with the Parent, under which the Parent will share in $62.6 million of these liabilities in exchange for a proportionate percentage of the fees received under these agreements. The Internal Revenue Service examined the transactions underlying these commitments, including the Company's role in the transactions. The examination did not result in a material loss to the Company. At December 31, 2004, the Company held reserves for GICs with maturity dates as follows: $186.5 million in 2005 and $28.8 million in 2024. F-20 RECENTLY ISSUED ACCOUNTING STANDARDS In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts." (For further discussion see Note 2 of Notes to Consolidated Financial Statements.) CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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. DIRECTORS AND OFFICERS Directors are elected for one year terms at the annual meeting of the shareholder. They receive no additional compensation for serving as directors. The board of directors elects executive officers to one year terms subject to removal at the board's discretion. The directors and principal officers of AIG SunAmerica Life Assurance Company (the "Company") as of March 31, 2005 are listed below, together with information as to their ages, dates of election and principal business occupations during the last five years (if other than their present business occupations).
YEAR ASSUMED OTHER POSITIONS AND OTHER BUSINESS EXPERIENCE NAME AGE PRESENT POSITION POSITION WITHIN LAST FIVE YEARS FROM-TO - ---- --- ---------------------- -------- --------------------------------------------- --------- Jay S. Wintrob*.......... 48 Chairman and Chief 2001 Chief Executive Officer, AIGRS, SunAmerica 2001- Executive Officer Life Insurance Company ("SALIC") and First 2001- SunAmerica Life Insurance Company ("FSA") President, FSA 2001- President, AIGRS 2000- Chief Operating Officer, AIGRS 1998-2000 Vice Chairman, AIGRS (Joined AIGRS in 1987) 1995-2000 James R. Belardi*........ 48 Senior Vice President 1994 President, SALIC 2002- Executive Vice President, AIGRS (Joined AIGRS 1995- in 1986) Marc H. Gamsin*.......... 49 Senior Vice President 1999 Executive Vice President, AIGRS 2001- Senior Vice President, SALIC and FSA 1999- Executive Vice President SunAmerica 1998- Investments, Inc. N. Scott Gillis*......... 51 Senior Vice President 2003 Chief Financial Officer, AIGRS, SALIC and FSA 2003- and Chief Financial Senior Vice President, AIGRS 2002- Officer Controller, AIGRS 2000- Vice President, AIGRS (Joined AIGRS in 1985) 1998-2002 Jana W. Greer*........... 53 President 2002 Executive Vice President, AIGRS 2001- President, SunAmerica Retirement Markets, 1996- Inc. 1994- Senior Vice President, SALIC and FSA 1992-2000 Senior Vice President, AIGRS (Joined AIGRS in 1974) Michael J. Akers......... 55 Senior Vice President 2003 Chief Actuary, AIGRS 2003- Senior Vice President, SALIC and FSA 2003- Senior Vice President, AIGRS 2002- Senior Vice President and Chief Actuary, The 1999-2002 Variable Annuity Life Insurance Company Christine A. Nixon....... 40 Senior Vice President, 2003 Senior Vice President, General Counsel and 2003- General Counsel and Secretary, SALIC and FSA Secretary Chief Compliance Officer, AIGRS 2003 Secretary and Deputy Chief Legal Counsel, 2002- AIGRS 2000- Vice President, AIGRS (Joined AIGRS in 1993) 1997-2000 Associate General Counsel, AIGRS Gregory M. Outcalt....... 42 Senior Vice President 2000 Vice President, SunAmerica Investments, Inc. 2002- Senior Vice President, SALIC and FSA (Joined 2000- AIGRS in 1986) DIRECTOR NAME SINCE - ---- -------- Jay S. Wintrob*.......... 1990 James R. Belardi*........ 1990 Marc H. Gamsin*.......... 2000 N. Scott Gillis*......... 2000 Jana W. Greer*........... 1993 Michael J. Akers......... -- Christine A. Nixon....... -- Gregory M. Outcalt....... --
F-21
YEAR ASSUMED OTHER POSITIONS AND OTHER BUSINESS EXPERIENCE NAME AGE PRESENT POSITION POSITION WITHIN LAST FIVE YEARS FROM-TO - ---- --- ---------------------- -------- --------------------------------------------- --------- Stewart Polakov.......... 45 Senior Vice President 2003 Senior Vice President and Controller, FSA and 2003- and Controller SALIC Vice President, SALIC and FSA (Joined AIGRS 1997-2003 in 1991) Edwin R. Raquel.......... 47 Senior Vice President 1995 Senior Vice President and Chief Actuary, 1995- and Chief Actuary SALIC and FSA (Joined AIGRS in 1990) Mallary L. Reznik........ 36 Vice President 2005 Vice President, FSA 2005- Associate General Counsel, AIGRS 1998- Stephen J. Stone......... 46 Vice President 2005 Vice President, FSA 2005- Senior Portfolio Manager, Allstate Insurance 1989-2004 Company Edward T. Texeria........ 40 Vice President 2003 Vice President, SALIC and FSA 2003- Assistant Controller, AIGRS 2003- Assistant Controller, SALIC and FSA 2000-2003 Senior Manager, Assurance and Advisory 1994-2000 Business Services, Ernst & Young LLP DIRECTOR NAME SINCE - ---- -------- Stewart Polakov.......... -- Edwin R. Raquel.......... -- Mallary L. Reznik........ -- Stephen J. Stone......... -- Edward T. Texeria........ --
- --------------- * Also serves as a director The Company does not have an audit committee and relies on the Audit Committee of the Board of Directors of AIG. EXECUTIVE COMPENSATION The Company's executive officers provide services for the Company, its subsidiaries and, for certain officers, its affiliates. Allocations have been made to the Company and its subsidiaries based upon each individual's time devoted to his or her duties for the Company and its subsidiaries. All compensation information provided under this Item 11 is based on these allocations. The following table sets forth allocable compensation awarded to, earned by or paid to the Company's chief executive officer and four other most highly compensated executive officers for the years ended December 31, 2004, 2003 and 2002: SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ANNUAL COMPENSATION --------------------------- ---------------------------------- SECURITIES NAME AND OTHER ANNUAL UNDERLYING LTIP ALL OTHER SICO LTIP PRINCIPAL POSITION YEAR SALARY BONUS(1) COMPENSATION OPTIONS (#)(2) PAYOUTS(3) COMPENSATION(4) AWARDS(5) - ------------------ ---- -------- -------- ------------ -------------- ---------- --------------- --------- Jay S. Wintrob............ 2004 $ 84,500 $104,000 $21,580 6,500 $194,526 $ 5,068 $341,484 Chief Executive Officer 2003 86,125 71,500 18,330 10,400 183,365 3,041 -- 2002 316,050 215,600 56,840 19,600 719,992 2,467,413 907,088 Jana W. Greer............. 2004 329,648 517,634 -- 6,762 417,973 18,109 695,051 President 2003 318,000 371,353 -- 10,560 327,366 17,208 -- 2002 220,789 111,250 -- 4,005 363,902 2,014,889 556,054 Peter A. Harbeck.......... 2004 254,567 442,500 -- 7,500 364,920 14,475 531,927 President & Chief Executive 2003 331,250 390,000 -- 13,000 389,782 18,950 -- Officer, Asset Management 2002 223,269 160,000 50,000 6,500 444,581 1,512,950 590,070 N. Scott Gillis........... 2004 69,863 65,138 -- 1,782 36,437 5,360 170,217 Senior Vice President and 2003 69,317 58,050 -- 3,240 24,726 6,448 -- Chief Financial Officer 2002 61,027 71,750 -- 2,460 49,230 169,465 104,361 Christine A. Nixon........ 2004 92,250 50,840 -- 2,009 20,997 7,558 64,619 Senior Vice President, General 2003 89,038 39,600 -- 3,600 15,860 7,889 -- Counsel and Secretary 2002 46,142 27,900 -- 1,395 14,839 65,863 57,387
- --------------- (1) Amounts represent year-end and bonuses paid quarterly pursuant to a quarterly bonus program sponsored by AIG and marketing incentives. (2) Amounts represent the number of shares of common stock of AIG subject to options granted during the year indicated. (3) Amounts shown represent payments under the Company's 2000 and 2001 Five-Year Deferred Bonus Plans. Awards were granted under these plans in 2000 and 2001 and additional grants are not anticipated. Each award pays out in 20% installments over five years of continued employment. The last installment is to be paid in 2006. (4) Amounts shown primarily represent Company matching contributions under the 401(k) Plan and the Executive Savings Plan. Additionally, the 2002 amounts shown for Mr. Wintrob, Ms. Greer, Mr. Harbeck, Mr. Gillis and Ms. Nixon include allocated retention bonuses awarded in connection with the acquisition of SunAmerica Inc. by AIG consummated on January 1, 1999. F-22 (5) The SICO LTIP awards were granted by Starr International Company, Inc. pursuant to its Deferred Compensation Profit Participation Plan (the "SICO Plan"). The following table summarizes certain information with respect to the allocable portion of grants of options to purchase AIG common stock which were granted during 2004 to the individuals named in the Summary Compensation Table. OPTION GRANTS IN 2004
POTENTIAL REALIZABLE VALUE* PERCENTAGE OF AT ASSUMED ANNUAL RATES OF NUMBER OF TOTAL OPTIONS STOCK APPRECIATION FOR SECURITIES GRANTED TO AIG EXERCISE OPTION TERM DATE OF UNDERLYING EMPLOYEES PRICE PER EXPIRATION ---------------------------- NAME GRANT OPTIONS(1) DURING 2004(2) SHARE DATE 5 PERCENT(3) 10 PERCENT(4) - ---- ---------- ---------- -------------- --------- ---------- ------------ ------------- Jay S. Wintrob................. 12/16/2004 6,500 0.19% $64.47 12/16/14 $263,510 $667,875 Jana W. Greer.................. 12/16/2004 6,762 0.20% 64.47 12/16/14 274,131 694,795 Peter A. Harbeck............... 12/16/2004 7,500 0.22% 64.47 12/16/14 304,050 770,625 N. Scott Gillis................ 12/16/2004 1,782 0.05% 64.47 12/16/14 72,242 183,101 Christine A. Nixon............. 12/16/2004 2,009 0.06% 64.47 12/16/14 81,445 206,425
- --------------- * Options would have no realizable value if there were no appreciation or if there were depreciation from the price at which options were granted. (1) All options relate to shares of common stock of AIG and were granted pursuant to AIG's Amended and Restated 1999 Stock Option Plan at an exercise price equal to the fair market value of such stock at the date of grant. The option grants in 2004 provide that 25 percent of the options granted on any date become exercisable on each anniversary date in each of the successive four years and expire ten years from the date of grant. (2) It is impractical to determine the percent the grant represents of total options granted to the Company's employees, since the Company has no employees. The percentage is provided with regard to options granted to employees of AIG and its subsidiaries. (3) The appreciated price per share at 5 percent is $105.01 per share. (4) The appreciated price per share at 10 percent is $167.22 per share. The following table summarizes certain information with respect to the allocable exercise of options to purchase AIG common stock during 2004 by the individuals named in the Summary Compensation Table and the allocable unexercised options to purchase AIG common stock held by such individuals at December 31, 2004 based on the allocations described above. AGGREGATED OPTION EXERCISES DURING THE YEAR ENDED DECEMBER 31, 2004 AND DECEMBER 31, 2004 OPTION VALUES
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT SHARES DECEMBER 31, 2004 DECEMBER 31, 2004(2) ACQUIRED ON VALUE --------------------------- --------------------------- NAME EXERCISE REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ----------- ----------- ------------- ----------- ------------- Jay S. Wintrob............................ 21,101 $1,368,055 95,143 21,288 $ 4,474,328 $98,683 Jana W. Greer............................. 53,023 3,315,702 259,354 61,642 11,565,498 87,719 Peter A. Harbeck.......................... 14,428 710,616 57,373 45,471 1,464,499 94,203 N. Scott Gillis........................... 1,144 50,969 12,170 8,937 275,270 30,452 Christine A. Nixon........................ 3,549 203,628 12,983 9,364 377,754 34,657
- --------------- (1) Aggregate market value on date of exercise (closing sale price as reported in the New York Stock Exchange Composite Transactions Report) less aggregate exercise price. (2) Aggregate market value on December 31, 2004 (closing sale price as reported in the New York Stock Exchange Composite Transactions Report) less aggregate exercise price. F-23 The following table summarizes certain information with respect to benefits granted under the SICO Plan which were granted during 2002 (with respect to the 2003-2004 period) to the individuals named in the Summary Compensation Table. SICO LONG-TERM INCENTIVE PLANS(1)
NUMBER UNIT AWARD ESTIMATED NAME OF UNITS PERIOD FUTURE PAYOUTS - ---- -------- ---------- ---------------- Jay S. Wintrob.............................................. 325 Two years 5,200 shares Jana W. Greer............................................... 882 Two years 10,584 shares Peter A. Harbeck............................................ 675 Two years 8,100 shares N. Scott Gillis............................................. 216 Two years 2,592 shares Christine A. Nixon.......................................... 123 Two years 984 shares
- --------------- (1) Awards represent grants of units under the SICO Plan with respect to the two-year period from January 1, 2003 through December 31, 2004. The SICO Plan contains neither threshold amounts nor maximum payout limitations. The number of shares of AIG common stock, if any, allocated to a unit for the benefit of a participant in the SICO Plan is primarily dependent upon two factors: the growth in future earnings of AIG during the unit award period and the book value of AIG at the end of the award period. Prior to earning the right to payout, the participant is not entitled to any equity interest with respect to such shares, and the shares are subject to forfeiture under certain conditions, including but not limited to the participant's voluntary termination of employment with AIG or its subsidiaries prior to normal retirement age other than by death or disability. EMPLOYEE BENEFIT PLANS The Company participates in several employee benefit plans sponsored by AIG. RETIREMENT PLANS: The American International Group, Inc. Retirement Plan (the "AIG Plan") is a non-contributory, qualified, defined benefit plan. For employees of AIGRS and its subsidiaries, the formula equals .925% times Average Final Compensation (defined as the average annual compensation, which includes base pay and sales commissions, subject to limitations for certain highly compensated employees imposed by law, during the three consecutive years in the last ten years of credited service affording the highest such average) up to 150% of the employee's "covered compensation" (the average of the Social Security Wage Bases during the 35 years preceding the Social Security retirement age), plus 1.425% times Average Final Compensation in excess of 150% of the employee's "covered compensation" times years of credited service up to 35 years; plus 1.425% times Average Final Compensation times years of credited service in excess of 35 years but limited to 44 years. AIG also has in place the AIG Excess Retirement Income Plan ("AIG Excess Plan") for employees participating in the AIG Plan whose benefits under the AIG Plan are limited by applicable tax laws. The AIG Excess Plan provides benefits in excess of the AIG Plan benefits determined as if the benefit under the AIG Plan has been calculated without the limitations imposed by applicable tax laws. The AIG Excess Plan is a nonqualified, unfunded plan. AIG also has approved a Supplemental Executive Retirement Plan ("AIG SERP") which provides annual benefits to certain employees of AIGRS and its subsidiaries, not to exceed 60% of Average Final Compensation, that accrue at a rate of 2.4% of Average Final Compensation for each year of service or fraction thereof for each full month of active employment. The benefit payable under the AIG SERP is reduced by payments from the AIG Plan, the AIG Excess Plan, Social Security and any payments from a qualified pension plan of a prior employer. F-24 Annual amounts of normal retirement pension commencing at normal retirement age of 65 based upon Average Final Compensation and credited service under the AIG Plan and the AIG Excess Plan are illustrated in the following table: ESTIMATED ANNUAL PENSION AT AGE 65
AVERAGE FINAL COMPENSATION 10 YEARS 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS 40 YEARS - ------------- -------- -------- -------- -------- -------- -------- ---------- $ 125,000 $ 14,341 $ 21,512 $ 28,682 $ 35,853 $ 43,024 $ 50,194 $ 59,100 $ 150,000 17,904 26,856 35,807 44,759 53,711 62,663 73,350 $ 175,000 21,466 32,199 42,932 53,666 64,399 75,132 87,600 $ 200,000 25,029 37,543 50,057 62,572 75,086 87,600 101,850 $ 225,000 28,591 42,887 57,182 71,478 85,774 100,069 116,100 $ 250,000 32,154 48,231 64,307 80,384 96,461 112,538 130,350 $ 300,000 39,279 58,918 78,557 98,197 117,836 137,475 158,850 $ 375,000 49,966 74,949 99,932 124,916 149,899 174,882 201,600 $ 400,000 53,529 80,293 107,057 133,822 160,586 187,350 215,850 $ 500,000 67,779 101,668 135,557 169,447 203,336 237,225 272,850 $ 750,000 103,404 155,106 206,807 258,509 310,211 361,913 415,350 $1,000,000 139,029 208,543 278,057 347,572 417,086 486,600 557,850 $1,200,000 167,529 251,293 335,057 418,822 502,586 586,350 671,850 $1,400,000 196,029 294,043 392,057 490,072 588,086 686,100 785,850 $1,600,000 224,529 336,793 449,057 561,322 673,586 785,850 899,850 $1,800,000 253,029 379,543 506,057 632,572 759,086 885,600 1,013,850 $2,000,000 281,529 422,293 563,057 703,822 844,586 985,350 1,127,850
Each of the individuals named in the Summary Compensation Table have 2.0 years of credited service (under both plans) through December 31, 2004. Pensionable salary includes the regular salary paid by AIG and its subsidiaries and does not include amounts attributable to supplementary bonuses or overtime pay. For such named individuals, pensionable salary allocable to the Company during 2004 was as follows: Mr. Wintrob - $84,500; Ms. Greer - $329,648; Mr. Harbeck - $339,423; Mr. Gillis - $69,863; and Ms. Nixon - $92,250. Employees of AIGRS and its subsidiaries participate in the American International Group, Inc. Incentive Savings Plan (the "Incentive Savings Plan"), a 401(k) plan established by AIG which includes salary reduction contributions by employees and matching contributions. Matching contributions vary based on the number of years the employee has been employed. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Board of Directors of the Company does not have a Compensation Committee. Compensation decisions regarding the Chief Executive Officer are made by AIG. Compensation decisions regarding other executive officers are made by the Chief Executive Officer. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The Company is an indirect wholly owned subsidiary of American International Group, Inc. The number of shares of AIG common stock beneficially owned as of January 31, 2005, by directors, executive officers named in the Summary Compensation Table (as set forth in Item 11) and directors and executive officers as a group were as follows:
AIG COMMON STOCK -------------------- AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP DIRECTOR OR EXECUTIVE OFFICER (1)(2)(3)(5) - ----------------------------- -------------------- Jay S. Wintrob(4)........................................... 2,087,506 James R. Belardi............................................ 861,222 Marc H. Gamsin.............................................. 140,616 N. Scott Gillis............................................. 47,439 Jana W. Greer............................................... 304,877 Peter A. Harbeck............................................ 132,846 Christine A. Nixon.......................................... 33,003 All Directors and Executive Officers as a Group............. 3,607,509
F-25 - --------------- (1) The number of shares of AIG common stock owned by each individual and by all directors and executive officers as a group represents less than 1% of the outstanding shares of AIG common stock. (2) The number of shares of AIG common stock shown includes shares with respect to which the individual shares voting and investment power as follows: Mr. Belardi - 237 shares with his spouse; Ms. Greer - 39,105 shares with co-trustee. (3) The number of shares of AIG common stock shown includes shares subject to options which may be exercised within 60 days as follows: Mr. Wintrob - 741,870; Mr. Belardi - 305,397; Ms. Greer - 265,772; Mr. Gillis - 46,575; Mr. Gamsin - 140,216; Mr. Harbeck - 78,122; Ms. Nixon - 32,790; and all directors and executive officers as a group - 1,610,742. (4) Mr. Wintrob holds equity securities of C.V. Starr & Co., Inc. of 750 shares of Common Stock and 3,750 shares of various series of Preferred Stock. (5) The number of shares of AIG common stock shown excludes the following shares owned by members of the named individual's immediate family as to which such individual has disclaimed beneficial ownership: Mr. Wintrob - 4,009 shares held by various family members. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS During 2004, the Company paid cash dividends to its shareholder aggregating $2.5 million and received a capital contribution of 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo") (formerly SunAmerica Asset Management Corp.) which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica Fund Services, Inc. ("SFS") (formerly SunAmerica Fund Services, Inc.). This capital contribution increased the Company's equity by $150,653,000. Beginning in 2004, the Company and its subsidiaries are included in the consolidated federal income tax return of its ultimate parent, AIG. The Company is a party to a written agreement (the "Tax Sharing Agreement") with AIG setting forth the manner in which the total consolidated U.S. Federal income tax is allocated to each entity that joins in the consolidated return. The Tax Sharing Agreement provides that AIG agrees not to charge us a greater portion of the consolidated tax liability than would have been paid by us had the Company filed a separate federal income tax return. Additionally, AIG agrees to reimburse the Company for any tax benefits arising out of net losses or tax credits, if any, within ninety days after the filing of the consolidated federal income tax return for the year in which such losses or tax credits are utilized by AIG. The Company paid commissions totaling $60,674,000 in 2004 to nine affiliated broker-dealers: Royal Alliance Associates, Inc.; SunAmerica Securities, Inc.; Advantage Capital Corporation; FSC Services Corporation; Sentra Securities Corporation; Spelman & Co., Inc.; VALIC Financial Advisors; American General Equity Securities Corporation and American General Securities Inc. These affiliated broker-dealers distribute a significant portion of the Company's variable annuity products amounting to approximately 23% of deposits in 2004. Of the Company's mutual fund sales, approximately 25% were distributed by these affiliated broker-dealers in 2004. On February 1, 2004, SAAMCo entered into an administrative services agreement with FSA whereby SAAMCo will pay to FSA a fee based on a percentage of all assets invested through FSA's variable annuity products in exchange for services performed. SAAMCo is the investment advisor for certain trusts that serve as investment options for FSA's variable annuity products. Amounts incurred by the Company under this agreement totaled $1,537,000 in 2004. On October 1, 2001, SAAMCo entered into two administrative services agreements with business trusts established by its affiliate, The Variable Annuity Life Insurance Company ("VALIC"), whereby the trust pays to SAAMCo a fee based on a percentage of average daily net assets invested through VALIC's annuity products in exchange for services performed. Amounts earned by SAAMCo under this agreement totaled $9,074,000 in 2004 and are net of certain administrative costs incurred by VALIC of $2,593,000. Pursuant to a cost allocation agreement, the Company purchases administrative, investment management, accounting, legal, marketing and data processing services from the Parent, AIGRS and AIG. The allocation of such costs for investment management services is based on the level of assets under management. The allocation of costs for other services is based on estimated levels of usage, transactions or time incurred in providing the respective services. Amounts paid for such services totaled $148,554,000 in 2004. The majority of the Company's invested assets are managed by an affiliate of the Company. The investment management fees incurred were $3,712,000 in 2004. Additionally, the Company incurred $1,113,000 of management fees to an affiliate of the Company to administer its securities lending program for 2004. F-26 FINANCIAL STATEMENTS The consolidated financial statements of AIG SunAmerica Life Assurance Company which are included in this prospectus should be considered only as bearing on the ability AIG SunAmerica Life to meet its obligations with respect to amounts allocated to the fixed investment options and with respect to the death and other living benefits and our assumption of the mortality and expense risks and the risks that withdrawal charge will not be sufficient to cover the cost of distributing the contracts. They should not be considered as bearing on the investment performance of the variable Portfolios. The value of the variable Portfolios is affected primarily by the performance of the underlying investments. F-27 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholder of AIG SunAmerica Life Assurance Company: In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income and comprehensive income and of cash flows, in all material respects, the financial position of AIG SunAmerica Life Assurance Company (the "Company"), an indirect wholly owned subsidiary of American International Group, Inc., at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards 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 consolidated financial statements, the Company changed its method of accounting and reporting for certain nontraditional long-duration contracts in 2004. PricewaterhouseCoopers LLP Los Angeles, California April 15, 2005 F-28 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED BALANCE SHEET
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Assets Investments and cash: Cash and short-term investments........................... $ 201,117 $ 133,105 Bonds, notes and redeemable preferred stocks available for sale, at fair value (amortized cost: December 31, 2004, $5,007,868; December 31, 2003, $5,351,183).............. 5,161,027 5,505,800 Mortgage loans............................................ 624,179 716,846 Policy loans.............................................. 185,958 200,232 Mutual funds.............................................. 6,131 21,159 Common stocks available for sale, at fair value (cost: December 31, 2004, $4,876; December 31, 2003, $635)..... 4,902 727 Real estate............................................... 20,091 22,166 Securities lending collateral............................. 883,792 514,145 Other invested assets..................................... 38,789 10,453 ----------- ----------- Total investments and cash................................ 7,125,986 7,124,633 Variable annuity assets held in separate accounts........... 22,612,451 19,178,796 Accrued investment income................................... 73,769 74,647 Deferred acquisition costs.................................. 1,349,089 1,268,621 Other deferred expenses..................................... 257,781 236,707 Income taxes currently receivable from Parent............... 9,945 15,455 Receivable from brokers for sales of securities............. 161 -- Goodwill.................................................... 14,038 14,038 Other assets................................................ 52,795 58,830 ----------- ----------- Total Assets................................................ $31,496,015 $27,971,727 =========== ===========
See accompanying notes to consolidated financial statements. F-29 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED BALANCE SHEET (Continued)
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Liabilities and Shareholder's Equity Reserves, payables and accrued liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 3,948,158 $ 4,274,329 Reserves for universal life insurance contracts........... 1,535,905 1,609,233 Reserves for guaranteed investment contracts.............. 215,331 218,032 Reserves for guaranteed benefits.......................... 76,949 12,022 Securities lending payable................................ 883,792 514,145 Due to affiliates......................................... 21,655 19,289 Payable to brokers........................................ -- 1,140 Other liabilities......................................... 190,198 247,435 ----------- ----------- Total reserves, payables and accrued liabilities.......... 6,871,988 6,895,625 Variable annuity liabilities related to separate accounts... 22,612,451 19,178,796 Subordinated notes payable to affiliates.................... -- 40,960 Deferred income taxes....................................... 257,532 242,556 ----------- ----------- Total liabilities........................................... 29,741,971 26,357,937 ----------- ----------- Shareholder's equity: Common stock.............................................. 3,511 3,511 Additional paid-in capital................................ 758,346 709,246 Retained earnings......................................... 919,612 828,423 Accumulated other comprehensive income.................... 72,575 72,610 ----------- ----------- Total shareholder's equity................................ 1,754,044 1,613,790 ----------- ----------- Total Liabilities and Shareholder's Equity.................. $31,496,015 $27,971,727 =========== ===========
See accompanying notes to consolidated financial statements. F-30 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Revenues: Fee income: Variable annuity policy fees, net of reinsurance........ $369,141 $281,359 $286,919 Asset management fees................................... 89,569 66,663 66,423 Universal life insurance fees, net of reinsurance....... 33,899 35,816 36,253 Surrender charges....................................... 26,219 27,733 32,507 Other fees.............................................. 15,753 15,520 21,900 -------- -------- -------- Total fee income...................................... 534,581 427,091 444,002 Investment income........................................... 363,594 402,923 387,355 Net realized investment losses.............................. (23,807) (30,354) (65,811) -------- -------- -------- Total revenues.............................................. 874,368 799,660 765,546 ======== ======== ======== Benefits and Expenses: Interest expense: Fixed annuity and fixed accounts of variable annuity contracts............................................... 140,889 153,636 142,973 Universal life insurance contracts........................ 73,745 76,415 80,021 Guaranteed investment contracts........................... 6,034 7,534 11,267 Subordinated notes payable to affiliates.................. 2,081 2,628 3,868 -------- -------- -------- Total interest expense...................................... 222,749 240,213 238,129 Amortization of bonus interest.............................. 10,357 19,776 16,277 General and administrative expenses......................... 131,612 119,093 115,210 Amortization of deferred acquisition costs and other deferred expenses......................................... 157,650 160,106 222,484 Annual commissions.......................................... 64,323 55,661 58,389 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 17,766 15,716 Guaranteed minimum death benefits, net of reinsurance recoveries................................................ 58,756 63,268 67,492 -------- -------- -------- Total benefits and expenses................................. 662,867 675,883 733,697 ======== ======== ======== Pretax Income Before Cumulative Effect of Accounting Change.................................................... 211,501 123,777 31,849 Income tax expense.......................................... 6,410 30,247 160 -------- -------- -------- Net Income Before Cumulative Effect of Accounting Change.... 205,091 93,530 31,689 Cumulative effect of accounting change, net of tax.......... (62,589) -- -- -------- -------- -------- Net Income.................................................. $142,502 $ 93,530 $ 31,689 ======== ======== ======== Other Comprehensive Income (Loss), Net of Tax: Net unrealized gains (losses) on debt and equity securities available for sale identified in the current period less related amortization of deferred acquisition costs and other deferred expenses....................... $(20,487) $ 67,125 $ 20,358 Less reclassification adjustment for net realized losses included in net income.................................. 19,263 19,194 52,285 Net unrealized gains (losses) on foreign currency......... 1,170 -- -- Change related to cash flow hedges........................ -- -- (2,218) Income tax (benefit) expense.............................. 19 (30,213) (24,649) -------- -------- -------- Other Comprehensive Income (Loss)........................... (35) 56,106 45,776 -------- -------- -------- Comprehensive Income........................................ $142,467 $149,636 $ 77,465 ======== ======== ========
See accompanying notes to consolidated financial statements. F-31 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, ------------------------------------- 2004 2003 2002 --------- ----------- ----------- (IN THOUSANDS) Cash Flow from Operating Activities: Net income.................................................. $ 142,502 $ 93,530 $ 31,689 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of accounting change, net of tax........ 62,589 -- -- Interest credited to: Fixed annuity and fixed accounts of variable annuity contracts.............................................. 140,889 153,636 142,973 Universal life insurance contracts...................... 73,745 76,415 80,021 Guaranteed investment contracts......................... 6,034 7,534 11,267 Net realized investment losses............................ 23,807 30,354 65,811 Accretion of net discounts on investments................. (1,277) (9,378) (2,412) Loss on other invested assets............................. 572 2,859 3,932 Amortization of deferred acquisition costs and other expenses................................................ 168,007 179,882 238,761 Acquisition costs deferred................................ (246,033) (212,251) (204,833) Other expenses deferred................................... (62,906) (70,158) (77,602) Depreciation of fixed assets.............................. 1,619 1,718 860 Provision for deferred income taxes....................... 49,337 (129,591) 106,044 Change in: Accrued investment income............................... 878 679 13,907 Other assets............................................ 4,416 (12,349) 4,736 Income taxes currently payable to/receivable from Parent................................................. 5,157 148,898 (43,629) Due from/to affiliates.................................. 2,366 (36,841) (7,743) Other liabilities....................................... 7,485 10,697 (7,143) Other, net................................................ 2,284 14,885 10,877 --------- ----------- ----------- Net Cash Provided by Operating Activities................... 381,471 250,519 367,516 --------- ----------- ----------- Cash Flows from Investing Activities: Purchases of: Bonds, notes and redeemable preferred stocks.............. (964,705) (2,078,310) (2,403,362) Mortgage loans............................................ (31,502) (44,247) (128,764) Other investments, excluding short-term investments....... (33,235) (20,266) (65,184) Sales of: Bonds, notes and redeemable preferred stocks.............. 383,695 1,190,299 849,022 Other investments, excluding short-term investments....... 22,283 12,835 825 Redemptions and maturities of: Bonds, notes and redeemable preferred stocks.............. 898,682 994,014 615,798 Mortgage loans............................................ 125,475 67,506 82,825 Other investments, excluding short-term investments....... 10,915 72,970 114,347 --------- ----------- ----------- Net Cash Provided By (Used in) Investing Activities......... $ 411,608 $ 194,801 $ (934,493) ========= =========== ===========
See accompanying notes to consolidated financial statements. F-32 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
YEARS ENDED DECEMBER 31, -------------------------------------- 2004 2003 2002 ----------- ----------- ---------- (IN THOUSANDS) Cash Flow from Financing Activities: Deposits received on: Fixed annuity and fixed accounts of variable annuity contracts............................................... $ 1,360,319 $ 1,553,000 $1,731,597 Universal life insurance contracts........................ 45,183 45,657 49,402 Net exchanges from the fixed accounts of variable annuity contracts................................................. (1,332,240) (1,108,030) (503,221) Withdrawal payments on: Fixed annuity and fixed accounts of variable annuity contracts............................................... (458,052) (464,332) (529,466) Universal life insurance contracts........................ (69,185) (61,039) (68,444) Guaranteed investment contracts........................... (8,614) (148,719) (135,084) Claims and annuity payments, net of reinsurance, on: Fixed annuity and fixed accounts of variable annuity contracts............................................... (108,691) (109,412) (98,570) Universal life insurance contracts........................ (105,489) (111,380) (100,995) Net receipt from (repayments of) other short-term financings................................................ (41,060) 14,000 -- Net payment related to a modified coinsurance transaction... (4,738) (26,655) (30,282) Capital contribution received from Parent................... -- -- 200,000 Dividends paid to Parent.................................... (2,500) (12,187) (10,000) ----------- ----------- ---------- Net Cash (Used in) Provided by Financing Activities......... (725,067) (429,097) 504,937 ----------- ----------- ---------- Net Increase (Decrease) in Cash and Short-term Investments............................................... 68,012 16,223 (62,040) Cash and Short-term Investments at Beginning of Period...... 133,105 116,882 178,922 ----------- ----------- ---------- Cash and Short-term Investments at End of Period............ $ 201,117 $ 133,105 $ 116,882 =========== =========== ========== Supplemental Cash Flow Formation: Interest paid on indebtedness............................... $ 2,081 $ 2,628 $ 3,868 =========== =========== ========== Net income taxes (received) paid to Parent.................. $ (47,749) $ 10,989 $ 5,856 =========== =========== ==========
See accompanying notes to consolidated financial statements. F-33 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AIG SunAmerica Life Assurance Company (formerly Anchor National Life Insurance Company) (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, retirement services and asset management. The Company is an Arizona-domiciled life insurance company principally engaged in the business of writing variable annuity contracts directed to the market for tax-deferred, long-term savings products. The Company changed its name to AIG SunAmerica Life Assurance Company on January 24, 2002. The Company continued to do business as Anchor National Life Insurance Company until February 28, 2003, at which time it began doing business under its new name. Effective January 1, 2004, the Parent contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo") (formerly SunAmerica Asset Management Corp.) which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica Fund Services, Inc. ("SFS") (formerly SunAmerica Fund Services, Inc.). Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary of the Company. Assets, liabilities and shareholder's equity at December 31, 2003 were restated to include $190,605,000, $39,952,000 and $150,653,000, respectively, of SAAMCo balances. Similarly, the results of operations and cash flows for the years ended December 31, 2003 and 2002 have been restated for the addition and subtraction to pretax income of $16,345,000 and $4,464,000 to reflect the SAAMCo activity. Prior to this capital contribution to the Company, SAAMCo distributed certain investments with a tax effect of $49,100,000 which was indemnified by its then parent, SALIC. See Note 10 of the Notes to Consolidated Financial Statements. SAAMCo and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS, are included in the Company's asset management segment (see Note 13). These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, managing certain subaccounts offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. 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. Products for the annuity operations and asset management operations are marketed through affiliated and independent broker-dealers, full-service securities firms and financial institutions. One independent selling organization in the annuity operations represented 24.8% of deposits in the year ended December 31, 2004, 14.6% of deposits in the year ended December 31, 2003 and 11.9% of deposits in the year ended December 31, 2002. No other independent selling organization was responsible for 10% or more of deposits for any such period. One independent selling organization in the asset management operations represented 16.0% of deposits in the year ended December 31, 2004 and 10.8% of deposits in the year ended December 31, 2003. No other independent selling organization was responsible for 10% or more of deposits for any such period. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION: The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the amounts reported in the financial F-34 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) statements and the accompanying notes. Actual results could differ from those estimates. Certain prior period items have been reclassified to conform to the current period's presentation. INVESTMENTS: Cash and short-term investments primarily include cash, commercial paper, money market investments and short-term bank 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 deferred acquisition costs, deferred other expenses and income tax, are credited or charged directly to the accumulated other comprehensive income or loss component of shareholder's equity. Bonds, notes, redeemable preferred stocks and common stocks are reduced to estimated net fair value when declines in such values 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. Mutual funds consist of seed money for mutual funds used as investment vehicles for the Company's variable annuity separate accounts and is carried at market value. Real estate is carried at the lower of cost or net realizable value. 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 fair value of securities pledged under the securities lending agreement were $862,481,000 and $502,885,000 as of December 31, 2004 and 2003, respectively, and represents securities included in bonds, notes and redeemable preferred stocks available for sale caption in the consolidated balance sheet as of December 31, 2004 and 2003, respectively. The Company receives primarily cash collateral in an amount in excess of the market value of the securities loaned. The affiliated lending agent 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 consolidated statement of income and comprehensive income. Other invested assets consist principally of investments in limited partnerships and put options on the S&P 500 index purchased to partially offset the risk of Guaranteed Minimum Account Value ("GMAV") benefits and Guaranteed Minimum Withdrawal ("GMWB") benefits (see Note 7). Limited partnerships are carried at cost. The put options do not qualify for hedge accounting and accordingly are marked to market and changes in market value are recorded through investment income. Realized gains and losses on the sale of investments are recognized in operations 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 consolidated statement of income and comprehensive income. Impairments writedowns totaled $21,050,000, $54,092,000 and $57,273,000 in the years ending December 31, 2004, 2003 and 2002. DERIVATIVE FINANCIAL INSTRUMENTS: Derivative financial instruments primarily used by the Company include interest rate swap agreements and put options on the S&P 500 index entered into to partially offset the risk of certain guarantees of annuity contract values. The Company is neither a dealer nor a trader in derivative financial instruments. F-35 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The Company recognizes all derivatives in the consolidated balance sheet at fair value. Hedge accounting requires a high correlation between changes in fair values or cash flows of the derivative financial instrument and the specific item being hedged, both at inception and throughout the life of the hedge. For fair value hedges, gains and losses in the fair value of both the derivative and the hedged item attributable to the risk being hedged are recognized in earnings. For cash flow hedges, to the extent the hedge is effective, gains and losses in the fair value of both the derivative and the hedged item attributable to the risk being hedged are recognized as component of accumulated other comprehensive income in shareholder's equity. Any ineffective portion of cash flow hedges is reported in investment income. On the date a derivative contract is entered into, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet. Interest rate swap agreements convert specific investment securities from a floating-rate to a fixed-rate basis, or vice versa, and hedge against the risk of declining rates on anticipated security purchases. Interest rate swaps in which the Company agrees to pay a fixed rate and receive a floating rate are accounted for as fair value hedges. Interest rate swaps in which the Company agrees to pay a floating rate and receive a fixed rate are accounted for as cash flow hedges. The difference between amounts paid and received on swap agreements is recorded as an adjustment to investment income or interest expense, as appropriate, on an accrual basis over the periods covered by the agreements. The related amount payable to or receivable from counterparties is included in other liabilities or other assets. The Company issues certain variable annuity products that offer an optional GMAV and GMWB living benefit. If elected by the contract holder at the time of contract issuance, the GMAV feature guarantees that the account value under the contract will equal or exceed the amount of the initial principal invested, adjusted for withdrawals, at the end of a ten-year waiting period. If elected by the contract holder at the time of contract issuance, the GMWB feature guarantees an annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days, adjusted for any subsequent withdrawals. There is a separate charge to the contract holder for these features. The Company bears the risk that protracted under-performance of the financial markets could result in GMAV and GMWB benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. Under Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities"("FAS 133"), the GMAV and GMWB benefits are considered embedded derivatives that are bifurcated and marked to market and recorded in other liabilities in the consolidated balance sheet. Changes in the market value of the estimated GMAV and GMWB benefits are recorded through investment income. DEFERRED ACQUISITION COSTS ("DAC"): Policy acquisition costs are deferred and amortized over the estimated lives of the annuity and universal life insurance contracts. Policy acquisition costs include commissions and other costs that vary with, and are primarily related to, the production or acquisition of new business. DAC is amortized based on a percentage of expected gross profits ("EGPs") over the life of the underlying contracts. EGPs are computed based on assumptions related to the underlying contracts, including their anticipated duration, the growth rate of the separate account assets (with respect to variable options of the variable annuity contracts) or general account assets (with respect to fixed options of variable annuity contracts ("Fixed Options") and universal life insurance contracts) supporting the annuity obligations, costs of providing for contract guarantees and the level of expenses necessary to maintain the contracts. The Company adjusts amortization of DAC and other deferred expenses (a "DAC unlocking") when estimates of future gross profits to be realized from its annuity contracts are revised. The assumption for the long-term annual net growth of the separate account assets used by the Company in the determination of DAC amortization with respect to its variable annuity contracts is 10% (the "long-term growth rate assumption"). The Company uses a "reversion to the mean" methodology that allows the Company to maintain this 10% long-term growth rate assumption, while also giving consideration to the effect of short-term swings in the equity markets. For example, if performance were 15% during the first year following the introduction of a product, the DAC model would assume that market returns for the following five years (the "short-term growth rate assumption") would approximate 9%, resulting in an average annual growth rate of 10% during the life of the product. Similarly, following periods of below 10% F-36 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) performance, the model will assume a short-term growth rate higher than 10%. A DAC unlocking will occur if management deems the short-term growth rate (i.e., the growth rate required to revert to the mean 10% growth rate over a five-year period) to be unreasonable. The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. As debt 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 debt and equity securities available for sale which is a component of accumulated other comprehensive income (loss) and is credited or charged directly to shareholder's equity. 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 amortization expense on the consolidated statement of income and comprehensive income. OTHER DEFERRED EXPENSES: The annuity operations currently offers enhanced crediting rates or bonus payments to contract holders on certain of its products. Such amounts are deferred and amortized over the life of the contract using the same methodology and assumptions used to amortize DAC. The Company previously deferred these expenses as part of DAC and reported the amortization of such amounts as part of DAC amortization. Upon implementation of Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1"), the Company reclassified $155,695,000 of these expenses from DAC to other deferred expenses, which is reported on the consolidated balance sheet. The prior period consolidated balance sheet and consolidated statements of income and comprehensive income presentation has been reclassified to conform to the new presentation. See Recently Issued Accounting Standards below. The asset management operations defer distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or contingent deferred sales charge feature (collectively, "Distribution Fee Revenue"). The Company amortizes these deferred distribution costs on a straight-line basis, adjusted for redemptions, over a period ranging from one year to eight years depending on share class. Amortization of these deferred distribution costs is increased if at any reporting period the value of the deferred amount exceeds the projected Distribution Fee Revenue. The projected Distribution Fee Revenue is impacted by estimated future withdrawal rates and the rates of market return. Management uses historical activity to estimate future withdrawal rates and average annual performance of the equity markets to estimate the rates of market return. The Company reviews the carrying value of other deferred expenses on at least an annual basis. Management considers estimated future gross profit margins as well as expected mortality, interest earned, credited rates, persistency, withdrawal rates, rates of market return 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 policy fees in the consolidated statement of income and comprehensive income. GOODWILL: Goodwill amounted to $14,038,000 (net of accumulated amortization of $18,838,000) at December 31, 2004 and 2003. In accordance with Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), the Company assesses goodwill for impairment on an annual basis, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of the impairment, if any. The Company has evaluated goodwill for impairment as of December 31, 2004 and 2003, and has determined that no impairment provision is necessary. RESERVES FOR FIXED ANNUITY CONTRACTS, FIXED ACCOUNTS OF VARIABLE ANNUITY CONTRACTS, UNIVERSAL LIFE INSURANCE CONTRACTS AND GICS: Reserves for fixed annuity, Fixed Options, universal life insurance and GIC contracts are accounted for in accordance with Statement of Financial Accounting Standards No. 97, F-37 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) "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). 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 consolidated statement of income and comprehensive income, as they are recorded directly to contract holders' liabilities upon receipt. RESERVES FOR GUARANTEED BENEFITS: Reserves for guaranteed minimum death benefits ("GMDB"), earnings enhancement benefit and guaranteed minimum income benefits are accounted for in accordance with SOP 03-1. See Recently Issued Accounting Standards below. FEE INCOME: Fee income includes variable annuity policy fees, asset management fees, universal life insurance fees, commissions and surrender charges. Variable annuity policy fees are generally based on the market value of assets in the separate accounts supporting the variable annuity contracts. Asset management fees include investment advisory fees and 12b-1 distribution fees and are based on the market value of assets managed in mutual funds and certain variable annuity portfolios by SAAMCo. Universal life insurance policy fees consist of mortality charges, up-front fees earned on deposits received and administrative fees, net of reinsurance premiums. Surrender charges are assessed on withdrawals occurring during the surrender charge period. All fee income is recorded as income when earned with net retained commissions are recognized as income on a trade date basis. INCOME TAXES: Prior to the 2004, the Company was included in a consolidated federal income tax return with its Parent. Also, prior to 2004, SAAMCO, SFS and SACS were included in a separate consolidated federal income tax return with their parent, Saamsun Holdings Corporation. Beginning in 2004, all of these companies are included in the consolidated federal income tax return of their ultimate parent, AIG. Income taxes have been calculated as if each entity files 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 July 2003, the American Institute of Certified Public Accountants issued SOP 03-1. This statement was effective as of January 1, 2004, and requires the Company to recognize a liability for GMDB and certain living benefits related to its variable annuity contracts, account for enhanced crediting rates or bonus payments to contract holders and modifies certain disclosures and financial statement presentations for these products. In addition, SOP 03-1 addresses the presentation and reporting of separate accounts and the capitalization and amortization of certain other expenses. The Company reported for the first quarter of 2004 a one-time cumulative accounting charge upon adoption of $62,589,000 ($96,291,000 pre-tax) to reflect the liability and the related impact of DAC and reinsurance as of January 1, 2004. 3. INVESTMENTS The amortized cost and estimated fair value of bonds, notes and redeemable preferred stocks by major category follow:
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) At December 31, 2004: U.S. government securities.................................. $ 28,443 $ 30,300 Mortgage-backed securities.................................. 926,274 956,567 Securities of public utilities.............................. 321,381 332,038 Corporate bonds and notes................................... 2,797,943 2,902,829 Redeemable preferred stocks................................. 20,140 21,550 Other debt securities....................................... 913,687 917,743 ---------- ---------- Total..................................................... $5,007,868 $5,161,027 ========== ==========
F-38 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued)
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) At December 31, 2003: U.S. government securities.................................. $ 22,393 $ 24,292 Mortgage-backed securities.................................. 1,148,452 1,191,817 Securities of public utilities.............................. 352,998 365,150 Corporate bonds and notes................................... 2,590,254 2,697,142 Redeemable preferred stocks................................. 21,515 22,175 Other debt securities....................................... 1,215,571 1,205,224 ---------- ---------- Total..................................................... $5,351,183 $5,505,800 ========== ==========
At December 31, 2004, bonds, notes and redeemable preferred stocks included $386,426,000 that were not rated investment grade. These non-investment-grade securities are comprised of bonds spanning 10 industries with 19%, 16%, 16% and 10% concentrated in telecommunications, utilities, financial institutions and noncyclical consumer products industries, respectively. No other industry concentration constituted more than 10% of these assets. At December 31, 2004, mortgage loans were collateralized by properties located in 30 states, with loans totaling approximately 27%, 11% and 10% of the aggregate carrying value of the portfolio secured by properties located in California, Michigan and Massachusetts, respectively. No more than 10% of the portfolio was secured by properties in any other single state. At December 31, 2004, the carrying value, which approximates its estimated fair value, of all investments in default as to the payment of principal or interest totaled $40,051,000 of bonds. As a component of its asset and liability management strategy, the Company utilizes interest rate swap agreements to match assets more closely to liabilities. Interest rate swap agreements exchange interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) with a counterparty, based on an underlying principal balance (notional principal) to hedge against interest rate changes. The Company typically utilizes swap agreements to create a hedge that effectively converts floating-rate assets and liabilities to fixed-rate instruments. At December 31, 2004, $10,505,000 of bonds, at amortized cost, were on deposit with regulatory authorities in accordance with statutory requirements. At December 31, 2004, no investments in any one entity or its affiliates exceeded 10% of the Company's shareholder's equity. The amortized cost and estimated fair value of bonds, notes and redeemable preferred stocks by contractual maturity, as of December 31, 2004, follow:
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) Due in one year or less..................................... $ 278,939 $ 281,954 Due after one year through five years....................... 2,076,145 2,138,574 Due after five years through ten years...................... 1,299,345 1,339,499 Due after ten years......................................... 427,165 444,433 Mortgage-backed securities.................................. 926,274 956,567 ---------- ---------- Total..................................................... $5,007,868 $5,161,027 ========== ==========
Actual maturities of bonds, notes and redeemable preferred stocks may differ from those shown above due to prepayments and redemptions. F-39 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued) Gross unrealized gains and losses on bonds, notes and redeemable preferred stocks by major category follow:
GROSS GROSS UNREALIZED UNREALIZED GAINS LOSSES ---------- ---------- (IN THOUSANDS) At December 31, 2004: U.S. government securities.................................. $ 1,857 $ -- Mortgage-backed securities.................................. 32,678 (2,385) Securities of public utilities.............................. 11,418 (761) Corporate bonds and notes................................... 118,069 (13,183) Redeemable preferred stocks................................. 1,410 -- Other debt securities....................................... 14,871 (10,815) -------- -------- Total..................................................... $180,303 $(27,144) ======== ========
GROSS GROSS UNREALIZED UNREALIZED GAINS LOSSES ---------- ---------- (IN THOUSANDS) At December 31, 2003: U.S. government securities.................................. $ 1,898 $ -- Mortgage-backed securities.................................. 46,346 (2,980) Securities of public utilities.............................. 13,467 (1,315) Corporate bonds and notes................................... 127,996 (21,108) Redeemable preferred stocks................................. 660 -- Other debt securities....................................... 24,366 (34,713) -------- -------- Total..................................................... $214,733 $(60,116) ======== ========
Gross unrealized gains on equity securities aggregated $26,000 at December 31, 2004 and $112,000 at December 31, 2003. There were no unrealized losses on equity securities at December 31, 2004 and gross unrealized losses on equity securities aggregated $20,000 at December 31, 2003. The following tables summarize 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, 2004 and 2003.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ----------------------------- ----------------------------- ------------------------------- FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSS ITEMS VALUE LOSS ITEMS VALUE LOSS ITEMS -------- ---------- ----- -------- ---------- ----- ---------- ---------- ----- (DOLLARS IN THOUSANDS) December 31, 2004 Mortgage-backed securities............... $125,589 $ (1,282) 23 $ 40,275 $ (1,103) 9 $ 165,864 $ (2,385) 32 Securities of public utilities................ 46,249 (761) 9 0 0 0 46,249 (761) 9 Corporate bonds and notes.................... 487,923 (7,418) 86 87,194 (5,765) 15 575,117 (13,183) 101 Other debt securities...... 207,378 (4,062) 36 79,782 (6,753) 12 287,160 (10,815) 48 -------- -------- --- -------- -------- -- ---------- -------- --- Total.................... $867,139 $(13,523) 154 $207,251 $(13,621) 36 $1,074,390 $(27,144) 190 ======== ======== === ======== ======== == ========== ======== ===
F-40 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued)
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ----------------------------- ---------------------------- ----------------------------- FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSS ITEMS VALUE LOSS ITEMS VALUE LOSS ITEMS -------- ---------- ----- ------- ---------- ----- -------- ---------- ----- December 31, 2003 Mortgage-backed securities..... $180,559 $ (2,882) 49 $13,080 $ (98) 6 $193,639 $ (2,980) 55 Securities of public utilities.................... 67,626 (1,315) 8 -- -- -- 67,626 (1,315) 8 Corporate bonds and notes...... 276,373 (17,086) 54 30,383 (4,022) 5 306,756 (21,108) 59 Other debt securities.......... 302,230 (33,951) 54 41,523 (762) 5 343,753 (34,713) 59 -------- -------- --- ------- ------- -- -------- -------- --- Total........................ $826,788 $(55,234) 165 $84,986 $(4,882) 16 $911,774 $(60,116) 181 ======== ======== === ======= ======= == ======== ======== ===
Realized investment gains and losses on sales of investments are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Bonds, Notes and Redeemable Preferred Stocks: Realized gains............................................ $ 12,240 $ 30,896 $ 25,013 Realized losses........................................... (12,623) (11,818) (32,865) Common Stocks: Realized gains............................................ 5 561 -- Realized losses........................................... (247) (117) (169)
The sources and related amounts of investment income are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Short-term investments...................................... $ 2,483 $ 1,363 $ 5,447 Bonds, notes and redeemable preferred stocks................ 293,258 321,493 305,480 Mortgage loans.............................................. 50,825 53,951 55,417 Partnerships................................................ 417 (478) 12,344 Policy loans................................................ 17,130 15,925 18,796 Real estate................................................. (202) (331) (276) Other invested assets....................................... 2,149 13,308 (7,496) Less: investment expenses................................... (2,466) (2,308) (2,357) -------- -------- -------- Total investment income................................... $363,594 $402,923 $387,355 ======== ======== ========
Investment income was attributable to the following products:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Fixed annuity contracts..................................... $ 34,135 $ 37,762 $ 41,856 Variable annuity contracts.................................. 222,660 239,863 201,766 Guaranteed investment contracts............................. 13,191 20,660 28,056 Universal life insurance contracts.......................... 92,645 100,019 105,878 Asset management............................................ 963 4,619 9,799 -------- -------- -------- Total..................................................... $363,594 $402,923 $387,355 ======== ======== ========
4. FAIR VALUE OF FINANCIAL INSTRUMENTS The 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 F-41 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) assets (including its real estate investments and other invested assets except for partnerships) 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 INSTRUMENTS: 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 that 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. POLICY LOANS: Carrying value is considered a reasonable estimate of fair value. MUTUAL FUNDS: Fair value is considered to be the market value of the underlying securities. COMMON STOCKS: Fair value is based principally on independent pricing services, broker quotes and other independent information. PARTNERSHIPS: Fair value of partnerships that invest in debt and equity securities is based upon the fair value of the net assets of the partnerships as determined by the general partners. VARIABLE ANNUITY ASSETS HELD IN SEPARATE ACCOUNTS: Variable annuity assets are carried at the market value of the underlying securities. RESERVES FOR FIXED ANNUITY AND FIXED ACCOUNTS OF VARIABLE 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. RESERVES FOR GUARANTEED INVESTMENT CONTRACTS: Fair value is based on the present value of future cash flows at current pricing rates. SECURITIES LENDING COLLATERAL/PAYABLE: Carrying value is considered to be a reasonable estimate of fair value. 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. SUBORDINATED NOTES TO/FROM AFFILIATES: Fair value is estimated based on the quoted market prices for similar issues. F-42 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) The estimated fair values of the Company's financial instruments at December 31, 2004 and 2003 compared with their respective carrying values, are as follows:
CARRYING FAIR VALUE VALUE ----------- ----------- (IN THOUSANDS) December 31, 2004: Assets: Cash and short-term investments........................... $ 201,117 $ 201,117 Bonds, notes and redeemable preferred stocks.............. 5,161,027 5,161,027 Mortgage loans............................................ 624,179 657,828 Policy loans.............................................. 185,958 185,958 Mutual funds.............................................. 6,131 6,131 Common stocks............................................. 4,902 4,902 Partnerships.............................................. 1,084 1,084 Securities lending collateral............................. 883,792 883,792 Put options hedging guaranteed benefits................... 37,705 37,705 Variable annuity assets held in separate accounts......... 22,612,451 22,612,451 Liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 3,948,158 $ 3,943,265 Reserves for guaranteed investment contracts.............. 215,331 219,230 Securities lending payable................................ 883,792 883,792 Variable annuity liabilities related to separate accounts................................................ 22,612,451 22,612,451
CARRYING FAIR VALUE VALUE ----------- ----------- (IN THOUSANDS) December 31, 2003: Assets: Cash and short-term investments........................... $ 133,105 $ 133,105 Bonds, notes and redeemable preferred stocks.............. 5,505,800 5,505,800 Mortgage loans............................................ 716,846 774,758 Policy loans.............................................. 200,232 200,232 Mutual funds.............................................. 21,159 21,159 Common stocks............................................. 727 727 Partnerships.............................................. 1,312 1,685 Securities lending collateral............................. 514,145 514,145 Put options hedging guaranteed benefits................... 9,141 9,141 Variable annuity assets held in separate accounts......... 19,178,796 19,178,796 Liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 4,274,329 $ 4,225,329 Reserves for guaranteed investment contracts.............. 218,032 223,553 Securities lending payable................................ 514,145 514,145 Variable annuity liabilities related to separate accounts................................................ 19,178,796 19,178,796 Subordinated note payable to affiliate.................... 40,960 40,960
F-43 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. DEFERRED ACQUISITION COSTS The following table summarizes the activity in deferred acquisition costs:
YEARS ENDED DECEMBER 31, ------------------------- 2004 2003 ----------- ----------- (IN THOUSANDS) Balance at beginning of year................................ $1,268,621 $1,224,101 Acquisition costs deferred.................................. 246,033 212,250 Effect of net unrealized gains (losses) on securities....... 267 (30,600) Amortization charged to income.............................. (126,142) (137,130) Cumulative effect of SOP 03-1............................... (39,690) -- ---------- ---------- Balance at end of year...................................... $1,349,089 $1,268,621 ========== ==========
6. OTHER DEFERRED EXPENSES The annuity operations defer enhanced crediting rates or bonus payments to contract holders on certain of its products ("Bonus Payments"). The asset management operations defer distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or contingent deferred sales charge feature. The following table summarizes the activity in these deferred expenses:
BONUS DISTRIBUTION PAYMENTS COSTS TOTAL -------- ------------ -------- (IN THOUSANDS) Year Ended December 31, 2004 Balance at beginning of year................................ $155,695 $ 81,012 $236,707 Expenses deferred........................................... 36,732 26,174 62,906 Effect of net unrealized gains (losses) on securities....... 33 -- 33 Amortization charged in income.............................. (10,357) (31,508) (41,865) -------- -------- -------- Balance at end of year...................................... $182,103 $ 75,678 $257,781 ======== ======== ======== Year Ended December 31, 2003 Balance at beginning of year................................ $140,647 $ 72,054 $212,701 Expenses deferred........................................... 38,224 31,934 70,158 Effect of net unrealized gains (losses) on securities....... (3,400) -- (3,400) Amortization charged in income.............................. (19,776) (22,976) (42,752) -------- -------- -------- Balance at end of year...................................... $155,695 $ 81,012 $236,707 ======== ======== ========
7. GUARANTEED BENEFITS The Company issues variable annuity contracts for which the investment risk is generally borne by the contract holder, except with respect to amounts invested in the Fixed Options. For many of the Company's variable annuity contracts, the Company offers contractual guarantees in the event of death, at specified dates during the accumulation period, upon certain withdrawals or at annuitization. Such benefits are referred to as GMDB, GMAV, GMWB and guaranteed minimum income benefits ("GMIB"), respectively. The Company also issues certain variable annuity products that offer an optional earnings enhancement benefit ("EEB") feature that provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The assets supporting the variable portion of variable annuity contracts are carried at fair value and reported as summary total "variable annuity assets held in separate accounts" with an equivalent summary total reported for liabilities. Amounts assessed against the contract holders for mortality, administrative, other services and certain features are included in variable annuity policy fees, net of reinsurance, in the consolidated statement of income and comprehensive income. Changes in liabilities for minimum guarantees are included in guaranteed benefits, net of reinsurance, in the consolidated statement of income and comprehensive income. Separate account net investment income, net investment gains and losses and the related liability charges are offset within the same line item in the consolidated statement of income and comprehensive income. F-44 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) The Company offers GMDB options that guarantee for virtually all contract holders, that upon death, the contract holder's beneficiary will receive the greater of (1) the contract holder's account value, or (2) a guaranteed minimum death benefit that varies by product and election by policy owner. The GMDB liability is determined each period end by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to guaranteed benefits, net of reinsurance recoveries, if actual experience or other evidence suggests that earlier assumptions should be revised. EEB is a feature the Company offers on certain variable annuity products. For contract holders who elect the feature, the EEB provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The Company bears the risk that account values following favorable performance of the financial markets will result in greater EEB death claims and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. If available and elected by the contract holder, GMIB provides a minimum fixed annuity payment guarantee after a seven, nine or ten-year waiting period. As there is a waiting period to annuitize using the GMIB, there are no policies eligible to receive this benefit at December 31, 2004. The GMIB liability is determined each period end by estimating the expected value of the annuitization benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to guaranteed benefits, net of reinsurance recoveries, if actual experience or other evidence suggests that earlier assumptions should be revised. GMAV is a feature offered on certain variable annuity products. If available and elected by the contract holder at the time of contract issuance, GMAV guarantees that the account value under the contract will at least equal the amount of deposits invested during the first ninety days, adjusted for any subsequent withdrawals, at the end of a ten-year waiting period. The Company purchases put options on the S&P 500 index to partially offset this risk. GMAVs are considered to be derivatives under FAS 133, and are recognized at fair value in the consolidated balance sheet and through investment income in the consolidated statement of income and comprehensive income. GMWB is a feature offered on certain variable annuity products. If available and elected by the contract holder at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days adjusted for any subsequent withdrawals ("Eligible Premium"). These guaranteed annual withdrawals of up to 10% of Eligible Premium are available after either a three-year or a five-year waiting period as elected by the contract holder at time of contract issuance, without reducing the future amounts guaranteed. If no withdrawals have been made during the waiting period of three or five years, the contract holder will realize an additional 10% or 20%, respectively, of Eligible Premium after all other amounts guaranteed under this benefit have been paid. GMWBs are considered to be derivatives under FAS 133 and are recognized at fair value in the consolidated balance sheet and through investment income in the consolidated statement of income and comprehensive income. F-45 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) Details concerning the Company's guaranteed benefit exposures as of December 31, 2004 are as follows:
HIGHEST SPECIFIED RETURN OF NET ANNIVERSARY ACCOUNT DEPOSITS PLUS A VALUE MINUS MINIMUM WITHDRAWALS POST RETURN ANNIVERSARY --------------- ------------------- (DOLLARS IN MILLIONS) In the event of death (GMDB and EEB): Account value............................................. $ 12,883 $12,890 Net amount at risk(a)..................................... $ 933 $ 1,137 Average attained age of contract holders.................. 67 64 Range of guaranteed minimum return rates.................. 0%-5% 0% At annuitization (GMIB): Account value............................................. $ 6,942 Net amount at risk(b)..................................... $ 3 Weighted average period remaining until earliest 3.8 Years annuitization........................................... Range of guaranteed minimum return rates.................. 0%-6.5% Accumulation at specified date (GMAV): Account value............................................. $ 1,533 Net amount at risk(c)..................................... $ -- Weighted average period remaining until guaranteed 9.0 Years payment................................................. Annual withdrawals at specified date (GMWB): Account value............................................. $ 294 Net amount at risk(d)..................................... $ -- Weighted average period remaining until expected payout... 13.9 Years
------------------- (a) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value, net of reinsurance, if all contract holders died at the same balance sheet date. The net amount at risk does not take into account the effect of caps and deductibles from the various reinsurance treaties. (b) Net amount at risk represents the present value of the expected annuitization payments at the expected annuitization dates in excess of the present value of the expected account value at the expected annuitization dates, net of reinsurance. (c) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value, if all contract holders reached the specified date at the same balance sheet date. (d) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value if all contract holders exercise the maximum withdrawal benefits at the same balance sheet date. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will realize an additional 10% or 20% of Eligible Premium, respectively, after all other amounts guaranteed under this benefit have been paid. The additional 10% or 20% enhancement increases the net amount at risk by $26.3 million and is payable no sooner than 13 or 15 years from contract issuance for the 3 or 5 year waiting periods, respectively. The following summarizes the reserve for guaranteed benefits, net of reinsurance, on variable contracts reflected in the general account:
(IN THOUSANDS) Balance at January 1, 2004 before reinsurance(e)............ $ 92,873 Guaranteed benefits incurred................................ 61,472 Guaranteed benefits paid.................................... (49,947) -------- Balance at December 31, 2004 before reinsurance............. 104,398 Less reinsurance.......................................... (27,449) -------- Balance at December 31, 2004, net of reinsurance............ $ 76,949 ========
(e) Includes amounts from the one-time cumulative accounting change resulting from the adoption of SOP 03-1. F-46 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) The following assumptions and methodology were used to determine the reserve for guaranteed benefits at December 31, 2004: - Data used was 5,000 stochastically generated investment performance scenarios. - Mean investment performance assumption was 10%. - Volatility assumption was 16%. - Mortality was assumed to be 64% of the 75-80 ALB table. - Lapse rates vary by contract type and duration and range from 0% to 40%. - The discount rate was approximately 8%. 8. REINSURANCE Reinsurance contracts do not relieve the Company from its obligations to contract holders. 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. The Company has no reinsurance recoverable or related concentration of credit risk greater than 10% of shareholder's equity. Variable policy fees are net of reinsurance premiums of $28,604,000, $30,795,000 and $22,500,000 in 2004, 2003 and 2002, respectively. Universal life insurance fees are net of reinsurance premiums of $34,311,000, $33,710,000 and $34,098,000 in 2004, 2003 and 2002, respectively. The Company has a reinsurance treaty under which the Company retains no more than $100,000 of risk on any one insured life in order to limit the exposure to loss on any single insured. Reinsurance recoveries recognized as a reduction of claims on universal life insurance contracts amounted to $34,163,000, $34,036,000 and $29,171,000 in 2004, 2003 and 2002, respectively. Guaranteed benefits were reduced by reinsurance recoveries of $2,716,000, $8,042,000 and $8,362,000 in 2004, 2003 and 2002, respectively. 9. COMMITMENTS AND CONTINGENT LIABILITIES The Company has six agreements outstanding in which it has provided liquidity support for certain short-term securities of municipalities and non-profit organizations by agreeing to purchase such securities in the event there is no other buyer in the short-term marketplace. In return the Company receives a fee. In addition, the Company guarantees the payment of these securities upon redemption. The maximum liability under these guarantees at December 31, 2004 is $195,442,000. These commitments have contractual maturity dates in 2005. Related to each of these agreements are participation agreements with the Parent under which the Parent will share in $62,590,000 of these liabilities in exchange for a proportionate percentage of the fees received under these agreements. The Internal Revenue Service has completed its examinations into the transactions underlying these commitments, including the Company's role in the transactions. The examination did not result in a material loss to the Company. At December 31, 2004, the Company has commitments to purchase a total of approximately $10,000,000 of asset- backed securities in the ordinary course of business. The expiration dates of these commitments are as follows: $2,000,000 in 2005 and $8,000,000 in 2007. Various federal, state and other regulatory agencies are reviewing certain transactions and practices of the Company and its subsidiaries in connection with industry-wide and other inquiries. In the opinion of the Company's management, based on the current status of these inquiries, it is not likely that any of these inquiries will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows of the Company. Various lawsuits against the Company and its subsidiaries have arisen in the ordinary course of business. Contingent liabilities arising from litigation, income taxes and regulatory and other matters are not considered material in relation to the consolidated financial position, results of operations or cash flows of the Company. F-47 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENT LIABILITIES (Continued) On April 5, 2004, a purported class action captioned Nitika Mehta, as Trustee of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case 04L0199, was filed in the Circuit Court, Twentieth Judicial District in St. Clair County, Illinois. The lawsuit alleges certain improprieties in conjunction with alleged market timing activities. The probability of any particular outcome cannot be reasonably estimated at this time. The Company cannot estimate a range because the litigation has not progressed beyond the preliminary stage. 10. SHAREHOLDER'S EQUITY The Company is authorized to issue 4,000 shares of its $1,000 par value Common Stock. At December 31, 2004 and 2003, 3,511 shares were outstanding. Changes in shareholder's equity are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Additional Paid-in Capital: Beginning balances........................................ $709,246 $709,246 $509,246 Capital contributions by Parent........................... 49,100 -- 200,000 -------- -------- -------- Ending balances........................................... $758,346 $709,246 $709,246 ======== ======== ======== Retained Earnings: Beginning balances........................................ $828,423 $730,321 $669,103 Net income................................................ 142,502 93,530 31,689 Dividends paid to Parent.................................. (2,500) (12,187) (10,000) Adjustment for tax benefit of distributed subsidiary...... 287 16,759 39,529 Tax effect on a distribution of investment................ (49,100) -- -- -------- -------- -------- Ending balances........................................... $919,612 $828,423 $730,321 ======== ======== ======== Accumulated Other Comprehensive Income (Loss): Beginning balances........................................ $ 72,610 $ 16,504 $(29,272) Change in net unrealized gains (losses) on debt securities available for sale...................................... (1,459) 118,725 98,718 Change in net unrealized gains (losses) on equity securities available for sale........................... (65) 1,594 (1,075) Change in net unrealized gains on foreign currency........ 1,170 -- -- Change in adjustment to deferred acquisition costs and other deferred expenses................................. 300 (34,000) (25,000) Net change related to cash flow hedges.................... -- -- (2,218) Tax effects of net changes................................ 19 (30,213) (24,649) -------- -------- -------- Ending balances........................................... $ 72,575 $ 72,610 $ 16,504 ======== ======== ========
Gross unrealized gains (losses) on fixed maturity and equity securities included in accumulated other comprehensive income are as follows:
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Gross unrealized gains...................................... $180,329 $214,845 Gross unrealized losses..................................... (27,144) (60,136) Unrealized gain on foreign currency......................... 1,170 -- Adjustment to DAC and other deferred expenses............... (42,700) (43,000) Deferred income taxes....................................... (39,080) (39,099) -------- -------- Accumulated other comprehensive income...................... $ 72,575 $ 72,610 ======== ========
On October 30, 2002, the Company received a capital contribution of $200,000,000 in cash from the Parent. F-48 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. SHAREHOLDER'S EQUITY (Continued) Dividends that the Company may pay to its shareholder in any year without prior approval of the Arizona Department of Insurance are limited by statute. The maximum amount of dividends which can be paid to shareholders of insurance companies domiciled in the state of Arizona without obtaining the prior approval of the Insurance Commissioner is limited to the lesser of either 10% of the preceding year's statutory surplus or the preceding year's statutory net gain from operations if, after paying the dividend, the Company's capital and surplus would be adequate in the opinion of the Arizona Department of Insurance. Accordingly, the maximum amount of dividends that can be paid to stockholder in the year 2005 without obtaining prior approval is $83,649,000. Dividends of $2,500,000 were paid in 2004. Prior to the capital contribution of SAAMCo to the Company, SAAMCo paid dividends to its parent, SunAmerica Life Insurance Company, of $12,187,000 and $10,000,000 in 2003 and 2002, respectively. Under statutory accounting principles utilized in filings with insurance regulatory authorities, the Company's net income totaled $99,288,000 for the year ended December 31, 2004, net income of $89,071,000 and net loss of $180,737,000 for the years ended December 31, 2003 and 2002, respectively. The Company's statutory capital and surplus totaled $840,001,000 at December 31, 2004 and $602,348,000 at December 31, 2003. 11. INCOME TAXES The components of the provisions for income taxes on pretax income consist of the following:
YEARS ENDED DECEMBER 31, ------------------------------- 2004 2003 2002 -------- -------- --------- (IN THOUSANDS) Current expense (benefit)................................... $(42,927) $127,655 $(105,369) Deferred expense (benefit).................................. 49,337 (97,408) 105,529 -------- -------- --------- Total income tax expense.................................... $ 6,410 $ 30,247 $ 160 ======== ======== =========
Income taxes computed at the United States federal income tax rate of 35% and income tax expenses reflected in statement of income and comprehensive income provided differ as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Amount computed at statutory rate........................... $ 74,025 $ 43,322 $ 11,147 Increases (decreases) resulting from: State income taxes, net of federal tax benefit............ 4,020 2,273 (567) Dividends received deduction.............................. (19,058) (15,920) (10,117) Tax credits............................................... (4,000) -- -- Adjustment to prior year tax liability(a)................. (39,730) -- -- Other, net................................................ (8,847) 572 (303) -------- -------- -------- Total income tax expense.................................. $ 6,410 $ 30,247 $ 160 ======== ======== ========
------------------ (a) In 2004, the Company revised its estimate of tax contingency amount for prior year based on additional information that became available. Under prior federal income tax law, one-half of the excess of a life insurance company's income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as "policyholders' surplus". At December 31, 2004, the Company had approximately $14,300,000 of policyholders' surplus on which no deferred tax liability has been recognized, as federal income taxes are not required unless this amount is distributed as a dividend or recognized under other specified conditions. The American Jobs Creation Act of 2004 modified federal income tax law to allow life insurance companies to distribute amounts from policyholders' surplus during 2005 and 2006 without incurring federal income tax on the distributions. The Company eliminated its policyholders' surplus balance in January 2005. At December 31, 2004, the Company had net operating carryforwards, capital loss carryforwards and tax credit carryforwards for Federal income tax purposes of $15,515,000, $63,774,000 and $44,604,000, respectively, arising from F-49 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. INCOME TAXES (Continued) affordable housing investments no longer owned by SAAMCo. Such carryforwards expire in 2018, 2006 to 2008 and 2018, respectively. 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 liability for deferred income taxes are as follows:
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Deferred Tax Liabilities: Deferred acquisition costs and other deferred expenses...... $ 432,868 $ 473,387 State income taxes.......................................... 10,283 5,744 Other liabilities........................................... 15,629 350 Net unrealized gains on debt and equity securities available for sale.................................................. 39,080 39,098 --------- --------- Total deferred tax liabilities.............................. 497,860 518,579 --------- --------- Deferred Tax Assets: Investments................................................. (28,915) (25,213) Contract holder reserves.................................... (122,691) (158,112) Guaranty fund assessments................................... (3,402) (3,408) Deferred income............................................. (5,604) (3,801) Other assets................................................ (1,068) (7,446) Net operating loss carryforward............................. (5,430) -- Capital loss carryforward................................... (22,321) (20,565) Low income housing credit carryforward...................... (44,604) (36,600) Partnership income/loss..................................... (6,293) (20,878) --------- --------- Total deferred tax assets................................... (240,328) (276,023) --------- --------- Deferred income taxes....................................... $ 257,532 $ 242,556 ========= =========
The Company has concluded that the deferred tax asset will be fully realized and no valuation allowance is necessary. 12. RELATED-PARTY MATTERS As of December 31, 2004, subordinated notes payable to affiliates were paid off except for accrued interest totaling $460,000 which is included in other liabilities on the consolidated balance sheet. On February 15, 2004, the Company entered into a short-term financing arrangement with the Parent whereby the Company has the right to borrow up to $500,000,000 from the Parent and vice versa. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On February 15, 2004, the Company entered into a short-term financing arrangement with its affiliate, First SunAmerica Life Insurance Company ("FSA"), whereby the Company has the right to borrow up to $15,000,000 from FSA and vice versa. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On December 19, 2001, the Company entered into a short-term financing arrangement with AIGRS whereby AIGRS has the right to borrow up to $500,000,000. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On December 19, 2001, the Company entered into a short-term financing arrangement with SunAmerica Investments, Inc. ("SAII"), whereby SAII has the right to borrow up to $500,000,000 from the Company. Any advances made under this agreement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. F-50 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. RELATED-PARTY MATTERS (Continued) On September 26, 2001, the Company entered into a short-term financing arrangement with AIGRS. Under the terms of this agreement, the Company has immediate access of up to $500,000,000. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On September 26, 2001, the Company entered into a short-term financing arrangement with SAII, whereby the Company has the right to borrow up to $500,000,000. Any advances made under this agreement must be repaid within 30 days. At December 31, 2004 and 2003, the Company owed $0 and $14,000,000, respectively, under this agreement, which was included in due to affiliates. On October 31, 2003, the Company became a party to an existing credit agreement under which the Company agreed to make loans to AIG in an aggregate amount of up to $60,000,000. This commitment expires on October 28, 2005. There were no balances outstanding under this agreement at December 31, 2004. For the years ended December 31, 2004, 2003 and 2002, the Company paid commissions totaling $60,674,000, $51,716,000 and $59,058,000, respectively, to nine affiliated broker-dealers: Royal Alliance Associates, Inc.; SunAmerica Securities, Inc.; Advantage Capital Corporation; FSC Services Corporation; Sentra Securities Corporation; Spelman & Co., Inc.; VALIC Financial Advisors; American General Equity Securities Corporation and American General Securities Inc. These affiliated broker-dealers distribute a significant portion of the Company's variable annuity products amounting to approximately 23%, 24% and 31% of deposits for each of the respective years. Of the Company's mutual fund sales, approximately 25%, 23% and 28% were distributed by these affiliated broker-dealers for the years ended December 31, 2004, 2003 and 2002, respectively. On February 1, 2004, SAAMCo entered into an administrative services agreement with FSA whereby SAAMCo will pay to FSA a fee based on a percentage of all assets invested through FSA's variable annuity products in exchange for services performed. SAAMCo is the investment advisor for certain trusts that serve as investment options for FSA's variable annuity products. Amounts incurred by the Company under this agreement totaled $1,537,000 in 2004 and are included in the Company's consolidated statement of income and comprehensive income. A fee of $150,000, $1,620,000 and $1,777,000 was paid under a different agreement in 2004, 2003 and 2002, respectively. On October 1, 2001, SAAMCo entered into two administrative services agreements with business trusts established by its affiliate, The Variable Annuity Life Insurance Company ("VALIC"), whereby the trust pays to SAAMCo a fee based on a percentage of average daily net assets invested through VALIC's annuity products in exchange for services performed. Amounts earned by SAAMCo under this agreement totaled $9,074,000, $7,587,000 and $7,614,000 in 2004, 2003 and 2002, respectively, and are net of certain administrative costs incurred by VALIC of $2,593,000, $2,168,000 and $2,175,000, respectively. The net amounts earned by SAAMCo are included in other fees in the consolidated statement of income and comprehensive income. The Company has a support agreement in effect between the Company and AIG (the "Support Agreement"), pursuant to which AIG has agreed that AIG will cause the Company to maintain a policyholder's surplus of not less than $1,000,000 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 obligations 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. Contract holders 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 contract holder when due, have the right to enforce the Support Agreement directly against AIG. The Company's insurance policy obligations are guaranteed by American Home Assurance Company ("American Home"), a subsidiary of AIG, and a member of an AIG intercompany pool. This guarantee is unconditional and irrevocable, and the Company's contract holders have the right to enforce the guarantee directly against American Home. While American Home does not publish financial statements, it does file statutory annual and quarterly 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 F-51 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. RELATED-PARTY MATTERS (Continued) 1934, and publishes annual reports on Form 10-K and quarterly reports on Form 10-Q, which are available from the Securities and Exchange Commission. The Company's ultimate parent, AIG, has announced that it has delayed filing its Annual Report on Form 10-K for the year ended December 31, 2004 to allow AIG's Board of Directors and new management adequate time to complete an extensive review of AIG's books and records. The review includes issues arising from pending investigations into non-traditional insurance products and certain assumed reinsurance transactions by the Office of the Attorney General for the State of New York and the SEC and from AIG's decision to review the accounting treatment of certain additional items. Circumstances affecting AIG can have an impact on the Company. For example, the recent downgrades and ratings actions taken by the major rating agencies with respect to AIG, resulted in corresponding downgrades and ratings actions being taken with respect to the Company's ratings. Accordingly, we can give no assurance that any further changes in circumstances for AIG will not impact us. While the outcome of this investigation is not determinable at this time, management believes that the ultimate outcome will not have a material adverse effect on Company operating results, cash flows or financial position. Pursuant to a cost allocation agreement, the Company purchases administrative, investment management, accounting, legal, marketing and data processing services from its Parent, AIGRS and AIG. The allocation of such costs for investment management services is based on the level of assets under management. The allocation of costs for other services is based on estimated levels of usage, transactions or time incurred in providing the respective services. Amounts paid for such services totaled $148,554,000 for the year ended December 31, 2004, $126,531,000 for the year ended December 31, 2003 and $119,981,000 for the year ended December 31, 2002. The component of such costs that relate to the production or acquisition of new business during these periods amounted to $60,183,000, $48,733,000 and $49,004,000 respectively, and is deferred and amortized as part of deferred acquisition costs. The other components of such costs are included in general and administrative expenses in the consolidated 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 $3,712,000, $3,838,000 and $3,408,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The Company incurred $1,113,000, $500,000 and $790,000 of management fees to an affiliate of the Company to administer its securities lending program for the years ended December 31, 2004, 2003 and 2002, respectively (see Note 2). In December 2003, the Company purchased an affiliated bond with a carrying value of $37,129,000. At December 31, 2004, the affiliated bond has a market value of $34,630,000. F-52 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS The Company conducts its business through two business segments, annuity operations and asset management operations. Annuity operations consists of the sale and administration of deposit-type insurance contracts, including fixed and variable annuity contracts, universal life insurance contracts and GICs. Asset management operations, which includes the managing, distributing and administering a diversified family of mutual funds, managing certain subaccounts offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios, is conducted by SAAMCo and its subsidiary and distributor, SACS, and its subsidiary and servicing administrator, SFS. Following is selected information pertaining to the Company's business segments.
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2004: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 369,141 $ -- $ 369,141 Asset management fees..................................... -- 89,569 89,569 Universal life insurance policy fees, net of reinsurance............................................. 33,899 -- 33,899 Surrender charges......................................... 26,219 -- 26,219 Other fees................................................ -- 15,753 15,753 ----------- -------- ----------- Total fee income............................................ 429,259 105,322 534,581 Investment income........................................... 362,631 963 363,594 Net realized investment gains (losses)...................... (24,100) 293 (23,807) ----------- -------- ----------- Total revenues.............................................. 767,790 106,578 874,368 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 220,668 2,081 222,749 Amortization of bonus interest.............................. 10,357 -- 10,357 General and administrative expenses......................... 93,188 38,424 131,612 Amortization of deferred acquisition costs and other deferred expenses......................................... 126,142 31,508 157,650 Annual commissions.......................................... 64,323 -- 64,323 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 -- 17,420 Guaranteed benefits, net of reinsurance recoveries.......... 58,756 -- 58,756 ----------- -------- ----------- Total benefits and expenses................................. 590,854 72,013 662,867 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 176,936 $ 34,565 $ 211,501 =========== ======== =========== Total assets................................................ $31,323,462 $217,155 $31,540,617 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 132 $ 132 =========== ======== ===========
F-53 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS (Continued)
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2003: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 281,359 $ -- $ 281,359 Asset management fees..................................... -- 66,663 66,663 Universal life insurance policy fees, net of reinsurance............................................. 35,816 -- 35,816 Surrender charges......................................... 27,733 -- 27,733 Other fees................................................ -- 15,520 15,520 ----------- -------- ----------- Total fee income............................................ 344,908 82,183 427,091 Investment income........................................... 398,304 4,619 402,923 Net realized investment losses.............................. (30,354) -- (30,354) ----------- -------- ----------- Total revenues.............................................. 712,858 86,802 799,660 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 237,585 2,628 240,213 Amortization of bonus interest.............................. 19,776 -- 19,776 General and administrative expenses......................... 83,013 36,080 119,093 Amortization of deferred acquisition costs and other deferred expenses......................................... 137,130 22,976 160,106 Annual commissions.......................................... 55,661 -- 55,661 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,766 -- 17,766 Guaranteed benefits, net of reinsurance recoveries.......... 63,268 -- 63,268 ----------- -------- ----------- Total benefits and expenses................................. 614,199 61,684 675,883 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 98,659 $ 25,118 $ 123,777 =========== ======== =========== Total assets................................................ $27,781,457 $190,270 $27,971,727 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 2,977 $ 2,977 =========== ======== ===========
F-54 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS (Continued)
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2002: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 286,919 $ -- $ 286,919 Asset management fees..................................... -- 66,423 66,423 Universal life insurance policy fees, net of reinsurance............................................. 36,253 -- 36,253 Surrender charges......................................... 32,507 -- 32,507 Other fees................................................ 3,304 18,596 21,900 ----------- -------- ----------- Total fee income............................................ 358,983 85,019 444,002 Investment income........................................... 377,556 9,799 387,355 Net realized investment losses.............................. (65,811) -- (65,811) ----------- -------- ----------- Total revenues.............................................. 670,728 94,818 765,546 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 234,261 3,868 238,129 Amortization of bonus interest.............................. 16,277 -- 16,277 General and administrative expenses......................... 79,287 35,923 115,210 Amortization of deferred acquisition costs and other deferred expenses......................................... 171,583 50,901 222,484 Annual commissions.......................................... 58,389 -- 58,389 Claims on universal life contracts, net of reinsurance recoveries................................................ 15,716 -- 15,716 Guaranteed benefits, net of reinsurance recoveries.......... 67,492 -- 67,492 ----------- -------- ----------- Total benefits and expenses................................. 643,005 90,692 733,697 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 27,723 $ 4,126 $ 31,849 =========== ======== =========== Total assets................................................ $23,538,832 $214,157 $23,752,989 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 7,297 $ 7,297 =========== ======== ===========
F-55 - -------------------------------------------------------------------------------- TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION - -------------------------------------------------------------------------------- Additional information concerning the operations of the separate account is contained in a Statement of Additional Information ("SAI"), which is available without charge upon written request addressed to us at our Annuity Service Center, P.O. Box 54299, Los Angeles, California 90054-0299 or by calling (800) 445-SUN2. The contents of the SAI are tabulated below.
PAGE ---- Separate Account............................................ 1 General Account............................................. 1 Support Agreement Between the Company and AIG............... 1 Performance Data............................................ 1 Income Payments............................................. 3 Annuity Unit Values......................................... 4 Taxes....................................................... 7 Distribution of Contracts................................... 12 Financial Statements........................................ 13
F-56 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- APPENDIX A - MARKET VALUE ADJUSTMENT ("MVA") - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The information in this Appendix applies only if you take money out of a FAGP (with a duration longer than 1 year) before the end of the guarantee period. We calculate the MVA by doing a comparison between current rates and the rate being credited to you in the FAGP. For the current rate We use a rate being offered by Us for a guarantee period that is equal to the time remaining in the FAGP from which you seek withdrawal (rounded up to a full number of years). If we are not currently offering a guarantee period for that period of time, We determine an applicable rate by using a formula to arrive at a number based on the interest rates currently offered for the two closest periods available. Where the MVA is negative, We first deduct the adjustment from any money remaining in the FAGP. If there is not enough money in the FAGP to meet the negative deduction, We deduct the remainder from your withdrawal. Where the MVA is positive, We add the adjustment to your withdrawal amount. If a withdrawal charge applies, it is deducted before the MVA calculation. The MVA is assessed on the amount withdrawn less any withdrawal charges. The MVA is computed by multiplying the amount withdrawn, transferred or taken under an income option by the following factor: [(1+I/(1+J+L)]N/12 - 1 where: I is the interest rate you are earning on the money invested in the FAGP; J is the interest rate then currently available for the period of time equal to the number of years remaining in the term you initially agreed to leave your money in the FAGP; N is the number of full months remaining in the term you initially agreed to leave your money in the FAGP; and L is 0.005 (some states require a different value. Please see your contract.) We do not assess an MVA against withdrawals from an FAGP under the following circumstances: - If a withdrawal is made within 30 days after the end of a guarantee period; - If a withdrawal is made to pay contract fees and charges; - To pay a death benefit; and - Upon beginning an income option, if occurring on the Latest Annuity Date. EXAMPLES OF THE MVA The purpose of the examples below is to show how the MVA adjustments are calculated and may not reflect the Guarantee periods available or Surrender Charges applicable under your contract. The examples below assume the following: (1) You made an initial Purchase Payment of $10,000 and allocated it to a FAGP at a rate of 5%; (2) You make a partial withdrawal of $4,000 when 1 1/2 years (18 months) remain in the term you initially agreed to leave your money in the FAGP (N=18); (3) You have not made any other transfers, additional Purchase Payments, or withdrawals; and (4) Your contract was issued in a state where L=0.005. POSITIVE ADJUSTMENT, NO WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for a new Purchase Payments in the 1-year FAGP is 3.5% and the 3-year FAGP is 4.5%. By linear interpolation, the interest rate for A-1 the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 4%. No withdrawal charge is reflected in this example, assuming that the Purchase Payment withdrawn falls within the free look amount. The MVA factor is = [(1+I/(1+J+0.005)]N/12 - 1 = [(1.05)/(1.04+0.005)](18/12) - 1 = (1.004785)1.5 - 1 = 1.007186 - 1 = + 0.007186 The requested withdrawal amount is multiplied by the MVA factor to determine the MVA: $4,000 X (+0.007186) = +$28.74 $28.74 represents the positive MVA that would be added to the withdrawal. NEGATIVE ADJUSTMENT, NO WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year FAGP is 5.5% and the 3-year FAGP is 6.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 6%. No withdrawal charge is reflected in this example, assuming that the Purchase Payment withdrawn falls with the free withdrawal amount. The MVA factor is = [(1+I)/(1+J+0.005)](N/12) - 1 = [(1.05)/(1.06+0.005)](18/12) - 1 = (0.985915)(1.5) - 1 = 0.978948 - 1 = - 0.021052 The requested withdrawal amount is multiplied by the MVA factor to determine the MVA: $4,000 X (-0.021052) = -$84.21 $84.21 represents the negative MVA that will be deducted from the money remaining in the 3-year FAGP. POSITIVE ADJUSTMENT, WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year FAGP is 3.5% and the 3-year FAGP is 4.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 4%. A withdrawal charge of 6% is reflected in this example, assuming that the Purchase Payment withdrawn exceeds the free withdrawal amount. The MVA factor is = [(1+I)/(I+J+0.005)](N/12) - 1 = [(1.05)/(1.04+0.005)](18/12) - 1 = (1.004785)(1.5) - 1 = 1.007186 - 1 = + 0.007186 The requested withdrawal amount, less the withdrawal charge ($4,000 - 6% = $3,760) is multiplied by the MVA factor to determine the MVA: $3,760 X (+0.007186) = +$27.02 $27.02 represents the positive MVA that would be added to the withdrawal. A-2 NEGATIVE ADJUSTMENT, WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year FAGP is 5.5% and the 3-year FAGP is 6.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 6%. A withdrawal charge of 6% is reflected in this example, assuming that the Purchase Payment withdrawn exceeds the free withdrawal amount. The MVA factor is = [(1+I)/(I+J+0.005)](N/12) - 1 = [(1.05)/(1.06+0.005)](18/12) - 1 = (0.985915)(1.5) - 1 = 0.978948 - 1 = - 0.021052 The requested withdrawal amount, less the withdrawal charge ($4,000 - 6% = $3,760) is multiplied by the MVA factor to determine the MVA: $3,760 X (-0.021052) = -$79.16 $79.16 represents the negative MVA that would be deducted from the withdrawal. A-3 APPENDIX B WITHDRAWALS AND WITHDRAWAL CHARGES PART 1 -- SEPARATE ACCOUNT (THE MVA DOES NOT APPLY TO THE SEPARATE ACCOUNT) These examples assume the following: (1) The initial Purchase Payment was $10,000, allocated solely to one Variable Portfolio; (2) The date of full surrender or partial withdrawal occurs during the 3rd contribution year; (3) The contract value at the time of surrender or withdrawal is $12,000; and (4) No other Purchase Payments or previous partial withdrawals have been made. EXAMPLE A -- FULL SURRENDER: (1) Earnings in the Variable Portfolio ($12,000 - $10,000 = $2,000) are not subject to the withdrawal charge. (2) The balance of the full surrender ($12,000 - $2,000 = $10,000) is subject to a 5% withdrawal charge applicable during the 3rd contribution year. (3) The amount of the withdrawal charge is .05 X $10,000 = $500. (4) The contract administration charge is deducted from the full surrender amount. The amount of the full surrender is $12,000 - $500 - $30 = $11,470. EXAMPLE B -- PARTIAL WITHDRAWAL (IN THE AMOUNT OF $3,000): (1) For the same reasons as given in Steps 1 and 2 of Example A, above, $2,000 can be withdrawn free of the withdrawal charge. (2) Although 10% of the Purchase Payment is available without imposition of a withdrawal charge (.10 X $10,000 = $1,000), this free withdrawal amount is, like the withdrawal charge, applied first to earnings. Since the earnings exceed the free withdrawal amount, only the earnings can be withdrawn free of the scheduled withdrawal charge. (3) The balance of the requested partial withdrawal ($3,000 - $2,000 = $1,000) is subject to the withdrawal charge applicable during the 3rd contribution year (5%). (4) The amount of the withdrawal charge is equal to the amount required to complete the partial withdrawal ($3,000 - $2,000 = $1,000) divided by (1 - .05) = 0.95, less the amount required to complete the partial withdrawal. withdrawal charge = ($1,000/0.95) - $1,000 = $52.63 In this example, in order for the owner to receive the amount requested ($3,000), a gross withdrawal of $3,052.63 must be processed with $52.63 representing the withdrawal charge calculated above. Examples C and D assume the following: (1) The initial Purchase Payment was $20,000, allocated solely to one Variable Portfolio; (2) The full surrender or partial withdrawal occurs during the 3rd contribution year; B-1 (3) The owner's contract value at the time of surrender or withdrawal is $21,500; and (4) No other Purchase Payments or partial withdrawals have been made. EXAMPLE C -- PARTIAL WITHDRAWAL (IN THE MAXIMUM AMOUNT AVAILABLE WITHOUT WITHDRAWAL CHARGE): (1) Earnings in the Variable Portfolio ($21,500 - $20,000 = $1,500) are not subject to the withdrawal charge. (2) An additional free withdrawal of 10% of the Purchase Payments less earnings (.10 X $20,000 - $1,500 = $500) is also available free of the withdrawal charge, so that (3) The maximum partial withdrawal without withdrawal charge is the sum of the earnings and the additional free withdrawal ($1,500 + $500 = $2,000). EXAMPLE D -- FULL SURRENDER IMMEDIATELY FOLLOWING THE PARTIAL WITHDRAWAL IN EXAMPLE C: (1) The owner's contract value after the partial withdrawal in Example C is $21,500 - $2,000 = $19,500. (2) The Purchase Payment amount for calculating the withdrawal charge is the original $20,000 (additional free withdrawal amounts do not reduce the Purchase Payment amount for purposes of calculating the withdrawal charge). (3) The amount of the withdrawal charge is .05 X $20,000 = $1,000. (4) The contract administration charge is deducted from the full surrender amount. The amount of the full surrender is $19,500 - $1,000 - $30 = $18,470. B-2 APPENDIX C - -------------------------------------------------------------------------------- CONDENSED FINANCIAL INFORMATION ACCUMULATION UNIT VALUES - --------------------------------------------------------------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR ENDED ENDED ENDED ENDED ENDED ENDED PORTFOLIOS 08/31/99 08/31/00 08/31/01 08/31/02 08/31/03 08/31/04* ---------- ----------- ----------- ----------- ----------- ----------- ----------- International Growth and Income Beginning AUV........................ $ 9.06 $ 11.17 $ 13.29 $ 9.86 $ 9.00 $ 9.52 Ending AUV........................... $ 11.17 $ 13.29 $ 9.86 $ 9.00 $ 9.52 $ 11.56 Ending Number of AUs................. 172,015 122,347 96,244 74,974 66,836 53,654 Marsico Growth Beginning AUV........................ $ 6.51 $ 8.38 $ 10.58 $ 9.32 $ 7.20 $ 8.77 Ending AUV........................... $ 8.38 $ 10.58 $ 9.32 $ 7.20 $ 8.77 $ 9.03 Ending Number of AUs................. 600,016 430,405 382,117 308,664 250,526 195,909 Davis Venture Value Beginning AUV........................ $ 26.42 $ 31.58 $ 34.37 $ 28.01 $ 23.28 $ 25.55 Ending AUV........................... $ 31.58 $ 34.37 $ 28.01 $ 23.28 $ 25.55 $ 28.59 Ending Number of AUs................. 191,670 138,405 127,654 103,707 84,804 61,759 MFS Total Return Beginning AUV........................ $ 22.28 $ 24.56 $ 26.48 $ 22.13 $ 19.88 $ 21.16 Ending AUV........................... $ 24.56 $ 26.48 $ 22.13 $ 19.88 $ 21.16 $ 23.40 Ending Number of AUs................. 58,170 46,711 43,603 39,791 32,277 24,555 Government and Quality Bond Beginning AUV........................ $ -- $ -- $ -- $ -- $ -- $ -- Ending AUV........................... $ -- $ -- $ -- $ -- $ -- $ 16.89 Ending Number of AUs................. -- -- -- -- -- 746 Cash Management Beginning AUV........................ $ 10.80 $ 10.61 $ 11.27 $ 12.12 $ 12.85 $ 12.91 Ending AUV........................... $ 10.61 $ 11.27 $ 12.12 $ 12.85 $ 12.91 $ 12.85 Ending Number of AUs................. 118,385 90,833 87,786 75,247 50,366 32,307
- --------------- AUV -- Accumulation Unit Value AU -- Accumulation Units * On December 5, 2003, the six portfolios of the Mutual Fund Variable Annuity Trust (the "old trust") were merged into five portfolios of the SunAmerica Series Trust (the "new trusts). In addition to the mergers a new portfolio was added of the Anchor Series Trust. As a result of this merger, the units outstanding and unit values for all prior years have been retroactively restated. C-1 - -------------------------------------------------------------------------------- Please forward a copy (without charge) of the Statement of Additional Information concerning Vista Capital Advantage issued by AIG SunAmerica Life Assurance Company to: (Please print or type and fill in all information.) --------------------------------------------------------------------- Name --------------------------------------------------------------------- Address --------------------------------------------------------------------- City/State/Zip Date: ------------------------------------ Signed: ---------------------------------------
Return to: AIG SunAmerica Life Assurance Company, Annuity Service Center, P.O. Box 52499, Los Angeles, California 90054-0299 - -------------------------------------------------------------------------------- (POLARIS CHOICE II LOGO) PROSPECTUS MAY 2, 2005 Please read this prospectus carefully FLEXIBLE PAYMENT DEFERRED ANNUITY CONTRACTS before investing and keep it for issued by future reference. It contains AIG SUNAMERICA LIFE ASSURANCE COMPANY important information about the in connection with variable annuity. VARIABLE SEPARATE ACCOUNT The annuity has several investment choices - Variable Portfolios listed below and To learn more about the annuity available fixed account options. The Variable Portfolios are part of the Anchor offered in this prospectus, you can Series Trust ("AST"), SunAmerica Series Trust ("SAST"), American Funds Insurance obtain a copy of the Statement of Series ("AFIS"), Lord Abbett Series Fund, Inc. ("LASF"), Nations Separate Account Additional Information ("SAI") dated Trust ("NSAT") and Van Kampen Life Investment Trust ("VKT"). May 2, 2005. The SAI has been filed with the United States Securities and STOCKS: Exchange Commission ("SEC") and is MANAGED BY AIG SUNAMERICA ASSET MANAGEMENT CORP. incorporated by reference into this - Aggressive Growth Portfolio SAST prospectus. The Table of Contents of - Blue Chip Growth Portfolio SAST the SAI appears at the end of this - "Dogs" of Wall Street Portfolio* SAST prospectus. For a free copy of the - Growth Opportunities Portfolio SAST SAI, call us at (800) 445-SUN2 or MANAGED BY ALLIANCEBERNSTEIN write to us at our Annuity Service - Small & Mid Cap Value Portfolio SAST Center, P.O. Box 54299, Los Angeles, MANAGED BY ALLIANCE CAPITAL MANAGEMENT L.P. California 90054-0299. - Alliance Growth Portfolio SAST - Global Equities Portfolio SAST In addition, the SEC maintains a - Growth & Income Portfolio SAST website (http://www.sec.gov) that MANAGED BY CAPITAL RESEARCH AND MANAGEMENT COMPANY contains the SAI, materials - American Funds Global Growth Portfolio AFIS incorporated by reference and other - American Funds Growth Portfolio AFIS information filed electronically with - American Funds Growth-Income Portfolio AFIS the SEC by the Company. MANAGED BY DAVIS ADVISORS - Davis Venture Value Portfolio SAST ANNUITIES INVOLVE RISKS, INCLUDING - Real Estate Portfolio SAST POSSIBLE LOSS OF PRINCIPAL, AND ARE MANAGED BY FEDERATED EQUITY MANAGEMENT COMPANY NOT A DEPOSIT OR OBLIGATION OF, OR - Federated American Leaders Portfolio* SAST GUARANTEED OR ENDORSED BY, ANY BANK. MANAGED BY GOLDMAN SACHS ASSET MANAGEMENT, L.P. THEY ARE NOT FEDERALLY INSURED BY THE - Goldman Sachs Research Portfolio SAST FEDERAL DEPOSIT INSURANCE MANAGED BY LORD, ABBETT & CO. CORPORATION, THE FEDERAL RESERVE - Lord Abbett Series Fund Growth and Income Portfolio LASF BOARD OR ANY OTHER AGENCY. MANAGED BY MARSICO CAPITAL MANAGEMENT, LLC - Nations Marsico Focused Equities Portfolio NSAT MANAGED BY MASSACHUSETTS FINANCIAL SERVICES COMPANY - MFS Massachusetts Investors Trust Portfolio SAST - MFS Mid-Cap Growth Portfolio SAST MANAGED BY PUTNAM INVESTMENT MANAGEMENT, LLC - Emerging Markets Portfolio SAST - International Growth & Income Portfolio SAST - Putnam Growth: Voyager Portfolio SAST MANAGED BY TEMPLETON INVESTMENT COUNSEL, LLC - Foreign Value Portfolio SAST MANAGED BY VAN KAMPEN/VAN KAMPEN ASSET MANAGEMENT - International Diversified Equities Portfolio SAST - Technology Portfolio SAST - Van Kampen LIT Comstock Portfolio, Class II Shares* VKT - Van Kampen LIT Emerging Growth Portfolio, Class II Shares VKT - Van Kampen LIT Growth and Income Portfolio, Class II Shares VKT MANAGED BY WELLINGTON MANAGEMENT COMPANY, LLP - Capital Appreciation Portfolio AST - Growth Portfolio AST - Natural Resources Portfolio AST BALANCED: MANAGED BY AIG SUNAMERICA ASSET MANAGEMENT CORP. - SunAmerica Balanced Portfolio SAST MANAGED BY MASSACHUSETTS FINANCIAL SERVICES COMPANY - MFS Total Return Portfolio SAST MANAGED BY WM ADVISORS, INC. - Asset Allocation Portfolio AST BONDS: MANAGED BY AIG SUNAMERICA ASSET MANAGEMENT CORP. - High-Yield Bond Portfolio SAST MANAGED BY FEDERATED INVESTMENT MANAGEMENT COMPANY - Corporate Bond Portfolio SAST MANAGED BY GOLDMAN SACHS ASSET MANAGEMENT INTERNATIONAL - Global Bond Portfolio SAST MANAGED BY MACKAY SHIELDS LLC - Nations High Yield Bond Portfolio NSAT MANAGED BY WELLINGTON MANAGEMENT COMPANY, LLP - Government & Quality Bond Portfolio AST MANAGED BY BANC OF AMERICA CAPITAL MANAGEMENT, LLC - Cash Management Portfolio SAST * "Dogs of Wall Street" Portfolio is an equity fund seeking total return; Federated American Leaders Portfolio is an equity fund seeking growth of capital and income; and Van Kampen LIT Comstock Portfolio is an equity fund, seeking capital growth and income.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION, NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
-------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------- TABLE OF CONTENTS -------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------- GLOSSARY........................................................................ 2 HIGHLIGHTS...................................................................... 3 FEE TABLES...................................................................... 4 Maximum Owner Transaction Expenses........................................... 4 Contract Maintenance Fee..................................................... 4 Separate Account Annual Expenses............................................. 4 Additional Optional Feature Fee.............................................. 4 Optional Polaris Income Rewards Fee.......................................... 4 Optional Capital Protector Fee............................................... 4 Underlying Fund Expenses..................................................... 4 EXAMPLES........................................................................ 5 THE POLARIS CHOICE(II) VARIABLE ANNUITY......................................... 6 PURCHASING A POLARIS CHOICE(II) VARIABLE ANNUITY................................ 6 Allocation of Purchase Payments.............................................. 7 Accumulation Units........................................................... 7 Right to Examine or Free Look................................................ 7 INVESTMENT OPTIONS.............................................................. 8 Variable Portfolios.......................................................... 8 Anchor Series Trust...................................................... 8 SunAmerica Series Trust.................................................. 8 American Funds Insurance Series.......................................... 8 Lord Abbett Series Fund, Inc. ........................................... 8 Nations Separate Account Trust........................................... 8 Van Kampen Life Investment Trust......................................... 8 Fixed Account Options........................................................ 9 Dollar Cost Averaging Fixed Accounts......................................... 9 Dollar Cost Averaging Program................................................ 10 Asset Allocation Program..................................................... 10 Transfers During the Accumulation Phase...................................... 11 Automatic Asset Rebalancing Program.......................................... 13 Return Plus Program.......................................................... 13 Voting Rights................................................................ 13 Substitution, Addition or Deletion of Variable Portfolios.................... 13 ACCESS TO YOUR MONEY............................................................ 14 Systematic Withdrawal Program................................................ 15 Minimum Contract Value....................................................... 15 OPTIONAL LIVING BENEFITS........................................................ 15 Polaris Income Rewards....................................................... 15 Capital Protector............................................................ 18 DEATH BENEFIT................................................................... 20 Standard Death Benefit....................................................... 21 Optional Enhanced Death Benefits............................................. 21 Optional EstatePlus Feature.................................................. 22 Spousal Continuation......................................................... 23 EXPENSES........................................................................ 23 Separate Account Expenses.................................................... 23 Withdrawal Charges........................................................... 23 Underlying Fund Fees......................................................... 24 Contract Maintenance Fee..................................................... 24 Transfer Fee................................................................. 24 Optional Polaris Income Rewards Fee.......................................... 24 Optional Capital Protector Fee............................................... 24 Optional Enhanced Death Benefit Fee.......................................... 42 Optional EstatePlus Fee...................................................... 24 Premium Tax.................................................................. 24 Income Taxes................................................................. 25 Reduction or Elimination of Charges and Expenses, and Additional Amounts Credited................................................................... 25 INCOME OPTIONS.................................................................. 25 Annuity Date................................................................. 25 Income Options............................................................... 25 Fixed or Variable Income Payments............................................ 26 Income Payments.............................................................. 26 Transfers During the Income Phase............................................ 26 Deferment of Payments........................................................ 26 TAXES........................................................................... 26 Annuity Contracts in General................................................. 26 Tax Treatment of Distributions - Non-Qualified Contracts..................... 27 Tax Treatment of Distributions - Qualified Contracts......................... 27 Minimum Distributions........................................................ 27 Tax Treatment of Death Benefits.............................................. 28 Contracts Owned by a Trust or Corporation.................................... 28 Gifts, Pledges and/or Assignments of a Contract.............................. 28 Diversification and Investor Control......................................... 29 OTHER INFORMATION............................................................... 29 The Separate Account......................................................... 29 The General Account.......................................................... 29 Registration Statements...................................................... 29 Payments in Connection with Distribution of the Contract..................... 29 Administration............................................................... 30 Legal Proceedings............................................................ 30 TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION........................ F-56 APPENDIX A - CONDENSED FINANCIALS............................................... A-1 APPENDIX B - MARKET VALUE ADJUSTMENT ("MVA").................................... B-1 APPENDIX C - DEATH BENEFITS FOLLOWING SPOUSAL CONTINUATION...................... C-1 APPENDIX D - POLARIS INCOME REWARDS EXAMPLES.................................... D-1 APPENDIX E - STATE CONTRACT AVAILABILITY AND/OR VARIATIONS OF CERTAIN FEATURES AND BENEFITS................................................................... E-1
---------------------------------------------------------------- ---------------------------------------------------------------- GLOSSARY ---------------------------------------------------------------- ---------------------------------------------------------------- We have capitalized some of the technical terms used in this prospectus. To help you understand these terms, we have defined them in this glossary. ACCUMULATION PHASE - The period during which you invest money in your contract. ACCUMULATION UNITS - A measurement we use to calculate the value of the variable portion of your contract during the Accumulation Phase. ANNUITANT - The person on whose life we base income payments. ANNUITY DATE - The date on which you select income payments to begin. ANNUITY UNITS - A measurement we use to calculate the amount of income payments you receive from the variable portion of your contract during the Income Phase. BENEFICIARY - The person designated to receive any benefits under the contract if you or the Annuitant dies. COMPANY - Refers to AIG SunAmerica Life Assurance Company, the insurer that issues this contract. The term "we," "us," "our," and "AIG SunAmerica Life" are also used to identify the Company. CONTINUING SPOUSE - Spouse of original contract owner at the time of death who elects to continue the contract after the death of the original contract owner. FIXED ACCOUNT - An account, if available, that we may offer in which you may invest money and earn a fixed rate of return. INCOME PHASE - The period during which we make income payments to you. LATEST ANNUITY DATE - Your 95th birthday or tenth contract anniversary, whichever is later. MARKET CLOSE - The close of the New York Stock Exchange, usually at 1:00 p.m. Pacific Time. NON-QUALIFIED (CONTRACT) - A contract purchased with after-tax dollars. In general, these contracts are not under any pension plan, specially sponsored program or individual retirement account ("IRA"). NYSE - New York Stock Exchange OWNER - The person or entity (if a non-natural owner) with an interest or title to this contract. The term "you" or "your" are also used to identify the Owner. PURCHASE PAYMENTS - The money you give us to buy and invest in the contract. QUALIFIED (CONTRACT) - A contract purchased with pretax dollars. These contracts are generally purchased under a pension plan, specially sponsored program or IRA. SEPARATE ACCOUNT - A segregated asset account maintained separately from the Company's regular portfolio of investments and general accounts. The Separate Account is established by the Company to purchase and hold the Variable Portfolios. TRUSTS - Collectively refers to the American Funds Insurance Series, Anchor Series Trust, the SunAmerica Series Trust, Lord Abbett Series Fund, Inc., Nations Separate Account Trust and Van Kampen Life Investment Trust. UNDERLYING FUNDS - The underlying investment portfolios of the Trusts in which the Variable Portfolios invest. VARIABLE PORTFOLIO(S) - The variable investment options available under the contract. Each Variable Portfolio has its own investment objective and is invested in the Underlying Funds of the Trusts. 2 ---------------------------------------------------------------- ---------------------------------------------------------------- HIGHLIGHTS ---------------------------------------------------------------- ---------------------------------------------------------------- The Polaris Choice(II) Variable Annuity is a contract between you and AIG SunAmerica Life. It is designed to help you invest on a tax-deferred basis and meet long-term financial goals. There are minimum Purchase Payment amounts required to purchase a contract. Purchase Payments may be invested in a variety of variable and fixed account options. Like all deferred annuities, the contract has an Accumulation Phase and an Income Phase. During the Accumulation Phase, you invest money in your contract. The Income Phase begins when you start receiving income payments from your annuity to provide for your retirement. FREE LOOK: You may cancel your contract within 10 days after receiving it (or whatever period is required in your state). You will receive whatever your contract is worth on the day that we receive your request. The amount refunded may be more or less than your original Purchase Payment. We will return your original Purchase Payment if required by law. Please see PURCHASING A POLARIS CHOICE(II) VARIABLE ANNUITY in the prospectus. EXPENSES: There are fees and charges associated with the contract. Each year, we deduct a $35 contract maintenance fee from your contract, which may be waived for contracts of $50,000 or more. We also deduct separate account charges which equal 1.52% annually of the average daily value of your contract allocated to the Variable Portfolios. There are investment charges on amounts invested in the Variable Portfolios. If you elect optional features available under the contract we may charge additional fees for those features. A separate withdrawal charge schedule applies to each Purchase Payment. The amount of the withdrawal charge declines over time. After a Purchase Payment has been in the contract for three complete years, withdrawal charges no longer apply to that Purchase Payment. Please see the FEE TABLE, PURCHASING A POLARIS CHOICE(II) VARIABLE ANNUITY and EXPENSES in the prospectus. ACCESS TO YOUR MONEY: You may withdraw money from your contract during the Accumulation Phase. If you do so, earnings are deemed to be withdrawn first. You will pay income taxes on earnings and untaxed contributions when you withdraw them. Payments received during the Income Phase are considered partly a return of your original investment. A federal tax penalty may apply if you make withdrawals before age 59 1/2. As noted above, a withdrawal charge may apply. Please see ACCESS TO YOUR MONEY and TAXES in the prospectus. OPTIONAL LIVING BENEFITS: You may elect one of the optional living benefits available under your contract. For an additional fee, these features are designed to protect a portion of your investment in the event your contract value declines due to unfavorable investment performance during the Accumulation Phase and before a death benefit is payable. See OPTIONAL LIVING BENEFITS below. DEATH BENEFIT: A death benefit feature is available under the contract to protect your Beneficiaries in the event of your death during the Accumulation Phase. Please see DEATH BENEFITS in the prospectus. INCOME OPTIONS: When you are ready to begin taking income, you can choose to receive income payments on a variable basis, fixed basis or a combination of both. You may also choose from five different income options, including an option for income that you cannot outlive. Please see INCOME OPTIONS in the prospectus. INQUIRIES: If you have questions about your contract call your financial representative or contact us at AIG SunAmerica Life Assurance Company Annuity Service Center P.O. Box 54299 Los Angeles, California 90054-0299. Telephone Number: (800) 445-SUN2. See Appendix E for information regarding state contract availability and state specific variations of certain features and benefits. THE COMPANY OFFERS SEVERAL DIFFERENT VARIABLE ANNUITY CONTRACTS TO MEET THE DIVERSE NEEDS OF OUR INVESTORS. OUR CONTRACTS MAY PROVIDE DIFFERENT FEATURES, BENEFITS AND PROGRAMS OFFERED AT DIFFERENT FEES AND EXPENSES. WHEN WORKING WITH YOUR FINANCIAL REPRESENTATIVE TO DETERMINE THE BEST PRODUCT TO MEET YOUR NEEDS, YOU SHOULD CONSIDER AMONG OTHER THINGS, WHETHER THE FEATURES OF THIS CONTRACT AND THE RELATED FEES PROVIDE THE MOST APPROPRIATE PACKAGE TO HELP YOU MEET YOUR RETIREMENT SAVINGS GOALS. IF YOU WOULD LIKE MORE INFORMATION REGARDING HOW MONEY IS SHARED AMONGST OUR BUSINESS PARTNERS, INCLUDING BROKER-DEALERS THROUGH WHICH YOU MAY PURCHASE A VARIABLE ANNUITY, SEE THE PAYMENTS IN CONNECTION WITH DISTRIBUTION OF THE CONTRACT SECTION UNDER OTHER INFORMATION. PLEASE READ THE PROSPECTUS CAREFULLY FOR MORE DETAILED INFORMATION REGARDING THESE AND OTHER FEATURES AND BENEFITS OF THE CONTRACT, AS WELL AS THE RISKS OF INVESTING. 3 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FEE TABLES - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU WILL PAY AT THE TIME THAT YOU BUY THE CONTRACT, TRANSFER CASH VALUE BETWEEN INVESTMENT OPTIONS OR SURRENDER THE CONTRACT. IF APPLICABLE, YOU MAY ALSO BE SUBJECT TO STATE PREMIUM TAXES. MAXIMUM OWNER TRANSACTION EXPENSES MAXIMUM WITHDRAWAL CHARGES (AS A PERCENTAGE OF EACH PURCHASE PAYMENT)(1) 7% TRANSFER FEE.................. $25 per transfer after the first 15 transfers in any contract year.
THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU MAY PAY PERIODICALLY DURING THE TIME THAT YOU OWN THE CONTRACT, NOT INCLUDING UNDERLYING FUND EXPENSES WHICH ARE OUTLINED IN THE NEXT SECTION. CONTRACT MAINTENANCE FEE(2) $35 SEPARATE ACCOUNT ANNUAL EXPENSES (deducted daily as a percentage of your average daily net asset value) Mortality and Expense Risk Fees................................................. 1.37% Distribution Expense Fee........................................................ 0.15% Optional Enhanced Death Benefit Fee(3).......................................... 0.20% Optional EstatePlus Fee(3,4).................................................... 0.25% ===== TOTAL SEPARATE ACCOUNT ANNUAL EXPENSES...................................... 1.97%
ADDITIONAL OPTIONAL FEATURE FEE You may elect only one of the following optional features: Capital Protector or Polaris Income Rewards described below. OPTIONAL POLARIS INCOME REWARDS FEE(5) (calculated as a percentage of your Purchase Payments received in the first 90 days adjusted for withdrawals)
TIME PERIOD ANNUALIZED FEE ----------- -------------- 0-7........................................................................... 0.65% 8-10.......................................................................... 0.45% 11+........................................................................... none
OPTIONAL CAPITAL PROTECTOR FEE(6) (calculated as a percentage of your contract value minus Purchase Payments received after the 90th day since you purchased your contract)
CONTRACT YEAR ANNUALIZED FEE ------------- -------------- 0-5........................................................................... 0.65% 6-10.......................................................................... 0.45% 11+........................................................................... none
FOOTNOTES TO THE FEE TABLES: (1) Withdrawal Charge Schedule (as a percentage of each Purchase Payment) declines over 3 years as follows: YEARS:...................................................... 1 2 3 4 7% 6% 5% 0%
(2) The contract maintenance fee may be waived if contract value is $50,000 or more. (3) If you do not elect the optional Enhanced Death Benefit and the EstatePlus feature, your total separate account annual expenses would be 1.52%. (4) EstatePlus is an optional earnings enhancement death benefit. EstatePlus can only be elected if an optional enhanced death benefit is also elected. (5) The Polaris Income Rewards feature is an optional guaranteed minimum withdrawal benefit. The fee is deducted from your contract value at the end of the first quarter following election and quarterly thereafter. (6) The Capital Protector feature is an optional guaranteed minimum accumulation benefit. The fee is deducted from your contract value at the end of the first quarter following election and quarterly thereafter. UNDERLYING FUND EXPENSES
TOTAL ANNUAL UNDERLYING FUND EXPENSES MINIMUM MAXIMUM ------------------------------------- ------- ------- (expenses that are deducted from Underlying Funds of the Trusts, including management fees, other expenses and 12b-1 fees if applicable)...................................... 0.55% 1.85%
4 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- MAXIMUM AND MINIMUM EXPENSE EXAMPLES - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- These examples are intended to help you compare the cost of investing in the contract with the cost of investing in other variable annuity contracts. These costs include owner transaction expenses, the contract maintenance fee if any, separate account annual expenses, available optional feature fees and Underlying Fund expenses. The examples assume that you invest $10,000 in the contract for the time periods indicated; that your investment has a 5% return each year; and you incur the maximum and minimum fees and expenses of the Underlying Fund. Although your actual costs may be higher or lower, based on these assumptions, your costs at the end of the stated period would be: MAXIMUM EXPENSE EXAMPLES (assuming maximum separate account annual expenses of 1.97% (including the optional Enhanced Death Benefit (0.20%) and the optional Estate Plus (0.25%)) and investment in an Underlying Fund with total expenses of 1.85%) (1) If you surrender your contract at the end of the applicable time period and you elect the optional Polaris Income Rewards (0.65% for years 0-7 and 0.45% for years 8-10)
1 YEAR 3 YEARS 5 YEARS 10 YEARS - --------------------------------------------------------------------- - --------------------------------------------------------------------- $1,153 $1,867 $2,289 $4,575 - --------------------------------------------------------------------- - ---------------------------------------------------------------------
(2) If you annuitize your contract at the end of the applicable time period:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - --------------------------------------------------------------------- - --------------------------------------------------------------------- $340 $1,036 $1,755 $3,658 - --------------------------------------------------------------------- - ---------------------------------------------------------------------
(3) If you do not surrender your contract and you elect the optional Polaris Income Rewards (0.65% for years 0-7 and 0.45% for years 8-10)
1 YEAR 3 YEARS 5 YEARS 10 YEARS - --------------------------------------------------------------------- - --------------------------------------------------------------------- $453 $1,367 $2,289 $4,575 - --------------------------------------------------------------------- - ---------------------------------------------------------------------
MINIMUM EXPENSE EXAMPLES (assuming minimum separate account annual expenses of 1.52% and investment in an Underlying Fund with total expenses of 0.55%) (1) If you surrender your contract at the end of the applicable time period and you do not elect any optional features:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - --------------------------------------------------------------------- - --------------------------------------------------------------------- $915 $1,165 $1,141 $2,456 - --------------------------------------------------------------------- - ---------------------------------------------------------------------
(2) If you annuitize your contract at the end of the applicable time period:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - --------------------------------------------------------------------- - --------------------------------------------------------------------- $210 $649 $1,114 $2,400 - --------------------------------------------------------------------- - ---------------------------------------------------------------------
(3) If you do not surrender your contract and you do not elect any optional features:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - --------------------------------------------------------------------- - --------------------------------------------------------------------- $215 $665 $1,141 $2,456 - --------------------------------------------------------------------- - ---------------------------------------------------------------------
EXPLANATION OF FEE TABLES AND EXAMPLES 1. The purpose of the Fee Table and Expense Examples is to show you the various fees and expenses you would incur directly and indirectly by investing in this variable annuity contract. The Fee Table and Expense Examples represent both fees of the separate account as well as the maximum and minimum total annual Underlying Fund operating expenses. We converted the contract maintenance fee to a percentage (0.05%). The actual impact of the contract maintenance fee may differ from this percentage and may be waived for contract values over $50,000. Additional information on the Underlying Fund fees can be found in the Trust prospectuses. 2. In addition to the stated assumptions, the Examples also assume that no transfer fees were imposed. Although premium taxes may apply in certain states, they are not reflected in the Expense Examples. 3. If you elected other optional features, your expenses would be lower than those shown in these Expense Examples. The optional living benefit fees are not calculated as a percentage of your daily net asset value but on other calculations more fully described in the prospectus. THESE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESSER THAN THOSE SHOWN. CONDENSED FINANCIAL INFORMATION APPEARS IN THE CONDENSED FINANCIAL INFORMATION APPENDIX OF THIS PROSPECTUS. 5 ---------------------------------------------------------------- ---------------------------------------------------------------- THE POLARIS CHOICE(II) VARIABLE ANNUITY ---------------------------------------------------------------- ---------------------------------------------------------------- When you purchase a variable annuity, a contract exists between you and an insurance company. You are the owner of the contract. The contract provides three main benefits: - Tax Deferral: This means that you do not pay taxes on your earnings from the contract until you withdraw them. - Death Benefit: If you die during the Accumulation Phase, the insurance company pays a death benefit to your Beneficiary. - Guaranteed Income: If elected, you receive a stream of income for your lifetime, or another available period you select. Tax-qualified retirement plans (e.g., IRAs, 401(k) or 403(b) plans) defer payment of taxes on earnings until withdrawal. If you are considering funding a tax-qualified retirement plan with an annuity, you should know that an annuity does not provide any additional tax deferral treatment of earnings beyond the treatment provided by the tax-qualified retirement plan itself. However, annuities do provide other features and benefits, which may be valuable to you. You should fully discuss this decision with your financial representative. This variable annuity was developed to help you contribute to your retirement savings. This variable annuity works in two stages: the Accumulation Phase and the Income Phase. Your contract is in the Accumulation Phase during the period when you make payments into the contract. The Income Phase begins after the specified waiting period when you start taking income payments. The contract is called a "variable" annuity because it allows you to invest in Variable Portfolios which, like mutual funds, have different investment objectives and performance. You can gain or lose money if you invest in these Variable Portfolios. The amount of money you accumulate in your contract depends on the performance of the Variable Portfolios in which you invest. Fixed Accounts, if available, earn interest at a rate set and guaranteed by the Company. If you allocate money to a Fixed Account, the amount of money that accumulates in the contract depends on the total interest credited to the particular Fixed Account in which you invest. For more information on investment options available under this contract, SEE INVESTMENT OPTIONS BELOW. This annuity is designed to assist in contributing to retirement savings of investors whose personal circumstances allow for a long-term investment time horizon. As a function of the Internal Revenue Code ("IRC"), you may be assessed a 10% federal tax penalty on any withdrawal made prior to your reaching age 59 1/2. Additionally, you will be charged a withdrawal charge on each Purchase Payment withdrawn prior to the end of the applicable withdrawal charge period, SEE FEE TABLES ABOVE. Because of these potential penalties, you should fully discuss all of the benefits and risks of this contract with your financial representative prior to purchase. ---------------------------------------------------------------- ---------------------------------------------------------------- PURCHASING A POLARIS CHOICE(II) VARIABLE ANNUITY ---------------------------------------------------------------- ---------------------------------------------------------------- An initial Purchase Payment is the money you give us to buy a contract. Any additional money you give us to invest in the contract after purchase is a subsequent Purchase Payment. The following chart shows the minimum initial and subsequent Purchase Payments permitted under your contract. These amounts depend upon whether a contract is Qualified or Non-qualified for tax purposes. FOR FURTHER EXPLANATION, SEE TAXES BELOW.
- -------------------------------------------------------------------------------------------- MINIMUM MINIMUM INITIAL SUBSEQUENT PURCHASE PAYMENT PURCHASE PAYMENT - -------------------------------------------------------------------------------------------- Qualified $2,000 $250 - -------------------------------------------------------------------------------------------- Non-Qualified $10,000 $500 - --------------------------------------------------------------------------------------------
Once you have contributed at least the minimum initial Purchase Payment, you can establish an automatic payment plan that allows you to make subsequent Purchase Payments of as little as $100. We reserve the right to require Company approval prior to accepting Purchase Payments greater than $1,000,000. For contracts owned by a non-natural owner, we reserve the right to require prior Company approval to accept Purchase Payments greater than $250,000. We reserve the right to change the amount at which pre-approval is required at any time. Subsequent Purchase Payments that would cause total Purchase Payments in all contracts issued by the Company or its affiliate, First SunAmerica Life Insurance Company, to the same owner and/or Annuitant to exceed these limits may also be subject to Company pre-approval. For any contracts that meet or exceed these dollar amount limitations, we further reserve the right to limit the death benefit amount payable in excess of contract value at the time we receive all required paperwork and satisfactory proof of death. Any limit on the maximum death benefit payable would be mutually agreed upon by you and the Company prior to purchasing the contract. We may not issue a contract to anyone age 86 or older on the contract issue date. We may not accept subsequent Purchase Payments from contract owners age 86 or older. In general, we will not issue a Qualified contract to anyone who is age 70 1/2 or older, unless it is shown that the minimum distribution required by the IRS is being made. If we learn of a misstatement of age, we reserve the right to fully pursue our remedies including termination of the contract and/or revocation of any age-driven benefits. We allow this contract to be jointly owned. We may require that the joint owners be spouses. However, the age of the 6 older spouse is used to determine the availability of any age driven benefits. The addition of a joint owner after the contract has been issued is contingent upon prior review and approval by the Company. You may assign this contract before beginning the Income Phase by sending us a written request for an assignment. Your rights and those of any other person with rights under this contract will be subject to the assignment. We reserve the right to not recognize assignments if it changes the risk profile of the owner of the contract, as determined in our sole discretion. Please see the Statement of Additional Information for details on the tax consequences of an assignment. ALLOCATION OF PURCHASE PAYMENTS In order to issue your contract, we must receive your initial Purchase Payment and all required paperwork including Purchase Payment allocation instructions at our Annuity Service Center. We will accept initial and subsequent Purchase Payments by electronic transmission from certain broker-dealer firms. In connection with arrangements we have to transact business electronically, we may have agreements in place whereby your broker-dealer may be deemed our agent for receipt of your Purchase Payments. Provided we have received your Purchase Payment and all required paperwork by Market Close, we allocate your initial Purchase Payment within two days of receiving it. If we do not have complete information necessary to issue your contract, we will contact you. If we do not have the information necessary to issue your contract within 5 business days, we will send your money back to you, or ask your permission to keep your money until we get the information necessary to issue the contract. We invest your subsequent Purchase Payments in the Variable Portfolios and Fixed Accounts according to any allocation instructions that accompany the subsequent Purchase Payment. If we receive a Purchase Payment without allocation instructions, we will invest the money according to your allocation instructions on file. SEE INVESTMENT OPTIONS BELOW. ACCUMULATION UNITS When you allocate a Purchase Payment to the Variable Portfolios, we credit your contract with Accumulation Units of the Separate Account. We base the number of Accumulation Units you receive on the unit value of the Variable Portfolio as of the day we receive your money if we receive it before Market Close, or on the next business day's unit value if we receive your money after Market Close. The value of an Accumulation Unit goes up and down based on the performance of the Variable Portfolios. We calculate the value of an Accumulation Unit each day that the NYSE is open as follows: 1. We determine the total value of money invested in a particular Variable Portfolio; 2. We subtract from that amount all applicable contract charges; and 3. We divide this amount by the number of outstanding Accumulation Units. We determine the number of Accumulation Units credited to your contract by dividing the Purchase Payment by the Accumulation Unit value for the specific Variable Portfolio. Example: We receive a $25,000 Purchase Payment from you on Wednesday. You allocate the money to Variable Portfolio A. We determine that the value of an Accumulation Unit for Variable Portfolio A is $11.10 at Market Close on Wednesday. We then divide $25,000 by $11.10 and credit your contract on Wednesday night with 2,252.2523 Accumulation Units for Variable Portfolio A. RIGHT TO EXAMINE OR FREE LOOK You may cancel your contract within ten days after receiving it (or longer if required by state law). We call this a "free look." To cancel, you must mail the contract along with your free look request to our Annuity Service Center at P.O. Box 54299, Los Angeles, California 90054-0299. If you decide to cancel your contract during the free look period, generally we will refund to you the value of your contract on the day we receive your request. Certain states require us to return your Purchase Payments upon a free look request. Additionally, all contracts issued as an IRA require the full return of Purchase Payments upon a free look. If your contract was issued in a state requiring return of Purchase Payments or as an IRA, and you cancel your contract during the free look period, we return the greater of (1) your Purchase Payments; or (2) the value of your contract. With respect to those contracts, we reserve the right to put your money in the Cash Management Variable Portfolio during the free look period. If we place your money in the Cash Management Variable Portfolio during the free look period, we will allocate your money according to your instructions at the end of the applicable free look period. EXCHANGE OFFERS From time to time, we may offer to allow you to exchange an older variable annuity issued by the Company or one of its affiliates, for a newer product with more current features and benefits also issued by the Company or one of its affiliates. Such an exchange offer will be made in accordance with 7 applicable state and federal securities and insurance rules and regulations. We will provide the specific terms and conditions of any such exchange offer at the time the offer is made. ---------------------------------------------------------------- ---------------------------------------------------------------- INVESTMENT OPTIONS ---------------------------------------------------------------- ---------------------------------------------------------------- VARIABLE PORTFOLIOS The Variable Portfolios invest in the Underlying Funds of the Trusts. Additional Variable Portfolios may be available in the future. The Variable Portfolios are only available through the purchase of certain insurance contracts. The Trusts serve as the underlying investment vehicles for other variable annuity contracts issued by the Company and other affiliated and unaffiliated insurance companies. Neither the Company nor the Trusts believe that offering shares of the Trusts in this manner disadvantages you. The Trusts are monitored for potential conflicts. The Trusts may have other Underlying Funds in addition to those listed here that are not available for investment under this contract. The Variable Portfolios along with their respective advisers are listed below: ANCHOR SERIES TRUST - CLASS 3 AIG SunAmerica Asset Management Corp. ("AIG SAAMCo"), an indirect wholly-owned subsidiary of AIG, is the investment adviser and Wellington Management Company, LLP is the subadviser to Anchor Series Trust ("AST"). SUNAMERICA SERIES TRUST - CLASS 3 AIG SAAMCo is the investment adviser and various managers are the subadvisers to SunAmerica Series Trust ("SAST"). AMERICAN FUNDS INSURANCE SERIES - CLASS 2 Capital Research and Management Company is the investment adviser for the American Funds Insurance Series ("AFIS"). LORD ABBETT SERIES FUND, INC. - CLASS VC Lord, Abbett & Co. is the investment adviser to the Lord Abbett Series Fund, Inc. ("LASF"). NATIONS SEPARATE ACCOUNT TRUST Bank of America Capital Management, LLC is the investment adviser and various managers are the subadvisers to Nations Separate Account Trust ("NSAT"). VAN KAMPEN LIFE INVESTMENT TRUST - CLASS II Van Kampen Asset Management is the investment adviser to the Van Kampen Life Investment Trust ("VKT"). STOCKS: MANAGED BY AIG SUNAMERICA ASSET MANAGEMENT CORP. - Aggressive Growth Portfolio SAST - Blue Chip Growth Portfolio SAST - "Dogs" of Wall Street Portfolio* SAST - Growth Opportunities Portfolio SAST MANAGED BY ALLIANCEBERNSTEIN - Small & Mid Cap Value Portfolio SAST MANAGED BY ALLIANCE CAPITAL MANAGEMENT L.P. - Alliance Growth Portfolio SAST - Global Equities Portfolio SAST - Growth & Income Portfolio SAST MANAGED BY CAPITAL RESEARCH AND MANAGEMENT COMPANY - American Funds Global Growth Portfolio AFIS - American Funds Growth Portfolio AFIS - American Funds Growth-Income Portfolio AFIS MANAGED BY DAVIS ADVISORS - Davis Venture Value Portfolio SAST - Real Estate Portfolio SAST MANAGED BY FEDERATED EQUITY MANAGEMENT COMPANY - Federated American Leaders Portfolio* SAST MANAGED BY LORD, ABBETT & CO. - Lord Abbett Series Fund Growth and Income Portfolio LASF MANAGED BY MARSICO CAPITAL MANAGEMENT, LLC - Nations Marsico Focused Equities Portfolio NSAT MANAGED BY MASSACHUSETTS FINANCIAL SERVICES COMPANY - MFS Massachusetts Investors Trust Portfolio SAST - MFS Mid-Cap Growth Portfolio SAST MANAGED BY PUTNAM INVESTMENT MANAGEMENT, LLC - Emerging Markets Portfolio SAST - International Growth & Income Portfolio SAST - Putnam Growth Portfolio SAST MANAGED BY TEMPLETON INVESTMENT COUNSEL, LLC - Foreign Value Portfolio SAST MANAGED BY VAN KAMPEN/VAN KAMPEN ASSET MANAGEMENT - International Diversified Equities Portfolio** SAST - Technology Portfolio** SAST - Van Kampen LIT Comstock Portfolio, Class II Shares* VKT - Van Kampen LIT Emerging Growth Portfolio, Class II Shares VKT - Van Kampen LIT Growth and Income Portfolio, Class II Shares VKT 8 MANAGED BY WELLINGTON MANAGEMENT COMPANY, LLP - Capital Appreciation Portfolio AST - Growth Portfolio AST - Natural Resources Portfolio AST BALANCED: MANAGED BY AIG SUNAMERICA ASSET MANAGEMENT CORP. - SunAmerica Balanced Portfolio SAST MANAGED BY MASSACHUSETTS FINANCIAL SERVICES COMPANY - MFS Total Return Portfolio SAST MANAGED BY WM ADVISORS, INC. - Asset Allocation Portfolio AST BONDS: MANAGED BY AIG SUNAMERICA ASSET MANAGEMENT CORP. - High-Yield Bond Portfolio SAST MANAGED BY FEDERATED INVESTMENT MANAGEMENT COMPANY - Corporate Bond Portfolio SAST MANAGED BY GOLDMAN SACHS ASSET MANAGEMENT INT'L. - Global Bond Portfolio SAST MANAGED BY MACKAY SHIELDS LLC - Nations High Yield Bond Portfolio NSAT MANAGED BY WELLINGTON MANAGEMENT COMPANY, LLP - Government & Quality Bond Portfolio AST CASH: MANAGED BY BANC OF AMERICA CAPITAL MANAGEMENT, LLC - Cash Management Portfolio SAST * "Dogs of Wall Street" Portfolio is an equity fund seeking total return; Federated American Leaders Portfolio is an equity fund seeking growth of capital and income; and Van Kampen LIT Comstock Portfolio is an equity fund, seeking capital growth and income. **Morgan Stanley Investment Management, Inc., the sub-adviser for the International Diversified Equities and Technology SAST Portfolios, does business in certain instances using the name Van Kampen. YOU SHOULD READ THE ACCOMPANYING PROSPECTUSES FOR THE TRUSTS CAREFULLY. THESE PROSPECTUSES CONTAIN DETAILED INFORMATION ABOUT THE VARIABLE PORTFOLIOS, INCLUDING EACH VARIABLE PORTFOLIO'S INVESTMENT OBJECTIVE AND RISK FACTORS. FIXED ACCOUNT OPTIONS Your contract may offer Fixed Accounts for varying guarantee periods. A Fixed Account may be available for differing lengths of time (such as 1, 3, or 5 years). Each guarantee period may have different guaranteed interest rates. We guarantee that the interest rate credited to amounts allocated to any Fixed Account guarantee periods will never be less than the minimum guaranteed interest rate specified in your contract. Once the rate is established, it will not change for the duration of the guarantee period. We determine which, if any, guarantee periods will be offered at any time in our sole discretion, unless state law requires us to do otherwise. Please check with your financial representative regarding the availability of Fixed Accounts. There are three categories of interest rates for money allocated to the Fixed Accounts. The applicable rate is guaranteed until the corresponding guarantee period expires. With each category of interest rate, your money may be credited a different rate as follows: - Initial Rate: The rate credited to any portion of the initial Purchase Payment allocated to a Fixed Account. - Current Rate: The rate credited to any portion of a subsequent Purchase Payment allocated to a Fixed Account. - Renewal Rate: The rate credited to money transferred from a Fixed Account or a Variable Portfolio into a Fixed Account and to money remaining in a Fixed Account after expiration of a guarantee period. When a guarantee period ends, you may leave your money in the same Fixed Account or you may reallocate your money to another Fixed Account or to the Variable Portfolios. If you do not want to leave your money in the same Fixed Account, you must contact us within 30 days after the end of the guarantee period and provide us with new allocation instructions. WE DO NOT CONTACT YOU. IF YOU DO NOT CONTACT US, YOUR MONEY WILL REMAIN IN THE SAME FIXED ACCOUNT WHERE IT WILL EARN INTEREST AT THE RENEWAL RATE THEN IN EFFECT FOR THAT FIXED ACCOUNT. If available, you may systematically transfer interest earned in available Fixed Accounts into any of the Variable Portfolios on certain periodic schedules offered by us. Systematic transfers may be started, changed or terminated at any time by contacting our Annuity Service Center. Check with you financial representative about the current availability of this service. All Fixed Accounts may not be available in your state. At any time we are crediting the minimum guaranteed interest rate specified in your contract, we reserve the right to restrict your ability to make transfers and Purchase Payments into the Fixed Accounts. DOLLAR COST AVERAGING FIXED ACCOUNTS You may invest initial and/or subsequent Purchase Payments in the dollar cost averaging ("DCA") Fixed Accounts, if available. The minimum Purchase Payment that you must invest for the 6-month DCA Fixed Account is $600 and for the 12-month DCA Fixed Account is $1,200. Purchase Payments less than these minimum amounts will automatically be allocated to the Variable Portfolios according to your instructions or your current allocation instruction on file. 9 DCA Fixed Accounts credit a fixed rate of interest and can only be elected to facilitate a DCA program. SEE DOLLAR COST AVERAGING PROGRAM BELOW for more information. Interest is credited to amounts allocated to the DCA Fixed Accounts while your money is transferred to the Variable Portfolios over certain specified time frames. The interest rates applicable to the DCA Fixed Accounts may differ from those applicable to any other Fixed Account but will never be less than the minimum guaranteed interest rate specified in your contract. However, when using a DCA Fixed Account, the annual interest rate is paid on a declining balance as you systematically transfer your money to the Variable Portfolios. Therefore, the actual effective yield will be less than the stated annual crediting rate. We reserve the right to change the availability of DCA Fixed Accounts offered, unless state law requires us to do otherwise. DOLLAR COST AVERAGING PROGRAM The DCA program allows you to invest gradually in the Variable Portfolios at no additional cost. Under the program, you systematically transfer a specified dollar amount or percentage of contract value from a Variable Portfolio, Fixed Account or DCA Fixed Account ("source account") to any other Variable Portfolio ("target account"). Transfers may occur on certain periodic schedules such as monthly or weekly. You may change the frequency to other available options at any time by notifying us in writing. The minimum transfer amount under the DCA program is $100 per transaction, regardless of the source account. Fixed Accounts are not available as target accounts for the DCA program. If available, you may systematically transfer interest earned in available Fixed Accounts into any of the Variable Portfolios on certain periodic schedules offered by us. You may change or terminate these systematic transfers by contacting our Annuity Service Center. Check with your financial representative about the current availability of this service. We may also offer DCA Fixed Accounts as source accounts exclusively to facilitate the DCA program for a specified time period. The DCA Fixed Account only accepts initial or subsequent Purchase Payments. You may not make a transfer from a Variable Portfolio or Fixed Account into a DCA Fixed Account. You may terminate the DCA program at any time. If you terminate the DCA program and money remains in the DCA Fixed Accounts, we transfer the remaining money according to your current allocation instructions on file. The DCA program is designed to lessen the impact of market fluctuations on your investment. However, the DCA program can neither guarantee a profit nor protect your investment against a loss. When you elect the DCA program, you are continuously investing in securities fluctuating at different price levels. You should consider your tolerance for investing through periods of fluctuating price levels. EXAMPLE OF DCA PROGRAM: Assume that you want to move $750 each quarter from one Variable Portfolio to another Variable Portfolio over six months. You set up a DCA program and purchase Accumulation Units at the following values:
------------------------------------------------------------------------- MONTH ACCUMULATION UNIT UNITS PURCHASED ------------------------------------------------------------------------- 1 $ 7.50 100 2 $ 5.00 150 3 $10.00 75 4 $ 7.50 100 5 $ 5.00 150 6 $ 7.50 100 -------------------------------------------------------------------------
You paid an average price of only $6.67 per Accumulation Unit over six months, while the average market price actually was $7.08. By investing an equal amount of money each month, you automatically buy more Accumulation Units when the market price is low and fewer Accumulation Units when the market price is high. This example is for illustrative purposes only. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE DCA PROGRAM AT ANY TIME. ASSET ALLOCATION PROGRAM PROGRAM DESCRIPTION The Asset Allocation program is offered at no additional cost to assist in diversifying your investment across various asset classes. The Asset Allocation program allows you to choose from one of several Asset Allocation models designed to assist in meeting your stated investment goals. Each Asset Allocation model is comprised of a carefully selected combination of Variable Portfolios. The Asset Allocation models allocate amongst the various asset classes based on historical asset class performance to meet stated investment time horizons and risk tolerances. ENROLLING IN THE ASSET ALLOCATION PROGRAM You may enroll in the Asset Allocation program by selecting the Asset Allocation model on the contract application form. If you already own a contract, you must complete and submit a program election form. You and your financial representative should determine the model most appropriate for you based on your financial needs, risk tolerance and investment time horizon. You may discontinue investing in the program at any time, subject to our rules, by providing a written request, calling our Annuity Service Center or logging onto our website. You may also choose to invest gradually into an Asset Allocation model through the DCA program. SEE THE DOLLAR COST AVERAGING PROGRAM ABOVE. You may only invest in one model at a time. You may invest in Variable Portfolios outside your selected Asset Allocation model but only in those Variable Portfolios that are not utilized in the Asset Allocation model you selected. A transfer into or out of one of the Variable Portfolios that are included 10 in your Asset Allocation model, outside the specifications in the Asset Allocation model will effectively terminate your participation in the program. WITHDRAWALS You may request withdrawals, as permitted by your contract, which will be taken proportionately from each of the allocations in the selected Asset Allocation model unless otherwise indicated in your withdrawal instructions. If you choose to make a non-proportional withdrawal from the Variable Portfolios in the Asset Allocation model, your investment may no longer be consistent with the Asset Allocation model's intended objectives. Withdrawals may be subject to a withdrawal charge. Withdrawals may also be taxable and a 10% IRS penalty may apply if you are under age 59 1/2. KEEPING YOUR PROGRAM ON TARGET REBALANCING THE MODELS You can elect to have your investment in the Asset Allocation models rebalanced quarterly, semi-annually, or annually to maintain the target asset allocation among the Variable Portfolios of the model you selected. Only those Variable Portfolios within each Asset Allocation model will be rebalanced. An investment in other Variable Portfolios not included in the model cannot be rebalanced. Over time, the asset allocation model you select may no longer align with its original investment objective due to the effects of Variable Portfolio performance and the ever-changing investment markets. In addition, your investment needs may change. You should speak with your financial representative about how to keep your Variable Portfolio allocations in line with your investment goals. IMPORTANT INFORMATION Using the Asset Allocation program does not guarantee greater or more consistent returns. Future market and asset class performance may differ from the historical performance upon which the Asset Allocation models are built. Also, allocation to a single asset class may outperform a model, so that you could have been better off investing in a single asset class than in a Asset Allocation model. However, such a strategy involves a greater degree of risk because of the concentration of similar securities in a single asset class. The Asset Allocation models represent suggested allocations that are provided to you as general guidance. You should work with your financial representative in determining if one of the models meets your financial needs, investment time horizon, and is consistent with your risk tolerance level. Information concerning the specific Asset Allocation models can be obtained from your financial representative. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE ASSET ALLOCATION PROGRAM AT ANY TIME. TRANSFERS DURING THE ACCUMULATION PHASE Subject to our rules, restrictions and policies, during the Accumulation Phase you may transfer funds between the Variable Portfolios and/or any Fixed Accounts by telephone or through the Company's website (http://www.aigsunamerica.com) or in writing by mail or facsimile. All transfer instructions submitted via facsimile must be sent to (818) 615-1543, otherwise they will not be considered received by us. We may accept transfers by telephone or the Internet unless you tell us not to on your contract application. When receiving instructions over the telephone or the Internet, we follow procedures we have adopted to provide reasonable assurance that the transactions executed are genuine. Thus, we are not responsible for any claim, loss or expense from any error resulting from instructions received over the telephone or the Internet. If we fail to follow our procedures, we may be liable for any losses due to unauthorized or fraudulent instructions. Any transfer request will be priced as of the day it is confirmed in good order by us if the request is processed before Market Close. If the transfer request is processed after Market Close, the request will be priced as of the next business day. Funds already in your contract cannot be transferred into the DCA Fixed Accounts. You must transfer at least $100 per transfer. If less than $100 remains in any Variable Portfolio after a transfer, that amount must be transferred as well. TRANSFER POLICIES We do not want to issue this variable annuity contract to contract owners engaged in trading strategies that seek to benefit from short-term price fluctuations or price inefficiencies in the Variable Portfolios of this product ("Short-Term Trading") and we discourage Short-Term Trading as more fully described below. However, we cannot always anticipate if a potential contract owner intends to engage in Short-Term Trading. Short-Term Trading may create risks that may result in adverse effects on investment return of an Underlying Fund. Such risks may include, but are not limited to: (1) interference with the management and planned investment strategies of an Underlying Fund and/or (2) increased brokerage and administrative costs due to forced and unplanned fund turnover; both of which may dilute the value of the shares in the Underlying Fund and reduce value for all investors in the Variable Portfolio. In addition to negatively impacting the contract owner, a reduction in contract value may also be harmful to annuitants and/or beneficiaries. We have adopted the following administrative procedures to discourage Short-Term Trading. We charge for transfers in excess of 15 in any contract year. Currently, the fee is $25 for each transfer exceeding this limit. Transfers resulting from your participation in the DCA 11 or Asset Rebalancing programs are not counted towards the number of free transfers per contract year. In addition to charging a fee when you exceed 15 transfers as described in the preceding paragraph, all transfer requests in excess of 5 transfers within a rolling six-month look-back period must be submitted by United States Postal Service first-class mail ("U.S. Mail") for twelve months from the date of your 5th transfer request ("Standard U.S. Mail Policy"). For example, if you made a transfer on February 15, 2004 and within the previous six months (from August 15, 2003 forward) you made 5 transfers including the February 15th transfer, then all transfers made for twelve months after February 15, 2004 must be submitted by U.S. Mail (from February 16, 2004 through February 15, 2005). We will not accept transfer requests sent by any other medium except U.S. Mail during this 12-month period. Transfer requests required to be submitted by U.S. Mail can only be cancelled by a written request sent by U.S. Mail with the appropriate paperwork received prior to the execution of the transfer. All transfers made on the same day prior to Market Close are considered one transfer request. Transfers resulting from your participation in the DCA or Asset Rebalancing programs are not included for the purposes of determining the number of transfers before applying the Standard U.S. Mail Policy. We apply the Standard U.S. Mail Policy uniformly and consistently to all contract owners except for omnibus group contracts as described below. We believe that the Standard U.S. Mail Policy is a sufficient deterrent to Short-Term Trading and we do not conduct any additional routine monitoring. However, we may become aware of transfer patterns among the Variable Portfolios and/or Fixed Accounts which reflect what we consider to be Short-Term Trading or otherwise detrimental to the Variable Portfolios but have not yet triggered the limitations of the Standard U.S. Mail Policy described above. If such transfer activity cannot be controlled by the Standard U.S. Mail Policy, we may require you to adhere to our Standard U.S. Mail Policy prior to reaching the specified number of transfers ("Accelerated U.S. Mail Policy"). To the extent we become aware of Short-Term Trading activities which cannot be reasonably controlled by the Standard U.S. Mail Policy or the Accelerated U.S. Mail Policy, we also reserve the right to evaluate, in our sole discretion, whether to impose further limits on the number and frequency of transfers you can make, impose minimum holding periods and/or reject any transfer request or terminate your transfer privileges. We will notify you in writing if your transfer privileges are terminated. In addition, we reserve the right to not accept transfers from a third party acting for you and not to accept preauthorized transfer forms. Some of the factors we may consider when determining whether to accelerate the Standard U.S. Mail Policy, reject or impose other conditions on transfer privileges include: (1) the number of transfers made in a defined period; (2) the dollar amount of the transfer; (3) the total assets of the Variable Portfolio involved in the transfer and/or transfer requests that represent a significant portion of the total assets of the Variable Portfolio; (4) the investment objectives and/or asset classes of the particular Variable Portfolio involved in your transfers; (5) whether the transfer appears to be part of a pattern of transfers to take advantage of short-term market fluctuations or market inefficiencies; and/or (6) other activity, as determined by us, that creates an appearance, real or perceived, of Short-Term Trading. Notwithstanding the administrative procedures above, there are limitations on the effectiveness of these procedures. Our ability to detect and/or deter Short-Term Trading is limited by operational systems and technological limitations. We cannot guarantee that we will detect and/or deter all Short- Term Trading. To the extent that we are unable to detect and/or deter Short-Term Trading, the Variable Portfolios may be negatively impacted as described above. Additionally, the Variable Portfolios may be harmed by transfer activity related to other insurance companies and/or retirement plans or other investors that invest in shares of the Underlying Fund. You should be aware that the design of our administrative procedures involves inherently subjective decisions, which we attempt to make in a fair and reasonable manner consistent with the interests of all owners of this contract. We do not enter into agreements with contract owners whereby we permit or intentionally disregard Short-Term Trading. The Standard and Accelerated U.S. Mail Policies are applied uniformly and consistently to contract owners utilizing third party trading services/strategies performing asset allocation services for a number of contract owners at the same time. You should be aware that such third party trading services may engage in transfer activities that can also be detrimental to the Variable Portfolios. These transfer activities may not be intended to take advantage of short-term price fluctuations or price inefficiencies. However, such activities can create the same or similar risks to Short-Term Trading and negatively impact the Variable Portfolios as described above. Omnibus group contracts may invest in the same Underlying Funds available in your contract but on an aggregate, not individual basis. Thus, we have limited ability to detect Short-Term Trading in omnibus group contracts and the Standard U.S. Mail Policy does not apply to these contracts. Our 12 inability to detect Short-Term Trading may negatively impact the Variable Portfolios as described above. WE RESERVE THE RIGHT TO MODIFY THE POLICIES AND PROCEDURES DESCRIBED IN THIS SECTION AT ANY TIME. To the extent that we exercise this reservation of rights, we will do so uniformly and consistently unless we disclose otherwise. For information regarding transfers during the Income Phase, SEE INCOME OPTIONS BELOW. AUTOMATIC ASSET REBALANCING PROGRAM Market fluctuations may cause the percentage of your investment in the Variable Portfolios to differ from your original allocations. Under the Automatic Asset Rebalancing program, your investments in the Variable Portfolios are periodically rebalanced to return your allocations to their original percentages for no additional charge. Automatic Asset Rebalancing typically involves shifting a portion of your money out of a Variable Portfolio with a higher return into a Variable Portfolio with a lower return. At your request, rebalancing occurs on a quarterly, semiannual or annual basis. EXAMPLE OF AUTOMATIC ASSET REBALANCING PROGRAM: Assume that you want your initial Purchase Payment split between two Variable Portfolios. You want 50% in a bond Variable Portfolio and 50% in a growth Variable Portfolio. Over the next calendar quarter, the bond market does very well while the stock market performs poorly. At the end of the calendar quarter, the bond Variable Portfolio now represents 60% of your holdings because it has increased in value and the growth Variable Portfolio represents 40% of your holdings. If you chose quarterly rebalancing, on the last day of that quarter, we would sell some of your Accumulation Units in the bond Variable Portfolio to bring its holdings back to 50% and use the money to buy more Accumulation Units in the growth Variable Portfolio to increase those holdings to 50%. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE AUTOMATIC ASSET REBALANCING PROGRAM AT ANY TIME. RETURN PLUS PROGRAM The Return Plus program, available only if we are offering multi-year Fixed Accounts, allows you to invest in one or more Variable Portfolios without putting your Purchase Payment at direct risk. The program, available for no additional charge, accomplishes this by allocating your investment strategically between the Fixed Accounts and Variable Portfolios. You decide how much you want to invest and approximately when you want a return of Purchase Payments. We calculate how much of your Purchase Payment to allocate to the particular Fixed Account to ensure that it grows to an amount equal to your total Purchase Payment invested under this program. We invest the rest of your Purchase Payment in the Variable Portfolio(s) according to your allocation instructions. EXAMPLE OF RETURN PLUS PROGRAM: Assume that you want to allocate a portion of your initial Purchase Payment of $100,000 to a multi-year Fixed Account. You want the amount allocated to the multi-year Fixed Account to grow to $100,000 in 7 years. If the 7-year Fixed Account is offering a 5% interest rate, Return Plus will allocate $71,069 to the 7-year Fixed Account to ensure that this amount will grow to $100,000 at the end of the 7-year period. The remaining $28,931 may be allocated among the Variable Portfolios according to your allocation instructions. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE RETURN PLUS PROGRAM AT ANY TIME. VOTING RIGHTS The Company is the legal owner of the Trusts' shares. However, when an Underlying Fund solicits proxies in conjunction with a shareholder vote, we must obtain your instructions on how to vote those shares. We vote all of the shares we own in proportion to your instructions. This includes any shares we own on our own behalf. Should we determine that we are no longer required to comply with these rules, we will vote the shares in our own right. SUBSTITUTION, ADDITION OR DELETION OF VARIABLE PORTFOLIOS We may, subject to any applicable law, make certain changes to the Variable Portfolios offered in your contract. We may, in our sole discretion, offer new Variable Portfolios or stop offering existing Variable Portfolios. New Variable Portfolios may be made available to existing contract owners and Variable Portfolios may be closed to new or subsequent Purchase Payments, transfers or allocations as we determine appropriate. In addition, we may also liquidate the shares of any Variable Portfolio, substitute the shares of one Underlying Fund for another and/or merge Underlying Funds. This would occur for various reasons, such as a determination that a Underlying Fund is no longer an appropriate investment for the contract due to continuing substandard performance; changes to the portfolio manager, investment objectives, risks and strategies; or changes in federal or state laws. To the extent required by the Investment Company Act of 1940, we may be required to obtain your approval through a proxy vote or SEC approval, prior to a substitution of shares of an Underlying Fund. We will notify you in writing of any proxies or substitutions that affect the Variable Portfolios offered in your contract. 13 ---------------------------------------------------------------- ---------------------------------------------------------------- ACCESS TO YOUR MONEY ---------------------------------------------------------------- ---------------------------------------------------------------- You can access money in your contract by making a partial withdrawal and/or by receiving income payments during the Income Phase. See INCOME OPTIONS below. Generally, we deduct a withdrawal charge applicable to any partial or total withdrawal before the end of the withdrawal charge period and a MVA if a withdrawal comes from certain fixed account options. If you made a total withdrawal, we also deduct premium taxes if applicable and a contract maintenance fee. SEE EXPENSES BELOW. Your contract provides for a free withdrawal amount each year. A free withdrawal amount is the portion of your contract that we allow you to take out each year without being charged a withdrawal charge. HOWEVER, UPON A FUTURE TOTAL WITHDRAWAL OF YOUR CONTRACT, IF WITHDRAWAL CHARGES ARE STILL APPLICABLE, ANY PREVIOUS FREE WITHDRAWALS WOULD BE SUBJECT TO A WITHDRAWAL CHARGE. Purchase Payments in excess of your free withdrawal amount, that are withdrawn prior to the end of the withdrawal schedule, will result in payment of a withdrawal charge. The amount of the withdrawal charge and how it applies are discussed more fully in EXPENSES below. You should consider, before purchasing this contract, the effect this withdrawal charge will have on your investment if you need to withdraw more money than the free withdrawal amount. You should fully discuss this decision with your financial representative. To determine your free withdrawal amount and your withdrawal charge, we refer to two special terms: "penalty free earnings" and the "total invested amount." The penalty-free earnings amount is your contract value less your total invested amount. The total invested amount is the total of all Purchase Payments less portions of prior withdrawals that reduce your total invested amount as follows: - Free withdrawals in any year that were in excess of your penalty-free earnings and were based on the portion of the total invested amount that was no longer subject to withdrawal charges at the time of the withdrawal; and - Any prior withdrawals (including withdrawal charges applicable to those withdrawals) of the total invested amount on which you already paid a withdrawal charge. When you make a withdrawal, we deduct it from penalty-free earnings first, then from the total invested amount on a first-in, first-out basis. This means that you can also access your Purchase Payments, which are no longer subject to a withdrawal charge before those Purchase Payments, which are still subject to the withdrawal charge. During the first year after we issue your contract, your free withdrawal amount is the greater of: (1) your penalty-free earnings; or (2) if you are participating in the Systematic Withdrawal program, a total of 10% of your total invested amount. After the first contract year, you can take out the greater of the following amounts each year: (1) your penalty-free earnings and any portion of your total invested amount no longer subject to a withdrawal charge; or (2) 10% of the portion of your total invested amount that has been in your contract for at least one year. We calculate withdrawal charges due on a total withdrawal on the day after we receive your request and your contract. We return your contract value less any applicable fees and charges. The withdrawal charge percentage is determined by the age of the Purchase Payment remaining in the contract at the time of the withdrawal. For the purpose of calculating the withdrawal charge, any prior free withdrawal is not subtracted from the total Purchase Payments still subject to withdrawal charges. For example, you make an initial Purchase Payment of $100,000. For purposes of this example we will assume a 0% growth rate over the life of the contract and no subsequent Purchase Payments. In contract year 2, you take out your maximum free withdrawal of $10,000. After that free withdrawal your contract value is $90,000. In the 3rd contract year, you request a total withdrawal of your contract. We will apply the following calculation: A-(B x C)=D, where: A=Your contract value at the time of your request for withdrawal ($90,000) B=The amount of your Purchase Payments still subject to withdrawal charge ($100,000) C=The withdrawal charge percentage applicable to the age of each Purchase Payment (assuming 5% is the applicable percentage) [B x C=$5,000] D=Your full contract value ($85,000) available for total withdrawal Under most circumstances, the partial withdrawal minimum is $1,000. We require that the value left in any Variable Portfolio or Fixed Accounts be at least $100, after the withdrawal and your total contract value must be at least $500. You must send a written withdrawal request. For withdrawals of $500,000 and more, you must submit a signature guarantee at the time of your request. Unless you provide us with different instructions, partial withdrawals will be made pro rata from each Variable Portfolio and the Fixed Account in which your contract is invested. IN THE EVENT THAT A PRO RATA PARTIAL WITHDRAWAL WOULD CAUSE THE VALUE OF 14 ANY VARIABLE PORTFOLIO OR FIXED ACCOUNT INVESTMENT TO BE LESS THAN $100, WE WILL CONTACT YOU TO OBTAIN ALTERNATE INSTRUCTIONS ON HOW TO STRUCTURE THE WITHDRAWAL. Withdrawals made prior to age 59 1/2 may result in a 10% IRS penalty tax. SEE TAXES BELOW. Under certain Qualified plans, access to the money in your contract may be restricted. We may be required to suspend or postpone the payment of a withdrawal for any period of time when: (1) the NYSE is closed (other than a customary weekend and holiday closings); (2) trading with the NYSE is restricted; (3) an emergency exists such that disposal of or determination of the value of shares of the Variable Portfolios is not reasonably practicable; (4) the SEC, by order, so permits for the protection of contract owners. Additionally, we reserve the right to defer payments for a withdrawal from a Fixed Account for up to six months. SYSTEMATIC WITHDRAWAL PROGRAM During the Accumulation Phase, you may elect to receive periodic income payments under the Systematic Withdrawal program for no additional charge. Under the program, you may choose to take monthly, quarterly, semi-annual or annual payments from your contract. Electronic transfer of these withdrawals to your bank account is also available. The minimum amount of each withdrawal is $100. There must be at least $500 remaining in your contract at all times. Withdrawals may be taxable and a 10% federal penalty tax may apply if you are under age 59 1/2. A withdrawal charge and/or MVA may apply. The program is not available to everyone. Please check with our Annuity Service Center which can provide the necessary enrollment forms. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE SYSTEMATIC WITHDRAWAL PROGRAM AT ANY TIME. MINIMUM CONTRACT VALUE Where permitted by state law, we may terminate your contract if both of the following occur: (1) your contract is less than $500 as a result of withdrawals; and (2) you have not made any Purchase Payments during the past three years. We will provide you with sixty days written notice that your contract is being terminated. At the end of the notice period, we will distribute the contract's remaining value to you. ---------------------------------------------------------------- ---------------------------------------------------------------- OPTIONAL LIVING BENEFITS ---------------------------------------------------------------- ---------------------------------------------------------------- YOU MAY ELECT ONE OF THE OPTIONAL LIVING BENEFITS DESCRIBED BELOW. THESE FEATURES ARE DESIGNED TO PROTECT A PORTION OF YOUR INVESTMENT IN THE EVENT YOUR CONTRACT VALUE DECLINES DUE TO UNFAVORABLE INVESTMENT PERFORMANCE DURING THE ACCUMULATION PHASE AND BEFORE A DEATH BENEFIT IS PAYABLE. PLEASE SEE THE DESCRIPTIONS BELOW FOR DETAILED INFORMATION. POLARIS INCOME REWARDS What is Polaris Income Rewards? Polaris Income Rewards is an optional living benefit feature. If you elect this feature, for which you will be charged an annualized fee, after a specified waiting period, you are guaranteed to receive withdrawals, over a minimum number of years that in total equal Purchase Payments made in the first 90 days adjusted for withdrawals during that period (the "Benefit"), even if the contract value falls to zero. Polaris Income Rewards may offer protection in the event your contract value declines due to unfavorable investment performance. Polaris Income Rewards has rules and restrictions that are discussed more fully below. What options are currently available? Three options are currently available under this feature. The available options, referred to as the Step-Up Options, provide a guaranteed minimum withdrawal amount over a minimum number of years equal to at least your initial Purchase Payment (adjusted for withdrawals) with an opportunity to receive a 10%, 20% or 50% step-up amount. If you take withdrawals prior to the Benefit Availability Date (as defined in the table below), the Benefit will be reduced and you may not receive a step-up amount depending on the option selected. Each option and its components are fully described below. You should read each option carefully and discuss the feature with your financial representative before electing an option. How and when can I elect the feature? You may only elect the feature at the time of contract issue and must choose one of the options discussed below. You may not change the option after election. You cannot elect the feature if you are age 81 or older on the contract issue date. Generally, once you elect the feature, it cannot be cancelled. Polaris Income Rewards cannot be elected if you elect the Capital Protector feature. SEE CAPITAL PROTECTOR BELOW. Polaris Income Rewards may not be available in your state or through the broker-dealer with which your financial representative is affiliated. Please check with your financial representative for availability. How is the Benefit calculated? In order to determine the Benefit's value, we calculate each of the components as described below. The Benefit's components and value may vary depending on the option you choose. The earliest date you may begin taking withdrawals under the Benefit is the BENEFIT AVAILABILITY DATE. Each one-year period beginning on the contract issue date and ending on the day before the contract anniversary date is considered a BENEFIT YEAR. 15 The table below is a summary of the three Step-Up Options we are currently offering:
- -------------------------------------------------------------------------------------------------------------------------------- MINIMUM WITHDRAWAL PERIOD* (IF MAXIMUM MAXIMUM ANNUAL ANNUAL BENEFIT WITHDRAWAL WITHDRAWAL AVAILABILITY STEP-UP AMOUNT+ AMOUNT TAKEN OPTION DATE AMOUNT PERCENTAGE EACH YEAR) - -------------------------------------------------------------------------------------------------------------------------------- 1 3 years following 10%* of Withdrawal 10% of Withdrawal Benefit 11 years contract issue date Benefit Base Base - -------------------------------------------------------------------------------------------------------------------------------- 2 5 years following 20%* of Withdrawal 10% of Withdrawal Benefit 12 years contract issue date Benefit Base Base - -------------------------------------------------------------------------------------------------------------------------------- 3 10 years following 50%** of Withdrawal 10% of Withdrawal Benefit 15 years contract issue date Benefit Base Base - --------------------------------------------------------------------------------------------------------------------------------
* You will not receive a Step-Up Amount if you elect Options 1 or 2 and take a withdrawal prior to the Benefit Availability Date. The Minimum Withdrawal Period for Options 1 and 2 will be 10 years if you do not receive a Step-Up Amount. ** If you elect Option 3 and take a withdrawal prior to the Benefit Availability Date, you will receive a reduced Step-Up Amount of 30% of the Withdrawal Benefit Base. The Minimum Withdrawal Period will be 13 years if you receive a reduced Step-Up Amount. + For contract holders subject to annual required minimum distributions, the Maximum Annual Withdrawal Amount for this contract will be the greater of: (1) the amount indicated in the table above; or (2) the annual required minimum distribution amount. Required minimum distributions may reduce your Minimum Withdrawal Period. How are the components for the Step-Up Options calculated? First, we determine the ELIGIBLE PURCHASE PAYMENTS, which include the amount of Purchase Payments made to the contract up to and including the 90th day after your contract issue date, adjusted for any withdrawals in the same proportion that the withdrawal reduced the contract value on the date of the withdrawal. Second, we determine the WITHDRAWAL BENEFIT BASE, on the Benefit Availability Date. The Withdrawal Benefit Base equals the sum of all Eligible Purchase Payments. Third, we determine a STEP-UP AMOUNT, if any, which is calculated as a specified percentage (listed in the table above) of the Withdrawal Benefit Base on the Benefit Availability Date. If you elect Option 1 or 2, you will not receive a Step-Up Amount if you take any withdrawals prior to the Benefit Availability Date. If you elect Option 3, the Step-Up Amount will be reduced to 30% of the Withdrawal Benefit Base if you take any withdrawals prior to the Benefit Availability Date. The Step-Up Amount is not considered a Purchase Payment and cannot be used in calculating any other benefits, such as death benefits, contract values or annuitization value. Fourth, we determine a STEPPED-UP BENEFIT BASE, which is the total amount available for withdrawal under the feature and is used to calculate the minimum time period over which you may take withdrawals under the feature. The Stepped-Up Benefit Base equals the Withdrawal Benefit Base plus the Step-Up Amount, if any. Fifth, we determine the MAXIMUM ANNUAL WITHDRAWAL AMOUNT, which is a stated percentage (listed in the table above) of the Withdrawal Benefit Base and represents the maximum amount of withdrawals that are available under this feature each Benefit Year after the Benefit Availability Date. Finally, we determine the MINIMUM WITHDRAWAL PERIOD, which is the minimum period over which you may take withdrawals under the feature. The Minimum Withdrawal Period is calculated by dividing the Stepped-Up Benefit Base by the Maximum Annual Withdrawal Amount. What is the fee for Polaris Income Rewards? The annualized Polaris Income Rewards fee will be assessed as a percentage of the Withdrawal Benefit Base. The fee will be deducted quarterly from your contract value starting on the first quarter following the contract issue date and ending upon the termination of the feature. If your contract value falls to zero before the feature has been terminated, the fee will no longer be assessed. We will not assess the quarterly fee if you surrender or annuitize before the end of a quarter.
---------------------------------------------------- CONTRACT YEAR ANNUALIZED FEE ---------------------------------------------------- 0-7 years 0.65% of Withdrawal Benefit Base ---------------------------------------------------- 8-10 years 0.45% of Withdrawal Benefit Base ---------------------------------------------------- 11+ years none ----------------------------------------------------
What are the effects of withdrawals on the Step-Up Options? The Benefit amount, Maximum Annual Withdrawal Amount and Minimum Withdrawal Period may change over time as a result of withdrawal activity. Withdrawals after the Benefit Availability Date equal to or less than the Maximum Annual Withdrawal Amount generally reduce the Benefit by the amount of the withdrawal. Withdrawals in excess of the Maximum Annual Withdrawal Amount will reduce the Benefit in the same proportion that the contract value was reduced at the time of the withdrawal. This means if investment performance is down and contract value is reduced, withdrawals greater than the Maximum Annual Withdrawal Amount will result in a greater reduction of the Benefit. The impact of withdrawals and the effect on each component of 16 Polaris Income Rewards are further explained through the calculations below: WITHDRAWAL BENEFIT BASE: Withdrawals prior to the Benefit Availability Date reduce the Withdrawal Benefit Base in the same proportion that the contract value was reduced at the time of the withdrawal. Withdrawals prior to the Benefit Availability Date also eliminate any Step-Up Amount for Options 1 and 2 and reduce the Step-Up Amount to 30% of the Withdrawal Benefit Base for Option 3. Withdrawals after the Benefit Availability Date will not reduce the Withdrawal Benefit Base until the sum of withdrawals after the Benefit Availability Date exceeds the Step-Up Amount. Thereafter, any withdrawal or portion of a withdrawal that exceeds the Step-Up Amount will reduce the Withdrawal Benefit Base as follows: (1) If the withdrawal does not cause total withdrawals in the Benefit Year to exceed the Maximum Annual Withdrawal Amount, the Withdrawal Benefit Base will be reduced by the amount of the withdrawal, or (2) If the withdrawal causes total withdrawals in the Benefit Year to exceed the Maximum Annual Withdrawal Amount, the Withdrawal Benefit Base is reduced to the lesser of (a) or (b), where: a. is the Withdrawal Benefit Base immediately prior to the withdrawal minus the amount of the withdrawal, or; b. is the Withdrawal Benefit Base immediately prior to the withdrawal minus the amount of the withdrawal that makes total withdrawals for the Benefit Year equal to the current Maximum Annual Withdrawal Amount, and further reduced in the same proportion that the contract value was reduced by the amount of the withdrawal that exceeds the Maximum Annual Withdrawal Amount. STEPPED-UP BENEFIT BASE: Since withdrawals prior to the Benefit Availability Date eliminate any Step-Up Amount for Options 1 and 2, the Stepped-Up Benefit Base will be equal to the Withdrawal Benefit Base if you take withdrawals prior to the Benefit Availability Date. For Option 3, if you take withdrawals prior to the Benefit Availability Date, the Stepped-Up Benefit Base will be equal to the Withdrawal Benefit Base plus the reduced Step-Up Amount which will be 30% of the Withdrawal Benefit Base, adjusted for such withdrawals. If you do not take withdrawals prior to the Benefit Availability Date, you will receive the entire Step-Up Amount and the Stepped-Up Benefit Base will equal the Withdrawal Benefit Base plus the Step-Up Amount. After the Benefit Availability Date, any withdrawal that does not cause total withdrawals in a Benefit Year to exceed the Maximum Annual Withdrawal Amount will reduce the Stepped-Up Benefit Base by the amount of the withdrawal. After the Benefit Availability Date, any withdrawal that causes total withdrawals in a Benefit Year to exceed the Maximum Annual Withdrawal Amount (in that Benefit Year) reduces the Stepped-Up Benefit Base to the lesser of (a) or (b), where: a. is the Stepped-Up Benefit Base immediately prior to the withdrawal minus the amount of the withdrawal, or; b. is the Stepped-Up Benefit Base immediately prior to the withdrawal minus the amount of the withdrawal that makes total withdrawals for the Benefit Year equal to the current Maximum Annual Withdrawal Amount, and further reduced in the same proportion that the contract value was reduced by the amount of the withdrawal that exceeds the Maximum Annual Withdrawal Amount. MAXIMUM ANNUAL WITHDRAWAL AMOUNT: If the sum of withdrawals in a Benefit Year does not exceed the Maximum Annual Withdrawal Amount for that Benefit Year, the Maximum Annual Withdrawal Amount does not change for the next Benefit Year. If total withdrawals in a Benefit Year exceed the Maximum Annual Withdrawal Amount, the Maximum Annual Withdrawal Amount will be recalculated at the start of the next Benefit Year. The new Maximum Annual Withdrawal Amount will equal the Stepped-Up Benefit Base on that Benefit Year anniversary divided by the Minimum Withdrawal Period on that Benefit Year anniversary. The new Maximum Annual Withdrawal Amount may be lower than your previous Maximum Annual Withdrawal Amounts. MINIMUM WITHDRAWAL PERIOD: After each withdrawal, a new Minimum Withdrawal Period is calculated. If total withdrawals in a Benefit Year are less than or equal to the current Maximum Annual Withdrawal Amount, the new Minimum Withdrawal Period equals the Stepped-Up Benefit Base after the withdrawal, divided by the current Maximum Annual Withdrawal Amount. During any Benefit Year in which the sum of withdrawals exceeds the Maximum Annual Withdrawal Amount, the new Minimum Withdrawal Period equals the Minimum Withdrawal Period calculated at the end of the prior Benefit Year reduced by one year. CONTRACT VALUE: Any withdrawal under the Benefit reduces the contract value by the amount of the withdrawal. THE POLARIS INCOME REWARDS EXAMPLES APPENDIX PROVIDES EXAMPLES OF THE EFFECTS OF WITHDRAWALS ON THE POLARIS INCOME REWARDS FEATURE. What happens if my contract value is reduced to zero? If the contract value is zero but the Stepped-Up Benefit Base is greater than zero, a Benefit remains payable under the feature. However, the contract and its other features and benefits will be terminated once the contract value equals zero. Once the contract is terminated, you may not make 17 subsequent Purchase Payments and no death benefit or future annuitization payments are available. Therefore, under adverse market conditions, withdrawals taken under the Benefit may reduce the contract value to zero eliminating any other benefits of the contract. To receive your remaining Benefit, you may select one of the following options: 1. Lump sum distribution of the actuarial present value as determined by us, of the total remaining guaranteed withdrawals; or 2. the current Maximum Annual Withdrawal Amount, paid equally on a quarterly, semi-annual or annual frequency as selected by you until the Stepped-Up Benefit Base equals zero; or 3. any payment option mutually agreeable between you and us. If you do not select a payment option, the remaining Benefit will be paid as the current Maximum Annual Withdrawal Amount on a quarterly basis. What happens to Polaris Income Rewards upon a spousal continuation? A Continuing Spouse may elect to continue or cancel the feature and its accompanying fee. The components of the feature will not change as a result of a spousal continuation. SEE SPOUSAL CONTINUATION BELOW. Can my non-spousal Beneficiary elect to receive any remaining withdrawals under Polaris Income Rewards upon my death? If the Stepped-Up Benefit Base is greater than zero when the original owner dies, and the contract value equals zero and therefore no death benefit is payable, a non-spousal Beneficiary may elect to continue receiving any remaining withdrawals under the feature. The components of the feature will not change. If the Stepped-Up Benefit Base and the contract value are greater than zero, a non-spousal Beneficiary must make a death claim under the contract provisions which terminates the Benefit. SEE DEATH BENEFITS BELOW. Can Polaris Income Rewards be cancelled? Once you elect the feature, you may not cancel it. The feature automatically terminates upon the occurrence of one of the following: 1. Stepped-Up Benefit Base is equal to zero; or 2. Annuitization of the contract; or 3. Full surrender of the contract; or 4. Death benefit is paid; or 5. Upon a spousal continuation, the Continuing Spouse elects not to continue the contract with the feature. We reserve the right to terminate the feature if withdrawals in excess of Maximum Annual Withdrawal Amount in any Benefit Year reduce the Stepped-Up Benefit Base by 50% or more. IMPORTANT INFORMATION Polaris Income Rewards is designed to offer protection of your initial investment in the event of a significant market down turn. Polaris Income Rewards may not guarantee an income stream based on all Purchase Payments made into your contract nor does it guarantee any investment gains. Polaris Income Rewards does not guarantee a withdrawal of any subsequent Purchase Payments made after the 90th day following the contract issue date. This feature also does not guarantee lifetime income payments. You may never need to rely on Polaris Income Rewards if your contract performs within a historically anticipated range. However, past performance is no guarantee of future results. Withdrawals under the feature are treated like any other withdrawal for the purpose of reducing the contract value, free withdrawal amounts and all other benefits, features and conditions of your contract. If you need to take withdrawals or are required to take required minimum distributions ("RMD") under the Internal Revenue Code ("IRC") from this contract prior to the Benefit Availability Date, you should know that such withdrawals may negatively impact the value of the Benefit. As noted above, your Stepped-Up Benefit Base will be reduced if you take withdrawals before the Benefit Availability Date. Any withdrawals taken under this feature or under the contract may be subject to a 10% IRS tax penalty if you are under age 59 1/2 at the time of the withdrawal. For information about how the feature is treated for income tax purposes, you should consult a qualified tax advisor concerning your particular circumstances. If you set up RMDs and have elected this feature, your distributions must be automated and will not be recalculated on an annual basis. We reserve the right at the time your contract is issued to limit the maximum Eligible Purchase Payments to $1 million. For prospectively issued contracts, we reserve the right to limit the investment options available under the contract if you elect this Polaris Income Rewards feature. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE POLARIS INCOME REWARDS FEATURE (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME FOR PROSPECTIVELY ISSUED CONTRACTS. CAPITAL PROTECTOR Capital Protector is an optional living benefit offered on your contract. If you elect this feature, you will be charged an annualized fee. At the end of 10 full contract years ("Waiting 18 Period"), the feature makes a one-time adjustment ("Benefit") so that your contract will be worth at least the amount of your guaranteed Purchase Payment(s) as specified below (less adjustments for withdrawals). Capital Protector offers protection in the event that your contract value declines due to unfavorable investment performance. How and when can I elect the feature? You may only elect this feature at the time your contract is issued, so long as the Waiting Period ends before your Latest Annuity Date. You cannot elect the feature if you are age 81 or older on the contract issue date. Capital Protector is not available if you elect Polaris Income Rewards. SEE POLARIS INCOME REWARDS ABOVE. Capital Protector may not be available in your state or through the broker-dealer with which your financial representative is affiliated. Please check with your financial representative for availability. Can Capital Protector be cancelled? Generally, this feature and its corresponding charge cannot be cancelled or terminated prior to the end of the Waiting Period. The feature terminates automatically following the end of the Waiting Period. In addition, the feature will no longer be available and no Benefit will be paid if a death benefit is paid or if the contract is fully surrendered or annuitized before the end of the Waiting Period. How is the Benefit calculated? The Benefit is a one-time adjustment to your contract in the event that your contract value at the end of the Waiting Period ("Benefit Date") is less than the Purchase Payments made, as follows:
- ---------------------------------------------------------------------------------- PERCENTAGE OF PURCHASE PAYMENTS TIME ELAPSED SINCE INCLUDED IN THE THE CONTRACT ISSUE DATE BENEFIT CALCULATION - ---------------------------------------------------------------------------------- 0-90 Days 100% - ---------------------------------------------------------------------------------- 91 Days + 0% - ----------------------------------------------------------------------------------
The benefit calculation is equal to your Benefit Base, as defined below, minus your contract value on the Benefit Date. If the resulting amount is positive, you will receive a Benefit under the feature. If the resulting amount is negative, you will not receive a Benefit. Your Benefit Base is equal to (a) minus (b) where: (a) is the Purchase Payments received on or after the contract issue date multiplied by the applicable percentages in the table above, and; (b) is an adjustment for all withdrawals and applicable fees and charges made subsequent to the contract issue date, in an amount proportionate to the amount by which the withdrawal decreased the contract value at the time of the withdrawal. What is the fee for Capital Protector? The annualized charge will be deducted from your contract value on a quarterly basis throughout the Waiting Period, beginning at the end of the first contract quarter following the contract issue date and up to and including on the Benefit Date. Once the feature is terminated, as discussed above, the charge will no longer be deducted. We will also not assess the quarterly fee if you surrender or annuitize before the end of the quarter.
- ---------------------------------------------------------------------------------- CONTRACT YEAR ANNUALIZED FEE* - ---------------------------------------------------------------------------------- 0-5 0.65% - ---------------------------------------------------------------------------------- 6-10 0.45% - ---------------------------------------------------------------------------------- 11+ none - ----------------------------------------------------------------------------------
* As a percentage of your contract value minus Purchase Payments received after the 90th day since the purchase of your contract. The amount of this charge is subject to change at any time for prospectively issued contracts. What happens to Capital Protector upon a spousal continuation? If your spouse chooses to continue this contract upon your death, this feature cannot be terminated. The Waiting Period starts from the original issue date. The corresponding Benefit Date will not change as a result of a spousal continuation. SEE SPOUSAL CONTINUATION BELOW. IMPORTANT INFORMATION Capital Protector may not guarantee a return of all of your Purchase Payments. If you plan to add subsequent Purchase Payments over the life of your contract, you should know that Capital Protector would not protect the majority of those payments. Since Capital Protector may not guarantee a return of all Purchase Payments at the end of the Waiting Period, it is important to realize that subsequent Purchase Payments made into the contract may decrease the value of the Benefit. For example, if near the end of the Waiting Period your Benefit Base is greater than your contract value, and you then make a subsequent Purchase Payment that causes your contract value to be larger than your Benefit Base on your Benefit Date, you will not receive any Benefit even though you have paid for Capital Protector throughout the Waiting Period. You should discuss making subsequent Purchase Payments with your financial representative as such activity may reduce the value of the Benefit. We will allocate any benefit amount contributed to the contract value on the Benefit Date to the Cash Management Variable Portfolio. Any Benefit paid is not considered a Purchase Payment for purposes of calculating other benefits or features of your contract. Benefits based on earnings, will continue to define earnings as the difference between contract value and Purchase Payments adjusted for withdrawals. For 19 information about how the Benefit is treated for income tax purposes, you should consult a qualified tax advisor for information concerning your particular circumstances. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE CAPITAL PROTECTOR (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME FOR PROSPECTIVELY ISSUED CONTRACTS. ---------------------------------------------------------------- ---------------------------------------------------------------- DEATH BENEFIT ---------------------------------------------------------------- ---------------------------------------------------------------- If you die during the Accumulation Phase of your contract, we pay a death benefit to your Beneficiary. You must select a death benefit option at the time you purchase your contract. Once selected, you cannot change your death benefit option. You should discuss the available options with your financial representative to determine which option is best for you. We do not pay a death benefit if you die after you switch to the Income Phase. In that case, your Beneficiary would receive any remaining guaranteed income payments in accordance with the income option you selected. SEE INCOME OPTIONS BELOW. You designate your Beneficiary who will receive any death benefit payments. You may change the Beneficiary at any time, unless you previously made an irrevocable Beneficiary designation. If your contract is jointly owned, the surviving joint owner is the sole beneficiary. We calculate and pay the death benefit when we receive all required paperwork and satisfactory proof of death. All death benefit calculations discussed below are as of the date we receive paperwork and satisfactory proof of death. We consider the following satisfactory proof of death: 1. a certified copy of the death certificate; or 2. a certified copy of a decree of a court of competent jurisdiction as to the finding of death; or 3. a written statement by a medical doctor who attended the deceased at the time of death; or 4. any other proof satisfactory to us. If the Beneficiary is the spouse of a deceased owner, he or she can elect to continue the Contract. SEE SPOUSAL CONTINUATION BELOW. If a Beneficiary does not elect a specific form of pay out, within 60 days of our receipt of all required paperwork and satisfactory proof of death, we pay a lump sum death benefit to the Beneficiary. The death benefit must be paid within 5 years of the date of death unless the Beneficiary elects to have it payable in the form of an income option. If the Beneficiary elects an income option, it must be paid over the Beneficiary's lifetime or for a period not extending beyond the Beneficiary's life expectancy. Payments must begin within one year of your death. A Beneficiary may also elect to continue the contract and take the death benefit amount in a series of payments based upon the Beneficiary's life expectancy under the Extended Legacy program described below, subject to the applicable Internal Revenue Code distribution requirements. Payments must begin under the selected Income Option or the Extended Legacy program no later than the first anniversary of your death for non-qualified contracts or December 31st of the year following the year of your death for IRAs. Your Beneficiary cannot participate in the Extended Legacy program if your Beneficiary has already elected another settlement option. Beneficiaries who do not begin taking payments within these specified time periods will not be eligible to elect an Income Option or participate in the Extended Legacy program. EXTENDED LEGACY PROGRAM AND BENEFICIARY CONTINUATION OPTIONS The Extended Legacy program can allow a Beneficiary to take the death benefit amount in the form of income payments over a longer period of time with the flexibility to withdraw more than the IRS required minimum distribution if they wish. The contract continues in the original owner's name for the benefit of the Beneficiary. A Beneficiary may elect to continue the contract and take the death benefit amount in a series of payments based upon the Beneficiary's life expectancy under the Extended Legacy program described below, subject to the applicable Internal Revenue Code distribution requirements. Payments under the selected income option must begin or under the Extended Legacy program no later than the first anniversary of your death for non-qualified contracts or December 31st of the year following the year of your death for IRAs. Beneficiaries who do not begin taking payments within these specified time periods will not be eligible to elect an income option or participate in the Extended Legacy program. Your Beneficiary cannot participate in the Extended Legacy program if your Beneficiary has already elected another payout option. The Extended Legacy program allows the Beneficiary to take distributions in the form of a series of payments similar to the required minimum distributions under an IRA. Generally, IRS required minimum distributions must be made at least annually over a period not to exceed the Beneficiary's life expectancy as determined in the calendar year after your death. A Beneficiary may withdraw all or a portion of the contract value at any time, name their own beneficiary to receive any remaining unpaid interest in the contract in the event of their death and make transfers among investment options. If the contract value is less than the death benefit amount as of the date we receive satisfactory proof of death and all required paperwork, we will increase the contract value by the amount which the death benefit exceeds contract value. Participation in the program may impact certain features of the contract that are detailed in the Death Claim Form. Please see your financial representative for additional information. 20 Other Beneficiary Continuation Options Alternatively to the Extended Legacy program, the Beneficiary may also elect to receive the death benefit under a 5-year option. The Beneficiary may take withdrawals as desired, but the entire contract value must be distributed by the fifth anniversary of your death for Non-qualified contracts or by December 31st of the year containing the fifth anniversary of your death for IRAs. For IRAs, the 5-year option is not available if the date of death is after the required beginning date for distributions (April 1 of the year following the year the owner reaches the age of 70 1/2). Please consult your tax advisor regarding tax implications and your particular circumstances. DEFINED TERMS The term "Net Purchase Payment" is used frequently in describing the death benefit payable. Net Purchase Payment is an on-going calculation. It does not represent a contract value. We define Net Purchase Payments as Purchase Payments less an adjustment for each withdrawal. If you have not taken any withdrawals from your contract, Net Purchase Payments equals total Purchase Payments into your contract. To calculate the adjustment amount for the first withdrawal made under the contract, we determine the percentage by which the withdrawal reduced the contract value. For example, a $10,000 withdrawal from a $100,000 contract is a 10% reduction in value. This percentage is calculated by dividing the amount of each withdrawal (and any applicable fees and charges) by the contract value immediately before taking the withdrawal. The resulting percentage is then multiplied by the amount of the total Purchase Payments and subtracted from the amount of the total Purchase Payments on deposit at the time of the withdrawal. The resulting amount is the initial Net Purchase Payment. To arrive at the Net Purchase Payment calculation for subsequent withdrawals, we determine the percentage by which the contract value is reduced, by taking the amount of the withdrawal in relation to the contract value immediately before the withdrawal. We then multiply the Net Purchase Payment calculation as determined prior to the withdrawal, by this percentage. We subtract that result from the Net Purchase Payment calculation as determined prior to the withdrawal to arrive at all subsequent Net Purchase Payment calculations. The term "withdrawals" as used in describing the death benefit options is defined as withdrawals and the fees and charges applicable to those withdrawals. STANDARD DEATH BENEFIT If the contract is issued prior to your 83rd birthday, the standard death benefit on your contract is the greater of: 1. Contract value; or 2. Net Purchase Payments received prior to your 86th birthday. If the contract is issued on or after the 83rd birthday but prior to your 86th birthday, the standard death benefit on your contract is the greater of: 1. Contract value; or 2. The lesser of: a. Net Purchase Payments received prior to your 86th birthday; or b. 125% of Contract Value. OPTIONAL ENHANCED DEATH BENEFITS For an additional fee, you may elect one of the enhanced death benefits below which can provide greater protection for your beneficiaries. If you elect an enhanced death benefit, you must choose one of the options listed below at the time you purchase your contract and you cannot change your election thereafter at any time. The fee for the enhanced death benefit is 0.20% of the average daily ending value of the assets you have allocated to the Variable Portfolios. OPTION 1 - PURCHASE PAYMENT ACCUMULATION OPTION If the contract is issued prior to your 75th birthday, the death benefit is the greatest of: 1. Contract value; or 2. Net Purchase Payments, compounded at 3% annual growth rate to the earlier of the 75th birthday or the date of death plus Net Purchase Payments received after the 75th birthday but prior to the 86th birthday; or 3. Contract value on the seventh contract anniversary, reduced for withdrawals since the seventh contract anniversary in the same proportion that the contract value was reduced on the date of such withdrawal, plus Net Purchase Payments received between the seventh contract anniversary but prior to the 86th birthday. The Purchase Payment Accumulation Option can only be elected prior to your 75th birthday. 21 OPTION 2 - MAXIMUM ANNIVERSARY VALUE OPTION If the contract is issued prior to your 83rd birthday, the death benefit is the greatest of: 1. Contract value; or 2. Net Purchase Payments received prior to your 86th birthday; or 3. Maximum anniversary value on any contract anniversary prior to your 83rd birthday. The anniversary values equal the contract value on a contract anniversary plus any Purchase Payments since that anniversary but prior to your 86th birthday; and reduced for any withdrawals since that contract anniversary in the same proportion that the withdrawal reduced the contract value on the date of the withdrawal. If you die on or after your 90th birthday, the Standard Death Benefit may provide more value to your beneficiaries than the Maximum Anniversary Value option. Under the Maximum Anniversary Value option, if you die on or after your 90th birthday the death benefit is equal to your contract value. However, if you had elected the Standard Death Benefit option and you die on or after your 90th birthday, your beneficiaries would receive the greater of contract value or Net Purchase Payments received prior to your 86th birthday capped at 125% of contract value. Further, there is no additional charge for the Standard Death Benefit and there is an additional charge for the Maximum Anniversary Value option. You should discuss the death benefit options with your financial representative prior to making an election. For contracts in which the aggregate of all Purchase Payments in contracts issued by AIG SunAmerica Life and/or First SunAmerica Life Insurance Company to the same owner are in excess of $1,000,000, we reserve the right to limit the death benefit amount that is in excess of contract value at the time we receive all paperwork and satisfactory proof of death. Any limit on the maximum death benefit payable would be mutually agreed upon by you and the Company prior to purchasing the contract. The death benefit options on contracts issued before June 1, 2004 would be subject to a different calculation. Please see the Statement of Additional Information for details. OPTIONAL ESTATEPLUS FEATURE EstatePlus, an optional benefit of your contract, may increase the death benefit amount if you have earnings in your contract at the time of death. The fee for the benefit is 0.25% of the average daily ending net asset value allocated to the Variable Portfolios. EstatePlus is not available if you are age 81 or older at the time we issue your contract. In order to elect EstatePlus, you must have also elected one of the optional enhanced death benefits described above. You must elect EstatePlus at the time we issue your contract and you may not terminate this election. Furthermore, EstatePlus is not payable after the Latest Annuity Date. You may pay for EstatePlus and your Beneficiary may never receive the benefit if you live past the Latest Annuity Date. We will add a percentage of your contract earnings (the "EstatePlus Percentage"), subject to a maximum dollar amount (the "Maximum EstatePlus Benefit"), to the death benefit payable. The contract year of your death will determine the EstatePlus Percentage and the Maximum EstatePlus Benefit. The table below applies to contracts issued prior to your 70th birthday:
- ---------------------------------------------------------------------------- CONTRACT YEAR ESTATEPLUS MAXIMUM OF DEATH PERCENTAGE ESTATEPLUS BENEFIT - ---------------------------------------------------------------------------- Years 0 - 4 25% of Earnings 40% of Net Purchase Payments - ---------------------------------------------------------------------------- Years 5 - 9 40% of Earnings 65% of Net Purchase Payments* - ---------------------------------------------------------------------------- Years 10+ 50% of Earnings 75% of Net Purchase Payments* - ----------------------------------------------------------------------------
The table below applies to contracts issued on or after your 70th birthday but prior to your 81st birthday:
- --------------------------------------------------------------------------------- CONTRACT YEAR ESTATEPLUS MAXIMUM OF DEATH PERCENTAGE ESTATEPLUS BENEFIT - --------------------------------------------------------------------------------- All Contract Years 25% of Earnings 40% of Net Purchase Payments* - ---------------------------------------------------------------------------------
* Purchase Payments received after the 5th contract anniversary must remain in the contract for at least 6 full months to be included as part of Net Purchase Payments for the purpose of the Maximum EstatePlus Benefit. What is the Contract Year of Death? Contract Year of Death is the number of full 12-month periods during which you have owned your contract ending on the date of death. Your Contract Year of Death is used to determine the EstatePlus Percentage and Maximum EstatePlus Benefit as indicated in the table above. What is the EstatePlus Percentage? We determine the EstatePlus benefit using the EstatePlus Percentage, indicated in the table above, which is a specified percentage of the earnings in your contract on the date of death. For the purpose of this calculation, earnings equals contract value minus Net Purchase Payments as of the date of death. If there are no earnings in your contract at the time of death, the amount of your EstatePlus benefit will be zero. What is the Maximum EstatePlus Benefit? The EstatePlus benefit is subject to a maximum dollar amount. The Maximum EstatePlus Benefit is equal to a 22 specified percentage of your Net Purchase Payments, as indicated in the table above. EstatePlus may not be available in your state or through the broker-dealer with which your financial representative is affiliated. Please contact your financial representative for information regarding availability. A Continuing Spouse may continue or terminate EstatePlus on the Continuation Date but cannot continue the contract with EstatePlus if they are age 81 or older on the Continuation Date. If the Continuing Spouse terminates EstatePlus or dies after the Latest Annuity Date, no EstatePlus benefit will be payable to the Continuing Spouse's Beneficiary. SEE SPOUSAL CONTINUATION BELOW. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE ESTATEPLUS (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME FOR PROSPECTIVELY ISSUED CONTRACTS. SPOUSAL CONTINUATION The Continuing Spouse may elect to continue the contract after your death. Generally, the contract and its benefit and elected features, if any, remain the same. The Continuing Spouse is subject to the same fees, charges and expenses applicable to the original owner of the contract. A spousal continuation can only take place once, upon the death of the original owner of the contract. To the extent that the Continuing Spouse invests in the Variable Portfolios, they will be subject to investment risk as was the original owner. Upon a spousal continuation, we will contribute to the contract value an amount by which the death benefit that would have been paid to the Beneficiary upon the death of the original owner, exceeds the contract value ("Continuation Contribution"), if any. We calculate the Continuation Contribution as of the date of the original owner's death. We will add the Continuation Contribution as of the date we receive both the Continuing Spouse's written request to continue the contract and proof of death of the original owner in a form satisfactory to us ("Continuation Date"). The Continuation Contribution is not considered a Purchase Payment for the purposes of any other calculations except the death benefit following the Continuing Spouse's death. Generally, the age of the Continuing Spouse on the Continuation Date and on the date of the Continuing Spouse's death will be used in determining any future death benefits under the contract. SEE THE SPOUSAL CONTINUATION APPENDIX FOR A DISCUSSION OF THE DEATH BENEFIT CALCULATIONS AFTER A SPOUSAL CONTINUATION. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE SPOUSAL CONTINUATION PROVISION (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME FOR PROSPECTIVELY ISSUED CONTRACTS. PLEASE SEE OPTIONAL LIVING BENEFITS AND DEATH BENEFITS ABOVE FOR INFORMATION ON THE EFFECT OF SPOUSAL CONTINUATION ON THOSE BENEFITS. ---------------------------------------------------------------- ---------------------------------------------------------------- EXPENSES ---------------------------------------------------------------- ---------------------------------------------------------------- There are fees and expenses associated with your contract which reduce your investment return. We will not increase the contract level fees, such as mortality and expense charges or withdrawal charges for the life of your contract. Underlying Fund fees may increase or decrease. Some states may require that we charge less than the amounts described below. SEPARATE ACCOUNT EXPENSES The mortality and expense risk charge and distribution expense charge is 1.52% of the average daily ending net asset value allocated to the Variable Portfolios. This charge compensates the Company for the mortality and expense risk and the costs of contract distribution assumed by the Company. Generally, the mortality risks assumed by the Company arise from its contractual obligations to make income payments after the Annuity Date and to provide a death benefit. The expense risk assumed by the Company is that the costs of administering the contracts and the Separate Account will exceed the amount received from the administrative fees and charges assessed under the contract. If these charges do not cover all of our expenses, we will pay the difference. Likewise, if these charges exceed our expenses, we will keep the difference. The mortality and expense risk charge is expected to result in a profit. Profit may be used for any legitimate cost or expense including supporting distribution, depending upon market conditions. SEE PAYMENTS IN CONNECTION WITH DISTRIBUTION OF THE CONTRACT BELOW. WITHDRAWAL CHARGES The contract provides a free withdrawal amount every year. SEE ACCESS TO YOUR MONEY ABOVE. You may incur a withdrawal charge if you take a withdrawal in excess of the free withdrawal amount and/or if you fully surrender your contract. We apply a withdrawal charge against each Purchase Payment you contribute to the contract. After a Purchase Payment has been in the contract for three complete years, a withdrawal charge no longer applies to that Purchase Payment. The withdrawal charge percentage declines each year a Purchase Payment is in the contract. The withdrawal charge schedule is as follows:
- ---------------------------------------------------------------- YEAR 1 2 3 4+ - ---------------------------------------------------------------- WITHDRAWAL CHARGE 7% 6% 5% 0% - ----------------------------------------------------------------
23 When calculating the withdrawal charge, we treat withdrawals as coming first from the Purchase Payments that have been in your contract the longest. However, for tax purposes, your withdrawals are considered as coming from earnings first, then Purchase Payments. SEE ACCESS TO YOUR MONEY ABOVE. Whenever possible, we deduct the withdrawal charge from the money remaining in your contract. If you fully surrender your contract value, we deduct any applicable withdrawal charges from the amount surrendered. We will not assess a withdrawal charge when we pay a death benefit, contract fees and/or when you switch to the Income Phase. Withdrawals made prior to age 59 1/2 may result in tax penalties. SEE TAXES BELOW. UNDERLYING FUND FEES INVESTMENT MANAGEMENT FEES The Separate Account purchases shares of the Variable Portfolios. The Accumulation Unit value for each Variable Portfolio reflects the investment management fees and other expenses of the Underlying Funds. These fees may vary. They are not fixed or specified in your annuity contract, rather the Variable Portfolios are governed by their own boards of trustees. 12b-1 FEES Shares of certain Trusts may be subject to fees imposed under a distribution and/or servicing plan adopted pursuant to Rule 12b-1 under the Investment Company Act of 1940. There is an annualized 0.25% fee applicable to Class 3 shares of Anchor Series Trust and SunAmerica Series Trust, Class II shares of the Van Kampen Life Investment Trust, Class 2 shares of American Funds Insurance Series, and Nations Separate Account Trust. This amount is generally used to pay financial intermediaries for services provided over the life of your contract. For more detailed information on these Underlying Fund fees, refer to the prospectuses for the Trusts. CONTRACT MAINTENANCE FEE During the Accumulation Phase, we deduct a contract maintenance fee of $35 from your contract once per year on your contract anniversary. This charge compensates us for the cost of administering your contract. We will deduct the contract maintenance fee on a pro-rata basis from your contract value on your contract anniversary. If you withdraw your entire contract value, we will deduct the contract maintenance fee from that withdrawal. If your contract value is $50,000 or more on your contract anniversary date, we are currently waiving this fee. This waiver is subject to change without notice. TRANSFER FEE Generally, we permit 15 free transfers between investment options each contract year. We charge you $25 for each additional transfer that contract year. SEE TRANSFERS DURING THE ACCUMULATION PHASE ABOVE. OPTIONAL POLARIS INCOME REWARDS FEE The annualized Polaris Income Rewards fee will be assessed as a percentage of the Withdrawal Benefit Base. The fee will be deducted quarterly from your contract value starting on the first quarter following the contract issue date and ending upon the termination of the feature. If your contract value falls to zero before the feature has been terminated, the fee will no longer be assessed. We will not assess the quarterly fee if you surrender or annuitize before the end of a quarter. The fee is as follows:
---------------------------------------------------- CONTRACT YEAR ANNUALIZED FEE ---------------------------------------------------- 0-7 years 0.65% of Withdrawal Benefit Base ---------------------------------------------------- 8-10 years 0.45% of Withdrawal Benefit Base ---------------------------------------------------- 11+ years none ----------------------------------------------------
OPTIONAL CAPITAL PROTECTOR FEE The annualized Capital Protector fee is calculated as a percentage of your contract value minus Purchase Payments received after the 90th day since contract issue date. If you elect the feature, the charge is deducted at the end of the first contract quarter and quarterly thereafter from your contract value. The fee is as follows:
- ---------------------------------------------------------------------------------- CONTRACT YEAR ANNUALIZED FEE - ---------------------------------------------------------------------------------- 0-5 0.65% - ---------------------------------------------------------------------------------- 6-10 0.45% - ---------------------------------------------------------------------------------- 11+ none - ----------------------------------------------------------------------------------
OPTIONAL ENHANCED DEATH BENEFIT FEE The fee for the optional enhanced death benefit is 0.20% of the average daily ending net asset value allocated to the Variable Portfolio. OPTIONAL ESTATEPLUS FEE The fee for EstatePlus is 0.25% of the average daily ending net asset value allocated to the Variable Portfolio. PREMIUM TAX Certain states charge the Company a tax on Purchase Payments up to a maximum of 3.5%. We deduct these premium tax charges when you fully surrender your contract or begin the Income Phase. In the future, we may deduct this premium tax at the time you make a Purchase Payment or upon payment of a death benefit. 24 INCOME TAXES We do not currently deduct income taxes from your contract. We reserve the right to do so in the future. REDUCTION OR ELIMINATION OF CHARGES AND EXPENSES, AND ADDITIONAL AMOUNTS CREDITED Sometimes sales of contracts to groups of similarly situated individuals may lower our fees and expenses. We reserve the right to reduce or waive certain fees and expenses when this type of sale occurs. In addition, we may also credit additional amounts to contracts sold to such groups. We determine which groups are eligible for this treatment. Some of the criteria we evaluate to make a determination are size of the group; amount of expected Purchase Payments; relationship existing between us and the prospective purchaser; length of time a group of contracts is expected to remain active; purpose of the purchase and whether that purpose increases the likelihood that our expenses will be reduced; and/or any other factors that we believe indicate that fees and expenses may be reduced. The Company may make such a determination regarding sales to its employees, it affiliates' employees and employees of currently contracted broker-dealers; its registered representatives; and immediate family members of all of those described. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE ANY SUCH DETERMINATION OR THE TREATMENT APPLIED TO A PARTICULAR GROUP AT ANY TIME. ---------------------------------------------------------------- ---------------------------------------------------------------- INCOME OPTIONS ---------------------------------------------------------------- ---------------------------------------------------------------- ANNUITY DATE During the Income Phase, we use the money accumulated in your contract to make regular income payments to you. You may switch to the Income Phase any time after your second contract anniversary. You must provide us with a written request of the date you want income payments to begin. Your annuity date is the first day of the month you select income payments to begin ("Annuity Date"). You may change your Annuity Date, so long as you do so at least seven days before the income payments are scheduled to begin. Except as indicated under Option 5 below, once you begin receiving income payments, you cannot otherwise access your money through a withdrawal or surrender. Income payments must begin on or before your Latest Annuity Date. If you do not choose an Annuity Date, your income payments will automatically begin on the Latest Annuity Date. If the Annuity Date is past your 85th birthday, your contract could lose its status as an annuity under Federal tax laws. This may cause you to incur adverse tax consequences. In addition, most Qualified contracts require you to take minimum distributions after you reach age 70 1/2. SEE TAXES BELOW. INCOME OPTIONS You must contact us to select an income option. Once you begin receiving income payments, you cannot change your income option before beginning the Income Phase. If you elect to receive income payments but do not select an option, your income payments shall be in accordance with Option 4 for a period of 10 years; for income payments based on joint lives, the default is Option 3 for a period of 10 years. We base our calculation of income payments on the life expectancy of the Annuitant and the annuity rates set forth in your contract. As the contract owner, you may change the Annuitant at any time prior to the Annuity Date. You must notify us if the Annuitant dies before the Annuity Date and designate a new Annuitant. Option 1 - Life Income Annuity This option provides income payments for the life of the Annuitant. Income payments stop when the Annuitant dies. Option 2 - Joint and Survivor Life Income Annuity This option provides income payments for the life of the Annuitant and for the life of another designated person. Upon the death of either person, we will continue to make income payments during the lifetime of the survivor. Income payments stop when the survivor dies. Option 3 - Joint and Survivor Life Income Annuity with 10 or 20 Years Guaranteed This option is similar to Option 2 above, with an additional guarantee of payments for at least 10 or 20 years, depending on the period chosen. If the Annuitant and the survivor die before all of the guaranteed income payments have been made, the remaining income payments are made to the Beneficiary under your contract. Option 4 - Life Income Annuity with 10 or 20 Years Guaranteed This option is similar to Option 1 above with an additional guarantee of payments for at least 10 or 20 years, depending on the period chosen. If the Annuitant dies before all guaranteed income payments are made, the remaining income payments are made to the Beneficiary under your contract. Option 5 - Income for a Specified Period This option provides income payments for a guaranteed period ranging from 5 to 30 years, depending on the period chosen. If the Annuitant dies before all the guaranteed income payments are made, the remaining income payments are made to the Beneficiary under your contract. Additionally, if variable income payments are elected under this option, you 25 (or the Beneficiary under the contract if the Annuitant dies prior to all guaranteed income payments being made) may redeem any remaining guaranteed variable income payments after the Annuity Date. The amount available upon such redemption would be the discounted present value of any remaining guaranteed variable income payments. If provided for in your contract, any applicable withdrawal charge will be deducted from the discounted value as if you fully surrendered your contract. The value of an Annuity Unit, regardless of the option chosen, takes into account the mortality and expense risk charge. Since Option 5 does not contain an element of mortality risk, no benefit is derived from this charge. Please read the Statement of Additional Information for a more detailed discussion of the income options. FIXED OR VARIABLE INCOME PAYMENTS You can choose income payments that are fixed, variable or both. Unless otherwise elected, if at the date when income payments begin you are invested in the Variable Portfolios only, your income payments will be variable and if your money is only in Fixed Accounts at that time, your income payments will be fixed in amount. Further, if you are invested in both fixed and variable investment options when income payments begin, your payments will be fixed and variable, unless otherwise elected. If income payments are fixed, the Company guarantees the amount of each payment. If the income payments are variable, the amount is not guaranteed. INCOME PAYMENTS We make income payments on a monthly, quarterly, semi-annual or annual basis. You instruct us to send you a check or to have the payments directly deposited into your bank account. If state law allows, we distribute annuities with a contract value of $5,000 or less in a lump sum. Also, if state law allows and the selected income option results in income payments of less than $50 per payment, we may decrease the frequency of payments. If you are invested in the Variable Portfolios after the Annuity date, your income payments vary depending on four things: - for life options, your age when payments begin; and - the contract value attributable to the Variable Portfolios on the Annuity Date; and - the 3.5% assumed investment rate used in the annuity table for the contract; and - the performance of the Variable Portfolios in which you are invested during the time you receive income payments. If you are invested in both the Fixed Accounts and the Variable Portfolios after the Annuity Date, the allocation of funds between the fixed and variable options also impacts the amount of your annuity payments. The value of variable income payments, if elected, is based on an assumed interest rate ("AIR") of 3.5% compounded annually. Variable income payments generally increase or decrease from one income payment date to the next based upon the performance of the applicable Variable Portfolios. If the performance of the Variable Portfolios selected is equal to the AIR, the income payments will remain constant. If performance of Variable Portfolios is greater than the AIR, the income payments will increase and if it is less than the AIR, the income payments will decline. TRANSFERS DURING THE INCOME PHASE During the Income Phase, one transfer per month is permitted between the Variable Portfolios. No other transfers are allowed during the Income Phase. DEFERMENT OF PAYMENTS We may defer making fixed payments for up to six months, or less if required by law. Interest is credited to you during the deferral period. SEE ALSO ACCESS TO YOUR MONEY ABOVE FOR A DISCUSSION OF WHEN PAYMENTS FROM A VARIABLE PORTFOLIO MAY BE SUSPENDED OR POSTPONED. - ---------------------------------------------------------------- - ---------------------------------------------------------------- TAXES - ---------------------------------------------------------------- - ---------------------------------------------------------------- NOTE: THE BASIC SUMMARY BELOW ADDRESSES BROAD FEDERAL TAXATION MATTERS, AND GENERALLY DOES NOT ADDRESS STATE TAXATION ISSUES OR QUESTIONS. IT IS NOT TAX ADVICE. WE CAUTION YOU TO SEEK COMPETENT TAX ADVICE ABOUT YOUR OWN CIRCUMSTANCES. WE DO NOT GUARANTEE THE TAX STATUS OF YOUR ANNUITY. TAX LAWS CONSTANTLY CHANGE; THEREFORE, WE CANNOT GUARANTEE THAT THE INFORMATION CONTAINED HEREIN IS COMPLETE AND/OR ACCURATE. WE HAVE INCLUDED AN ADDITIONAL DISCUSSION REGARDING TAXES IN THE STATEMENT OF ADDITIONAL INFORMATION. ANNUITY CONTRACTS IN GENERAL The Internal Revenue Code ("IRC") provides for special rules regarding the tax treatment of annuity contracts. Generally, taxes on the earnings in your annuity contract are deferred until you take the money out. Qualified retirement investments that satisfy specific tax and ERISA requirements automatically provide tax deferral regardless of whether the underlying contract is an annuity, a trust, or a custodial account. Different rules apply depending on how you take the money out and whether your contract is Qualified or Non-Qualified. If you do not purchase your contract under a pension plan, a specially sponsored employer program or an individual retirement account, your contract is referred to as a Non-Qualified contract. A Non-Qualified contract receives different tax treatment than a Qualified contract. In general, your cost in a Non-Qualified contract is equal to the Purchase Payments 26 you put into the contract. You have already been taxed on the cost basis in your contract. If you purchase your contract under a pension plan, a specially sponsored employer program or as an individual retirement account, your contract is referred to as a Qualified contract. Examples of qualified plans or arrangements are: Individual Retirement Accounts ("IRAs"), Roth IRAs, Tax-Sheltered Annuities (referred to as 403(b) contracts), plans of self-employed individuals (often referred to as H.R.10 Plans or Keogh Plans) and pension and profit sharing plans, including 401(k) plans. Typically, for employer plans and tax-deductible IRA contributions, you have not paid any tax on the Purchase Payments used to buy your contract and therefore, you have no cost basis in your contract. However, you normally will have cost basis in a Roth IRA, and you may have cost basis in a traditional IRA or in another Qualified Contract. TAX TREATMENT OF DISTRIBUTIONS - NON-QUALIFIED CONTRACTS If you make a partial or total withdrawal from a Non-Qualified contract, the IRC treats such a withdrawal as first coming from the earnings and then as coming from your Purchase Payments. Purchase payments made prior to August 14, 1982, however, are an important exception to this general rule, and for tax purposes are treated as being distributed before the earnings on those contributions. If you annuitize your contract, a portion of each income payment will be considered, for tax purposes, to be a return of a portion of your Purchase Payment(s). Any portion of each income payment that is considered a return of your Purchase Payment will not be taxed. Withdrawn earnings are treated as income to you and are taxable. The IRC provides for a 10% penalty tax on any earnings that are withdrawn other than in conjunction with the following circumstances: (1) after reaching age 59 1/2; (2) when paid to your Beneficiary after you die; (3) after you become disabled (as defined in the IRC); (4) when paid in a series of substantially equal periodic payments calculated over your life or for the joint lives of you and your Beneficiary for a period of 5 years or attainment of age 59 1/2, whichever is longer; (5) under an immediate annuity; or (6) which are attributable to Purchase Payments made prior to August 14, 1982. TAX TREATMENT OF DISTRIBUTIONS - QUALIFIED CONTRACTS (INCLUDING GOVERNMENTAL 457(b) ELIGIBLE DEFERRED COMPENSATION PLANS) Generally, you have not paid any taxes on the Purchase Payments used to buy a Qualified contract. As a result, with certain limited exceptions, any amount of money you take out as a withdrawal or as income payments is taxable income. In the case of certain Qualified contracts, the IRC further provides for a 10% penalty tax on any taxable withdrawal or income payment paid to you other than in conjunction with the following circumstances: (1) after reaching age 59 1/2; (2) when paid to your Beneficiary after you die; (3) after you become disabled (as defined in the IRC); (4) in a series of substantially equal periodic payments calculated over your life or for the joint lives of you and your Beneficiary, that begins after separation from service with the employer sponsoring the plan and continued for a period of 5 years until you attain age 59 1/2, whichever is longer; (5) to the extent such withdrawals do not exceed limitations set by the IRC for deductible amounts paid during the taxable year for medical care; (6) to fund higher education expenses (as defined in the IRC; only from an IRA); (7) to fund certain first-time home purchase expenses (only from an IRA); (8) when you separate from service after attaining age 55 (does not apply to an IRA); (9) when paid for health insurance, if you are unemployed and meet certain requirements; and (10) when paid to an alternate payee pursuant to a qualified domestic relations order (does not apply to IRAs). This 10% penalty tax does not apply to withdrawals or income payments from governmental 457(b) eligible deferred compensation plans, except to the extent that such withdrawals or income payments are attributable to a prior rollover to the plan (or earnings thereon) from another plan or arrangement that was subject to the 10% penalty tax. The IRC limits the withdrawal of an employee's voluntary Purchase Payments from a Tax-Sheltered Annuity (TSA). Withdrawals can only be made when an owner: (1) reaches age 59 1/2; (2) severs employment with the employer; (3) dies; (4) becomes disabled (as defined in the IRC); or (5) experiences a financial hardship (as defined in the IRC). In the case of hardship, the owner can only withdraw Purchase Payments. Additional plan limitations may also apply. Amounts held in a TSA annuity contract as of December 31, 1988 are not subject to these restrictions. Qualifying transfers of amounts from one TSA contract to another TSA contract under section 403(b) or to a custodial account under section 403(b)(7), and qualifying transfers to a state defined benefit plan to purchase service credits, are not considered distributions, and thus are not subject to these withdrawal limitations. If amounts are transferred from a custodial account described in Code section 403(b)(7) to this contract the transferred amount will retain the custodial account withdrawal restrictions. Withdrawals from other Qualified Contracts are often limited by the IRC and by the employer's plan. MINIMUM DISTRIBUTIONS Generally, the IRC requires that you begin taking annual distributions from qualified annuity contracts by April 1 of the calendar year following the later of (1) the calendar year in which you attain age 70 1/2 or (2) the calendar year in which you separate from service from the employer sponsoring the plan. If you own an IRA, you must begin taking distributions when you attain age 70 1/2. If you own more than one TSA, you may be permitted to take your annual distributions in any combination from your TSAs. A similar rule applies if you 27 own more than one IRA. However, you cannot satisfy this distribution requirement for your TSA contract by taking a distribution from an IRA, and you cannot satisfy the requirement for your IRA by taking a distribution from a TSA. You may be subject to a surrender charge on withdrawals taken to meet minimum distribution requirements, if the withdrawals exceed the contract's maximum penalty free amount. Failure to satisfy the minimum distribution requirements may result in a tax penalty. You should consult your tax advisor for more information. You may elect to have the required minimum distribution amount on your contract calculated and withdrawn each year under the automatic withdrawal option. You may select monthly, quarterly, semiannual, or annual withdrawals for this purpose. This service is provided as a courtesy and we do not guarantee the accuracy of our calculations. Accordingly, we recommend you consult your tax advisor concerning your required minimum distribution. You may terminate your election for automated minimum distribution at any time by sending a written request to our Annuity Service Center. We reserve the right to change or discontinue this service at any time. The IRS issued regulations, effective January 1, 2003, regarding required minimum distributions from qualified annuity contracts. One of the regulations effective January 1, 2006 will require that the annuity contract value used to determine required minimum distributions include the actuarial value of other benefits under the contract, such as optional death benefits. This regulation does not apply to required minimum distributions made under an irrevocable annuity income option. Generally, we are currently awaiting further clarification from the IRS on this regulation, including how the value of such benefits is determined. You should discuss the effect of these new regulations with your tax advisor. TAX TREATMENT OF DEATH BENEFITS Any death benefits paid under the contract are taxable to the Beneficiary. The rules governing the taxation of payments from an annuity contract, as discussed above, generally apply whether the death benefits are paid as lump sum or annuity payments. Estate taxes may also apply. Certain enhanced death benefits may be purchased under your contract. Although these types of benefits are used as investment protection and should not give rise to any adverse tax effects, the IRS could take the position that some or all of the charges for these death benefits should be treated as a partial withdrawal from the contract. In that case, the amount of the partial withdrawal may be includible in taxable income and subject to the 10% penalty if the owner is under 59 1/2. If you own a Qualified contract and purchase these enhanced death benefits, the IRS may consider these benefits "incidental death benefits." The IRC imposes limits on the amount of the incidental death benefits allowable for Qualified contracts. If the death benefit(s) selected by you are considered to exceed these limits, the benefit(s)could result in taxable income to the owner of the Qualified contract. Furthermore, the IRC provides that the assets of an IRA (including a Roth IRA) may not be invested in life insurance, but may provide, in the case of death during the Accumulation Phase, for a death benefit payment equal to the greater of Purchase Payments or Contract Value. This contract offers death benefits, which may exceed the greater of Purchase Payments or Contract Value. If the IRS determines that these benefits are providing life insurance, the contract may not qualify as an IRA (including Roth IRAs). You should consult your tax advisor regarding these features and benefits prior to purchasing a contract. CONTRACTS OWNED BY A TRUST OR CORPORATION A Trust or Corporation ("Non-Natural Owner") that is considering purchasing this contract should consult a tax advisor. Generally, the IRC does not treat a Non-Qualified contract owned by a non-natural owner as an annuity contract for Federal income tax purposes. The non-natural owner pays tax currently on the contract's value in excess of the owner's cost basis. However, this treatment is not applied to a contract held by a trust or other entity as an agent for a natural person nor to contracts held by Qualified Plans. See the SAI for a more detailed discussion of the potential adverse tax consequences associated with non-natural ownership of a non-qualified annuity contract. GIFTS, PLEDGES AND/OR ASSIGNMENTS OF A CONTRACT If you transfer ownership of your Non-Qualified contract to a person other than your spouse (or former spouse incident to divorce) as a gift you will pay federal income tax on the contract's cash value to the extent it exceeds your cost basis. The recipient's cost basis will be increased by the amount on which you will pay federal taxes. In addition, the IRC treats any assignment or pledge (or agreement to assign or pledge) of any portion of a Non- Qualified contract as a withdrawal. See the SAI for a more detailed discussion regarding potential tax consequences of gifting, assigning, or pledging a Non-Qualified contract. The IRC prohibits Qualified annuity contracts including IRAs from being transferred, assigned or pledged as security for a loan. This prohibition, however, generally does not apply to loans under an employer-sponsored plan (including loans from the annuity contract) that satisfy certain requirements, provided that: (a) the plan is not an unfunded deferred compensation plan; and (b) the plan funding vehicle is not an IRA. 28 DIVERSIFICATION AND INVESTOR CONTROL The IRC imposes certain diversification requirements on the underlying investments for a variable annuity. We believe that the management of the Underlying Funds monitors the Funds so as to comply with these requirements. To be treated as a variable annuity for tax purposes, the underlying investments must meet these requirements. The diversification regulations do not provide guidance as to the circumstances under which you, and not the Company, would be considered the owner of the shares of the Variable Portfolios under your Non-Qualified Contract, because of the degree of control you exercise over the underlying investments. This diversification requirement is sometimes referred to as "investor control." It is unknown to what extent owners are permitted to select investments, to make transfers among Variable Portfolios or the number and type of Variable Portfolios owners may select from. If any guidance is provided which is considered a new position, then the guidance should generally be applied prospectively. However, if such guidance is considered not to be a new position, it may be applied retroactively. This would mean that you, as the owner of the Non-qualified Contract, could be treated as the owner of the underlying Variable Portfolios. Due to the uncertainty in this area, we reserve the right to modify the contract in an attempt to maintain favorable tax treatment. These investor control limitations generally do not apply to Qualified Contracts, which are referred to as "Pension Plan Contracts" for purposes of this rule, although the limitations could be applied to Qualified Contracts in the future. - ---------------------------------------------------------------- - ---------------------------------------------------------------- OTHER INFORMATION - ---------------------------------------------------------------- - ---------------------------------------------------------------- THE SEPARATE ACCOUNT The Company established the Separate Account, Variable Separate Account, under Arizona law on January 1, 1996 when it assumed the Separate Account, originally established under California law on June 25, 1981. The Separate Account is registered with the SEC as a unit investment trust under the Investment Company Act of 1940, as amended. The Company owns the assets in the Separate Account. However, the assets in the Separate Account are not chargeable with liabilities arising out of any other business conducted by the Company. Income gains and losses (realized and unrealized) resulting from assets in the Separate Account are credited to or charged against the Separate Account without regard to other income gains or losses of the Company. THE GENERAL ACCOUNT Money allocated to any Fixed Accounts goes into the Company's general account. The general account consists of all of the company's assets other than assets attributable to a Separate Account. All of the assets in the general account are chargeable with the claims of any of the Company's contract holders as well as all of its creditors. The general account funds are invested as permitted under state insurance laws. The Company has a support agreement in effect between the Company and its ultimate parent company, American International Group, Inc. ("AIG"), and the Company's insurance policy obligations are guaranteed by American Home Assurance Company, a subsidiary of AIG. See the Statement of Additional Information for more information regarding these arrangements. REGISTRATION STATEMENTS Registration statements under the Securities Act of 1933, as amended, related to the contracts offered by this prospectus are on file with the SEC. This prospectus does not contain all of the information contained in the registration statements and exhibits. For further information regarding the Separate Account, the Company and its general account, the Variable Portfolios and the contract, please refer to the registration statements and exhibits. PAYMENTS IN CONNECTION WITH DISTRIBUTION OF THE CONTRACT PAYMENTS TO BROKER-DEALERS Registered representatives of broker-dealers sell the contract. We pay commissions to the broker-dealers for the sale of your contract ("Contract Commissions"). There are different structures by which a broker-dealer can choose to have their Contract Commissions paid. For example, as one option, we may pay upfront Contract Commission only, that may be up to a maximum 6% of each Purchase Payment you invest (which may include promotional amounts). Another option may be a lower upfront Contract Commission on each Purchase Payment, with a trail commission of up to a maximum 1.50% of contract value annually. Generally, the higher the upfront commissions, the lower the trail and vice versa. We pay Contract Commissions directly to the broker-dealer with whom your registered representative is affiliated. Registered representatives may receive a portion of these amounts we pay in accordance with any agreement in place between the registered representative and his/her broker-dealer firm. We may pay broker-dealers support fees in the form of additional cash or non-cash compensation. These payments may be intended to reimburse for specific expenses incurred or may be based on sales, certain assets under management, longevity of assets invested with us or a flat fee. These payments may be consideration for, among other things, product placement/preference, greater access to train and educate the firm's registered representatives about our products, our participation in sales conferences and educational seminars and allowing broker-dealers to perform due diligence on our products. The amount of these fees may 29 be tied to the anticipated level of our access in that firm. We enter into such arrangements in our discretion and we may negotiate customized arrangements with firms, including affiliated and non-affiliated broker-dealers based on various factors. We do not deduct these amounts directly from your Purchase Payments. We anticipate recovering these amounts from the fees and charges collected under the contract. Contract commissions and other support fees may influence the way that a broker-dealer and its registered representatives market the contracts and service customers who purchase the contracts and may influence the broker- dealer and its registered representatives to present this contract over others available in the market place. You should discuss with your broker-dealer and/or registered representative how they are compensated for sales of a contract and/or any resulting real or perceived conflicts of interest. AIG SunAmerica Capital Services, Inc., Harborside Financial Center, 3200 Plaza 5, Jersey City, NJ 07311-4992, distributes the contracts. AIG SunAmerica Capital Services, an affiliate of the Company, is a registered broker-dealer under the Exchange Act of 1934 and is a member of the National Association of Securities Dealers, Inc. No underwriting fees are paid in connection with the distribution of the contracts. PAYMENTS WE RECEIVE In addition to amounts received pursuant to established 12b-1 Plans from the Underlying Funds, we receive compensation of up to 0.50% annually based on assets under management from certain Trusts' investment advisers or their affiliates for services related to the availability of the Underlying Funds in the contract. We receive such payments in connection with each of the Trusts available in this Contract with the exception of AFIS. Such amounts received from our affiliate, AIG SAAMCo, are paid pursuant to a profit sharing agreement and are not expected to exceed 0.50%. Furthermore, certain investment advisers and/or subadvisers may help offset the costs we incur for training to support sales of the Underlying Funds in the contract. ADMINISTRATION We are responsible for the administrative servicing of your contract. Please contact our Annuity Service Center at (800) 445-SUN2, if you have any comment, question or service request. We send out transaction confirmations and quarterly statements. During the Accumulation Phase, you will receive confirmation of transactions within your contract. Transactions made pursuant to contractual or systematic agreements, such as dollar cost averaging, may be confirmed quarterly. Purchase Payments received through the automatic payment plan or a salary reduction arrangement, may also be confirmed quarterly. For all other transactions, we send confirmations immediately. It is your responsibility to review these documents carefully and notify us of any inaccuracies immediately. We investigate all inquiries. To the extent that we believe we made an error, we retroactively adjust your contract, provided you notify us within 30 days of receiving the transaction confirmation or quarterly statement. Any other adjustments we deem warranted are made as of the time we receive notice of the error. LEGAL PROCEEDINGS There are no pending legal proceedings affecting the Separate Account. The Company and its subsidiaries are parties to various kinds of litigation incidental to their respective business operations. In management's opinion, these matters are not material in relation to the financial position of the Company with the exception of the matter disclosed below. A purported class action captioned Nitika Mehta, as Trustee of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case 04L0199, was filed on April 5, 2004 in the Circuit Court, Twentieth Judicial District in St. Clair County, Illinois. The action has been transferred to and is currently pending in the United States District Court for the District of Maryland, Case No. 04-md-15863, as part of a Multi-District Litigation proceeding. The lawsuit alleges certain improprieties in conjunction with alleged market timing activities. The probability of any particular outcome cannot be reasonably estimated at this time. AIG has announced that it has delayed filing its Annual Report on Form 10-K for the year ended December 31, 2004 to allow AIG's Board of Directors and new management adequate time to complete an extensive review of AIG's books and records. The review includes issues arising from pending investigations into non-traditional insurance products and certain assumed reinsurance transactions by the Office of the Attorney General for the State of New York and the Securities and Exchange Commission and from AIG's decision to review the accounting treatment of certain additional items. Circumstances affecting AIG can have an impact on the Company. For example, the recent downgrades and ratings actions taken by the major rating agencies with respect to AIG resulted in corresponding downgrades and ratings actions being taken with respect to the Company's ratings. Accordingly, we can give no assurance that any further changes in circumstances for AIG will not impact us. 30 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AIG SUNAMERICA LIFE ASSURANCE COMPANY - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AIG SunAmerica Life Assurance Company (the "Company") was incorporated as Anchor National Life Insurance Company under the laws of the State of Arizona on April 12, 1965 while the Company changed its name to AIG SunAmerica Life Assurance Company on January 24, 2002. The Company continued to do business as Anchor National Life Insurance Company until February 28, 2003, after which time it began doing business under its new name, AIG SunAmerica Life Assurance Company. 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 has no employees; however, employees of AIGRS and other affiliates of the Company perform various services for the Company. AIGRS had approximately 1,900 employees at December 31, 2004, approximately 1,100 of whom perform services for the Company as well as for certain of its affiliates. The Company's primary activities are retirement services, herein discussed as annuity operations and asset management operations. The annuity operations consist of the sale and administration of deposit-type insurance contracts, such as variable and fixed annuity contracts, universal life insurance contracts and guaranteed investment contracts ("GICs"). The asset management operations are conducted by the Company's registered investment advisor subsidiary, AIG SunAmerica Asset Management Corp ("SAAMCo"), and its wholly owned distributor, AIG SunAmerica Capital Services, Inc. ("SACS"), and its wholly owned servicing administrator, AIG SunAmerica Fund Services, Inc. ("SFS"). See Note 13 of Notes to the Consolidated Financial Statements for operating results by segment. The Company ranks among the largest U.S. issuers of variable annuity contracts. The Company distributes its products and services through an extensive network of independent broker-dealers, full-service securities firms and financial institutions. In prior years, GICs were marketed directly to banks, municipalities, asset management firms and direct plan sponsors and through intermediaries, such as managers or consultants servicing these groups. In addition to distributing its variable annuity products through its nine affiliated broker-dealers, the Company distributes its products through a vast network of independent broker-dealers, full-service securities firms and financial institutions. In total, more than 84,000 independent sales representatives are appointed to sell the Company's annuity products. The Company's nine affiliated broker-dealers are among the largest networks of registered representatives in the nation. Sales through affiliated broker-dealers accounted for approximately a quarter of the Company's total annuity sales in 2004. 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 51 million to 69 million from 1994 to 2003, making this age group the fastest-growing segment of the U.S. population. Between 1994 and 2003, annual industry premiums from fixed and variable annuities increased from $155 billion to $267 billion. Benefiting from continued strong growth of the retirement savings 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 life operations on the sale of variable annuity contracts. In recent years, the Company has enhanced its marketing efforts and expanded its offerings of fee-based variable annuity contracts. Variable accounts within the Company's variable annuity business entail no portfolio credit risk and requires significantly less capital support than the fixed accounts of variable annuity contracts ("Fixed Options"), which generate net investment income. F-1 The following table shows the Company's investment income, net realized investment losses and fee income for the year ended December 31, 2004 by primary product line or service: NET INVESTMENT AND FEE INCOME
AMOUNT PERCENT PRIMARY PRODUCT OR SERVICE --------- -------- ----------------------------------------- (IN THOUSANDS, EXCEPT FOR PERCENTAGES) Fee income: Variable annuity policy fees, net of reinsurance.......... $369,141 42.2% Variable annuity contracts Asset management fees..................................... 89,569 10.2 Asset management Universal life policy fees, net of reinsurance............ 33,899 3.9 Universal life products Surrender charges......................................... 26,219 3.0 Fixed and variable annuity contracts Other fees................................................ 15,753 1.8 Asset management -------- ----- Total fee income.......................................... 534,581 61.1 Investment income........................................... 363,594 41.6 Fixed annuity contracts and Fixed Options Net realized investment losses.............................. (23,807) (2.7) Fixed annuity contracts and Fixed Options -------- ----- Total net investment and fee income......................... $874,368 100.0% ======== =====
ANNUITY OPERATIONS - SEPARATE ACCOUNT The annuity operations principally engaged in the business of issuing variable annuity contracts directed to the market for tax-deferred, long-term savings products. It also administers closed blocks of fixed annuity contracts, universal life insurance contracts and GICs directed to the institutional marketplace. The Company's variable annuity products offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as Fixed Options. The Company earns fees on the amounts earned in variable account options of its variable annuity products held in separate accounts and net investment income on the Fixed Options held in the general account. Variable annuity contracts offer retirement planning features similar to those offered by fixed annuity contracts, but differ in that the contract holder'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 contract holder. Because the investment risk is generally borne by the customer in all but the Fixed Options, these products require significantly less capital support than fixed annuity contracts. At December 31, 2004, variable product liabilities were $26.04 billion, of which $22.61 billion were held in separate accounts and $3.43 billion were the liabilities of the Fixed Options, held in the Company's general account. The Company's variable annuity products incorporate incentives, surrender charges and/or other restrictions to encourage persistency. At December 31, 2004, 71% of the Company's variable annuity liabilities held in 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 2004 was approximately $74,000. ANNUITY OPERATIONS - GENERAL ACCOUNT The Company's general account obligations are fixed-rate products, principally Fixed Options, but also including fixed annuity contracts, GICs and universal life insurance contracts ("Fixed-Rate Products") issued in prior years. The Fixed Options provide interest rate guarantees of certain periods ranging up to ten years. Although the Company's annuity contracts remain in force an average of seven to ten years, approximately 77% of the reserves for fixed annuity contracts and Fixed Options, as well as the universal life insurance contracts, reprice annually at discretionary rates determined by the Company subject to a minimum rate guarantee ranging from 1.5% to 4.0%, 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. In prior years, the Company augmented its retail annuity business with the sale of institutional products. At December 31, 2004, the Company had $211.4 million of fixed-maturity, variable-rate GIC obligations that reprice periodically based upon certain defined indices and $3.9 million of fixed-maturity, fixed-rate GICs. The Company designs its Fixed-Rate Products and conducts its investment operations in order to closely match the duration and cash flows of the assets in its investment portfolio to its fixed-rate 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-Rate Products incorporate incentives, surrender charges and other restrictions in order to encourage F-2 persistency. Approximately 77% of the Company's reserves for Fixed-Rate Products had incentives, surrender penalties and/or other restrictions at December 31, 2004. INVESTMENT OPERATIONS The Company believes a portfolio principally composed of fixed-rate investments that generate predictable rates of return should back its liabilities for Fixed-Rate Products. 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 an affiliate 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." ASSET MANAGEMENT OPERATIONS Effective January 1, 2004, the Parent contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, SAAMCo, which in turn has two wholly owned subsidiaries: SACS and SFS. Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary of the Company. This contribution increased the Company's shareholder's equity by $150,653,000. Assets, liabilities and shareholder's equity at December 31, 2003 were restated to include $190,605,000, $39,952,000 and $150,653,000, respectively, of SAAMCo balances. Similarly, the results of operations and cash flows have been restated for the years ended December 31, 2003 and 2002 for the addition and subtraction to pretax income of $16,345,000 and $4,464,000, respectively, to reflect the SAAMCo activity. The asset management operations are conducted by the Company's registered investment advisor subsidiary, SAAMCo, and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS. These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, serving as investment advisor to certain variable investment portfolios offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. 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 an 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 contract, deposits of securities for the benefit of contract holders, 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 contract holders rather than security holders. 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, 2004. The federal government does not directly regulate the business of insurance, however, the Company, its subsidiaries and its products are governed by federal agencies, including the Securities and Exchange Commission ("SEC"), the Internal Revenue Service and the self-regulatory organization, National Association of Securities Dealers, Inc. ("NASD"). 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 the F-3 Employee Retirement Income Security Act 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, among other items, after-hours trading, short-term trading (sometimes referred to as market timing), suitability, revenue sharing arrangements and greater transparency regarding compensation arrangements. There are several rule proposals pending at the SEC, the NASD and on a federal level, which, if passed, could have an impact on the business of the Company and/or its subsidiaries. COMPETITION The businesses conducted by the Company are highly competitive. The Company competes with other life insurers, and also competes for customers' 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 2003, net annuity premiums written among the top 100 companies ranged from approximately $79 million to approximately $20 billion annually. The Company together with its affiliates ranked third 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. AVAILABLE INFORMATION AIG SunAmerica Life Assurance Company (the "Company") files annual, quarterly, and current reports and other information with the Securities and Exchange Commission (the "SEC"). The SEC maintains a website that contains annual, quarterly, and current reports and other information that issuers (including the Company) file electronically with the SEC. The SEC's website is http://www.sec.gov. Additionally, any materials the Company files with the SEC may be read and copied at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company does not maintain a website. The Company makes available free of charge, Annual Reports on Form 10-K, Quarterly Reports of Form 10-Q and Current Reports of Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such materials are electronically filed with, or furnished to the SEC. SECURITIES AND EXCHANGE COMMISSION POSITION ON INDEMNIFICATION Indemnification for liabilities arising under the 1933 Act is provided to the Company's officers, directors and controlling persons. The SEC has advised that it believes such indemnification is against public policy under the Securities Act and unenforceable. If a claim for indemnification against such liabilities (other than for payment of expenses incurred or paid by its directors, officers or controlling persons in the successful defense of any legal action) is asserted by a director, officer or controlling person of the Company in connection with the securities registered under this prospectus, the Company will submit to a court with jurisdiction to determine whether the indemnification is against public policy under the Act. The Company will be governed by final judgment of the issue. However, if in the opinion of the Company's counsel this issue has been determined by controlling precedent, the Company will not submit the issue to a court for determination. DESCRIPTION OF PROPERTY The Company's executive offices and its principal office are in leased premises at 1 SunAmerica Center, Los Angeles, California 90067. The Company, through an affiliate, also leases office space in Woodland Hills, California and Jersey City, New Jersey. The Company believes that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of its businesses. F-4 SELECTED FINANCIAL DATA The following selected financial data of the Company should be read in conjunction with the consolidated 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. The following selected financial date of the Company for years prior to December 31, 2004 have been restated as if the contribution of SAAMCo and its related subsidiaries were effective as of the earliest period reported below. The following amounts include only the subsidiaries of SAAMCo as of December 31, 2004.
YEARS ENDED DECEMBER 31, ---------------------------------------------------- 2004 2003 2002 2001 2000 -------- -------- -------- -------- -------- (IN THOUSANDS) Results of Operations Revenues: Fee income, net of reinsurance.............................. $534,581 $427,091 $444,002 $481,945 $549,970 Investment income........................................... 363,594 402,923 387,355 370,198 398,168 Net realized investment losses.............................. (23,807) (30,354) (65,811) (59,784) (15,177) -------- -------- -------- -------- -------- Total revenues............................................ 874,368 799,660 765,546 792,359 932,961 Benefits and Expenses: Interest expense............................................ 222,749 240,213 238,129 244,614 264,493 Amortization of bonus interest.............................. 10,357 19,776 16,277 11,938 3,824 General and administrative expenses......................... 131,612 119,093 115,210 99,232 138,955 Amortization of deferred acquisition costs and other deferred expenses......................................... 157,650 160,106 222,484 208,378 154,183 Annual commissions.......................................... 64,323 55,661 58,389 58,278 56,473 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 17,766 15,716 17,566 19,914 Guaranteed minimum death benefits, net of reinsurance recoveries................................................ 58,756 63,268 67,492 17,839 614 -------- -------- -------- -------- -------- Total benefits & expenses................................. 662,867 675,883 733,697 657,845 638,456 -------- -------- -------- -------- -------- Pretax income before cumulative effect of accounting change.................................................... 211,501 123,777 31,849 134,514 294,505 Income tax expense.......................................... 6,410 30,247 160 21,824 94,400 -------- -------- -------- -------- -------- Net income before cumulative effect of accounting change.... 205,091 93,530 31,689 112,690 200,105 -------- -------- -------- -------- -------- Cumulative effect of accounting change, net of tax.......... (62,589) -- -- (10,342) -- -------- -------- -------- -------- -------- Net Income.................................................. $142,502 $ 93,530 $ 31,689 $102,348 $200,105 ======== ======== ======== ======== ========
In 2004, the Company adopted AICPA Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"), which was recorded as a cumulative effect of accounting change. (See Note 2 of Notes to Consolidated Financial Statements). F-5 In 2001, the Company adopted EITF 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" and Statement of Financial Accounting Standard 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), which were recorded as a cumulative effect of accounting change.
DECEMBER 31, ------------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS) Financial Position Investments and cash.................................. $ 7,125,986 $ 7,124,633 $ 7,248,324 $ 6,294,148 $ 5,249,827 Variable annuity assets held in separate accounts..... 22,612,451 19,178,796 14,758,642 18,526,413 20,393,820 Deferred acquisition costs and other deferred expenses............................................ 1,606,870 1,505,328 1,436,802 1,419,498 1,286,456 Other assets.......................................... 150,708 162,970 309,221 258,446 177,468 ----------- ----------- ----------- ----------- ----------- Total Assets.......................................... $31,496,015 $27,971,727 $23,752,989 $26,498,505 $27,107,571 =========== =========== =========== =========== =========== Reserves for fixed annuity and fixed accounts of variable annuity contracts.......................... $ 3,948,158 $ 4,274,329 $ 4,285,098 $ 3,498,917 $ 2,778,229 Reserves for universal life insurance contracts....... 1,535,905 1,609,233 1,676,073 1,738,493 1,832,667 Reserves for guaranteed investment contracts.......... 215,331 218,032 359,561 483,861 610,672 Variable annuity liabilities related to separate accounts............................................ 22,612,451 19,178,796 14,758,642 18,526,413 20,393,820 Other payables and accrued liabilities................ 1,172,594 794,031 831,138 839,032 268,201 Subordinated notes payable to affiliates.............. -- 40,960 40,960 47,960 55,119 Deferred income taxes................................. 257,532 242,556 341,935 211,242 81,989 Shareholder's equity.................................. 1,754,044 1,613,790 1,459,582 1,152,587 1,086,874 ----------- ----------- ----------- ----------- ----------- Total Liabilities and Shareholder's Equity............ $31,496,015 $27,971,727 $23,752,989 $26,498,505 $27,107,571 =========== =========== =========== =========== ===========
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 AIG SunAmerica Life Assurance Company (the "Company") for the years ended December 31, 2004 ("2004"), 2003 ("2003") and 2002 ("2002") 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 and profitability of the Company's activities. 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. CRITICAL ACCOUNTING POLICIES The Company considers its most critical accounting policies those policies with respect to valuation of certain financial instruments, amortization of deferred acquisition costs ("DAC") and other deferred expenses and the reserve for guaranteed benefits. 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. F-6 Valuation of Certain Financial Instruments: Gross unrealized losses on debt and equity securities available for sale amounted to $27.1 million at December 31, 2004. 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 investments in debt and 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 $813.0 million at December 31, 2004 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 the Company 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 and Other Deferred Expenses: Policy acquisition costs include commissions and other costs that vary with, and are primarily related to, the production or acquisition of new business. Such costs are deferred and amortized over the estimated lives of the annuity contracts. Approximately 81% of the amortization of DAC and other deferred expenses was attributed to policy acquisition costs deferred by the annuity operations and 19% was attributed to the distribution costs deferred by the asset management operations. For the annuity operations, the Company amortizes DAC and other deferred expenses 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, the growth rate of the separate account assets (with respect to variable options of the variable annuity contracts) or general account assets (with respect to fixed annuity contracts, Fixed Options and universal life insurance contracts) supporting these obligations, costs of providing contract guarantees and the level of expenses necessary to administer the policies. The Company adjusts amortization of DAC and other deferred expenses (a "DAC unlocking") when current or estimates of future gross profits to be realized from its annuity contracts are revised as more fully described below. Substantially all of the DAC balance attributed to annuity operations at December 31, 2004 related to variable annuity contracts. DAC amortization on annuities is impacted by surrender rates, claims costs, and the actual and assumed future growth rate of the assets supporting the Company's obligations under annuity policies. With respect to Fixed Options, the growth rate depends on the yield on the general account assets supporting those annuity contracts. With respect to the variable options of the variable annuity contracts, the growth rate depends on the performance of the investment options available under the annuity contract and the allocation of assets among these various investment options. The assumption the Company uses for the long-term annual net growth rate of the separate account assets in the determination of DAC amortization with respect to its variable annuity contracts is 10% (the "long-term growth rate assumption"). The Company uses a "reversion to the mean" methodology that allows it to maintain this 10% long-term growth rate assumption, while also giving consideration to the effect of short-term swings in the equity markets. For example, if performance was 15% during the first year following the introduction of a product, the DAC model would assume that market returns for the following five years (the "short-term growth rate assumption") would be approximately 9%, resulting in an average annual growth rate of 10% during the life of the product. Similarly, following periods of below 10% performance, the model will assume a short-term growth rate higher than 10%. A DAC unlocking will occur if management deems the short-term growth rate assumption (i.e., the growth rate required to revert to the mean 10% growth rate over a five-year period) to be unreasonable. The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. For the asset management operations, the Company defers distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or a contingent deferred sales charge feature (collectively, "Distribution Fee Revenue"). These costs are amortized on a straight-line basis, adjusted for redemptions, over a period ranging from one year to eight years depending on share class. The carrying value of the deferred asset is subject to continuous review based on projected Distribution Fee Revenue. Amortization of deferred distribution costs is increased if at any reporting period the value of the deferred amount exceeds the projected Distribution Fee Revenue. The projected Distribution Fee Revenue is impacted by estimated future withdrawal rates and the rates of market return. Management uses historical activity to estimate future withdrawal rates and average annual performance of the equity markets to estimate the rates of market return. F-7 Reserve for Guaranteed Benefits: Pursuant to the adoption of Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1") which was adopted on January 1, 2004, the Company is required to recognize a liability for guaranteed minimum death benefits and other guaranteed benefits. In calculating the projected liability, five thousand stochastically generated investment performance scenarios were developed using the Company's best estimates. These assumptions included, among others, mean equity return and volatility, mortality rates and lapse rates. The estimation of cash flow and the determination of the assumptions used require judgment, which can, at times, be subjective. Several of the guaranteed benefits are sensitive to equity market conditions. The Company uses the purchase of reinsurance and capital market hedging strategies to mitigate the risk of paying benefits in excess of account values as a result of significant downturns in equity markets. Risk mitigation may or may not reduce the volatility of net income resulting from equity market volatility. Reinsurance or hedges are secured when the cost is less than the risk reduction. The Company expects to use either additional reinsurance or capital market hedges for risk mitigation on an opportunistic basis. Despite the purchase of reinsurance or hedges, the reinsurance or hedge secured may be inadequate to completely offset the effects of changes in equity markets. BUSINESS SEGMENTS Effective January 1, 2004, SunAmerica Life Insurance Company (the "Parent"), the parent of the Company, contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo"), which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") and AIG SunAmerica Fund Services, Inc. ("SFS"). This contribution increased the Company's shareholder's equity by approximately $150.7 million (see Note 1 of Notes to Consolidated Financial Statements). Effective January 1, 2004, the Company's earnings include the asset management operations of SAAMCo, SACS and SFS. Prior year results have been restated to account for this contribution as if it had occurred at the beginning of the earliest period presented. The Company has two business segments: annuity operations and asset management operations. The annuity operations consist of the sale and administration of deposit-type insurance contracts, such as variable and fixed annuity contracts, universal life insurance contracts and guaranteed investment contracts. The Company focuses primarily on the marketing of variable annuity products. The variable annuity products offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as Fixed Options. The Company earns fee income on amounts invested in the variable account options and net investment spread on the Fixed Options. The asset management operations are conducted by the Company's registered investment advisor subsidiary, SAAMCo, and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS. These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, servicing as investment advisor to certain variable investment portfolios offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. RESULTS OF OPERATIONS NET INCOME totaled $142.5 million in 2004, compared with $93.5 million in 2003 and $31.7 million in 2002. CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflected the adoption of SOP 03-1 on January 1, 2004. The Company recorded a loss of $62.6 million, net of tax, which is recognized in the consolidated statement of income and comprehensive income as a cumulative effect of accounting change for the year ended December 31, 2004. PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $211.5 million in 2004, compared with $123.8 million in 2003 and $31.8 million in 2002. The increase in 2004 compared to 2003 was primarily due to higher variable annuity policy fee and asset management fee income, partially offset by lower investment income and higher general and administrative and other expenses. The increase in 2003 compared to 2002 was primarily due to reductions in net realized investment losses and amortization of DAC and other expenses. INCOME TAX EXPENSE totaled $6.4 million in 2004, $30.2 million in 2003 and $0.2 million in 2002 representing effective tax rates of 3%, 24% and 1%, respectively. The tax expense in 2004 included the benefit of $39.7 million resulting from the reduction of the prior year tax liability based on additional information becoming available. Excluding this benefit the effective tax rate is 22% in 2004. The unusually low effective tax rate for 2002 is due primarily to the lower relative pretax income without corresponding reductions in permanent tax differences. See Note 11 of the Notes to Consolidated Financial Statements for a reconciliation of income tax expense to the federal statutory rate. F-8 ANNUITY OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $176.9 million in 2004, compared with $98.7 million in 2003 and $27.7 million in 2002. The increase in 2004 compared to 2003 was primarily due to higher variable annuity policy fee income and lower amortization of deferred acquisition costs and other deferred expenses partially offset by higher general and administrative and other expenses. The increase in 2003 compared to 2002 was primarily due to lower net realized investment losses and improved net investment income as customers allocated more dollars to the fixed rate portion of variable annuity contracts. NET INVESTMENT SPREAD, a non-GAAP measure, represents investment income less interest credited to Fixed-Rate Products is a key measurement used by the Company in evaluating the profitability of its annuity business. Investment income includes income earned on invested assets, as well as the mark-to-market on both purchased derivatives and embedded derivatives inherent in certain product guarantees. 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 investments pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". In the calculation of average invested assets, the Company excludes collateral received from a securities lending program, which is offset by a securities lending payable in the same amount. 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 an affiliate to administer the program. An analysis of net investment spread and a reconciliation to pretax income before cumulative effect of accounting change is presented in the following table:
YEARS ENDED DECEMBER 31, --------------------------------- 2004 2003 2002 --------- --------- --------- (IN THOUSANDS) Investment income........................................... $ 362,631 $ 398,304 $ 377,556 Interest credited to fixed annuity contracts and Fixed Options................................................... (140,889) (153,636) (142,973) Interest credited to universal life insurance contracts..... (73,745) (76,415) (80,021) Interest credited to guaranteed investment contracts........ (6,034) (7,534) (11,267) --------- --------- --------- Net investment spread....................................... 141,963 160,719 143,295 Net realized investment losses.............................. (24,100) (30,354) (65,811) Fee income, net of reinsurance.............................. 429,259 344,908 358,983 Amortization of bonus interest.............................. (10,357) (19,776) (16,277) General and administrative expenses......................... (93,188) (83,013) (79,287) Amortization of DAC and other deferred expenses............. (126,142) (137,130) (171,583) Annual commissions.......................................... (64,323) (55,661) (58,389) Claims on UL contracts, net of reinsurance recoveries....... (17,420) (17,766) (15,716) Guaranteed benefits, net of reinsurance recoveries.......... (58,756) (63,268) (67,492) --------- --------- --------- Pretax income before cumulative effect of accounting change.................................................... $ 176,936 $ 98,659 $ 27,723 ========= ========= =========
Net investment spread totaled $142.0 million in 2004, compared to $160.7 million in 2003 and $143.3 million in 2002. These amounts equal 2.28% on average invested assets (computed on a daily basis) of $6.22 billion in 2004, 2.37% on average invested assets of $6.66 billion in 2003 and 2.41% on average invested assets of $6.09 billion in 2002. The decrease in net investment spread in 2004 from 2003 reflected results from lower average invested assets as discussed below and reinvesting in the historically low prevailing interest rate environment that has persisted throughout 2003 and 2004. The increase in net investment spread in 2003 from 2002 resulted from substantial growth in average invested assets and effective management of interest crediting rates to offset lower yields available on invested assets. F-9 The components of net investment spread were as follows:
YEARS ENDED DECEMBER 31, --------------------------------------- 2004 2003 2002 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Net investment spread....................................... $ 141,963 $ 160,719 $ 143,295 Average invested assets..................................... 6,216,792 6,656,360 6,086,517 Average interest-bearing liabilities........................ (5,942,627) (6,407,102) (5,962,521) Yield on average invested assets............................ 5.83% 5.98% 6.20% Rate paid on average interest-bearing liabilities........... 3.71 3.71 3.93 ----------- ----------- ----------- Difference between yield and interest rate paid............. 2.12% 2.27% 2.27% =========== =========== =========== Net investment spread as a percentage of average invested assets.................................................... 2.28% 2.41% 2.35% =========== =========== ===========
The decline in average invested assets resulted primarily from net exchanges from Fixed Options into the separate accounts of variable annuity contracts, partially offset by new deposits of Fixed Options. Deposits of Fixed Options and renewal deposits on its universal life insurance contracts totaled $1.41 billion 2004, $1.58 billion in 2003 and $1.78 billion in 2002, and are primarily deposits for the Fixed Options. Deposits of Fixed Options represent 24% in 2004, 27% in 2003 and 34% in 2002, of the related reserve balances at the beginning of the respective periods. Net investment spread includes the effect of income earned or interest paid on the difference between average invested assets and average interest-bearing liabilities. Average invested assets exceeded average interest-bearing liabilities by $274.2 million in 2004, compared with $249.3 million in 2003 and $124.0 million in 2002. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities was 2.12% in 2004 and 2.27% in 2003 and 2.27% in 2002. Investment income (and the related yields on average invested assets) totaled $362.6 million (5.83%) in 2004, compared with $398.3 million (5.98%) in 2003 and $377.6 million (6.20%) in 2002. The decrease in the investment yield primarily reflects the reinvesting in the historically low prevailing interest rate environment that has persisted throughout 2002, 2003 and 2004, as well as a $4.3 million reduction in income from the mark to market of the S&P 500 put options and the guaranteed minimum account value and guaranteed minimum withdrawal benefit embedded derivatives in 2004. Excluding the impact of the put options and embedded derivatives, investment income would have been $361.6 million (5.82%) and $393.0 million (5.90%) in 2004 and 2003, respectively. Expenses incurred to manage the investment portfolio amounted to $2.5 million in 2004, $2.3 million in 2003 and $2.4 million in 2002. These expenses are included as a reduction of investment income in the consolidated statement of income and comprehensive income. Interest expense (and the related rate paid on average interest-bearing liabilities) totaled $220.7 million (3.71%) in 2004, $237.6 million (3.71%) in 2003 and $234.3 million (3.93%) in 2002. Interest-bearing liabilities averaged $5.94 billion during 2004, $6.41 billion during 2003 and $5.96 billion during 2002. NET REALIZED INVESTMENT LOSSES totaled $24.1 million in 2004, $30.4 million in 2003 and $65.8 million in 2002 and include impairment writedowns of $21.1 million, $54.1 million and $57.3 million, respectively. Thus, net realized losses from sales and redemptions of investments totaled $3.0 million in 2004, compared with net realized gains of $23.7 million in 2003 and net realized losses of $8.5 million in 2002. The Company sold or redeemed invested assets, principally bonds and notes, aggregating $1.97 billion in 2004, $2.21 billion in 2003 and $1.60 billion in 2002. 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 0.05%, 0.36% and 0.14% of average invested assets for 2004, 2003 and 2002, 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 $21.1 million, $54.1 million and $57.3 million of provisions principally applied to bonds in 2004, 2003 and 2002, respectively. Impairment writedowns represent 0.34%, 0.81% and 0.96% of average invested assets in the respective periods. For the five years ended December 31, 2004, impairment writedowns as a percentage of average invested assets have ranged from 0.34% to 1.27% and have averaged 0.75%. 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. F-10 VARIABLE ANNUITY POLICY FEES, NET OF REINSURANCE are generally based on the market value of assets in the separate accounts supporting variable annuity contracts. Such fees totaled $369.1 million in 2004, $281.4 million in 2003 and $286.9 million in 2002 and are net of reinsurance premiums of $28.6 million, $30.8 million and $22.5 million, respectively. The increased fees in 2004 compared to 2003 primarily reflect the improved equity market conditions in 2004 and the latter part of 2003, and the resulting favorable impact on market values of the assets in the separate accounts. The decreased fees in 2003 as compared to 2002 reflected increased reinsurance premiums. Variable annuity policy fees represent 1.8%, 1.7% and 1.7% of average variable annuity assets in 2004, 2003 and 2002, respectively. Variable annuity assets averaged $20.41 billion, $16.32 billion and $16.45 billion during the respective periods. Variable annuity deposits, which exclude deposits allocated to the Fixed Options, totaled $2.65 billion in 2004, $1.73 billion in 2003 and $1.18 billion in 2002. These amounts represent 14%, 12% and 6% of variable annuity reserves at the beginning of the respective periods. The increase in variable annuity deposits in 2004 and 2003 reflected increased demand for variable annuity products due to the improved equity market conditions in 2004 and the latter part of 2003. Transfers from the Fixed Options to the separate accounts 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 the Fixed Options) ("Variable Annuity Product Sales") amounted to $4.01 billion, $3.27 billion and $2.92 billion in 2004, 2003 and 2002, respectively. Such sales primarily reflect those of the Company's Polaris and Seasons families of variable annuity products. The Company's variable annuity products are primarily multi-manager variable annuities that offer investors a choice of several variable funds as well as up to seven fixed funds, depending on the product. The increase in Variable Annuity Product Sales in 2004 and 2003 reflects the generally improved equity market conditions in 2004 and the latter part of 2003. 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"). With respect to all reinsurance agreements, 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. Due to the high credit ratings and periodic monitoring of these ratings of the reinsurers, such risks are considered to be minimal. UNIVERSAL LIFE INSURANCE POLICY FEES, NET OF REINSURANCE amounted to $33.9 million in 2004, $35.8 million in 2003 and $36.3 million in 2002 and are net of reinsurance premiums of $34.3 million, $33.7 million and $34.1 million, respectively. Universal life insurance policy 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 insurance contracts as part of the acquisition of business from MBL Life Assurance Corporation on December 31, 1998 and does not actively market such contracts. Such fees represent 2.20%, 2.23% and 2.17% of average reserves for universal life insurance contracts in the respective periods. SURRENDER CHARGES on variable annuity and universal life insurance contracts totaled $26.2 million in 2004, $27.7 million in 2003 and $32.5 million in 2002. 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. GENERAL AND ADMINISTRATIVE EXPENSES totaled $93.2 million in 2004, $83.0 million in 2003 and $79.3 million in 2002. The increase in 2004 results from higher information technology costs and payroll related expenses resulting from the servicing of a larger block of annuity contracts. 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 AND OTHER DEFERRED EXPENSES totaled $126.1 million in 2004, compared with $137.1 million in 2003 and $171.6 million in 2002. DAC amortization in 2003 reflected a declining market which led to higher DAC amortization (i.e. impairments on specific products) during the first nine months of 2003 and is partially offset by an $18.0 million DAC unlocking. The higher amortization in 2002 was primarily related to lower estimates of future gross profits on variable annuity contracts compared to the prior years in light of the downturn in the equity markets in 2002, and additional variable annuity product sales over the last twelve months and the subsequent amortization of related deferred commissions and other direct selling costs. ANNUAL COMMISSIONS totaled $64.3 million in 2004, compared with $55.7 million in 2003 and $58.4 million in 2002. Annual commissions generally 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. The vast majority of the Company's average balances of its variable annuity products are currently subject to such annual commissions. F-11 CLAIMS ON UNIVERSAL LIFE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled $17.4 million in 2004, compared with $17.8 million in 2003 and $15.7 million in 2002 (net of reinsurance recoveries of $34.2 million in 2004, $34.0 million in 2003 and $29.2 million in 2002). The change in such claims resulted principally from changes in mortality experience and the reinsurance recoveries there on. GUARANTEED BENEFITS, NET OF REINSURANCE RECOVERIES on variable annuity contracts totaled $58.8 million in 2004, compared with $63.3 million in 2003 and $67.5 million in 2002 and are net of reinsurance recoveries of $2.7 million, $8.0 million and $8.4 million, respectively. These guaranteed benefits consist primarily of guaranteed minimum death benefits as well as immaterial amounts of earnings enhancement benefits and guaranteed minimum income benefits. These guarantees are described in more detail in the following paragraphs. The decrease during 2004 reflects the generally improved equity market conditions in 2004 and the latter part of 2003. Downturns in the equity markets could increase these expenses. Guaranteed minimum death benefits ("GMDB") are issued on a majority of the Company's variable annuity products. GMDB provides that, upon the death of a contract holder, the contract holder's beneficiary will receive the greater of (1) the contract holder's account value, or (2) a guaranteed minimum death benefit that varies by product and election by the contract holder. The Company bears the risk that death claims following a decline in the debt and equity markets may exceed contract holder account balances and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. On January 1, 2004, the Company recorded a liability for guaranteed benefits including GMDB (see Note 2 of Notes to Consolidated Financial Statements) pursuant to adoption of a new accounting standard, SOP 03-1. Earnings enhancement benefit ("EEB") is a feature the Company offers on certain variable annuity products. For contract holders who elect the feature, the EEB provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The Company bears the risk that account values following favorable performance of the financial markets will result in greater EEB death claims and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. Guaranteed minimum income benefit ("GMIB") is a feature the Company offers on certain variable annuity products. This feature provides a minimum fixed annuity payment guarantee for those contract holders who choose to receive fixed lifetime annuity payments after a seven, nine, or ten-year waiting period in their deferred annuity contracts. The Company bears the risk that the performance of the financial markets will not be sufficient for accumulated contract holder account balances to support GMIB benefits and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. As there is a waiting period to annuitize using the GMIB, there are no policies eligible to receive this benefit at December 31, 2004. The Company has eliminated offering a GMIB feature that guarantees a return in excess of the amount to be annuitized in order to mitigate its exposure. Guaranteed minimum account value ("GMAV") is a feature the Company offers on certain variable annuity products in the third quarter of 2002. If available and elected by the contract holder at the time of contract issuance, this feature guarantees that the account value under the contract will at least equal the amount of the deposits invested during the first ninety days of the contract, adjusted for any subsequent withdrawals, at the end of a ten-year waiting period. The Company bears the risk that protracted under-performance of the financial markets could result in GMAV benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The Company purchased put options on the S&P 500 index to partially offset this risk. Changes in the market value of both the GMAV benefit and the put options are recorded in investment income in the accompanying consolidated statement of income and comprehensive income. Guaranteed minimum withdrawal benefit ("GMWB") is a feature the Company began offering on certain variable annuity products in May of 2004. If available and elected by the contract holder at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days adjusted for any subsequent withdrawals ("Eligible Premium"). These guaranteed annual withdrawals of up to 10% of Eligible Premium are available after either a three-year or a five-year waiting period, as elected by the contract holder at the time of contract issuance, without reducing the future amounts guaranteed. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will realize an additional 10% or 20%, respectively, of Eligible Premium after all other amounts guaranteed under this benefit have been paid. The Company bears the risk that protracted under-performance of the financial markets could result in GMWB benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The Company purchased put options on the S&P 500 index to partially offset this risk. Changes in the market value of both the GMWB benefit and the put options are recorded in investment income in the accompanying consolidated statement of income and comprehensive income. F-12 Management expects substantially all of the Company's near-term exposure to guaranteed benefits will relate to GMDB and EEB. As sales of products with other guaranteed benefits increase, the Company expects these other guarantees to have an increasing impact on operating results, under current hedging strategies. ASSET MANAGEMENT OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $34.6 million in 2004, compared to $25.1 million in 2003 and $4.1 million in 2002. The increases in 2004 from 2003 resulted from the impact of higher average asset base and higher margin on account servicing fees, partially offset by increased amortization of DAC and other deferred expenses. The increase in 2003 from 2002 resulted from decreased amortization of DAC and other deferred expenses. ASSET MANAGEMENT FEES, which include investment advisory fees and 12b-1 distribution fees, are based on the market value of assets managed by SAAMCo in its mutual funds and certain variable annuity portfolios. Such fees totaled $89.6 million on average assets managed of $9.65 billion in 2004, $66.7 million on average assets managed of $8.15 billion in 2003 and $66.4 million on average assets managed of $7.64 billion in 2002. The increase in asset management fees is primarily the result of a higher average asset base and higher margin on account servicing fees. Mutual fund sales, excluding sales of money market accounts and private accounts, totaled $2.14 billion in 2004, compared to $2.23 billion in 2003 and $1.67 billion in 2002. Redemptions of mutual funds, excluding redemptions of money market accounts, amounted to $1.56 billion in 2004, $1.55 billion in 2003 and $1.55 billion in 2002, which represent 20%, 25% and 25%, respectively, of average related mutual fund assets. The 4% decrease in mutual fund sales in 2004 compared to 2003 primarily reflects generally difficult equity market conditions in the second and third quarters of 2004. The increase in sales in 2003 principally reflects increasing demand for equity products, due to generally improved equity market conditions in the latter part of 2003. GENERAL AND ADMINISTRATIVE EXPENSES totaled $38.4 million in 2004, $36.1 million in 2003 and $35.9 million in 2002. General and administrative expenses increased in 2004 due primarily to higher employee-related costs. AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES includes amortization of distribution costs that totaled $31.5 million in 2004, compared with $23.0 million in 2003 and $35.9 million in 2002. The increased amortization in 2004 was primarily due to additional mutual fund sales and amortization of the deferred commissions thereon. In 2002, amortization of deferred acquisition costs and other deferred expenses included additional amortization of $24.2 million, resulting from certain distribution costs whose carrying value exceeded projected revenue. CAPITAL RESOURCES AND LIQUIDITY SHAREHOLDER'S EQUITY increased to $1.75 billion at December 31, 2004 from $1.61 billion at December 31, 2003 due to $142.5 million of net income and $49.1 million of capital contribution from Parent partially offset by a $49.1 million tax effect on a distribution of investment and a $2.5 million dividend to the Parent. F-13 INVESTMENTS AND CASH at December 31, 2004 totaled $7.13 billion, compared with $7.14 billion at December 31, 2003. The Company's invested assets are managed by an affiliate. The following table summarizes the Company's portfolio of bonds, notes and redeemable preferred stocks (the "Bond Portfolio") and other investments and cash at December 31, 2004 and 2003:
DECEMBER 31, 2004 DECEMBER 31, 2003 ----------------------- ----------------------- FAIR PERCENT OF FAIR PERCENT OF VALUE PORTFOLIO VALUE PORTFOLIO ---------- ---------- ---------- ---------- BOND PORTFOLIO: (IN THOUSANDS, EXCEPT FOR PERCENTAGES) U.S. government securities.................................. $ 30,300 0.4% $ 24,292 0.3% Mortgage-backed securities.................................. 956,567 13.4 1,191,817 16.7 Securities of public utilities.............................. 332,038 4.7 365,150 5.1 Corporate bonds and notes................................... 2,902,829 40.8 2,697,142 37.9 Redeemable preferred stocks................................. 21,550 0.3 22,175 0.3 Other debt securities....................................... 917,743 12.9 1,205,224 16.9 ---------- ----- ---------- ----- Total Bond Portfolio........................................ 5,161,027 72.5 5,505,800 77.2 Mortgage loans.............................................. 624,179 8.7 716,846 10.1 Common stocks............................................... 4,902 0.1 727 0.0 Cash and short-term investments............................. 201,117 2.8 133,105 1.9 Securities lending collateral............................... 883,792 12.4 514,145 7.2 Other invested assets....................................... 250,969 3.5 254,010 3.6 ---------- ----- ---------- ----- Total investments and cash.................................. $7,125,986 100.0% $7,124,633 100.0% ========== ===== ========== =====
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 72% of the Company's total investment portfolio at December 31, 2004, had an aggregate fair value that was $153.2 million greater than its amortized cost at December 31, 2004, compared with $154.6 million at December 31, 2003. At December 31, 2004, the Bond Portfolio had an aggregate fair value of $5.16 billion and an aggregate amortized cost of $5.01 billion. At December 31, 2004, the Bond Portfolio (excluding $21.6 million of redeemable preferred stocks) included $4.50 billion of bonds rated by Standard & Poor's ("S&P"), Moody's Investors Service ("Moody's") or Fitch ("Fitch") and $638.1 million of bonds rated by the National Association of Insurance Commissioners ("NAIC") or the Company pursuant to statutory ratings guidelines established by the NAIC. At December 31, 2004, approximately $4.75 billion of the Bond Portfolio was investment grade, including $986.8 million of mortgage-backed securities ("MBS") and U.S. government/agency securities. At December 31, 2004, the Bond Portfolio included $386.4 million of bonds that were not investment grade. These non-investment-grade bonds accounted for approximately 1% of the Company's total assets and approximately 5% 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 to decline. At December 31, 2004, the Company's non-investment-grade bond portfolio consisted of 171 issues with no single issuer representing more than 10% of the total non-investment-grade portfolio. These non-investment-grade securities are comprised of bonds spanning 10 industries with 19%, 16%, 16% and 10% concentrated in telecommunications, utilities, financial services and noncyclical consumer products industries, respectively. No other industry concentration constituted more than 10% of these assets. F-14 The table below summarizes the Company's rated bonds by rating classification as of December 31, 2004. RATED BONDS BY RATING CLASSIFICATION
ISSUES RATED BY ISSUES NOT RATED BY S&P/MOODY'S/FITCH S&P/MOODY'S/FITCH, BY NAIC CATEGORY TOTAL - ------------------------------------------ ------------------------------------- ------------------------------------------ S&P/MOODY'S/FITCH AMORTIZED ESTIMATED NAIC AMORTIZED ESTIMATED AMORTIZED ESTIMATED PERCENT OF TOTAL CATEGORY(1) COST FAIR VALUE CATEGORY(2) COST FAIR VALUE COST FAIR VALUE INVESTED ASSETS - ----------------- ---------- ---------- ------------ --------- ---------- ---------- ---------- ---------------- (DOLLARS IN THOUSANDS) AAA+ to A- (Aaa to A3) [AAA to A-] $2,888,647 $2,964,803 1 $266,034 $270,334 $3,154,681 $3,235,137 45.40% BBB+ to BBB- (Baa to Baa3) [BBB+ to BBB-] 1,203,109 1,233,692 2 276,973 284,221 1,480,082 1,517,913 21.30% BB+ to BB- (Bal to Ba3) [BB+ to BB-] 133,070 138,091 3 36,371 36,462 169,441 174,553 2.45% B+ to B- (Bl to B3) [B+ to B-] 129,347 140,699 4 11,600 11,524 140,947 152,223 2.14% CCC+ to CCC- (Caal to Caa3) [CCC+ to CCC-] 18,954 19,353 5 7,305 6,695 26,259 26,048 0.37% CC to D (Ca to C) [CC to D] 1,842 4,722 6 14,476 28,880 16,318 33,602 0.47% ---------- ---------- -------- -------- ---------- ---------- TOTAL RATED ISSUES $4,374,969 $4,501,360 $612,759 $638,116 $4,987,728 $5,139,476 ========== ========== ======== ======== ========== ==========
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 $131.5 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; (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. F-15 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 sale. As a result of these policies, the Company recorded pretax impairment writedowns of $21.1 million, $54.1 million and $57.3 million in 2004, 2003 and 2002, respectively. No individual impairment loss, net of DAC and taxes, during the year exceeded 10% of the Company's net income for the year ended December 31, 2004. 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, 2004, the fair value of the Company's Bond Portfolio aggregated $5.16 billion. Of this aggregate fair value, approximately 0.03% 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 DAC and decreases in income taxes. At December 31, 2004, approximately $3.91 billion, at amortized cost, of the Bond Portfolio had a fair value of $4.09 billion resulting in an aggregate unrealized gain of $180.3 million. At December 31, 2004, approximately $1.10 billion, at amortized cost, of the Bond Portfolio had a fair value of $1.07 billion resulting in an aggregate unrealized loss of $27.1 million. No single issuer accounted for more than 10% of unrealized losses. Approximately 36%, 15% and 11% of unrealized losses were from the financial services, transportation and noncyclical consumer products industries, respectively. No other industry accounted for more than 10% of unrealized losses. The amortized cost of the Bond Portfolio in an unrealized loss position at December 31, 2004, by contractual maturity, is shown below.
AMORTIZED COST -------------- (IN THOUSANDS) Due in one year or less..................................... $ 46,250 Due after one year through five years....................... 422,237 Due after five years through ten years...................... 389,073 Due after ten years......................................... 243,973 ---------- Total....................................................... $1,101,533 ==========
F-16 The aging of the Bond Portfolio in an unrealized loss position at December 31, 2004 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 ------------------------------- ------------------------------ ------------------------------ AMORTIZED UNREALIZED AMORTIZED UNREALIZED AMORTIZED UNREALIZED MONTHS COST LOSS ITEMS COST LOSS ITEMS COST LOSS ITEMS - ------ ---------- ---------- ----- --------- ---------- ----- --------- ---------- ----- (DOLLARS IN THOUSANDS) Investment Grade Bonds 0-6 $ 455,818 $ (4,128) 73 $ -- $ -- -- $ -- $ -- -- 7-12 387,123 (6,808) 57 -- -- -- -- -- -- >12 171,695 (7,108) 22 17,477 (4,046) 3 -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $1,014,636 $(18,044) 152 $17,477 $(4,046) 3 $ -- $ -- -- ========== ======== === ======= ======= ==== ==== ===== ==== Below Investment Grade Bonds 0-6 $ 28,496 $ (1,806) 13 $ -- $ -- -- $452 $(292) 3 7-12 8,773 (489) 8 -- -- -- -- -- -- >12 31,699 (2,467) 11 -- -- -- -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $ 68,968 $ (4,762) 32 $ -- $ -- -- $452 $(292) 3 ========== ======== === ======= ======= ==== ==== ===== ==== Total Bonds 0-6 $ 484,314 $ (5,934) 86 $ -- $ -- -- $452 $(292) 3 7-12 395,896 (7,297) 65 -- -- -- -- -- -- >12 203,394 (9,575) 33 17,477 (4,046) 3 -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $1,083,604 $(22,806) 184 $17,477 $(4,046) 3 $452 $(292) 3 ========== ======== === ======= ======= ==== ==== ===== ==== TOTAL ------------------------------- AMORTIZED UNREALIZED MONTHS COST LOSS ITEMS - ------ ---------- ---------- ----- (DOLLARS IN THOUSANDS) Investment Grade Bonds 0-6 $ 455,818 $ (4,128) 73 7-12 387,123 (6,808) 57 >12 189,172 (11,154) 25 ---------- -------- --- Total $1,032,113 $(22,090) 155 ========== ======== === Below Investment Grade Bonds 0-6 $ 28,948 $ (2,098) 16 7-12 8,773 (489) 8 >12 31,699 (2,467) 11 ---------- -------- --- Total $ 69,420 $ (5,054) 35 ========== ======== === Total Bonds 0-6 $ 484,766 $ (6,226) 89 7-12 395,896 (7,297) 65 >12 220,871 (13,621) 36 ---------- -------- --- Total $1,101,533 $(27,144) 190 ========== ======== ===
In 2004, the pretax realized losses incurred with respect to the sale of fixed-rate securities in the Bond Portfolio was $12.6 million. The aggregate fair value of securities sold was $140.3 million, which was approximately 92% of amortized cost. The average period of time that securities sold at a loss during 2004 were trading continuously at a price below amortized cost was approximately 21 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 fair value of these securities at December 31, 2004 was approximately $813.0 million. 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. 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. 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 $277.2 million at December 31, 2004. Secured Loans are senior to subordinated debt and equity and are secured by assets of the issuer. At December 31, 2004, Secured Loans consisted of $190.1 million of privately traded securities and $87.1 million of publicly traded securities. These Secured Loans are composed of loans to 59 borrowers spanning 10 industries, with 26%, 18%, 15%, 12% and 11% from the utilities, telecommunications, transportation, noncyclical consumer products and cyclical consumer products industries, respectively. No other industry 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. F-17 MORTGAGE LOANS aggregated $624.2 million at December 31, 2004 and consisted of 100 commercial first mortgage loans with an average loan balance of approximately $6.2 million, collateralized by properties located in 30 states. Approximately 32% of this portfolio was office, 17% was manufactured housing, 17% was multifamily residential, 11% was industrial, 11% was hotels, and 12% was other types. At December 31, 2004, approximately 27%, 11% and 10% of this portfolio were secured by properties located in California, Michigan and Massachusetts, respectively. No more than 10% of this portfolio was secured by properties located in any other single state. At December 31, 2004, 13 mortgage loans have an outstanding balance of $10 million or more, which collectively aggregated approximately 45% of this portfolio. At December 31, 2004, approximately 42% of the mortgage loan portfolio consisted of loans with balloon payments due before January 1, 2008. During 2004 and 2003, loans delinquent by more than 90 days, foreclosed loans and structured loans have not been significant in relation to the total mortgage loan portfolio. Substantially all of the mortgage loan portfolio has been originated by the Company under its 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 Company's underwriting standards, the Company believes that it has prudently managed the risk attributable to its mortgage loan portfolio while maintaining attractive yields. SECURITIES LENDING COLLATERAL totaled $883.8 million at December 31, 2004, compared to $514.1 million at December 31, 2003, and consisted of cash collateral invested in highly rated short-term securities received in connection with the Company's securities lending program. The increase in securities lending collateral in 2004 results from increased demand for securities in the Company's portfolio. 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 in an effort to minimize the risks of interest rate fluctuations and disintermediation (i.e. the risk of being forced to sell investments during unfavorable market conditions). 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 incentives, surrender charges and/or other restrictions in order to encourage persistency. Approximately 77% of the Company's reserves for Fixed-Rate Products had surrender penalties or other restrictions at December 31, 2004. 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 and cash flows of the fixed-rate assets to that of its fixed-rate liabilities. The fixed-rate assets in the Company's asset-liability modeling include: cash and short-term investments; bonds, notes and redeemable preferred stocks; mortgage loans; policy loans; and investments in limited partnerships that invest primarily in fixed-rate securities. At December 31, 2004, these assets had an aggregate fair value of $6.17 billion with an option-adjusted duration of 3.2 years. The Company's fixed-rate liabilities include Fixed Options, as well as universal life insurance, fixed annuity and GIC contracts. At December 31, 2004, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $5.54 billion with an option-adjusted duration of 3.6 years. The Company's potential exposure due to a relative 10% decrease in prevailing interest rates from its December 31, 2004 levels is a loss of approximately $0.3 million, representing an 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 years 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 F-18 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 and these differences may be material. A significant portion of the Company's fixed annuity contracts (including the Fixed Options) 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. 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 the earlier discussion under "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 2004, 2003 and 2002 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:
2004 2003 2002 ---- ---- ---- AVERAGE 10-YEAR U.S. TREASURY BOND RATE:.................... 4.26% 4.01% 4.61% AIG SunAmerica Life Assurance Company: Average yield on Bond Portfolio........................... 5.66 5.75 6.23 Rate paid on average interest-bearing liabilities......... 3.71 3.71 3.93
Since the Company's investing strategy is to hold fixed-rate assets for long-term investment, the Company's average yield tends to trail movements in the average U.S. treasury yield. For further discussion on average yield on the bond portfolio and the rate paid on average interest-bearing liabilities, see discussion on "Investment Spread." As a component of its asset-liability management strategy, the Company may utilize interest rate swap agreements ("Swap Agreements") to match assets more closely to liabilities. Swap Agreements exchange interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) with a counterparty, based on an underlying principal balance (notional principal) to hedge against interest rate changes. 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. No Dollar Roll Repos were outstanding at December 31, 2004. The Company also seeks to provide liquidity by investing in MBS. MBS are generally investment-grade securities collateralized by large pools of mortgage loans. MBS 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 and Swap Agreements is counterparty risk. The Company believes, however, that the counterparties to its Dollar Roll Repos and Swap Agreements 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. In addition to counterparty risk, Swap Agreements also have interest rate risk. However, the Company's Swap Agreements are intended to hedge variable-rate assets or liabilities. The primary risk associated with MBS 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 least quarterly to determine whether specific investments should be placed on a nonaccrual 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 F-19 value of the underlying collateral. For investments in partnerships, management reviews the financial statements and other information provided by the general partners. The carrying values of investments that are determined to have declines in value that are other than temporary are reduced to net realizable 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 $40.1 million of bonds at December 31, 2004, and constituted approximately 0.6% of total invested assets. At December 31, 2003, defaulted investments totaled $49.6 million of bonds, which constituted approximately 0.7% 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, reverse repurchase agreement capacity on invested assets and, if required, proceeds from invested asset sales. The Company's liquidity is primarily derived from operating cash flows from annuity operations. At December 31, 2004, approximately $4.09 billion of the Bond Portfolio had an aggregate unrealized gain of $180.3 million, while approximately $1.07 billion of the Bond Portfolio had an aggregate unrealized loss of $27.1 million. In addition, the Company's investment portfolio currently provides approximately $44.0 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 Fixed-Rate Products 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 interest rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its Fixed-Rate Products. 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. 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 The Company has six agreements outstanding in which it has provided liquidity support for certain short-term securities of municipalities and non-profit organizations by agreeing to purchase such securities in the event there is no other buyer in the short-term marketplace. In return the Company receives a fee. In addition, the Company guarantees the payment of these securities upon redemption. The maximum liability under these guarantees at December 31, 2004 is $195.4 million. These commitments have contractual maturity dates in 2005. Related to each of these agreements are participation agreements with the Parent, under which the Parent will share in $62.6 million of these liabilities in exchange for a proportionate percentage of the fees received under these agreements. The Internal Revenue Service examined the transactions underlying these commitments, including the Company's role in the transactions. The examination did not result in a material loss to the Company. At December 31, 2004, the Company held reserves for GICs with maturity dates as follows: $186.5 million in 2005 and $28.8 million in 2024. F-20 RECENTLY ISSUED ACCOUNTING STANDARDS In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts." (For further discussion see Note 2 of Notes to Consolidated Financial Statements.) CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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. DIRECTORS AND OFFICERS Directors are elected for one year terms at the annual meeting of the shareholder. They receive no additional compensation for serving as directors. The board of directors elects executive officers to one year terms subject to removal at the board's discretion. The directors and principal officers of AIG SunAmerica Life Assurance Company (the "Company") as of March 31, 2005 are listed below, together with information as to their ages, dates of election and principal business occupations during the last five years (if other than their present business occupations).
YEAR ASSUMED OTHER POSITIONS AND OTHER BUSINESS EXPERIENCE NAME AGE PRESENT POSITION POSITION WITHIN LAST FIVE YEARS FROM-TO - ---- --- ---------------------- -------- --------------------------------------------- --------- Jay S. Wintrob*.......... 48 Chairman and Chief 2001 Chief Executive Officer, AIGRS, SunAmerica 2001- Executive Officer Life Insurance Company ("SALIC") and First 2001- SunAmerica Life Insurance Company ("FSA") President, FSA 2001- President, AIGRS 2000- Chief Operating Officer, AIGRS 1998-2000 Vice Chairman, AIGRS (Joined AIGRS in 1987) 1995-2000 James R. Belardi*........ 48 Senior Vice President 1994 President, SALIC 2002- Executive Vice President, AIGRS (Joined AIGRS 1995- in 1986) Marc H. Gamsin*.......... 49 Senior Vice President 1999 Executive Vice President, AIGRS 2001- Senior Vice President, SALIC and FSA 1999- Executive Vice President SunAmerica 1998- Investments, Inc. N. Scott Gillis*......... 51 Senior Vice President 2003 Chief Financial Officer, AIGRS, SALIC and FSA 2003- and Chief Financial Senior Vice President, AIGRS 2002- Officer Controller, AIGRS 2000- Vice President, AIGRS (Joined AIGRS in 1985) 1998-2002 Jana W. Greer*........... 53 President 2002 Executive Vice President, AIGRS 2001- President, SunAmerica Retirement Markets, 1996- Inc. 1994- Senior Vice President, SALIC and FSA 1992-2000 Senior Vice President, AIGRS (Joined AIGRS in 1974) Michael J. Akers......... 55 Senior Vice President 2003 Chief Actuary, AIGRS 2003- Senior Vice President, SALIC and FSA 2003- Senior Vice President, AIGRS 2002- Senior Vice President and Chief Actuary, The 1999-2002 Variable Annuity Life Insurance Company Christine A. Nixon....... 40 Senior Vice President, 2003 Senior Vice President, General Counsel and 2003- General Counsel and Secretary, SALIC and FSA Secretary Chief Compliance Officer, AIGRS 2003 Secretary and Deputy Chief Legal Counsel, 2002- AIGRS 2000- Vice President, AIGRS (Joined AIGRS in 1993) 1997-2000 Associate General Counsel, AIGRS Gregory M. Outcalt....... 42 Senior Vice President 2000 Vice President, SunAmerica Investments, Inc. 2002- Senior Vice President, SALIC and FSA (Joined 2000- AIGRS in 1986) DIRECTOR NAME SINCE - ---- -------- Jay S. Wintrob*.......... 1990 James R. Belardi*........ 1990 Marc H. Gamsin*.......... 2000 N. Scott Gillis*......... 2000 Jana W. Greer*........... 1993 Michael J. Akers......... -- Christine A. Nixon....... -- Gregory M. Outcalt....... --
F-21
YEAR ASSUMED OTHER POSITIONS AND OTHER BUSINESS EXPERIENCE NAME AGE PRESENT POSITION POSITION WITHIN LAST FIVE YEARS FROM-TO - ---- --- ---------------------- -------- --------------------------------------------- --------- Stewart Polakov.......... 45 Senior Vice President 2003 Senior Vice President and Controller, FSA and 2003- and Controller SALIC Vice President, SALIC and FSA (Joined AIGRS 1997-2003 in 1991) Edwin R. Raquel.......... 47 Senior Vice President 1995 Senior Vice President and Chief Actuary, 1995- and Chief Actuary SALIC and FSA (Joined AIGRS in 1990) Mallary L. Reznik........ 36 Vice President 2005 Vice President, FSA 2005- Associate General Counsel, AIGRS 1998- Stephen J. Stone......... 46 Vice President 2005 Vice President, FSA 2005- Senior Portfolio Manager, Allstate Insurance 1989-2004 Company Edward T. Texeria........ 40 Vice President 2003 Vice President, SALIC and FSA 2003- Assistant Controller, AIGRS 2003- Assistant Controller, SALIC and FSA 2000-2003 Senior Manager, Assurance and Advisory 1994-2000 Business Services, Ernst & Young LLP DIRECTOR NAME SINCE - ---- -------- Stewart Polakov.......... -- Edwin R. Raquel.......... -- Mallary L. Reznik........ -- Stephen J. Stone......... -- Edward T. Texeria........ --
- --------------- * Also serves as a director The Company does not have an audit committee and relies on the Audit Committee of the Board of Directors of AIG. EXECUTIVE COMPENSATION The Company's executive officers provide services for the Company, its subsidiaries and, for certain officers, its affiliates. Allocations have been made to the Company and its subsidiaries based upon each individual's time devoted to his or her duties for the Company and its subsidiaries. All compensation information provided under this Item 11 is based on these allocations. The following table sets forth allocable compensation awarded to, earned by or paid to the Company's chief executive officer and four other most highly compensated executive officers for the years ended December 31, 2004, 2003 and 2002: SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ANNUAL COMPENSATION --------------------------- ---------------------------------- SECURITIES NAME AND OTHER ANNUAL UNDERLYING LTIP ALL OTHER SICO LTIP PRINCIPAL POSITION YEAR SALARY BONUS(1) COMPENSATION OPTIONS (#)(2) PAYOUTS(3) COMPENSATION(4) AWARDS(5) - ------------------ ---- -------- -------- ------------ -------------- ---------- --------------- --------- Jay S. Wintrob............ 2004 $ 84,500 $104,000 $21,580 6,500 $194,526 $ 5,068 $341,484 Chief Executive Officer 2003 86,125 71,500 18,330 10,400 183,365 3,041 -- 2002 316,050 215,600 56,840 19,600 719,992 2,467,413 907,088 Jana W. Greer............. 2004 329,648 517,634 -- 6,762 417,973 18,109 695,051 President 2003 318,000 371,353 -- 10,560 327,366 17,208 -- 2002 220,789 111,250 -- 4,005 363,902 2,014,889 556,054 Peter A. Harbeck.......... 2004 254,567 442,500 -- 7,500 364,920 14,475 531,927 President & Chief Executive 2003 331,250 390,000 -- 13,000 389,782 18,950 -- Officer, Asset Management 2002 223,269 160,000 50,000 6,500 444,581 1,512,950 590,070 N. Scott Gillis........... 2004 69,863 65,138 -- 1,782 36,437 5,360 170,217 Senior Vice President and 2003 69,317 58,050 -- 3,240 24,726 6,448 -- Chief Financial Officer 2002 61,027 71,750 -- 2,460 49,230 169,465 104,361 Christine A. Nixon........ 2004 92,250 50,840 -- 2,009 20,997 7,558 64,619 Senior Vice President, General 2003 89,038 39,600 -- 3,600 15,860 7,889 -- Counsel and Secretary 2002 46,142 27,900 -- 1,395 14,839 65,863 57,387
- --------------- (1) Amounts represent year-end and bonuses paid quarterly pursuant to a quarterly bonus program sponsored by AIG and marketing incentives. (2) Amounts represent the number of shares of common stock of AIG subject to options granted during the year indicated. (3) Amounts shown represent payments under the Company's 2000 and 2001 Five-Year Deferred Bonus Plans. Awards were granted under these plans in 2000 and 2001 and additional grants are not anticipated. Each award pays out in 20% installments over five years of continued employment. The last installment is to be paid in 2006. (4) Amounts shown primarily represent Company matching contributions under the 401(k) Plan and the Executive Savings Plan. Additionally, the 2002 amounts shown for Mr. Wintrob, Ms. Greer, Mr. Harbeck, Mr. Gillis and Ms. Nixon include allocated retention bonuses awarded in connection with the acquisition of SunAmerica Inc. by AIG consummated on January 1, 1999. F-22 (5) The SICO LTIP awards were granted by Starr International Company, Inc. pursuant to its Deferred Compensation Profit Participation Plan (the "SICO Plan"). The following table summarizes certain information with respect to the allocable portion of grants of options to purchase AIG common stock which were granted during 2004 to the individuals named in the Summary Compensation Table. OPTION GRANTS IN 2004
POTENTIAL REALIZABLE VALUE* PERCENTAGE OF AT ASSUMED ANNUAL RATES OF NUMBER OF TOTAL OPTIONS STOCK APPRECIATION FOR SECURITIES GRANTED TO AIG EXERCISE OPTION TERM DATE OF UNDERLYING EMPLOYEES PRICE PER EXPIRATION ---------------------------- NAME GRANT OPTIONS(1) DURING 2004(2) SHARE DATE 5 PERCENT(3) 10 PERCENT(4) - ---- ---------- ---------- -------------- --------- ---------- ------------ ------------- Jay S. Wintrob................. 12/16/2004 6,500 0.19% $64.47 12/16/14 $263,510 $667,875 Jana W. Greer.................. 12/16/2004 6,762 0.20% 64.47 12/16/14 274,131 694,795 Peter A. Harbeck............... 12/16/2004 7,500 0.22% 64.47 12/16/14 304,050 770,625 N. Scott Gillis................ 12/16/2004 1,782 0.05% 64.47 12/16/14 72,242 183,101 Christine A. Nixon............. 12/16/2004 2,009 0.06% 64.47 12/16/14 81,445 206,425
- --------------- * Options would have no realizable value if there were no appreciation or if there were depreciation from the price at which options were granted. (1) All options relate to shares of common stock of AIG and were granted pursuant to AIG's Amended and Restated 1999 Stock Option Plan at an exercise price equal to the fair market value of such stock at the date of grant. The option grants in 2004 provide that 25 percent of the options granted on any date become exercisable on each anniversary date in each of the successive four years and expire ten years from the date of grant. (2) It is impractical to determine the percent the grant represents of total options granted to the Company's employees, since the Company has no employees. The percentage is provided with regard to options granted to employees of AIG and its subsidiaries. (3) The appreciated price per share at 5 percent is $105.01 per share. (4) The appreciated price per share at 10 percent is $167.22 per share. The following table summarizes certain information with respect to the allocable exercise of options to purchase AIG common stock during 2004 by the individuals named in the Summary Compensation Table and the allocable unexercised options to purchase AIG common stock held by such individuals at December 31, 2004 based on the allocations described above. AGGREGATED OPTION EXERCISES DURING THE YEAR ENDED DECEMBER 31, 2004 AND DECEMBER 31, 2004 OPTION VALUES
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT SHARES DECEMBER 31, 2004 DECEMBER 31, 2004(2) ACQUIRED ON VALUE --------------------------- --------------------------- NAME EXERCISE REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ----------- ----------- ------------- ----------- ------------- Jay S. Wintrob............................ 21,101 $1,368,055 95,143 21,288 $ 4,474,328 $98,683 Jana W. Greer............................. 53,023 3,315,702 259,354 61,642 11,565,498 87,719 Peter A. Harbeck.......................... 14,428 710,616 57,373 45,471 1,464,499 94,203 N. Scott Gillis........................... 1,144 50,969 12,170 8,937 275,270 30,452 Christine A. Nixon........................ 3,549 203,628 12,983 9,364 377,754 34,657
- --------------- (1) Aggregate market value on date of exercise (closing sale price as reported in the New York Stock Exchange Composite Transactions Report) less aggregate exercise price. (2) Aggregate market value on December 31, 2004 (closing sale price as reported in the New York Stock Exchange Composite Transactions Report) less aggregate exercise price. F-23 The following table summarizes certain information with respect to benefits granted under the SICO Plan which were granted during 2002 (with respect to the 2003-2004 period) to the individuals named in the Summary Compensation Table. SICO LONG-TERM INCENTIVE PLANS(1)
NUMBER UNIT AWARD ESTIMATED NAME OF UNITS PERIOD FUTURE PAYOUTS - ---- -------- ---------- ---------------- Jay S. Wintrob.............................................. 325 Two years 5,200 shares Jana W. Greer............................................... 882 Two years 10,584 shares Peter A. Harbeck............................................ 675 Two years 8,100 shares N. Scott Gillis............................................. 216 Two years 2,592 shares Christine A. Nixon.......................................... 123 Two years 984 shares
- --------------- (1) Awards represent grants of units under the SICO Plan with respect to the two-year period from January 1, 2003 through December 31, 2004. The SICO Plan contains neither threshold amounts nor maximum payout limitations. The number of shares of AIG common stock, if any, allocated to a unit for the benefit of a participant in the SICO Plan is primarily dependent upon two factors: the growth in future earnings of AIG during the unit award period and the book value of AIG at the end of the award period. Prior to earning the right to payout, the participant is not entitled to any equity interest with respect to such shares, and the shares are subject to forfeiture under certain conditions, including but not limited to the participant's voluntary termination of employment with AIG or its subsidiaries prior to normal retirement age other than by death or disability. EMPLOYEE BENEFIT PLANS The Company participates in several employee benefit plans sponsored by AIG. RETIREMENT PLANS: The American International Group, Inc. Retirement Plan (the "AIG Plan") is a non-contributory, qualified, defined benefit plan. For employees of AIGRS and its subsidiaries, the formula equals .925% times Average Final Compensation (defined as the average annual compensation, which includes base pay and sales commissions, subject to limitations for certain highly compensated employees imposed by law, during the three consecutive years in the last ten years of credited service affording the highest such average) up to 150% of the employee's "covered compensation" (the average of the Social Security Wage Bases during the 35 years preceding the Social Security retirement age), plus 1.425% times Average Final Compensation in excess of 150% of the employee's "covered compensation" times years of credited service up to 35 years; plus 1.425% times Average Final Compensation times years of credited service in excess of 35 years but limited to 44 years. AIG also has in place the AIG Excess Retirement Income Plan ("AIG Excess Plan") for employees participating in the AIG Plan whose benefits under the AIG Plan are limited by applicable tax laws. The AIG Excess Plan provides benefits in excess of the AIG Plan benefits determined as if the benefit under the AIG Plan has been calculated without the limitations imposed by applicable tax laws. The AIG Excess Plan is a nonqualified, unfunded plan. AIG also has approved a Supplemental Executive Retirement Plan ("AIG SERP") which provides annual benefits to certain employees of AIGRS and its subsidiaries, not to exceed 60% of Average Final Compensation, that accrue at a rate of 2.4% of Average Final Compensation for each year of service or fraction thereof for each full month of active employment. The benefit payable under the AIG SERP is reduced by payments from the AIG Plan, the AIG Excess Plan, Social Security and any payments from a qualified pension plan of a prior employer. F-24 Annual amounts of normal retirement pension commencing at normal retirement age of 65 based upon Average Final Compensation and credited service under the AIG Plan and the AIG Excess Plan are illustrated in the following table: ESTIMATED ANNUAL PENSION AT AGE 65
AVERAGE FINAL COMPENSATION 10 YEARS 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS 40 YEARS - ------------- -------- -------- -------- -------- -------- -------- ---------- $ 125,000 $ 14,341 $ 21,512 $ 28,682 $ 35,853 $ 43,024 $ 50,194 $ 59,100 $ 150,000 17,904 26,856 35,807 44,759 53,711 62,663 73,350 $ 175,000 21,466 32,199 42,932 53,666 64,399 75,132 87,600 $ 200,000 25,029 37,543 50,057 62,572 75,086 87,600 101,850 $ 225,000 28,591 42,887 57,182 71,478 85,774 100,069 116,100 $ 250,000 32,154 48,231 64,307 80,384 96,461 112,538 130,350 $ 300,000 39,279 58,918 78,557 98,197 117,836 137,475 158,850 $ 375,000 49,966 74,949 99,932 124,916 149,899 174,882 201,600 $ 400,000 53,529 80,293 107,057 133,822 160,586 187,350 215,850 $ 500,000 67,779 101,668 135,557 169,447 203,336 237,225 272,850 $ 750,000 103,404 155,106 206,807 258,509 310,211 361,913 415,350 $1,000,000 139,029 208,543 278,057 347,572 417,086 486,600 557,850 $1,200,000 167,529 251,293 335,057 418,822 502,586 586,350 671,850 $1,400,000 196,029 294,043 392,057 490,072 588,086 686,100 785,850 $1,600,000 224,529 336,793 449,057 561,322 673,586 785,850 899,850 $1,800,000 253,029 379,543 506,057 632,572 759,086 885,600 1,013,850 $2,000,000 281,529 422,293 563,057 703,822 844,586 985,350 1,127,850
Each of the individuals named in the Summary Compensation Table have 2.0 years of credited service (under both plans) through December 31, 2004. Pensionable salary includes the regular salary paid by AIG and its subsidiaries and does not include amounts attributable to supplementary bonuses or overtime pay. For such named individuals, pensionable salary allocable to the Company during 2004 was as follows: Mr. Wintrob - $84,500; Ms. Greer - $329,648; Mr. Harbeck - $339,423; Mr. Gillis - $69,863; and Ms. Nixon - $92,250. Employees of AIGRS and its subsidiaries participate in the American International Group, Inc. Incentive Savings Plan (the "Incentive Savings Plan"), a 401(k) plan established by AIG which includes salary reduction contributions by employees and matching contributions. Matching contributions vary based on the number of years the employee has been employed. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Board of Directors of the Company does not have a Compensation Committee. Compensation decisions regarding the Chief Executive Officer are made by AIG. Compensation decisions regarding other executive officers are made by the Chief Executive Officer. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The Company is an indirect wholly owned subsidiary of American International Group, Inc. The number of shares of AIG common stock beneficially owned as of January 31, 2005, by directors, executive officers named in the Summary Compensation Table (as set forth in Item 11) and directors and executive officers as a group were as follows:
AIG COMMON STOCK -------------------- AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP DIRECTOR OR EXECUTIVE OFFICER (1)(2)(3)(5) - ----------------------------- -------------------- Jay S. Wintrob(4)........................................... 2,087,506 James R. Belardi............................................ 861,222 Marc H. Gamsin.............................................. 140,616 N. Scott Gillis............................................. 47,439 Jana W. Greer............................................... 304,877 Peter A. Harbeck............................................ 132,846 Christine A. Nixon.......................................... 33,003 All Directors and Executive Officers as a Group............. 3,607,509
F-25 - --------------- (1) The number of shares of AIG common stock owned by each individual and by all directors and executive officers as a group represents less than 1% of the outstanding shares of AIG common stock. (2) The number of shares of AIG common stock shown includes shares with respect to which the individual shares voting and investment power as follows: Mr. Belardi - 237 shares with his spouse; Ms. Greer - 39,105 shares with co-trustee. (3) The number of shares of AIG common stock shown includes shares subject to options which may be exercised within 60 days as follows: Mr. Wintrob - 741,870; Mr. Belardi - 305,397; Ms. Greer - 265,772; Mr. Gillis - 46,575; Mr. Gamsin - 140,216; Mr. Harbeck - 78,122; Ms. Nixon - 32,790; and all directors and executive officers as a group - 1,610,742. (4) Mr. Wintrob holds equity securities of C.V. Starr & Co., Inc. of 750 shares of Common Stock and 3,750 shares of various series of Preferred Stock. (5) The number of shares of AIG common stock shown excludes the following shares owned by members of the named individual's immediate family as to which such individual has disclaimed beneficial ownership: Mr. Wintrob - 4,009 shares held by various family members. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS During 2004, the Company paid cash dividends to its shareholder aggregating $2.5 million and received a capital contribution of 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo") (formerly SunAmerica Asset Management Corp.) which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica Fund Services, Inc. ("SFS") (formerly SunAmerica Fund Services, Inc.). This capital contribution increased the Company's equity by $150,653,000. Beginning in 2004, the Company and its subsidiaries are included in the consolidated federal income tax return of its ultimate parent, AIG. The Company is a party to a written agreement (the "Tax Sharing Agreement") with AIG setting forth the manner in which the total consolidated U.S. Federal income tax is allocated to each entity that joins in the consolidated return. The Tax Sharing Agreement provides that AIG agrees not to charge us a greater portion of the consolidated tax liability than would have been paid by us had the Company filed a separate federal income tax return. Additionally, AIG agrees to reimburse the Company for any tax benefits arising out of net losses or tax credits, if any, within ninety days after the filing of the consolidated federal income tax return for the year in which such losses or tax credits are utilized by AIG. The Company paid commissions totaling $60,674,000 in 2004 to nine affiliated broker-dealers: Royal Alliance Associates, Inc.; SunAmerica Securities, Inc.; Advantage Capital Corporation; FSC Services Corporation; Sentra Securities Corporation; Spelman & Co., Inc.; VALIC Financial Advisors; American General Equity Securities Corporation and American General Securities Inc. These affiliated broker-dealers distribute a significant portion of the Company's variable annuity products amounting to approximately 23% of deposits in 2004. Of the Company's mutual fund sales, approximately 25% were distributed by these affiliated broker-dealers in 2004. On February 1, 2004, SAAMCo entered into an administrative services agreement with FSA whereby SAAMCo will pay to FSA a fee based on a percentage of all assets invested through FSA's variable annuity products in exchange for services performed. SAAMCo is the investment advisor for certain trusts that serve as investment options for FSA's variable annuity products. Amounts incurred by the Company under this agreement totaled $1,537,000 in 2004. On October 1, 2001, SAAMCo entered into two administrative services agreements with business trusts established by its affiliate, The Variable Annuity Life Insurance Company ("VALIC"), whereby the trust pays to SAAMCo a fee based on a percentage of average daily net assets invested through VALIC's annuity products in exchange for services performed. Amounts earned by SAAMCo under this agreement totaled $9,074,000 in 2004 and are net of certain administrative costs incurred by VALIC of $2,593,000. Pursuant to a cost allocation agreement, the Company purchases administrative, investment management, accounting, legal, marketing and data processing services from the Parent, AIGRS and AIG. The allocation of such costs for investment management services is based on the level of assets under management. The allocation of costs for other services is based on estimated levels of usage, transactions or time incurred in providing the respective services. Amounts paid for such services totaled $148,554,000 in 2004. The majority of the Company's invested assets are managed by an affiliate of the Company. The investment management fees incurred were $3,712,000 in 2004. Additionally, the Company incurred $1,113,000 of management fees to an affiliate of the Company to administer its securities lending program for 2004. F-26 FINANCIAL STATEMENTS The consolidated financial statements of AIG SunAmerica Life Assurance Company which are included in this prospectus should be considered only as bearing on the ability AIG SunAmerica Life to meet its obligations with respect to amounts allocated to the fixed investment options and with respect to the death and other living benefits and our assumption of the mortality and expense risks and the risks that withdrawal charge will not be sufficient to cover the cost of distributing the contracts. They should not be considered as bearing on the investment performance of the variable Portfolios. The value of the variable Portfolios is affected primarily by the performance of the underlying investments. F-27 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholder of AIG SunAmerica Life Assurance Company: In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income and comprehensive income and of cash flows, in all material respects, the financial position of AIG SunAmerica Life Assurance Company (the "Company"), an indirect wholly owned subsidiary of American International Group, Inc., at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards 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 consolidated financial statements, the Company changed its method of accounting and reporting for certain nontraditional long-duration contracts in 2004. PricewaterhouseCoopers LLP Los Angeles, California April 15, 2005 F-28 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED BALANCE SHEET
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Assets Investments and cash: Cash and short-term investments........................... $ 201,117 $ 133,105 Bonds, notes and redeemable preferred stocks available for sale, at fair value (amortized cost: December 31, 2004, $5,007,868; December 31, 2003, $5,351,183).............. 5,161,027 5,505,800 Mortgage loans............................................ 624,179 716,846 Policy loans.............................................. 185,958 200,232 Mutual funds.............................................. 6,131 21,159 Common stocks available for sale, at fair value (cost: December 31, 2004, $4,876; December 31, 2003, $635)..... 4,902 727 Real estate............................................... 20,091 22,166 Securities lending collateral............................. 883,792 514,145 Other invested assets..................................... 38,789 10,453 ----------- ----------- Total investments and cash................................ 7,125,986 7,124,633 Variable annuity assets held in separate accounts........... 22,612,451 19,178,796 Accrued investment income................................... 73,769 74,647 Deferred acquisition costs.................................. 1,349,089 1,268,621 Other deferred expenses..................................... 257,781 236,707 Income taxes currently receivable from Parent............... 9,945 15,455 Receivable from brokers for sales of securities............. 161 -- Goodwill.................................................... 14,038 14,038 Other assets................................................ 52,795 58,830 ----------- ----------- Total Assets................................................ $31,496,015 $27,971,727 =========== ===========
See accompanying notes to consolidated financial statements. F-29 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED BALANCE SHEET (Continued)
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Liabilities and Shareholder's Equity Reserves, payables and accrued liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 3,948,158 $ 4,274,329 Reserves for universal life insurance contracts........... 1,535,905 1,609,233 Reserves for guaranteed investment contracts.............. 215,331 218,032 Reserves for guaranteed benefits.......................... 76,949 12,022 Securities lending payable................................ 883,792 514,145 Due to affiliates......................................... 21,655 19,289 Payable to brokers........................................ -- 1,140 Other liabilities......................................... 190,198 247,435 ----------- ----------- Total reserves, payables and accrued liabilities.......... 6,871,988 6,895,625 Variable annuity liabilities related to separate accounts... 22,612,451 19,178,796 Subordinated notes payable to affiliates.................... -- 40,960 Deferred income taxes....................................... 257,532 242,556 ----------- ----------- Total liabilities........................................... 29,741,971 26,357,937 ----------- ----------- Shareholder's equity: Common stock.............................................. 3,511 3,511 Additional paid-in capital................................ 758,346 709,246 Retained earnings......................................... 919,612 828,423 Accumulated other comprehensive income.................... 72,575 72,610 ----------- ----------- Total shareholder's equity................................ 1,754,044 1,613,790 ----------- ----------- Total Liabilities and Shareholder's Equity.................. $31,496,015 $27,971,727 =========== ===========
See accompanying notes to consolidated financial statements. F-30 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Revenues: Fee income: Variable annuity policy fees, net of reinsurance........ $369,141 $281,359 $286,919 Asset management fees................................... 89,569 66,663 66,423 Universal life insurance fees, net of reinsurance....... 33,899 35,816 36,253 Surrender charges....................................... 26,219 27,733 32,507 Other fees.............................................. 15,753 15,520 21,900 -------- -------- -------- Total fee income...................................... 534,581 427,091 444,002 Investment income........................................... 363,594 402,923 387,355 Net realized investment losses.............................. (23,807) (30,354) (65,811) -------- -------- -------- Total revenues.............................................. 874,368 799,660 765,546 ======== ======== ======== Benefits and Expenses: Interest expense: Fixed annuity and fixed accounts of variable annuity contracts............................................... 140,889 153,636 142,973 Universal life insurance contracts........................ 73,745 76,415 80,021 Guaranteed investment contracts........................... 6,034 7,534 11,267 Subordinated notes payable to affiliates.................. 2,081 2,628 3,868 -------- -------- -------- Total interest expense...................................... 222,749 240,213 238,129 Amortization of bonus interest.............................. 10,357 19,776 16,277 General and administrative expenses......................... 131,612 119,093 115,210 Amortization of deferred acquisition costs and other deferred expenses......................................... 157,650 160,106 222,484 Annual commissions.......................................... 64,323 55,661 58,389 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 17,766 15,716 Guaranteed minimum death benefits, net of reinsurance recoveries................................................ 58,756 63,268 67,492 -------- -------- -------- Total benefits and expenses................................. 662,867 675,883 733,697 ======== ======== ======== Pretax Income Before Cumulative Effect of Accounting Change.................................................... 211,501 123,777 31,849 Income tax expense.......................................... 6,410 30,247 160 -------- -------- -------- Net Income Before Cumulative Effect of Accounting Change.... 205,091 93,530 31,689 Cumulative effect of accounting change, net of tax.......... (62,589) -- -- -------- -------- -------- Net Income.................................................. $142,502 $ 93,530 $ 31,689 ======== ======== ======== Other Comprehensive Income (Loss), Net of Tax: Net unrealized gains (losses) on debt and equity securities available for sale identified in the current period less related amortization of deferred acquisition costs and other deferred expenses....................... $(20,487) $ 67,125 $ 20,358 Less reclassification adjustment for net realized losses included in net income.................................. 19,263 19,194 52,285 Net unrealized gains (losses) on foreign currency......... 1,170 -- -- Change related to cash flow hedges........................ -- -- (2,218) Income tax (benefit) expense.............................. 19 (30,213) (24,649) -------- -------- -------- Other Comprehensive Income (Loss)........................... (35) 56,106 45,776 -------- -------- -------- Comprehensive Income........................................ $142,467 $149,636 $ 77,465 ======== ======== ========
See accompanying notes to consolidated financial statements. F-31 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, ------------------------------------- 2004 2003 2002 --------- ----------- ----------- (IN THOUSANDS) Cash Flow from Operating Activities: Net income.................................................. $ 142,502 $ 93,530 $ 31,689 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of accounting change, net of tax........ 62,589 -- -- Interest credited to: Fixed annuity and fixed accounts of variable annuity contracts.............................................. 140,889 153,636 142,973 Universal life insurance contracts...................... 73,745 76,415 80,021 Guaranteed investment contracts......................... 6,034 7,534 11,267 Net realized investment losses............................ 23,807 30,354 65,811 Accretion of net discounts on investments................. (1,277) (9,378) (2,412) Loss on other invested assets............................. 572 2,859 3,932 Amortization of deferred acquisition costs and other expenses................................................ 168,007 179,882 238,761 Acquisition costs deferred................................ (246,033) (212,251) (204,833) Other expenses deferred................................... (62,906) (70,158) (77,602) Depreciation of fixed assets.............................. 1,619 1,718 860 Provision for deferred income taxes....................... 49,337 (129,591) 106,044 Change in: Accrued investment income............................... 878 679 13,907 Other assets............................................ 4,416 (12,349) 4,736 Income taxes currently payable to/receivable from Parent................................................. 5,157 148,898 (43,629) Due from/to affiliates.................................. 2,366 (36,841) (7,743) Other liabilities....................................... 7,485 10,697 (7,143) Other, net................................................ 2,284 14,885 10,877 --------- ----------- ----------- Net Cash Provided by Operating Activities................... 381,471 250,519 367,516 --------- ----------- ----------- Cash Flows from Investing Activities: Purchases of: Bonds, notes and redeemable preferred stocks.............. (964,705) (2,078,310) (2,403,362) Mortgage loans............................................ (31,502) (44,247) (128,764) Other investments, excluding short-term investments....... (33,235) (20,266) (65,184) Sales of: Bonds, notes and redeemable preferred stocks.............. 383,695 1,190,299 849,022 Other investments, excluding short-term investments....... 22,283 12,835 825 Redemptions and maturities of: Bonds, notes and redeemable preferred stocks.............. 898,682 994,014 615,798 Mortgage loans............................................ 125,475 67,506 82,825 Other investments, excluding short-term investments....... 10,915 72,970 114,347 --------- ----------- ----------- Net Cash Provided By (Used in) Investing Activities......... $ 411,608 $ 194,801 $ (934,493) ========= =========== ===========
See accompanying notes to consolidated financial statements. F-32 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
YEARS ENDED DECEMBER 31, -------------------------------------- 2004 2003 2002 ----------- ----------- ---------- (IN THOUSANDS) Cash Flow from Financing Activities: Deposits received on: Fixed annuity and fixed accounts of variable annuity contracts............................................... $ 1,360,319 $ 1,553,000 $1,731,597 Universal life insurance contracts........................ 45,183 45,657 49,402 Net exchanges from the fixed accounts of variable annuity contracts................................................. (1,332,240) (1,108,030) (503,221) Withdrawal payments on: Fixed annuity and fixed accounts of variable annuity contracts............................................... (458,052) (464,332) (529,466) Universal life insurance contracts........................ (69,185) (61,039) (68,444) Guaranteed investment contracts........................... (8,614) (148,719) (135,084) Claims and annuity payments, net of reinsurance, on: Fixed annuity and fixed accounts of variable annuity contracts............................................... (108,691) (109,412) (98,570) Universal life insurance contracts........................ (105,489) (111,380) (100,995) Net receipt from (repayments of) other short-term financings................................................ (41,060) 14,000 -- Net payment related to a modified coinsurance transaction... (4,738) (26,655) (30,282) Capital contribution received from Parent................... -- -- 200,000 Dividends paid to Parent.................................... (2,500) (12,187) (10,000) ----------- ----------- ---------- Net Cash (Used in) Provided by Financing Activities......... (725,067) (429,097) 504,937 ----------- ----------- ---------- Net Increase (Decrease) in Cash and Short-term Investments............................................... 68,012 16,223 (62,040) Cash and Short-term Investments at Beginning of Period...... 133,105 116,882 178,922 ----------- ----------- ---------- Cash and Short-term Investments at End of Period............ $ 201,117 $ 133,105 $ 116,882 =========== =========== ========== Supplemental Cash Flow Formation: Interest paid on indebtedness............................... $ 2,081 $ 2,628 $ 3,868 =========== =========== ========== Net income taxes (received) paid to Parent.................. $ (47,749) $ 10,989 $ 5,856 =========== =========== ==========
See accompanying notes to consolidated financial statements. F-33 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AIG SunAmerica Life Assurance Company (formerly Anchor National Life Insurance Company) (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, retirement services and asset management. The Company is an Arizona-domiciled life insurance company principally engaged in the business of writing variable annuity contracts directed to the market for tax-deferred, long-term savings products. The Company changed its name to AIG SunAmerica Life Assurance Company on January 24, 2002. The Company continued to do business as Anchor National Life Insurance Company until February 28, 2003, at which time it began doing business under its new name. Effective January 1, 2004, the Parent contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo") (formerly SunAmerica Asset Management Corp.) which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica Fund Services, Inc. ("SFS") (formerly SunAmerica Fund Services, Inc.). Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary of the Company. Assets, liabilities and shareholder's equity at December 31, 2003 were restated to include $190,605,000, $39,952,000 and $150,653,000, respectively, of SAAMCo balances. Similarly, the results of operations and cash flows for the years ended December 31, 2003 and 2002 have been restated for the addition and subtraction to pretax income of $16,345,000 and $4,464,000 to reflect the SAAMCo activity. Prior to this capital contribution to the Company, SAAMCo distributed certain investments with a tax effect of $49,100,000 which was indemnified by its then parent, SALIC. See Note 10 of the Notes to Consolidated Financial Statements. SAAMCo and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS, are included in the Company's asset management segment (see Note 13). These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, managing certain subaccounts offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. 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. Products for the annuity operations and asset management operations are marketed through affiliated and independent broker-dealers, full-service securities firms and financial institutions. One independent selling organization in the annuity operations represented 24.8% of deposits in the year ended December 31, 2004, 14.6% of deposits in the year ended December 31, 2003 and 11.9% of deposits in the year ended December 31, 2002. No other independent selling organization was responsible for 10% or more of deposits for any such period. One independent selling organization in the asset management operations represented 16.0% of deposits in the year ended December 31, 2004 and 10.8% of deposits in the year ended December 31, 2003. No other independent selling organization was responsible for 10% or more of deposits for any such period. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION: The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the amounts reported in the financial F-34 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) statements and the accompanying notes. Actual results could differ from those estimates. Certain prior period items have been reclassified to conform to the current period's presentation. INVESTMENTS: Cash and short-term investments primarily include cash, commercial paper, money market investments and short-term bank 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 deferred acquisition costs, deferred other expenses and income tax, are credited or charged directly to the accumulated other comprehensive income or loss component of shareholder's equity. Bonds, notes, redeemable preferred stocks and common stocks are reduced to estimated net fair value when declines in such values 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. Mutual funds consist of seed money for mutual funds used as investment vehicles for the Company's variable annuity separate accounts and is carried at market value. Real estate is carried at the lower of cost or net realizable value. 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 fair value of securities pledged under the securities lending agreement were $862,481,000 and $502,885,000 as of December 31, 2004 and 2003, respectively, and represents securities included in bonds, notes and redeemable preferred stocks available for sale caption in the consolidated balance sheet as of December 31, 2004 and 2003, respectively. The Company receives primarily cash collateral in an amount in excess of the market value of the securities loaned. The affiliated lending agent 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 consolidated statement of income and comprehensive income. Other invested assets consist principally of investments in limited partnerships and put options on the S&P 500 index purchased to partially offset the risk of Guaranteed Minimum Account Value ("GMAV") benefits and Guaranteed Minimum Withdrawal ("GMWB") benefits (see Note 7). Limited partnerships are carried at cost. The put options do not qualify for hedge accounting and accordingly are marked to market and changes in market value are recorded through investment income. Realized gains and losses on the sale of investments are recognized in operations 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 consolidated statement of income and comprehensive income. Impairments writedowns totaled $21,050,000, $54,092,000 and $57,273,000 in the years ending December 31, 2004, 2003 and 2002. DERIVATIVE FINANCIAL INSTRUMENTS: Derivative financial instruments primarily used by the Company include interest rate swap agreements and put options on the S&P 500 index entered into to partially offset the risk of certain guarantees of annuity contract values. The Company is neither a dealer nor a trader in derivative financial instruments. F-35 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The Company recognizes all derivatives in the consolidated balance sheet at fair value. Hedge accounting requires a high correlation between changes in fair values or cash flows of the derivative financial instrument and the specific item being hedged, both at inception and throughout the life of the hedge. For fair value hedges, gains and losses in the fair value of both the derivative and the hedged item attributable to the risk being hedged are recognized in earnings. For cash flow hedges, to the extent the hedge is effective, gains and losses in the fair value of both the derivative and the hedged item attributable to the risk being hedged are recognized as component of accumulated other comprehensive income in shareholder's equity. Any ineffective portion of cash flow hedges is reported in investment income. On the date a derivative contract is entered into, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet. Interest rate swap agreements convert specific investment securities from a floating-rate to a fixed-rate basis, or vice versa, and hedge against the risk of declining rates on anticipated security purchases. Interest rate swaps in which the Company agrees to pay a fixed rate and receive a floating rate are accounted for as fair value hedges. Interest rate swaps in which the Company agrees to pay a floating rate and receive a fixed rate are accounted for as cash flow hedges. The difference between amounts paid and received on swap agreements is recorded as an adjustment to investment income or interest expense, as appropriate, on an accrual basis over the periods covered by the agreements. The related amount payable to or receivable from counterparties is included in other liabilities or other assets. The Company issues certain variable annuity products that offer an optional GMAV and GMWB living benefit. If elected by the contract holder at the time of contract issuance, the GMAV feature guarantees that the account value under the contract will equal or exceed the amount of the initial principal invested, adjusted for withdrawals, at the end of a ten-year waiting period. If elected by the contract holder at the time of contract issuance, the GMWB feature guarantees an annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days, adjusted for any subsequent withdrawals. There is a separate charge to the contract holder for these features. The Company bears the risk that protracted under-performance of the financial markets could result in GMAV and GMWB benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. Under Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities"("FAS 133"), the GMAV and GMWB benefits are considered embedded derivatives that are bifurcated and marked to market and recorded in other liabilities in the consolidated balance sheet. Changes in the market value of the estimated GMAV and GMWB benefits are recorded through investment income. DEFERRED ACQUISITION COSTS ("DAC"): Policy acquisition costs are deferred and amortized over the estimated lives of the annuity and universal life insurance contracts. Policy acquisition costs include commissions and other costs that vary with, and are primarily related to, the production or acquisition of new business. DAC is amortized based on a percentage of expected gross profits ("EGPs") over the life of the underlying contracts. EGPs are computed based on assumptions related to the underlying contracts, including their anticipated duration, the growth rate of the separate account assets (with respect to variable options of the variable annuity contracts) or general account assets (with respect to fixed options of variable annuity contracts ("Fixed Options") and universal life insurance contracts) supporting the annuity obligations, costs of providing for contract guarantees and the level of expenses necessary to maintain the contracts. The Company adjusts amortization of DAC and other deferred expenses (a "DAC unlocking") when estimates of future gross profits to be realized from its annuity contracts are revised. The assumption for the long-term annual net growth of the separate account assets used by the Company in the determination of DAC amortization with respect to its variable annuity contracts is 10% (the "long-term growth rate assumption"). The Company uses a "reversion to the mean" methodology that allows the Company to maintain this 10% long-term growth rate assumption, while also giving consideration to the effect of short-term swings in the equity markets. For example, if performance were 15% during the first year following the introduction of a product, the DAC model would assume that market returns for the following five years (the "short-term growth rate assumption") would approximate 9%, resulting in an average annual growth rate of 10% during the life of the product. Similarly, following periods of below 10% F-36 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) performance, the model will assume a short-term growth rate higher than 10%. A DAC unlocking will occur if management deems the short-term growth rate (i.e., the growth rate required to revert to the mean 10% growth rate over a five-year period) to be unreasonable. The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. As debt 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 debt and equity securities available for sale which is a component of accumulated other comprehensive income (loss) and is credited or charged directly to shareholder's equity. 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 amortization expense on the consolidated statement of income and comprehensive income. OTHER DEFERRED EXPENSES: The annuity operations currently offers enhanced crediting rates or bonus payments to contract holders on certain of its products. Such amounts are deferred and amortized over the life of the contract using the same methodology and assumptions used to amortize DAC. The Company previously deferred these expenses as part of DAC and reported the amortization of such amounts as part of DAC amortization. Upon implementation of Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1"), the Company reclassified $155,695,000 of these expenses from DAC to other deferred expenses, which is reported on the consolidated balance sheet. The prior period consolidated balance sheet and consolidated statements of income and comprehensive income presentation has been reclassified to conform to the new presentation. See Recently Issued Accounting Standards below. The asset management operations defer distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or contingent deferred sales charge feature (collectively, "Distribution Fee Revenue"). The Company amortizes these deferred distribution costs on a straight-line basis, adjusted for redemptions, over a period ranging from one year to eight years depending on share class. Amortization of these deferred distribution costs is increased if at any reporting period the value of the deferred amount exceeds the projected Distribution Fee Revenue. The projected Distribution Fee Revenue is impacted by estimated future withdrawal rates and the rates of market return. Management uses historical activity to estimate future withdrawal rates and average annual performance of the equity markets to estimate the rates of market return. The Company reviews the carrying value of other deferred expenses on at least an annual basis. Management considers estimated future gross profit margins as well as expected mortality, interest earned, credited rates, persistency, withdrawal rates, rates of market return 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 policy fees in the consolidated statement of income and comprehensive income. GOODWILL: Goodwill amounted to $14,038,000 (net of accumulated amortization of $18,838,000) at December 31, 2004 and 2003. In accordance with Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), the Company assesses goodwill for impairment on an annual basis, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of the impairment, if any. The Company has evaluated goodwill for impairment as of December 31, 2004 and 2003, and has determined that no impairment provision is necessary. RESERVES FOR FIXED ANNUITY CONTRACTS, FIXED ACCOUNTS OF VARIABLE ANNUITY CONTRACTS, UNIVERSAL LIFE INSURANCE CONTRACTS AND GICS: Reserves for fixed annuity, Fixed Options, universal life insurance and GIC contracts are accounted for in accordance with Statement of Financial Accounting Standards No. 97, F-37 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) "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). 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 consolidated statement of income and comprehensive income, as they are recorded directly to contract holders' liabilities upon receipt. RESERVES FOR GUARANTEED BENEFITS: Reserves for guaranteed minimum death benefits ("GMDB"), earnings enhancement benefit and guaranteed minimum income benefits are accounted for in accordance with SOP 03-1. See Recently Issued Accounting Standards below. FEE INCOME: Fee income includes variable annuity policy fees, asset management fees, universal life insurance fees, commissions and surrender charges. Variable annuity policy fees are generally based on the market value of assets in the separate accounts supporting the variable annuity contracts. Asset management fees include investment advisory fees and 12b-1 distribution fees and are based on the market value of assets managed in mutual funds and certain variable annuity portfolios by SAAMCo. Universal life insurance policy fees consist of mortality charges, up-front fees earned on deposits received and administrative fees, net of reinsurance premiums. Surrender charges are assessed on withdrawals occurring during the surrender charge period. All fee income is recorded as income when earned with net retained commissions are recognized as income on a trade date basis. INCOME TAXES: Prior to the 2004, the Company was included in a consolidated federal income tax return with its Parent. Also, prior to 2004, SAAMCO, SFS and SACS were included in a separate consolidated federal income tax return with their parent, Saamsun Holdings Corporation. Beginning in 2004, all of these companies are included in the consolidated federal income tax return of their ultimate parent, AIG. Income taxes have been calculated as if each entity files 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 July 2003, the American Institute of Certified Public Accountants issued SOP 03-1. This statement was effective as of January 1, 2004, and requires the Company to recognize a liability for GMDB and certain living benefits related to its variable annuity contracts, account for enhanced crediting rates or bonus payments to contract holders and modifies certain disclosures and financial statement presentations for these products. In addition, SOP 03-1 addresses the presentation and reporting of separate accounts and the capitalization and amortization of certain other expenses. The Company reported for the first quarter of 2004 a one-time cumulative accounting charge upon adoption of $62,589,000 ($96,291,000 pre-tax) to reflect the liability and the related impact of DAC and reinsurance as of January 1, 2004. 3. INVESTMENTS The amortized cost and estimated fair value of bonds, notes and redeemable preferred stocks by major category follow:
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) At December 31, 2004: U.S. government securities.................................. $ 28,443 $ 30,300 Mortgage-backed securities.................................. 926,274 956,567 Securities of public utilities.............................. 321,381 332,038 Corporate bonds and notes................................... 2,797,943 2,902,829 Redeemable preferred stocks................................. 20,140 21,550 Other debt securities....................................... 913,687 917,743 ---------- ---------- Total..................................................... $5,007,868 $5,161,027 ========== ==========
F-38 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued)
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) At December 31, 2003: U.S. government securities.................................. $ 22,393 $ 24,292 Mortgage-backed securities.................................. 1,148,452 1,191,817 Securities of public utilities.............................. 352,998 365,150 Corporate bonds and notes................................... 2,590,254 2,697,142 Redeemable preferred stocks................................. 21,515 22,175 Other debt securities....................................... 1,215,571 1,205,224 ---------- ---------- Total..................................................... $5,351,183 $5,505,800 ========== ==========
At December 31, 2004, bonds, notes and redeemable preferred stocks included $386,426,000 that were not rated investment grade. These non-investment-grade securities are comprised of bonds spanning 10 industries with 19%, 16%, 16% and 10% concentrated in telecommunications, utilities, financial institutions and noncyclical consumer products industries, respectively. No other industry concentration constituted more than 10% of these assets. At December 31, 2004, mortgage loans were collateralized by properties located in 30 states, with loans totaling approximately 27%, 11% and 10% of the aggregate carrying value of the portfolio secured by properties located in California, Michigan and Massachusetts, respectively. No more than 10% of the portfolio was secured by properties in any other single state. At December 31, 2004, the carrying value, which approximates its estimated fair value, of all investments in default as to the payment of principal or interest totaled $40,051,000 of bonds. As a component of its asset and liability management strategy, the Company utilizes interest rate swap agreements to match assets more closely to liabilities. Interest rate swap agreements exchange interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) with a counterparty, based on an underlying principal balance (notional principal) to hedge against interest rate changes. The Company typically utilizes swap agreements to create a hedge that effectively converts floating-rate assets and liabilities to fixed-rate instruments. At December 31, 2004, $10,505,000 of bonds, at amortized cost, were on deposit with regulatory authorities in accordance with statutory requirements. At December 31, 2004, no investments in any one entity or its affiliates exceeded 10% of the Company's shareholder's equity. The amortized cost and estimated fair value of bonds, notes and redeemable preferred stocks by contractual maturity, as of December 31, 2004, follow:
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) Due in one year or less..................................... $ 278,939 $ 281,954 Due after one year through five years....................... 2,076,145 2,138,574 Due after five years through ten years...................... 1,299,345 1,339,499 Due after ten years......................................... 427,165 444,433 Mortgage-backed securities.................................. 926,274 956,567 ---------- ---------- Total..................................................... $5,007,868 $5,161,027 ========== ==========
Actual maturities of bonds, notes and redeemable preferred stocks may differ from those shown above due to prepayments and redemptions. F-39 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued) Gross unrealized gains and losses on bonds, notes and redeemable preferred stocks by major category follow:
GROSS GROSS UNREALIZED UNREALIZED GAINS LOSSES ---------- ---------- (IN THOUSANDS) At December 31, 2004: U.S. government securities.................................. $ 1,857 $ -- Mortgage-backed securities.................................. 32,678 (2,385) Securities of public utilities.............................. 11,418 (761) Corporate bonds and notes................................... 118,069 (13,183) Redeemable preferred stocks................................. 1,410 -- Other debt securities....................................... 14,871 (10,815) -------- -------- Total..................................................... $180,303 $(27,144) ======== ========
GROSS GROSS UNREALIZED UNREALIZED GAINS LOSSES ---------- ---------- (IN THOUSANDS) At December 31, 2003: U.S. government securities.................................. $ 1,898 $ -- Mortgage-backed securities.................................. 46,346 (2,980) Securities of public utilities.............................. 13,467 (1,315) Corporate bonds and notes................................... 127,996 (21,108) Redeemable preferred stocks................................. 660 -- Other debt securities....................................... 24,366 (34,713) -------- -------- Total..................................................... $214,733 $(60,116) ======== ========
Gross unrealized gains on equity securities aggregated $26,000 at December 31, 2004 and $112,000 at December 31, 2003. There were no unrealized losses on equity securities at December 31, 2004 and gross unrealized losses on equity securities aggregated $20,000 at December 31, 2003. The following tables summarize 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, 2004 and 2003.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ----------------------------- ----------------------------- ------------------------------- FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSS ITEMS VALUE LOSS ITEMS VALUE LOSS ITEMS -------- ---------- ----- -------- ---------- ----- ---------- ---------- ----- (DOLLARS IN THOUSANDS) December 31, 2004 Mortgage-backed securities............... $125,589 $ (1,282) 23 $ 40,275 $ (1,103) 9 $ 165,864 $ (2,385) 32 Securities of public utilities................ 46,249 (761) 9 0 0 0 46,249 (761) 9 Corporate bonds and notes.................... 487,923 (7,418) 86 87,194 (5,765) 15 575,117 (13,183) 101 Other debt securities...... 207,378 (4,062) 36 79,782 (6,753) 12 287,160 (10,815) 48 -------- -------- --- -------- -------- -- ---------- -------- --- Total.................... $867,139 $(13,523) 154 $207,251 $(13,621) 36 $1,074,390 $(27,144) 190 ======== ======== === ======== ======== == ========== ======== ===
F-40 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued)
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ----------------------------- ---------------------------- ----------------------------- FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSS ITEMS VALUE LOSS ITEMS VALUE LOSS ITEMS -------- ---------- ----- ------- ---------- ----- -------- ---------- ----- December 31, 2003 Mortgage-backed securities..... $180,559 $ (2,882) 49 $13,080 $ (98) 6 $193,639 $ (2,980) 55 Securities of public utilities.................... 67,626 (1,315) 8 -- -- -- 67,626 (1,315) 8 Corporate bonds and notes...... 276,373 (17,086) 54 30,383 (4,022) 5 306,756 (21,108) 59 Other debt securities.......... 302,230 (33,951) 54 41,523 (762) 5 343,753 (34,713) 59 -------- -------- --- ------- ------- -- -------- -------- --- Total........................ $826,788 $(55,234) 165 $84,986 $(4,882) 16 $911,774 $(60,116) 181 ======== ======== === ======= ======= == ======== ======== ===
Realized investment gains and losses on sales of investments are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Bonds, Notes and Redeemable Preferred Stocks: Realized gains............................................ $ 12,240 $ 30,896 $ 25,013 Realized losses........................................... (12,623) (11,818) (32,865) Common Stocks: Realized gains............................................ 5 561 -- Realized losses........................................... (247) (117) (169)
The sources and related amounts of investment income are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Short-term investments...................................... $ 2,483 $ 1,363 $ 5,447 Bonds, notes and redeemable preferred stocks................ 293,258 321,493 305,480 Mortgage loans.............................................. 50,825 53,951 55,417 Partnerships................................................ 417 (478) 12,344 Policy loans................................................ 17,130 15,925 18,796 Real estate................................................. (202) (331) (276) Other invested assets....................................... 2,149 13,308 (7,496) Less: investment expenses................................... (2,466) (2,308) (2,357) -------- -------- -------- Total investment income................................... $363,594 $402,923 $387,355 ======== ======== ========
Investment income was attributable to the following products:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Fixed annuity contracts..................................... $ 34,135 $ 37,762 $ 41,856 Variable annuity contracts.................................. 222,660 239,863 201,766 Guaranteed investment contracts............................. 13,191 20,660 28,056 Universal life insurance contracts.......................... 92,645 100,019 105,878 Asset management............................................ 963 4,619 9,799 -------- -------- -------- Total..................................................... $363,594 $402,923 $387,355 ======== ======== ========
4. FAIR VALUE OF FINANCIAL INSTRUMENTS The 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 F-41 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) assets (including its real estate investments and other invested assets except for partnerships) 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 INSTRUMENTS: 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 that 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. POLICY LOANS: Carrying value is considered a reasonable estimate of fair value. MUTUAL FUNDS: Fair value is considered to be the market value of the underlying securities. COMMON STOCKS: Fair value is based principally on independent pricing services, broker quotes and other independent information. PARTNERSHIPS: Fair value of partnerships that invest in debt and equity securities is based upon the fair value of the net assets of the partnerships as determined by the general partners. VARIABLE ANNUITY ASSETS HELD IN SEPARATE ACCOUNTS: Variable annuity assets are carried at the market value of the underlying securities. RESERVES FOR FIXED ANNUITY AND FIXED ACCOUNTS OF VARIABLE 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. RESERVES FOR GUARANTEED INVESTMENT CONTRACTS: Fair value is based on the present value of future cash flows at current pricing rates. SECURITIES LENDING COLLATERAL/PAYABLE: Carrying value is considered to be a reasonable estimate of fair value. 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. SUBORDINATED NOTES TO/FROM AFFILIATES: Fair value is estimated based on the quoted market prices for similar issues. F-42 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) The estimated fair values of the Company's financial instruments at December 31, 2004 and 2003 compared with their respective carrying values, are as follows:
CARRYING FAIR VALUE VALUE ----------- ----------- (IN THOUSANDS) December 31, 2004: Assets: Cash and short-term investments........................... $ 201,117 $ 201,117 Bonds, notes and redeemable preferred stocks.............. 5,161,027 5,161,027 Mortgage loans............................................ 624,179 657,828 Policy loans.............................................. 185,958 185,958 Mutual funds.............................................. 6,131 6,131 Common stocks............................................. 4,902 4,902 Partnerships.............................................. 1,084 1,084 Securities lending collateral............................. 883,792 883,792 Put options hedging guaranteed benefits................... 37,705 37,705 Variable annuity assets held in separate accounts......... 22,612,451 22,612,451 Liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 3,948,158 $ 3,943,265 Reserves for guaranteed investment contracts.............. 215,331 219,230 Securities lending payable................................ 883,792 883,792 Variable annuity liabilities related to separate accounts................................................ 22,612,451 22,612,451
CARRYING FAIR VALUE VALUE ----------- ----------- (IN THOUSANDS) December 31, 2003: Assets: Cash and short-term investments........................... $ 133,105 $ 133,105 Bonds, notes and redeemable preferred stocks.............. 5,505,800 5,505,800 Mortgage loans............................................ 716,846 774,758 Policy loans.............................................. 200,232 200,232 Mutual funds.............................................. 21,159 21,159 Common stocks............................................. 727 727 Partnerships.............................................. 1,312 1,685 Securities lending collateral............................. 514,145 514,145 Put options hedging guaranteed benefits................... 9,141 9,141 Variable annuity assets held in separate accounts......... 19,178,796 19,178,796 Liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 4,274,329 $ 4,225,329 Reserves for guaranteed investment contracts.............. 218,032 223,553 Securities lending payable................................ 514,145 514,145 Variable annuity liabilities related to separate accounts................................................ 19,178,796 19,178,796 Subordinated note payable to affiliate.................... 40,960 40,960
F-43 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. DEFERRED ACQUISITION COSTS The following table summarizes the activity in deferred acquisition costs:
YEARS ENDED DECEMBER 31, ------------------------- 2004 2003 ----------- ----------- (IN THOUSANDS) Balance at beginning of year................................ $1,268,621 $1,224,101 Acquisition costs deferred.................................. 246,033 212,250 Effect of net unrealized gains (losses) on securities....... 267 (30,600) Amortization charged to income.............................. (126,142) (137,130) Cumulative effect of SOP 03-1............................... (39,690) -- ---------- ---------- Balance at end of year...................................... $1,349,089 $1,268,621 ========== ==========
6. OTHER DEFERRED EXPENSES The annuity operations defer enhanced crediting rates or bonus payments to contract holders on certain of its products ("Bonus Payments"). The asset management operations defer distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or contingent deferred sales charge feature. The following table summarizes the activity in these deferred expenses:
BONUS DISTRIBUTION PAYMENTS COSTS TOTAL -------- ------------ -------- (IN THOUSANDS) Year Ended December 31, 2004 Balance at beginning of year................................ $155,695 $ 81,012 $236,707 Expenses deferred........................................... 36,732 26,174 62,906 Effect of net unrealized gains (losses) on securities....... 33 -- 33 Amortization charged in income.............................. (10,357) (31,508) (41,865) -------- -------- -------- Balance at end of year...................................... $182,103 $ 75,678 $257,781 ======== ======== ======== Year Ended December 31, 2003 Balance at beginning of year................................ $140,647 $ 72,054 $212,701 Expenses deferred........................................... 38,224 31,934 70,158 Effect of net unrealized gains (losses) on securities....... (3,400) -- (3,400) Amortization charged in income.............................. (19,776) (22,976) (42,752) -------- -------- -------- Balance at end of year...................................... $155,695 $ 81,012 $236,707 ======== ======== ========
7. GUARANTEED BENEFITS The Company issues variable annuity contracts for which the investment risk is generally borne by the contract holder, except with respect to amounts invested in the Fixed Options. For many of the Company's variable annuity contracts, the Company offers contractual guarantees in the event of death, at specified dates during the accumulation period, upon certain withdrawals or at annuitization. Such benefits are referred to as GMDB, GMAV, GMWB and guaranteed minimum income benefits ("GMIB"), respectively. The Company also issues certain variable annuity products that offer an optional earnings enhancement benefit ("EEB") feature that provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The assets supporting the variable portion of variable annuity contracts are carried at fair value and reported as summary total "variable annuity assets held in separate accounts" with an equivalent summary total reported for liabilities. Amounts assessed against the contract holders for mortality, administrative, other services and certain features are included in variable annuity policy fees, net of reinsurance, in the consolidated statement of income and comprehensive income. Changes in liabilities for minimum guarantees are included in guaranteed benefits, net of reinsurance, in the consolidated statement of income and comprehensive income. Separate account net investment income, net investment gains and losses and the related liability charges are offset within the same line item in the consolidated statement of income and comprehensive income. F-44 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) The Company offers GMDB options that guarantee for virtually all contract holders, that upon death, the contract holder's beneficiary will receive the greater of (1) the contract holder's account value, or (2) a guaranteed minimum death benefit that varies by product and election by policy owner. The GMDB liability is determined each period end by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to guaranteed benefits, net of reinsurance recoveries, if actual experience or other evidence suggests that earlier assumptions should be revised. EEB is a feature the Company offers on certain variable annuity products. For contract holders who elect the feature, the EEB provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The Company bears the risk that account values following favorable performance of the financial markets will result in greater EEB death claims and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. If available and elected by the contract holder, GMIB provides a minimum fixed annuity payment guarantee after a seven, nine or ten-year waiting period. As there is a waiting period to annuitize using the GMIB, there are no policies eligible to receive this benefit at December 31, 2004. The GMIB liability is determined each period end by estimating the expected value of the annuitization benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to guaranteed benefits, net of reinsurance recoveries, if actual experience or other evidence suggests that earlier assumptions should be revised. GMAV is a feature offered on certain variable annuity products. If available and elected by the contract holder at the time of contract issuance, GMAV guarantees that the account value under the contract will at least equal the amount of deposits invested during the first ninety days, adjusted for any subsequent withdrawals, at the end of a ten-year waiting period. The Company purchases put options on the S&P 500 index to partially offset this risk. GMAVs are considered to be derivatives under FAS 133, and are recognized at fair value in the consolidated balance sheet and through investment income in the consolidated statement of income and comprehensive income. GMWB is a feature offered on certain variable annuity products. If available and elected by the contract holder at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days adjusted for any subsequent withdrawals ("Eligible Premium"). These guaranteed annual withdrawals of up to 10% of Eligible Premium are available after either a three-year or a five-year waiting period as elected by the contract holder at time of contract issuance, without reducing the future amounts guaranteed. If no withdrawals have been made during the waiting period of three or five years, the contract holder will realize an additional 10% or 20%, respectively, of Eligible Premium after all other amounts guaranteed under this benefit have been paid. GMWBs are considered to be derivatives under FAS 133 and are recognized at fair value in the consolidated balance sheet and through investment income in the consolidated statement of income and comprehensive income. F-45 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) Details concerning the Company's guaranteed benefit exposures as of December 31, 2004 are as follows:
HIGHEST SPECIFIED RETURN OF NET ANNIVERSARY ACCOUNT DEPOSITS PLUS A VALUE MINUS MINIMUM WITHDRAWALS POST RETURN ANNIVERSARY --------------- ------------------- (DOLLARS IN MILLIONS) In the event of death (GMDB and EEB): Account value............................................. $ 12,883 $12,890 Net amount at risk(a)..................................... $ 933 $ 1,137 Average attained age of contract holders.................. 67 64 Range of guaranteed minimum return rates.................. 0%-5% 0% At annuitization (GMIB): Account value............................................. $ 6,942 Net amount at risk(b)..................................... $ 3 Weighted average period remaining until earliest 3.8 Years annuitization........................................... Range of guaranteed minimum return rates.................. 0%-6.5% Accumulation at specified date (GMAV): Account value............................................. $ 1,533 Net amount at risk(c)..................................... $ -- Weighted average period remaining until guaranteed 9.0 Years payment................................................. Annual withdrawals at specified date (GMWB): Account value............................................. $ 294 Net amount at risk(d)..................................... $ -- Weighted average period remaining until expected payout... 13.9 Years
------------------- (a) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value, net of reinsurance, if all contract holders died at the same balance sheet date. The net amount at risk does not take into account the effect of caps and deductibles from the various reinsurance treaties. (b) Net amount at risk represents the present value of the expected annuitization payments at the expected annuitization dates in excess of the present value of the expected account value at the expected annuitization dates, net of reinsurance. (c) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value, if all contract holders reached the specified date at the same balance sheet date. (d) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value if all contract holders exercise the maximum withdrawal benefits at the same balance sheet date. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will realize an additional 10% or 20% of Eligible Premium, respectively, after all other amounts guaranteed under this benefit have been paid. The additional 10% or 20% enhancement increases the net amount at risk by $26.3 million and is payable no sooner than 13 or 15 years from contract issuance for the 3 or 5 year waiting periods, respectively. The following summarizes the reserve for guaranteed benefits, net of reinsurance, on variable contracts reflected in the general account:
(IN THOUSANDS) Balance at January 1, 2004 before reinsurance(e)............ $ 92,873 Guaranteed benefits incurred................................ 61,472 Guaranteed benefits paid.................................... (49,947) -------- Balance at December 31, 2004 before reinsurance............. 104,398 Less reinsurance.......................................... (27,449) -------- Balance at December 31, 2004, net of reinsurance............ $ 76,949 ========
(e) Includes amounts from the one-time cumulative accounting change resulting from the adoption of SOP 03-1. F-46 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) The following assumptions and methodology were used to determine the reserve for guaranteed benefits at December 31, 2004: - Data used was 5,000 stochastically generated investment performance scenarios. - Mean investment performance assumption was 10%. - Volatility assumption was 16%. - Mortality was assumed to be 64% of the 75-80 ALB table. - Lapse rates vary by contract type and duration and range from 0% to 40%. - The discount rate was approximately 8%. 8. REINSURANCE Reinsurance contracts do not relieve the Company from its obligations to contract holders. 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. The Company has no reinsurance recoverable or related concentration of credit risk greater than 10% of shareholder's equity. Variable policy fees are net of reinsurance premiums of $28,604,000, $30,795,000 and $22,500,000 in 2004, 2003 and 2002, respectively. Universal life insurance fees are net of reinsurance premiums of $34,311,000, $33,710,000 and $34,098,000 in 2004, 2003 and 2002, respectively. The Company has a reinsurance treaty under which the Company retains no more than $100,000 of risk on any one insured life in order to limit the exposure to loss on any single insured. Reinsurance recoveries recognized as a reduction of claims on universal life insurance contracts amounted to $34,163,000, $34,036,000 and $29,171,000 in 2004, 2003 and 2002, respectively. Guaranteed benefits were reduced by reinsurance recoveries of $2,716,000, $8,042,000 and $8,362,000 in 2004, 2003 and 2002, respectively. 9. COMMITMENTS AND CONTINGENT LIABILITIES The Company has six agreements outstanding in which it has provided liquidity support for certain short-term securities of municipalities and non-profit organizations by agreeing to purchase such securities in the event there is no other buyer in the short-term marketplace. In return the Company receives a fee. In addition, the Company guarantees the payment of these securities upon redemption. The maximum liability under these guarantees at December 31, 2004 is $195,442,000. These commitments have contractual maturity dates in 2005. Related to each of these agreements are participation agreements with the Parent under which the Parent will share in $62,590,000 of these liabilities in exchange for a proportionate percentage of the fees received under these agreements. The Internal Revenue Service has completed its examinations into the transactions underlying these commitments, including the Company's role in the transactions. The examination did not result in a material loss to the Company. At December 31, 2004, the Company has commitments to purchase a total of approximately $10,000,000 of asset- backed securities in the ordinary course of business. The expiration dates of these commitments are as follows: $2,000,000 in 2005 and $8,000,000 in 2007. Various federal, state and other regulatory agencies are reviewing certain transactions and practices of the Company and its subsidiaries in connection with industry-wide and other inquiries. In the opinion of the Company's management, based on the current status of these inquiries, it is not likely that any of these inquiries will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows of the Company. Various lawsuits against the Company and its subsidiaries have arisen in the ordinary course of business. Contingent liabilities arising from litigation, income taxes and regulatory and other matters are not considered material in relation to the consolidated financial position, results of operations or cash flows of the Company. F-47 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENT LIABILITIES (Continued) On April 5, 2004, a purported class action captioned Nitika Mehta, as Trustee of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case 04L0199, was filed in the Circuit Court, Twentieth Judicial District in St. Clair County, Illinois. The lawsuit alleges certain improprieties in conjunction with alleged market timing activities. The probability of any particular outcome cannot be reasonably estimated at this time. The Company cannot estimate a range because the litigation has not progressed beyond the preliminary stage. 10. SHAREHOLDER'S EQUITY The Company is authorized to issue 4,000 shares of its $1,000 par value Common Stock. At December 31, 2004 and 2003, 3,511 shares were outstanding. Changes in shareholder's equity are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Additional Paid-in Capital: Beginning balances........................................ $709,246 $709,246 $509,246 Capital contributions by Parent........................... 49,100 -- 200,000 -------- -------- -------- Ending balances........................................... $758,346 $709,246 $709,246 ======== ======== ======== Retained Earnings: Beginning balances........................................ $828,423 $730,321 $669,103 Net income................................................ 142,502 93,530 31,689 Dividends paid to Parent.................................. (2,500) (12,187) (10,000) Adjustment for tax benefit of distributed subsidiary...... 287 16,759 39,529 Tax effect on a distribution of investment................ (49,100) -- -- -------- -------- -------- Ending balances........................................... $919,612 $828,423 $730,321 ======== ======== ======== Accumulated Other Comprehensive Income (Loss): Beginning balances........................................ $ 72,610 $ 16,504 $(29,272) Change in net unrealized gains (losses) on debt securities available for sale...................................... (1,459) 118,725 98,718 Change in net unrealized gains (losses) on equity securities available for sale........................... (65) 1,594 (1,075) Change in net unrealized gains on foreign currency........ 1,170 -- -- Change in adjustment to deferred acquisition costs and other deferred expenses................................. 300 (34,000) (25,000) Net change related to cash flow hedges.................... -- -- (2,218) Tax effects of net changes................................ 19 (30,213) (24,649) -------- -------- -------- Ending balances........................................... $ 72,575 $ 72,610 $ 16,504 ======== ======== ========
Gross unrealized gains (losses) on fixed maturity and equity securities included in accumulated other comprehensive income are as follows:
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Gross unrealized gains...................................... $180,329 $214,845 Gross unrealized losses..................................... (27,144) (60,136) Unrealized gain on foreign currency......................... 1,170 -- Adjustment to DAC and other deferred expenses............... (42,700) (43,000) Deferred income taxes....................................... (39,080) (39,099) -------- -------- Accumulated other comprehensive income...................... $ 72,575 $ 72,610 ======== ========
On October 30, 2002, the Company received a capital contribution of $200,000,000 in cash from the Parent. F-48 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. SHAREHOLDER'S EQUITY (Continued) Dividends that the Company may pay to its shareholder in any year without prior approval of the Arizona Department of Insurance are limited by statute. The maximum amount of dividends which can be paid to shareholders of insurance companies domiciled in the state of Arizona without obtaining the prior approval of the Insurance Commissioner is limited to the lesser of either 10% of the preceding year's statutory surplus or the preceding year's statutory net gain from operations if, after paying the dividend, the Company's capital and surplus would be adequate in the opinion of the Arizona Department of Insurance. Accordingly, the maximum amount of dividends that can be paid to stockholder in the year 2005 without obtaining prior approval is $83,649,000. Dividends of $2,500,000 were paid in 2004. Prior to the capital contribution of SAAMCo to the Company, SAAMCo paid dividends to its parent, SunAmerica Life Insurance Company, of $12,187,000 and $10,000,000 in 2003 and 2002, respectively. Under statutory accounting principles utilized in filings with insurance regulatory authorities, the Company's net income totaled $99,288,000 for the year ended December 31, 2004, net income of $89,071,000 and net loss of $180,737,000 for the years ended December 31, 2003 and 2002, respectively. The Company's statutory capital and surplus totaled $840,001,000 at December 31, 2004 and $602,348,000 at December 31, 2003. 11. INCOME TAXES The components of the provisions for income taxes on pretax income consist of the following:
YEARS ENDED DECEMBER 31, ------------------------------- 2004 2003 2002 -------- -------- --------- (IN THOUSANDS) Current expense (benefit)................................... $(42,927) $127,655 $(105,369) Deferred expense (benefit).................................. 49,337 (97,408) 105,529 -------- -------- --------- Total income tax expense.................................... $ 6,410 $ 30,247 $ 160 ======== ======== =========
Income taxes computed at the United States federal income tax rate of 35% and income tax expenses reflected in statement of income and comprehensive income provided differ as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Amount computed at statutory rate........................... $ 74,025 $ 43,322 $ 11,147 Increases (decreases) resulting from: State income taxes, net of federal tax benefit............ 4,020 2,273 (567) Dividends received deduction.............................. (19,058) (15,920) (10,117) Tax credits............................................... (4,000) -- -- Adjustment to prior year tax liability(a)................. (39,730) -- -- Other, net................................................ (8,847) 572 (303) -------- -------- -------- Total income tax expense.................................. $ 6,410 $ 30,247 $ 160 ======== ======== ========
------------------ (a) In 2004, the Company revised its estimate of tax contingency amount for prior year based on additional information that became available. Under prior federal income tax law, one-half of the excess of a life insurance company's income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as "policyholders' surplus". At December 31, 2004, the Company had approximately $14,300,000 of policyholders' surplus on which no deferred tax liability has been recognized, as federal income taxes are not required unless this amount is distributed as a dividend or recognized under other specified conditions. The American Jobs Creation Act of 2004 modified federal income tax law to allow life insurance companies to distribute amounts from policyholders' surplus during 2005 and 2006 without incurring federal income tax on the distributions. The Company eliminated its policyholders' surplus balance in January 2005. At December 31, 2004, the Company had net operating carryforwards, capital loss carryforwards and tax credit carryforwards for Federal income tax purposes of $15,515,000, $63,774,000 and $44,604,000, respectively, arising from F-49 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. INCOME TAXES (Continued) affordable housing investments no longer owned by SAAMCo. Such carryforwards expire in 2018, 2006 to 2008 and 2018, respectively. 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 liability for deferred income taxes are as follows:
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Deferred Tax Liabilities: Deferred acquisition costs and other deferred expenses...... $ 432,868 $ 473,387 State income taxes.......................................... 10,283 5,744 Other liabilities........................................... 15,629 350 Net unrealized gains on debt and equity securities available for sale.................................................. 39,080 39,098 --------- --------- Total deferred tax liabilities.............................. 497,860 518,579 --------- --------- Deferred Tax Assets: Investments................................................. (28,915) (25,213) Contract holder reserves.................................... (122,691) (158,112) Guaranty fund assessments................................... (3,402) (3,408) Deferred income............................................. (5,604) (3,801) Other assets................................................ (1,068) (7,446) Net operating loss carryforward............................. (5,430) -- Capital loss carryforward................................... (22,321) (20,565) Low income housing credit carryforward...................... (44,604) (36,600) Partnership income/loss..................................... (6,293) (20,878) --------- --------- Total deferred tax assets................................... (240,328) (276,023) --------- --------- Deferred income taxes....................................... $ 257,532 $ 242,556 ========= =========
The Company has concluded that the deferred tax asset will be fully realized and no valuation allowance is necessary. 12. RELATED-PARTY MATTERS As of December 31, 2004, subordinated notes payable to affiliates were paid off except for accrued interest totaling $460,000 which is included in other liabilities on the consolidated balance sheet. On February 15, 2004, the Company entered into a short-term financing arrangement with the Parent whereby the Company has the right to borrow up to $500,000,000 from the Parent and vice versa. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On February 15, 2004, the Company entered into a short-term financing arrangement with its affiliate, First SunAmerica Life Insurance Company ("FSA"), whereby the Company has the right to borrow up to $15,000,000 from FSA and vice versa. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On December 19, 2001, the Company entered into a short-term financing arrangement with AIGRS whereby AIGRS has the right to borrow up to $500,000,000. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On December 19, 2001, the Company entered into a short-term financing arrangement with SunAmerica Investments, Inc. ("SAII"), whereby SAII has the right to borrow up to $500,000,000 from the Company. Any advances made under this agreement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. F-50 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. RELATED-PARTY MATTERS (Continued) On September 26, 2001, the Company entered into a short-term financing arrangement with AIGRS. Under the terms of this agreement, the Company has immediate access of up to $500,000,000. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On September 26, 2001, the Company entered into a short-term financing arrangement with SAII, whereby the Company has the right to borrow up to $500,000,000. Any advances made under this agreement must be repaid within 30 days. At December 31, 2004 and 2003, the Company owed $0 and $14,000,000, respectively, under this agreement, which was included in due to affiliates. On October 31, 2003, the Company became a party to an existing credit agreement under which the Company agreed to make loans to AIG in an aggregate amount of up to $60,000,000. This commitment expires on October 28, 2005. There were no balances outstanding under this agreement at December 31, 2004. For the years ended December 31, 2004, 2003 and 2002, the Company paid commissions totaling $60,674,000, $51,716,000 and $59,058,000, respectively, to nine affiliated broker-dealers: Royal Alliance Associates, Inc.; SunAmerica Securities, Inc.; Advantage Capital Corporation; FSC Services Corporation; Sentra Securities Corporation; Spelman & Co., Inc.; VALIC Financial Advisors; American General Equity Securities Corporation and American General Securities Inc. These affiliated broker-dealers distribute a significant portion of the Company's variable annuity products amounting to approximately 23%, 24% and 31% of deposits for each of the respective years. Of the Company's mutual fund sales, approximately 25%, 23% and 28% were distributed by these affiliated broker-dealers for the years ended December 31, 2004, 2003 and 2002, respectively. On February 1, 2004, SAAMCo entered into an administrative services agreement with FSA whereby SAAMCo will pay to FSA a fee based on a percentage of all assets invested through FSA's variable annuity products in exchange for services performed. SAAMCo is the investment advisor for certain trusts that serve as investment options for FSA's variable annuity products. Amounts incurred by the Company under this agreement totaled $1,537,000 in 2004 and are included in the Company's consolidated statement of income and comprehensive income. A fee of $150,000, $1,620,000 and $1,777,000 was paid under a different agreement in 2004, 2003 and 2002, respectively. On October 1, 2001, SAAMCo entered into two administrative services agreements with business trusts established by its affiliate, The Variable Annuity Life Insurance Company ("VALIC"), whereby the trust pays to SAAMCo a fee based on a percentage of average daily net assets invested through VALIC's annuity products in exchange for services performed. Amounts earned by SAAMCo under this agreement totaled $9,074,000, $7,587,000 and $7,614,000 in 2004, 2003 and 2002, respectively, and are net of certain administrative costs incurred by VALIC of $2,593,000, $2,168,000 and $2,175,000, respectively. The net amounts earned by SAAMCo are included in other fees in the consolidated statement of income and comprehensive income. The Company has a support agreement in effect between the Company and AIG (the "Support Agreement"), pursuant to which AIG has agreed that AIG will cause the Company to maintain a policyholder's surplus of not less than $1,000,000 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 obligations 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. Contract holders 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 contract holder when due, have the right to enforce the Support Agreement directly against AIG. The Company's insurance policy obligations are guaranteed by American Home Assurance Company ("American Home"), a subsidiary of AIG, and a member of an AIG intercompany pool. This guarantee is unconditional and irrevocable, and the Company's contract holders have the right to enforce the guarantee directly against American Home. While American Home does not publish financial statements, it does file statutory annual and quarterly 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 F-51 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. RELATED-PARTY MATTERS (Continued) 1934, and publishes annual reports on Form 10-K and quarterly reports on Form 10-Q, which are available from the Securities and Exchange Commission. The Company's ultimate parent, AIG, has announced that it has delayed filing its Annual Report on Form 10-K for the year ended December 31, 2004 to allow AIG's Board of Directors and new management adequate time to complete an extensive review of AIG's books and records. The review includes issues arising from pending investigations into non-traditional insurance products and certain assumed reinsurance transactions by the Office of the Attorney General for the State of New York and the SEC and from AIG's decision to review the accounting treatment of certain additional items. Circumstances affecting AIG can have an impact on the Company. For example, the recent downgrades and ratings actions taken by the major rating agencies with respect to AIG, resulted in corresponding downgrades and ratings actions being taken with respect to the Company's ratings. Accordingly, we can give no assurance that any further changes in circumstances for AIG will not impact us. While the outcome of this investigation is not determinable at this time, management believes that the ultimate outcome will not have a material adverse effect on Company operating results, cash flows or financial position. Pursuant to a cost allocation agreement, the Company purchases administrative, investment management, accounting, legal, marketing and data processing services from its Parent, AIGRS and AIG. The allocation of such costs for investment management services is based on the level of assets under management. The allocation of costs for other services is based on estimated levels of usage, transactions or time incurred in providing the respective services. Amounts paid for such services totaled $148,554,000 for the year ended December 31, 2004, $126,531,000 for the year ended December 31, 2003 and $119,981,000 for the year ended December 31, 2002. The component of such costs that relate to the production or acquisition of new business during these periods amounted to $60,183,000, $48,733,000 and $49,004,000 respectively, and is deferred and amortized as part of deferred acquisition costs. The other components of such costs are included in general and administrative expenses in the consolidated 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 $3,712,000, $3,838,000 and $3,408,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The Company incurred $1,113,000, $500,000 and $790,000 of management fees to an affiliate of the Company to administer its securities lending program for the years ended December 31, 2004, 2003 and 2002, respectively (see Note 2). In December 2003, the Company purchased an affiliated bond with a carrying value of $37,129,000. At December 31, 2004, the affiliated bond has a market value of $34,630,000. F-52 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS The Company conducts its business through two business segments, annuity operations and asset management operations. Annuity operations consists of the sale and administration of deposit-type insurance contracts, including fixed and variable annuity contracts, universal life insurance contracts and GICs. Asset management operations, which includes the managing, distributing and administering a diversified family of mutual funds, managing certain subaccounts offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios, is conducted by SAAMCo and its subsidiary and distributor, SACS, and its subsidiary and servicing administrator, SFS. Following is selected information pertaining to the Company's business segments.
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2004: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 369,141 $ -- $ 369,141 Asset management fees..................................... -- 89,569 89,569 Universal life insurance policy fees, net of reinsurance............................................. 33,899 -- 33,899 Surrender charges......................................... 26,219 -- 26,219 Other fees................................................ -- 15,753 15,753 ----------- -------- ----------- Total fee income............................................ 429,259 105,322 534,581 Investment income........................................... 362,631 963 363,594 Net realized investment gains (losses)...................... (24,100) 293 (23,807) ----------- -------- ----------- Total revenues.............................................. 767,790 106,578 874,368 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 220,668 2,081 222,749 Amortization of bonus interest.............................. 10,357 -- 10,357 General and administrative expenses......................... 93,188 38,424 131,612 Amortization of deferred acquisition costs and other deferred expenses......................................... 126,142 31,508 157,650 Annual commissions.......................................... 64,323 -- 64,323 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 -- 17,420 Guaranteed benefits, net of reinsurance recoveries.......... 58,756 -- 58,756 ----------- -------- ----------- Total benefits and expenses................................. 590,854 72,013 662,867 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 176,936 $ 34,565 $ 211,501 =========== ======== =========== Total assets................................................ $31,323,462 $217,155 $31,540,617 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 132 $ 132 =========== ======== ===========
F-53 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS (Continued)
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2003: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 281,359 $ -- $ 281,359 Asset management fees..................................... -- 66,663 66,663 Universal life insurance policy fees, net of reinsurance............................................. 35,816 -- 35,816 Surrender charges......................................... 27,733 -- 27,733 Other fees................................................ -- 15,520 15,520 ----------- -------- ----------- Total fee income............................................ 344,908 82,183 427,091 Investment income........................................... 398,304 4,619 402,923 Net realized investment losses.............................. (30,354) -- (30,354) ----------- -------- ----------- Total revenues.............................................. 712,858 86,802 799,660 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 237,585 2,628 240,213 Amortization of bonus interest.............................. 19,776 -- 19,776 General and administrative expenses......................... 83,013 36,080 119,093 Amortization of deferred acquisition costs and other deferred expenses......................................... 137,130 22,976 160,106 Annual commissions.......................................... 55,661 -- 55,661 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,766 -- 17,766 Guaranteed benefits, net of reinsurance recoveries.......... 63,268 -- 63,268 ----------- -------- ----------- Total benefits and expenses................................. 614,199 61,684 675,883 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 98,659 $ 25,118 $ 123,777 =========== ======== =========== Total assets................................................ $27,781,457 $190,270 $27,971,727 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 2,977 $ 2,977 =========== ======== ===========
F-54 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS (Continued)
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2002: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 286,919 $ -- $ 286,919 Asset management fees..................................... -- 66,423 66,423 Universal life insurance policy fees, net of reinsurance............................................. 36,253 -- 36,253 Surrender charges......................................... 32,507 -- 32,507 Other fees................................................ 3,304 18,596 21,900 ----------- -------- ----------- Total fee income............................................ 358,983 85,019 444,002 Investment income........................................... 377,556 9,799 387,355 Net realized investment losses.............................. (65,811) -- (65,811) ----------- -------- ----------- Total revenues.............................................. 670,728 94,818 765,546 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 234,261 3,868 238,129 Amortization of bonus interest.............................. 16,277 -- 16,277 General and administrative expenses......................... 79,287 35,923 115,210 Amortization of deferred acquisition costs and other deferred expenses......................................... 171,583 50,901 222,484 Annual commissions.......................................... 58,389 -- 58,389 Claims on universal life contracts, net of reinsurance recoveries................................................ 15,716 -- 15,716 Guaranteed benefits, net of reinsurance recoveries.......... 67,492 -- 67,492 ----------- -------- ----------- Total benefits and expenses................................. 643,005 90,692 733,697 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 27,723 $ 4,126 $ 31,849 =========== ======== =========== Total assets................................................ $23,538,832 $214,157 $23,752,989 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 7,297 $ 7,297 =========== ======== ===========
F-55 - ---------------------------------------------------------------- - ---------------------------------------------------------------- TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION - ---------------------------------------------------------------- - ---------------------------------------------------------------- Additional information concerning the operations of the Separate Account is contained in the Statement of Additional Information, which is available without charge upon written request. Please use the request form at the back of this prospectus and send it to our Annuity Service Center at P.O. Box 54299, Los Angeles, California 90054-0299 or by calling (800) 445-SUN2. The contents of the SAI are listed below. Separate Account.............................. 3 General Account............................... 3 Support Agreement Between the Company and AIG......................................... 4 Performance Data.............................. 4 Income Payments............................... 8 Income Protector.............................. 9 Annuity Unit Values........................... 9 Death Benefit Options for Contracts Issued Before October 24, 2001..................... 12 Death Benefit Options for Contracts Issued Between October 24, 2001 and June 1, 2004... 14 Death Benefits following Spousal Continuation for Contracts Issued between October 24, 2001 and June 1, 2004....................... 14 Taxes......................................... 15 Distribution of Contracts..................... 20 Financial Statements.......................... 20
F-56 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- APPENDIX A - CONDENSED FINANCIALS - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
FISCAL YEAR FISCAL YEAR INCEPTION TO ENDED ENDED 12/31/02 12/31/03 12/31/04 ------------ ----------- ------------ Capital Appreciation (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$24.182 $25.794 (a)$33.529 (b)$24.182 $25.757 (b)$33.333 Ending AUV.......................................... (a)$25.794 $33.529 (a)$35.945 (b)$25.757 $33.333 (b)$35.575 Ending Number of AUs................................ (a)5,223 112,395 (a)611,914 (b)6,392 33,168 (b)116,883 - ----------------------------------------------------------------------------------------------------- Government and Quality Bond (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$16.370 $16.472 (a)$16.588 (b)$16.370 $16.437 (b)$16.480 Ending AUV.......................................... (a)$16.472 $16.588 (a)$16.854 (b)$16.437 $16.480 (b)$16.668 Ending Number of AUs................................ (a)25,155 508,662 (a)1,474,006 (b)11,301 111,382 (b)276,030 - ----------------------------------------------------------------------------------------------------- Growth (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$19.417 $20.848 (a)$26.615 (b)$19.417 $20.812 (b)$26.450 Ending AUV.......................................... (a)$20.848 $26.615 (a)$28.987 (b)$20.812 $26.450 (b)$28.679 Ending Number of AUs................................ (a)5,529 78.215 (a)353,397 (b)4,179 27,219 (b)75,432 - ----------------------------------------------------------------------------------------------------- Natural Resources (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$13.753 $15.272 (a)$22.162 (b)$13.753 $15.232 (b)$22.010 Ending AUV.......................................... (a)$15.272 $22.162 (a)$27.232 (b)$15.232 $22.010 (b)$26.927 Ending Number of AUs................................ (a)11 4,303 (a)56,948 (b)206 468 (b)10,813 - ----------------------------------------------------------------------------------------------------- Aggressive Growth (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$10.011 $10.077 (a)$12.720 (b)$10.011 $10.044 (b)$12.618 Ending AUV.......................................... (a)$10.077 $12.720 (a)$14.595 (b)$10.044 $12.618 (b)$14.415 Ending Number of AUs................................ (a)15 9,125 (a)42,664 (b)2,951 3,476 (b)29,103 - ----------------------------------------------------------------------------------------------------- Alliance Growth (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$21.881 $21.940 (a)$27.122 (b)$21.881 $21.898 (b)$26.950 Ending AUV.......................................... (a)$21.940 $27.122 (a)$28.764 (b)$21.898 $26.950 (b)$28.454 Ending Number of AUs................................ (a)2,961 42,581 (a)244,408 (b)1,192 23,501 (b)55,721 - ----------------------------------------------------------------------------------------------------- Asset Allocation (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$16.137 $16.887 (a)$20.421 (b)$16.137 $16.891 (b)$20.329 Ending AUV.......................................... (a)$16.887 $20.421 (a)$22.135 (b)$16.891 $20.329 (b)$21.936 Ending Number of AUs................................ (a)1,003 23,493 (a)83,655 (b)3,344 5,847 (b)22,011 - ----------------------------------------------------------------------------------------------------- Blue Chip Growth (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$4.530 $4.659 (a)$5.769 (b)$4.530 $4.648 (b)$5.732 Ending AUV.......................................... (a)$4.659 $5.769 (a)$5.965 (b)$4.648 $5.732 (b)$5.900 Ending Number of AUs................................ (a)2,553 28,163 (a)108,190 (b)840 2,662 (b)22,413 - ----------------------------------------------------------------------------------------------------- Cash Management (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$13.025 $13.018 (a)$12.878 (b)$13.025 $12.993 (b)$12.795 Ending AUV.......................................... (a)$13.018 $12.878 (a)$12.756 (b)$12.993 $12.795 (b)$12.617 Ending Number of AUs................................ (a)10,725 199,592 (a)934,948 (b)14,522 178,114 (b)97,826 - ----------------------------------------------------------------------------------------------------- Corporate Bond (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$14.394 $14.704 (a)$16.174 (b)$14.394 $14.725 (b)$16.124 Ending AUV.......................................... (a)$14.704 $16.174 (a)$16.975 (b)$14.725 $16.124 (b)$16.848 Ending Number of AUs................................ (a)3,690 169,147 (a)749,579 (b)1,695 29,139 (b)104,194 - ----------------------------------------------------------------------------------------------------- AUV -- Accumulation Unit Value AU -- Accumulation Units (a) Without election of the enhanced death benefit and EstatePlus. (b) With election of the enhanced death benefit and EstatePlus.
A-1
FISCAL YEAR FISCAL YEAR INCEPTION TO ENDED ENDED 12/31/02 12/31/03 12/31/04 ------------ ----------- ------------ Davis Venture Value (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$20.108 $21.460 (a)$28.069 (b)$20.108 $21.425 (b)$27.899 Ending AUV.......................................... (a)$21.460 $28.069 (a)$31.304 (b)$21.425 $27.899 (b)$30.975 Ending Number of AUs................................ (a)16,558 148,924 (a)689,137 (b)5,061 48,397 (b)148,711 - ----------------------------------------------------------------------------------------------------- "Dogs" of Wall Street (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$8.149 $8.902 (a)$10.500 (b)$8.149 $8.887 (b)$10.431 Ending AUV.......................................... (a)$8.902 $10.500 (a)$11.309 (b)$8.887 $10.431 (b)$11.186 Ending Number of AUs................................ (a)2,695 104,430 (a)234,152 (b)1,182 3,152 (b)47,202 - ----------------------------------------------------------------------------------------------------- Emerging Markets (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$5.486 $5.958 (a)$8.933 (b)$5.486 $5.951 (b)$8.879 Ending AUV.......................................... (a)$5.958 $8.933 (a)$10.934 (b)$5.951 $8.879 (b)$10.821 Ending Number of AUs................................ (a)27 11,853 (a)133,236 (b)676 1,324 (b)197,354 - ----------------------------------------------------------------------------------------------------- Federated American Leaders (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$11.895 $12.912 (a)$16.184 (b)$11.895 $12.849 (b)$15.979 Ending AUV.......................................... (a)$12.912 $16.184 (a)$17.475 (b)$12.849 $15.979 (b)$17.177 Ending Number of AUs................................ (a)80 69,514 (a)400,147 (b)13 7,288 (b)41,250 - ----------------------------------------------------------------------------------------------------- Foreign Value (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$8.970 $9.407 (a)$12.463 (b)$8.970 $9.387 (b)$12.382 Ending AUV.......................................... (a)$9.407 $12.463 (a)$14.701 (b)$9.387 $12.382 (b)$14.541 Ending Number of AUVs............................... (a)22,862 220,157 (a)1,102,222 (b)6,640 87,063 (b)266,370 - ----------------------------------------------------------------------------------------------------- Global Bond (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$16.095 $16.324 (a)$16.611 (b)$16.095 $16.270 (b)$16.482 Ending AUV.......................................... (a)$16.324 $16.611 (a)$16.968 (b)$16.270 $16.482 (b)$16.761 Ending Number of AUs................................ (a)400 55,290 (a)140,782 (b)254 5,351 (b)28,911 - ----------------------------------------------------------------------------------------------------- Global Equities (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$11.708 $12.546 (a)$15.584 (b)$11.708 $12.523 (b)$15.488 Ending AUV.......................................... (a)$12.546 $15.584 (a)$17.129 (b)$12.523 $15.488 (b)$16.949 Ending Number of AUs................................ (a)221 22,810 (a)103,807 (b)127 1,950 (b)18,553 - ----------------------------------------------------------------------------------------------------- Goldman Sachs Research (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$4.675 $5.058 (a)$6.224 (b)$4.675 $5.054 (b)$6.192 Ending AUV.......................................... (a)$5.058 $6.224 (a)$6.910 (b)$5.054 $6.192 (b)$6.851 Ending Number of AUs................................ (a)2,153 8,495 (a)39,067 (b)319 460 (b)581 - ----------------------------------------------------------------------------------------------------- Growth-Income (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$20.102 $20.787 (a)$25.658 (b)$20.102 $20.751 (b)$25.497 Ending AUV.......................................... (a)$20.787 $25.658 (a)$28.116 (b)$20.751 $25.497 (b)$27.815 Ending Number of AUs................................ (a)3,510 15,886 (a)91,174 (b)3,892 5,990 (b)14,855 - ----------------------------------------------------------------------------------------------------- Growth Opportunities (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$3.230 $3.435 (a)$4.557 (b)$3.230 $3.426 (b)$4.492 Ending AUV.......................................... (a)$3.435 $4.557 (a)$4.753 (b)$3.426 $4.492 (b)$4.666 Ending Number of AUs................................ (a)3,018 15,716 (a)30,848 (b)46 1,328 (b)33,842 - ----------------------------------------------------------------------------------------------------- AUV -- Accumulation Unit Value AU -- Accumulation Units (a) Without election of the enhanced death benefit and EstatePlus. (b) With election of the enhanced death benefit and EstatePlus.
A-2
FISCAL YEAR FISCAL YEAR INCEPTION TO ENDED ENDED 12/31/02 12/31/03 12/31/04 ------------ ----------- ------------ High-Yield Bond (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$10.951 $11.586 (a)$14.978 (b)$10.951 $11.556 (b)$14.862 Ending AUV.......................................... (a)$11.586 $14.978 (a)$17.285 (b)$11.556 $14.862 (b)$17.073 Ending Number of AUs................................ (a)714 108,391 (a)253,779 (b)1,431 43,508 (b)71,943 - ----------------------------------------------------------------------------------------------------- International Diversified Equities (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$6.995 $7.170 (a)$9.286 (b)$6.995 $7.158 (b)$9.229 Ending AUV.......................................... (a)$7.170 $9.286 (a)$10.629 (b)$7.158 $9.229 (b)$10.516 Ending Number of AUs................................ (a)6,735 148,898 (a)880,413 (b)6,666 85,430 (b)233,937 - ----------------------------------------------------------------------------------------------------- International Growth and Income (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$8.000 $8.330 (a)$11.204 (b)$8.000 $8.329 (b)$11.155 Ending AUV.......................................... (a)$8.330 $11.204 (a)$13.305 (b)$8.329 $11.155 (b)$13.187 Ending Number of AUs................................ (a)3,894 81,478 (a)371,957 (b)3,716 24,616 (b)47,062 - ----------------------------------------------------------------------------------------------------- MFS Massachusetts Investors Trust (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$14.084 $14.930 (a)$17.969 (b)$14.084 $14.903 (b)$17.857 Ending AUV.......................................... (a)$14.930 $17.969 (a)$19.749 (b)$14.903 $17.857 (b)$19.538 Ending Number of AUs................................ (a)4,255 35,251 (a)140,744 (b)1,058 11,673 (b)33,298 - ----------------------------------------------------------------------------------------------------- MFS Mid-Cap Growth (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$6.525 $6.965 (a)$9.392 (b)$6.525 $6.952 (b)$9.333 Ending AUV.......................................... (a)$6.965 $9.392 (a)$10.528 (b)$6.952 $9.333 (b)$10.415 Ending Number of AUs................................ (a)11,688 150,416 (a)441,435 (b)3,867 45,327 (b)117,679 - ----------------------------------------------------------------------------------------------------- MFS Total Return (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$18.961 $19.853 (a)$22.797 (b)$18.961 $19.789 (b)$22.623 Ending AUV.......................................... (a)$19.853 $22.797 (a)$24.931 (b)$19.789 $22.623 (b)$24.630 Ending Number of AUs................................ (a)9,719 98,897 (a)607,636 (b)3,411 43,520 (b)124,731 - ----------------------------------------------------------------------------------------------------- Putnam Growth: Voyager (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$13.178 $13.785 (a)$16.795 (b)$13.178 $13.709 (b)$16.458 Ending AUV.......................................... (a)$13.785 $16.795 (a)$17.326 (b)$13.709 $16.458 (b)$16.900 Ending Number of AUs................................ (a)930 12,618 (a)14,403 (b)11 2,309 (b)3,564 - ----------------------------------------------------------------------------------------------------- Real Estate (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$11.543 $11.836 (a)$16.050 (b)$11.543 $11.827 (b)$15.963 Ending AUV.......................................... (a)$11.836 $16.050 (a)$21.219 (b)$11.827 $15.963 (b)$21.012 Ending Number of AUs................................ (a)1,002 37,684 (a)133,136 (b)2,360 7,286 (b)28,988 - ----------------------------------------------------------------------------------------------------- Small & Mid Cap Value (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$9.180 $10.122 (a)$13.588 (b)$9.180 $10.100 (b)$13.498 Ending AUV.......................................... (a)$10.122 $13.588 (a)$15.770 (b)$10.100 $13.498 (b)$15.595 Ending Number of AUVs............................... (a)10,970 170,268 (a)801,687 (b)11,296 56,714 (b)186,871 - ----------------------------------------------------------------------------------------------------- SunAmerica Balanced (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$12.518 $12.509 (a)$14.149 (b)$12.518 $12.488 (b)$14.060 Ending AUV.......................................... (a)$12.509 $14.149 (a)$14.844 (b)$12.488 $14.060 (b)$14.683 Ending Number of AUs................................ (a)1,187 22,990 (a)98,255 (b)904 1,156 (b)10,163 - ----------------------------------------------------------------------------------------------------- AUV -- Accumulation Unit Value AU -- Accumulation Units (a) Without election of the enhanced death benefit and EstatePlus. (b) With election of the enhanced death benefit and EstatePlus.
A-3
FISCAL YEAR FISCAL YEAR INCEPTION TO ENDED ENDED 12/31/02 12/31/03 12/31/04 ------------ ----------- ------------ Technology (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$1.432 $1.716 (a)$2.544 (b)$1.432 $1.714 (b)$2.529 Ending AUV.......................................... (a)$1.716 $2.544 (a)$2.436 (b)$1.714 $2.529 (b)$2.410 Ending Number of AUs................................ (a)41,215 89,460 (a)344,000 (b)4,246 21,043 (b)96,578 - ----------------------------------------------------------------------------------------------------- American Funds Global Growth (Inception Date - 9/30/02) Beginning AUV....................................... (a)$10.000 $10.949 (a)$14.590 (b)$10.000 $10.933 (b)$14.503 Ending AUV.......................................... (a)$10.949 $14.590 (a)$16.310 (b)$10.933 $14.503 (b)$16.140 Ending Number of AUs................................ (a)1,759 110,089 (a)661,228 (b)5,946 39,615 (b)125,700 - ----------------------------------------------------------------------------------------------------- American Funds Growth (Inception Date - 9/30/02) Beginning AUV....................................... (a)$10.000 $10.884 (a)$14.667 (b)$10.000 $10.872 (b)$14.585 Ending AUV.......................................... (a)$10.884 $14.667 (a)$16.252 (b)$10.872 $14.585 (b)$16.089 Ending Number of AUs................................ (a)18,592 257,126 (a)1,297,514 (b)15,567 86,419 (b)279,778 - ----------------------------------------------------------------------------------------------------- American Funds Growth-Income (Inception Date - 9/30/02) Beginning AUV....................................... (a)$10.000 $10.884 (a)$14.197 (b)$10.000 $10.865 (b)$14.110 Ending AUV.......................................... (a)$10.884 $14.197 (a)$15.434 (b)$10.865 $14.110 (b)$15.271 Ending Number of AUs................................ (a)17,313 354,757 (a)1,506,194 (b)19,216 122,079 (b)325,264 - ----------------------------------------------------------------------------------------------------- Lord Abbett Growth and Income (Inception Date - 9/30/02) Beginning AUV....................................... (a)$7.486 $8.180 (a)$10.556 (b)$7.447 $8.101 (b)$10.408 Ending AUV.......................................... (a)$8.180 $10.556 (a)$11.713 (b)$8.101 $10.408 (b)$11.497 Ending Number of AUVs............................... (a)660 84,269 (a)407,761 (b)1,227 22,532 (b)99,359 - ----------------------------------------------------------------------------------------------------- Nations High Yield Bond (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$9.364 $10.162 (a)$13.134 (b)$9.348 $10.134 (b)$13.038 Ending AUV.......................................... (a)$10.162 $13.134 (a)$14.412 (b)$10.134 $13.038 (b)$14.242 Ending Number of AUs................................ (a)4,034 202,591 (a)515,144 (b)5,945 16,459 (b)54,442 - ----------------------------------------------------------------------------------------------------- Nations Marsico Focused Equities (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$7.389 $7.184 (a)$9.418 (b)$7.383 $7.171 (b)$9.358 Ending AUV.......................................... (a)$7.184 $9.418 (a)$10.329 (b)$7.171 $9.358 (b)$10.217 Ending Number of AUs................................ (a)11,344 259,474 (a)1,049,795 (b)16,480 53,353 (b)139,545 - ----------------------------------------------------------------------------------------------------- Van Kampen LIT Comstock (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$7.347 $8.155 (a)$10.504 (b)$7.283 $8.075 (b)$10.354 Ending AUV.......................................... (a)$8.155 $10.504 (a)$12.149 (b)$8.075 $10.354 (b)$11.922 Ending Number of AUs................................ (a)15,234 195,289 (a)801,426 (b)6,342 42,490 (b)207,957 - ----------------------------------------------------------------------------------------------------- Van Kampen LIT Emerging Growth (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$7.223 $6.997 (a)$8.755 (b)$7.215 $6.982 (b)$8.697 Ending AUV.......................................... (a)$6.997 $8.755 (a)$9.208 (b)$6.982 $8.697 (b)$9.105 Ending Number of AUs................................ (a)367 26,989 (a)78,093 (b)376 3,276 (b)28,390 - ----------------------------------------------------------------------------------------------------- Van Kampen LIT Growth and Income (Inception Date -- 9/30/02) Beginning AUV....................................... (a)$8.149 $8.791 (a)$11.056 (b)$8.204 $8.840 (b)$11.068 Ending AUV.......................................... (a)$8.791 $11.056 (a)$12.428 (b)$8.840 $11.068 (b)$12.385 Ending Number of AUs................................ (a)15,096 205,358 (a)1,010,305 (b)11,770 86,024 (b)242,735 - ----------------------------------------------------------------------------------------------------- AUV -- Accumulation Unit Value AU -- Accumulation Units (a) Without election of the enhanced death benefit and EstatePlus. (b) With election of the enhanced death benefit and EstatePlus.
A-4 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- APPENDIX B - MARKET VALUE ADJUSTMENT ("MVA") - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Multi-year Fixed Accounts may not available if you purchased your contract on or after June 1, 2004. If you take money out of any available multi-year Fixed Account before the guarantee period ends, we make an adjustment to your contract. We refer to this adjustment as a market value adjustment ("MVA"). The MVA does not apply to any available one-year Fixed Account. The MVA reflects any difference in the interest rate environment between the time you place your money in the multi-year Fixed Account and the time when you withdraw or transfer that money. This adjustment can increase or decrease your contract value. Generally, if interest rates drop between the time you put your money into a multi-year Fixed Account and the time you take it out, we credit a positive adjustment to your contract. Conversely, if interest rates increase during the same period, we post a negative adjustment to your contract. You have 30 days after the end of each guarantee period to reallocate your funds without incurring any MVA. The information in this Appendix applies only if you take money out of a Fixed Account (with a duration longer than 1 year) before the end of the guarantee period. We calculate the MVA by doing a comparison between current rates and the rate being credited to you in the Fixed Account. For the current rate we use a rate being offered by us for a guarantee period that is equal to the time remaining in the Fixed Account from which you seek withdrawal (rounded up to a full number of years). If we are not currently offering a guarantee period for that period of time, we determine an applicable rate by using a formula to arrive at a number based on the interest rates currently offered for the two closest periods available. Where the MVA is negative, we first deduct the adjustment from any money remaining in the Fixed Account. If there is not enough money in the Fixed Account to meet the negative deduction, we deduct the remainder from your withdrawal. Where the MVA is positive, we add the adjustment to your withdrawal amount. If a withdrawal charge applies, it is deducted before the MVA calculation. The MVA is assessed on the amount withdrawn less any withdrawal charges. The MVA is computed by multiplying the amount withdrawn, transferred or taken under an income option by the following factor: [(1+I/(1+J+L)]N/12 - 1 where: I is the interest rate you are earning on the money invested in the Fixed Account; J is the interest rate then currently available for the period of time equal to the number of years remaining in the term you initially agreed to leave your money in the Fixed Account; N is the number of full months remaining in the term you initially agreed to leave your money in the Fixed Account; and L is 0.005 (Some states require a different value. Please see your contract.) We do not assess an MVA against withdrawals from an Fixed Account under the following circumstances: - If a withdrawal is made within 30 days after the end of a guarantee period; - If a withdrawal is made to pay contract fees and charges; - To pay a death benefit; and - Upon beginning an income option, if occurring on the Latest Annuity Date. EXAMPLES OF THE MVA The purpose of the examples below is to show how the MVA adjustments are calculated and may not reflect the Guarantee periods available or Surrender Charges applicable under your contract. The examples below assume the following: (1) You made an initial Purchase Payment of $10,000 and allocated it to a Fixed Account at a rate of 5%; (2) You make a partial withdrawal of $4,000 when 1 1/2 years (18 months) remain in the term you initially agreed to leave your money in the Fixed Account (N = 18); (3) You have not made any other transfers, additional Purchase Payments, or withdrawals; and (4) Your contract was issued in a state where L = 0.005. B-1 POSITIVE ADJUSTMENT, NO WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year Fixed Account is 3.5% and the 3-year Fixed Account is 4.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 4%. No withdrawal charge is reflected in this example, assuming that the Purchase Payment withdrawn falls within the free withdrawal amount. The MVA factor is = [(1+I/(1+J+0.005)]N/12 - 1 = [(1.05)/(1.04+0.005)]18/12 - 1 = (1.004785)(1.5) - 1 = 1.007186 - 1 = + 0.007186 The requested withdrawal amount is multiplied by the MVA factor to determine the MVA: $4,000 X (+0.007186) = +$28.74 $28.74 represents the positive MVA that would be added to the withdrawal. NEGATIVE ADJUSTMENT, NO WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year Fixed Account is 5.5% and the 3-year Fixed Account is 6.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 6%. No withdrawal charge is reflected in this example, assuming that the Purchase Payment withdrawn falls with the free withdrawal amount. The MVA factor is = [(1+I/(1+J+0.005)]N/12 - 1 = [(1.05)/(1.06+0.005)]18/12 - 1 = (0.985915)(1.5) - 1 = 0.978948 - 1 = - 0.021052 The requested withdrawal amount is multiplied by the MVA factor to determine the MVA: $4,000 X (-0.021052) = -$84.21 $84.21 represents the negative MVA that will be deducted from the withdrawal. POSITIVE ADJUSTMENT, WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year Fixed Account is 3.5% and the 3-year Fixed Account is 4.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 4%. A withdrawal charge of 6% is reflected in this example, assuming that the Purchase Payment withdrawn exceeds the free withdrawal amount. The MVA factor is = [(1+I)/(1+J+0.005)]N/12 - 1 = [(1.05)/(1.04+0.005)]18/12 - 1 = (1.004785)(1.5) - 1 = 1.007186 - 1 = + 0.007186 The requested withdrawal amount, less the withdrawal charge ($4,000 - 6% = $3,760) is multiplied by the MVA factor to determine the MVA: $3,760 X (+0.007186) = +$27.02 $27.02 represents the positive MVA that would be added to the withdrawal. B-2 NEGATIVE ADJUSTMENT, WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year Fixed Account is 5.5% and the 3-year Fixed Account is 6.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 6%. A withdrawal charge of 6% is reflected in this example, assuming that the Purchase Payment withdrawn exceeds the free withdrawal amount. The MVA factor is = [(1+I/(1+J+0.005)]N/12 - 1 = [(1.05)/(1.06+0.005)]18/12 - 1 = (0.985915)(1.5) - 1 = 0.978948 - 1 = -0.021052 The requested withdrawal amount, less the withdrawal charge ($4,000 - 6% = $3,760) is multiplied by the MVA factor to determine the MVA: $3,760 X (-0.021052) = -$79.16 $79.16 represents the negative MVA that would be deducted from the withdrawal. B-3 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- APPENDIX C - DEATH BENEFITS FOLLOWING SPOUSAL CONTINUATION - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The following details the death benefit options and EstatePlus benefit available upon the Continuing Spouse's death. The death benefit we will pay to the new Beneficiary chosen by the Continuing Spouse varies depending on the death benefit option elected by the original owner of the contract, and the age of the Continuing Spouse as of the Continuation Date and Continuing Spouse's date of death. The term "Continuation Net Purchase Payment" is used frequently in describing the death benefit payable upon a spousal continuation. We define Continuation Net Purchase Payment as Net Purchase Payments made as of the Continuation Date. For the purpose of calculating Continuation Net Purchase Payments, the amount that equals the contract value on the Continuation Date, including the Continuation Contribution is considered a Purchase Payment. If the Continuing Spouse makes no additional Purchase Payments or withdrawals, the Continuation Net Purchase Payments equals the contract value on the Continuation Date, including the Continuation Contribution. The term "withdrawals" as used in describing the death benefits is defined as withdrawals and the fees and charges applicable to those withdrawals. The following details the death benefit options and EstatePlus benefit upon the Continuing Spouse's death: The death benefit we will pay to the new Beneficiary chosen by the Continuing Spouse varies depending on the death benefit option elected by the original owner of the contract and the age of the Continuing Spouse as of the Continuation Date. A. DEATH BENEFIT PAYABLE UPON CONTINUING SPOUSE'S DEATH: 1. Standard Death Benefit If the Continuing Spouse is age 82 or younger on the Continuation Date, the death benefit will be the greater of: a. Contract value; or b. Contract value on the Continuation Date plus any Continuation Net Purchase Payments received prior to the Continuing Spouse's 86th birthday. If the Continuing Spouse is age 83-85 on the Continuation Date, the death benefit will be the greater of: a. Contract value; or b. The lesser of: (1) Contract value on the Continuation Date plus Continuation Net Purchase Payments received prior to the Continuing Spouse's 86th birthday; or (2) 125% of the contract value. If the Continuing Spouse is age 86 and older on the Continuation Date, the death benefit is equal to the contract value. 2. Purchase Payment Accumulation Option If the Continuing Spouse is age 74 or younger on the Continuation Date, the death benefit will be the greatest of: a. Contract value; or b. Contract value on the Continuation Date plus Continuation Net Purchase Payments, compounded at 3% annual growth rate, to the earlier of the Continuing Spouse's 75th birthday or date of death; reduced for any withdrawals made and increased by any Continuation Net Purchase Payments received after the Continuing Spouse's 75th birthday to the earlier of the Continuing Spouse's 86th birthday or date of death; or c. Contract value on the seventh contract anniversary (from the original contract issue date), reduced for withdrawals made since the seventh contract anniversary in the same proportion that the contract value was reduced on the date of such withdrawal, plus any Net Purchase Payments received between the seventh contract anniversary date but prior to the Continuing Spouse's 86th birthday. If the Continuing Spouse is age 75-82 on the Continuation Date, the death benefit will be the greatest of: a. Contract value; or b. Contract value on the Continuation Date plus any Continuation Net Purchase Payments received prior to the Continuing Spouse's 86th birthday; or c. Maximum anniversary value on any contract anniversary that occurred after the Continuation Date, but prior to the Continuing Spouse's 83rd birthday. The anniversary value for any year is equal to the contract value on the applicable contract anniversary date, plus any Purchase Payments received since that anniversary date but prior to the Continuing Spouse's 86th birthday, and reduced for any withdrawals made since that contract anniversary in the same proportion that the withdrawal reduced the contract value on the date of withdrawal. If the Continuing Spouse is age 83-85 on the Continuation Date, then the death benefit will be the Standard Death Benefit described above and the fee C-1 for the Purchase Payment Accumulation option will no longer be deducted as of the Continuation Date. If the Continuing Spouse is age 86 or older on the Continuation Date, the death benefit is equal to contract value. 3. Maximum Anniversary Value Option If the Continuing Spouse is age 82 or younger on the Continuation Date, the death benefit will be the greatest of: a. Contract value; or b. Contract value on the Continuation Date plus Continuation Net Purchase Payments received prior to the Continuing Spouse's 86th birthday; or c. Maximum anniversary value on any contract anniversary that occurred after the Continuation Date, but prior to the Continuing Spouse's 83rd birthday. The anniversary value for any year is equal to the contract value on the applicable contract anniversary date after the Continuation Date, plus any Purchase Payments received since that anniversary date but prior to the Continuing Spouse's 86th birthday, and reduced for any withdrawals made since that contract anniversary in the same proportion that the withdrawal reduced the contract value on the date of withdrawal. If the Continuing Spouse is age 83-85 on the Continuation Date, the death benefit will be the Standard Death Benefit described above and the fee for the Maximum Anniversary Value option will not longer be deducted as of the Continuation Date. If the Continuing Spouse is age 86 and older on the Continuation Date or age 90 or older on the date of death, the death benefit is equal to contract value. Please see the Statement of Additional Information for a description of the death benefit calculations following a Spousal Continuation for contracts issued before June 1, 2004. B. THE ESTATEPLUS BENEFIT PAYABLE UPON CONTINUING SPOUSE'S DEATH: The EstatePlus benefit is only available if the original owner elected EstatePlus and the Continuing Spouse is age 80 or younger on the Continuation Date. EstatePlus benefit is not payable after the Latest Annuity Date. If the Continuing Spouse had earnings in the contract at the time of his/her death, we will add a percentage of those earnings (the "EstatePlus Percentage"), subject to a maximum dollar amount (the "Maximum EstatePlus Percentage"), to the death benefit payable. The contract year of death will determine the EstatePlus Percentage and the Maximum EstatePlus Benefit. The EstatePlus benefit, if any, is added to the death benefit payable under the Purchase Payment Accumulation or the Maximum Anniversary option. On the Continuation Date, if the Continuing Spouse is 69 or younger, the table below shows the available EstatePlus benefit:
- ---------------------------------------------------------------- CONTRACT YEAR ESTATEPLUS MAXIMUM OF DEATH PERCENTAGE ESTATEPLUS AMOUNT - ---------------------------------------------------------------- Years 0-4 25% of Earnings 40% of Continuation Net Purchase Payments - ---------------------------------------------------------------- Years 5-9 40% of Earnings 65% of Continuation Net Purchase Payments* - ---------------------------------------------------------------- Years 10+ 50% of Earnings 75% of Continuation Net Purchase Payments* - ----------------------------------------------------------------
On the Continuation Date, if the Continuing Spouse is between his/her 70th and 81st birthdays, table below shows the available EstatePlus benefit:
- ---------------------------------------------------------------- CONTRACT YEAR ESTATEPLUS MAXIMUM OF DEATH PERCENTAGE ESTATEPLUS AMOUNT - ---------------------------------------------------------------- All Contract 25% of Earnings 40% of Continuation Net Years Purchase Payments* - ----------------------------------------------------------------
* Purchase Payments received after the 5th anniversary of the Continuation Date must remain in the contract for at least 6 full months to be included as part of the Continuation Net Purchase Payments for the purpose of the Maximum EstatePlus Percentage calculation. What is the Contract Year of Death? Contract Year of Death is the number of full 12-month periods starting on the Continuation Date and ending on the Continuing Spouse's date of death. What is the EstatePlus Benefit? We determine the EstatePlus benefit based upon a percentage of earnings, as indicated in the tables above, in the contract at the time of the Continuing Spouse's death. For the purpose of this calculation, earnings are defined as (1) minus (2) where (1) equals the contract value on the Continuing Spouse's date of death; (2) equals the Continuation Net Purchase Payment(s). What is the Maximum EstatePlus Benefit? The EstatePlus benefit is subject to a maximum dollar amount. The Maximum EstatePlus Benefit is equal to a specified percentage of the Continuation Net Purchase Payments, as indicated in the tables above. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE SPOUSAL CONTINUATION PROVISION (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME WITH RESPECT TO PROSPECTIVELY ISSUED CONTRACTS. C-2 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- APPENDIX D - POLARIS INCOME REWARDS EXAMPLES - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The following examples demonstrate the operation of the Polaris Income Rewards feature: EXAMPLE 1: Assume you elect Polaris Income Rewards Option 2 and you invest a single Purchase Payment of $100,000. If you make no additional Purchase Payments and no withdrawals, your Withdrawal Benefit Base is $100,000 on the Benefit Availability Date. Your Stepped-Up Benefit Base equals Withdrawal Benefit Base plus the Step-Up Amount ($100,000 + (20% X $100,000) = $120,000). Your Maximum Annual Withdrawal Amount as of the Benefit Availability Date is 10% of your Withdrawal Benefit Base ($100,000 X 10% = $10,000). The Minimum Withdrawal Period is equal to the Stepped-Up Benefit Base divided by the Maximum Annual Withdrawal Amount, which is 12 years ($120,000/$10,000). Therefore, you may take $120,000 in withdrawals of up to $10,000 annually over a minimum of 12 years beginning on or after the Benefit Availability Date. EXAMPLE 2 - IMPACT OF WITHDRAWALS PRIOR TO THE BENEFIT AVAILABILITY DATE FOR OPTIONS 1 AND 2: Assume you elect Polaris Income Rewards Option 2 and you invest a single Purchase Payment of $100,000. You make a withdrawal of $11,000 prior to the Benefit Availability Date. Prior to the withdrawal, your contract value is $110,000. You make no other withdrawals before the Benefit Availability Date. Immediately following the withdrawal, your Withdrawal Benefit Base is recalculated by first determining the proportion by which your contract value was reduced by the withdrawal ($11,000/$110,000 = 10%). Next, we reduce your Withdrawal Benefit Base by the percentage by which the contract value was reduced by the withdrawal ($100,000 - (10% X 100,000) = $90,000). Since the Step-Up Amount is zero because a withdrawal was made prior to the Benefit Availability Date, your Stepped-Up Benefit Base on the Benefit Availability Date equals your Withdrawal Benefit Base. Therefore, the Stepped-Up Benefit Base also equals $90,000. Your Maximum Annual Withdrawal Amount is 10% of the Withdrawal Benefit Base on the Benefit Availability Date ($90,000). This equals $9,000. Therefore, you may take withdrawals of up to $9,000 annually over a minimum of 10 years ($90,000/$9,000 = 10). EXAMPLE 3 - IMPACT OF WITHDRAWALS PRIOR TO THE BENEFIT AVAILABILITY DATE FOR OPTION 3: Assume you elect Polaris Income Rewards Option 3 and you invest a single Purchase Payment of $100,000. You make a withdrawal of $11,000 prior to the Benefit Availability Date. Prior to the withdrawal, your contract value is $110,000. You make no other withdrawals before the Benefit Availability Date. Immediately following the withdrawal, your Withdrawal Benefit Base is recalculated by first determining the proportion by which your contract value was reduced by the withdrawal ($11,000/$110,000 = 10%). Next, we reduce your Withdrawal Benefit Base by the percentage by which the contract value was reduced by the withdrawal ($100,000 - (10% X 100,000) = $90,000). Since the withdrawal occurred prior to the Benefit Availability Date, your Step-Up Amount will be reduced to 30% of your Withdrawal Benefit Base ((30% X $90,000) = $27,000). Therefore, your Stepped-Up Benefit Base on the Benefit Availability Date equals the Withdrawal Benefit Base plus the Step-Up Amount (($90,000 + $27,000) = $117,000). Your Maximum Annual Withdrawal Amount is 10% of the Withdrawal Benefit Base on the Benefit Availability Date ($90,000). This equals $9,000. Therefore, you may take withdrawals of up to $9,000 annually over a minimum of 13 years ($117,000/$9,000 = 13). EXAMPLE 4 - IMPACT OF WITHDRAWALS LESS THAN OR EQUAL TO MAXIMUM ANNUAL WITHDRAWAL AMOUNT AFTER THE BENEFIT AVAILABILITY DATE: Assume you elect Polaris Income Rewards Option 2 and you invest a single Purchase Payment of $100,000. You make a withdrawal of $7,500 during the first year after the Benefit Availability Date. Because the withdrawal is less than or equal to your Maximum Annual Withdrawal Amount ($10,000), your Stepped-Up Benefit Base ($120,000) is reduced by the total dollar amount of the withdrawal ($7,500). Your new Stepped-Up Benefit Base equals $112,500. Your Maximum Annual Withdrawal Amount remains $10,000. Your new Minimum Withdrawal Period following the withdrawal is equal to the new Stepped-Up Benefit Base divided by your current Maximum Annual Withdrawal Amount, ($112,500/$10,000). Therefore, you may take withdrawals of up to $10,000 over a minimum of 11 years and 3 months. EXAMPLE 5 - IMPACT OF WITHDRAWALS IN EXCESS OF MAXIMUM ANNUAL WITHDRAWAL AMOUNT AFTER THE BENEFIT AVAILABILITY DATE: Assume you elect Polaris Income Rewards Option 2 and you invest a single Purchase Payment of $100,000. Your Withdrawal Benefit Base is $100,000 and your Stepped-Up Benefit Base is $120,000. You make a withdrawal of $15,000 during the first year after the Benefit Availability Date. Your contract value is $125,000 at the time of the withdrawal. Because the withdrawal is greater than your Maximum Annual Withdrawal Amount ($10,000), we recalculate D-1 your Stepped-Up Benefit Base ($120,000) by taking the lesser of two calculations. For the first calculation, we deduct the amount of the withdrawal from the Stepped-Up Benefit Base ($120,000 - $15,000 = $105,000). For the second calculation, we deduct the amount of the Maximum Annual Withdrawal Amount from the Stepped-Up Benefit Base ($120,000 - $10,000 = $110,000). Next, we calculate the excess portion of the withdrawal ($5,000) and determine the proportion by which the contract value was reduced by the excess portion of the withdrawal ($5,000 /$125,000 = 4%). Finally we reduce $110,000 by that proportion (4%) which equals $105,600. Your Stepped-Up Benefit Base is the lesser of these two calculations or $105,000. The Minimum Withdrawal Period following the withdrawal is equal to the Minimum Withdrawal Period at the end of the prior year (12 years) reduced by one year (11 years). Your Maximum Annual Withdrawal Amount is your Stepped-Up Benefit Base divided by your Minimum Withdrawal Period ($105,000/11), which equals $9,545.45. D-2 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- APPENDIX E - STATE CONTRACT AVAILABILITY AND/OR VARIATIONS OF CERTAIN FEATURES AND BENEFITS - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------- PROSPECTUS PROVISION AVAILABILITY OR VARIATION STATES - -------------------------------------------------------------------------------------------------------------------- Transfer Privilege Any transfer over the limit of 15 will incur a $10 transfer Pennsylvania fee. Texas - -------------------------------------------------------------------------------------------------------------------- Administration Charge Contract Maintenance Fee is $30. North Dakota - -------------------------------------------------------------------------------------------------------------------- Administration Charge Will be deducted pro-rata from variable portfolios only. If Oregon premiums are allocated among fixed funds only, no Texas Administration Charge will be deducted. Washington - -------------------------------------------------------------------------------------------------------------------- Capital Protector Charge will be deducted pro-rata from variable portfolios Washington only. If premiums are allocated among fixed funds only, no Capital Protector charge will be deducted. - -------------------------------------------------------------------------------------------------------------------- Free Look Free Look period is 20 days. Idaho North Dakota Utah - -------------------------------------------------------------------------------------------------------------------- Free Look If you reside in California and are age 60 or older on your California Contract Date, the Free Look period is 30 days. - -------------------------------------------------------------------------------------------------------------------- Free Look If you cancel your contract during the Free Look period, we Minnesota return the greater of (1) your Purchase Payments; or (2) the value of your contract. - -------------------------------------------------------------------------------------------------------------------- Free Look If you cancel your contract during the Free Look period, we Colorado return the greater of Purchase Payment(s) paid or contract Delaware value. Georgia Hawaii Idaho Iowa Kansas Louisiana Massachusetts Michigan Missouri Nebraska Nevada New Hampshire North Carolina Ohio Oklahoma Rhode Island South Carolina Utah Washington West Virginia - -------------------------------------------------------------------------------------------------------------------- Free Withdrawal Amounts DURING THE FIRST CONTRACT YEAR: Washington You may withdraw the greater of (1) your penalty-free earnings; (2) if you are participating in the Systematic Withdrawal program, a total of 10% of your total invested amount or (3) interest earnings from the amounts allocated to the fixed accounts, not previously withdrawn. AFTER THE FIRST CONTRACT YEAR: Your maximum free withdrawal amount is the greater of (1) your penalty-free earnings and any portion of your total invested amount no longer subject to a withdrawal charge; (2) 10% of the portion of your total invested amount that has been in your contract for at least one year; or (3) interest earnings from amounts allocated to the fixed accounts, no previously withdrawn. - -------------------------------------------------------------------------------------------------------------------- Systematic Withdrawal Minimum withdrawal amount is $250 per withdrawal or the Oregon penalty free withdrawal amount. - -------------------------------------------------------------------------------------------------------------------- Minimum Contract Value We may terminate your contract if both the following occur: Texas (1) your contract is less than $500 as a result of withdrawals; and (2) you have not made any Purchase Payments during the past three years. We will provide you with sixty days written notice. At the end of the notice period, we will distribute the contract's remaining value to you. - -------------------------------------------------------------------------------------------------------------------- Market Value Adjustment L equal to zero Pennsylvania - --------------------------------------------------------------------------------------------------------------------
E-1
- -------------------------------------------------------------------------------------------------------------------- PROSPECTUS PROVISION AVAILABILITY OR VARIATION STATES - -------------------------------------------------------------------------------------------------------------------- Market Value Adjustment L equal to 0.0025 Florida - -------------------------------------------------------------------------------------------------------------------- Premium Tax We do not deduct premium tax charges when you surrender your New Mexico contract or begin the Income Phase. Texas Washington - --------------------------------------------------------------------------------------------------------------------
E-2 - -------------------------------------------------------------------------------- Please forward a copy (without charge) of the Polaris Choice(II) Variable Annuity Statement of Additional Information to: (Please print or type and fill in all information.) ---------------------------------------------------------------- Name ---------------------------------------------------------------- Address ---------------------------------------------------------------- City/State/Zip Date: Signed: - ----------------------------------- -----------------------------------
Return to: AIG SunAmerica Life Assurance Company, Annuity Service Center, P.O. Box 52499, Los Angeles, California 90054-0299 - -------------------------------------------------------------------------------- [WM DIVERSIFIED III LOGO] PROSPECTUS May 2, 2005 FLEXIBLE PAYMENT DEFERRED ANNUITY CONTRACT issued by VARIABLE SEPARATE ACCOUNT and AIG SUNAMERICA LIFE ASSURANCE COMPANY The annuity contract has several investment choices - available fixed-interest investment options which offer interest rates guaranteed by AIG SunAmerica Life Assurance Company ("AIG SunAmerica Life") for different periods of time and variable investment portfolios. The variable portfolios are part of Anchor Series Trust ("AST"), the SunAmerica Series Trust ("SAST"), Van Kampen Life Investment Trust ("VKT") or the WM Variable Trust ("WMVT"). STRATEGIC ASSET MANAGEMENT PORTFOLIOS FLEXIBLE INCOME PORTFOLIO WM ADVISORS, INC. WMVT CONSERVATIVE BALANCED PORTFOLIO WM ADVISORS, INC. WMVT BALANCED PORTFOLIO WM ADVISORS, INC. WMVT CONSERVATIVE GROWTH PORTFOLIO WM ADVISORS, INC. WMVT STRATEGIC GROWTH PORTFOLIO WM ADVISORS, INC. WMVT
EQUITY FUNDS TECHNOLOGY PORTFOLIO VAN KAMPEN SAST GLOBAL EQUITIES PORTFOLIO ALLIANCE CAPITAL MANAGEMENT, L.P. SAST REIT FUND WM ADVISORS, INC. WMVT EQUITY INCOME FUND WM ADVISORS, INC. WMVT GROWTH & INCOME FUND WM ADVISORS, INC. WMVT WEST COAST EQUITY FUND WM ADVISORS, INC. WMVT MID CAP STOCK FUND WM ADVISORS, INC. WMVT GROWTH FUND SALOMON BROTHERS ASSET MANAGEMENT, INC., WMVT JANUS CAPITAL MANAGEMENT LLC, AND OPPENHEIMERFUNDS, INC. SMALL CAP GROWTH FUND DELAWARE MANAGEMENT COMPANY AND WMVT OBERWEIS ASSET MANAGEMENT, INC. SMALL CAP VALUE* WM ADVISORS, INC. WMVT INTERNATIONAL GROWTH FUND CAPITAL GUARDIAN TRUST COMPANY WMVT MFS MID-CAP GROWTH PORTFOLIO MASSACHUSETTS FINANCIAL SERVICES COMPANY SAST CAPITAL APPRECIATION PORTFOLIO WELLINGTON MANAGEMENT COMPANY, LLP AST ALLIANCE GROWTH PORTFOLIO ALLIANCE CAPITAL MANAGEMENT L.P. SAST VAN KAMPEN LIT COMSTOCK PORTFOLIO** VAN KAMPEN/VAN KAMPEN ASSET MANAGEMENT VKT
FIXED-INCOME FUNDS SHORT TERM INCOME FUND WM ADVISORS, INC. WMVT U.S. GOVERNMENT SECURITIES FUND WM ADVISORS, INC. WMVT INCOME FUND WM ADVISORS, INC. WMVT MONEY MARKET FUND WM ADVISORS, INC. WMVT
* Available on or about July 1, 2005 ** An equity fund seeking capital growth and income. You can put your money into any one or all of the Variable Portfolios and/or available fixed investment options. Please read this prospectus carefully before investing and keep it for future reference. It contains important information about the variable annuity. To learn more about the annuity offered in this prospectus, you can obtain a copy of the Statement of Additional Information ("SAI") dated May 2, 2005. The SAI has been filed with the United States Securities and Exchange Commission ("SEC") and is incorporated by reference into this prospectus. The Table of Contents of the SAI appears at the end of this prospectus. For a free copy of the SAI, call us at (877) 311-WMVA (9682) or write to us at our Annuity Service Center, P.O. Box 54299, Los Angeles, California 90054-0299. In addition, the SEC maintains a website (http://www.sec.gov) that contains the SAI, materials incorporated by reference and other information filed electronically with the SEC by the Company. ANNUITIES INVOLVE RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL, AND ARE NOT A DEPOSIT OR OBLIGATION OF, OR GUARANTEED OR ENDORSED BY, ANY BANK. THEY ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER AGENCY. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION, NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF CONTENTS GLOSSARY.................................................... 4 HIGHLIGHTS.................................................. 5 FEE TABLES.................................................. 6 Maximum Owner Transaction Expenses..................... 6 Contract Maintenance Charge............................ 6 Separate Account Annual Expenses....................... 6 Additional Optional Feature Fee........................ 6 Optional Diversified Strategies Income Rewards Fee..... 6 Optional Capital Protector Fee......................... 6 Portfolio Expenses..................................... 6 MAXIMUM AND MINIMUM EXPENSE EXAMPLES........................ 7 THE WM DIVERSIFIED STRATEGIES(III) VARIABLE ANNUITY......... 8 PURCHASING A WM DIVERSIFIED STRATEGIES(III) VARIABLE ANNUITY................................................... 9 Allocation of Purchase Payments........................ 9 Accumulation Units..................................... 10 Right to Examine or Free Look.......................... 10 Exchange Offers........................................ 10 Exchange Offer from WM Advantage variable annuity issued by American General Life Insurance Company to WM Diversified Strategies(III) variable annuity....... 11 INVESTMENT OPTIONS.......................................... 11 Variable Portfolios.................................... 11 Anchor Series Trust.................................... 11 SunAmerica Series Trust................................ 11 Van Kampen Life Investment Trust....................... 11 WM Variable Trust...................................... 12 Fixed Account Options.................................. 12 Dollar Cost Averaging Program.......................... 13 Transfers During the Accumulation Phase................ 14 Asset Allocation Rebalancing Program................... 16 Voting Rights.......................................... 17 Substitution, Addition or Deletion of Variable Portfolios............................................ 17 ACCESS TO YOUR MONEY........................................ 17 Free Withdrawal Provision.............................. 17 Systematic Withdrawal Program.......................... 19 Minimum Contract Value................................. 19 OPTIONAL LIVING BENEFITS.................................... 19 Diversified Strategies Income Rewards.................. 19 Capital Protector...................................... 24 DEATH BENEFIT............................................... 25 Extended Legacy Program and Beneficiary Continuation Options............................................... 26 Standard Death Benefit................................. 27 Optional Enhanced Death Benefit(s)..................... 27 Spousal Continuation................................... 29 EXPENSES.................................................... 30 Separate Account Charges............................... 30 Withdrawal Charges..................................... 31 Underlying Fund Expenses............................... 31 Contract Maintenance Fee............................... 31 Transfer Fee........................................... 31 Optional Diversified Strategies Income Rewards Fee..... 32 Optional Capital Protector Fee......................... 32 Optional Enhanced Death Benefit Fee.................... 32 Optional Earnings Advantage Fee........................ 32 Premium Tax............................................ 32 Income Taxes........................................... 32 Reduction or Elimination of Fees, Expenses and Additional Amounts Credited........................... 32
2 INCOME OPTIONS.............................................. 33 Annuity Date........................................... 33 Income Options......................................... 33 Allocation of Annuity Payments......................... 34 Transfers During the Income Phase...................... 35 Deferment of Payments.................................. 35 TAXES....................................................... 35 Annuity Contracts in General........................... 35 Tax Treatment of Distributions--Non-Qualified Contracts............................................. 35 Tax Treatment of Distributions--Qualified Contracts (including governmental 457(b) eligible deferred compensation plans)................................... 36 Minimum Distributions.................................. 36 Tax Treatment of Death Benefits........................ 37 Contracts Owned by a Trust or Corporation.............. 37 Gifts, Pledges and/or Assignments of a Contract........ 37 Diversification and Investor Control................... 38 OTHER INFORMATION........................................... 38 The Separate Account................................... 38 The General Account.................................... 38 Registration Statements................................ 39 Administration......................................... 40 Legal Proceedings...................................... 40 TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION.... F-56 APPENDIX A--DEATH BENEFITS FOLLOWING SPOUSAL CONTINUATION... A-1 APPENDIX B--DIVERSIFIED STRATEGIES INCOME REWARDS EXAMPLES.................................................. B-1 APPENDIX C--EXCHANGE OFFER.................................. C-1 APPENDIX D--CONDENSED FINANCIAL INFORMATION................. D-1 APPENDIX E--STATE CONTRACT AVAILABILITY AND/OR VARIATIONS OF CERTAIN FEATURES AND BENEFITS............................. E-1 APPENDIX F--MARKET VALUE ADJUSTMENT......................... F-1
3 GLOSSARY We have capitalized some of the technical terms used in this prospectus. To help you understand these terms, we have defined them in this glossary. ACCUMULATION PHASE--The period during which you invest money in your contract. ACCUMULATION UNITS--A measurement we use to calculate the value of the variable portion of your contract during the Accumulation Phase. ANNUITANT--The person on whose life we base income payments. ANNUITY DATE--The date on which you select income payments to begin. ANNUITY UNITS--A measurement we use to calculate the amount of income payments you receive from the variable portion of your contract during the Income Phase. BENEFICIARY--The person designated to receive any benefits under the contract if you or the Annuitant dies. COMPANY--Refers to AIG SunAmerica Life Assurance Company, the insurer that issues this contract. The term "we," "us," "our," and "AIG SunAmerica Life" are also used to identify the Company. CONTINUING SPOUSE--Spouse of original contract owner at the time of death who elects to continue the contract after the death of the original contract owner. FIXED ACCOUNT--An account, if available, that we may offer in which you may invest money and earn a fixed rate of return. INCOME PHASE--The period during which we make income payments to you. LATEST ANNUITY DATE--Your 95th birthday or tenth contract anniversary, whichever is later. MARKET CLOSE--The close of the New York Stock Exchange, usually at 1:00 p.m. Pacific Time. NON-QUALIFIED (CONTRACT)--A contract purchased with after-tax dollars. In general, these contracts are not under any pension plan, specially sponsored program or individual retirement account ("IRA"). NYSE--New York Stock Exchange OWNER--The person or entity (if a non-natural owner) with an interest or title to this contract. The term "you" or "your" are also used to identify the Owner. PURCHASE PAYMENTS--The money you give us to buy and invest in the contract. QUALIFIED (CONTRACT)--A contract purchased with pretax dollars. These contracts are generally purchased under a pension plan, specially sponsored program or IRA. SEPARATE ACCOUNT--A segregated asset account maintained separately from the Company's regular portfolio of investments and general accounts. The Separate Account is established by the Company to purchase and hold the Variable Portfolios. TRUSTS--Collectively refers to the Anchor Series Trust, SunAmerica Series Trust, Van Kampen Life Investment Trust and the WM Variable Trust. UNDERLYING FUNDS--The underlying investment portfolios of the Trusts in which the Variable Portfolios invest. VARIABLE PORTFOLIO(S)--The variable investment options available under the contract. Each Variable Portfolio has its own investment objective and is invested in the Underlying Funds of the Trusts. 4 HIGHLIGHTS The WM Diversified Strategies(III) Variable Annuity is a contract between you and AIG SunAmerica Life Assurance Company (AIG SunAmerica Life). It is designed to help you invest on a tax-deferred basis and meet long-term financial goals. There are minimum Purchase Payment amounts required to purchase a contract. Purchase Payments may be invested in a variety of variable and fixed account options. Like all deferred annuities, the contract has an Accumulation Phase and an Income Phase. During the Accumulation Phase, you invest money in your contract. The Income Phase begins when you start receiving income payments from your annuity to provide for your retirement. FREE LOOK: You may cancel your contract within 10 days after receiving it (or whatever period is required in your state). You will receive whatever your contract is worth on the day that we receive your request. The amount refunded may be more or less than your original Purchase Payment. We will return your original Purchase Payment if required by law. Please see PURCHASING A WM DIVERSIFIED STRATEGIES(III) VARIABLE ANNUITY below. EXPENSES: There are fees and charges associated with the contract. Each year, we deduct a $35 contract maintenance fee from your contract, which may be waived for contracts of $50,000 or more. We also deduct insurance charges, which equal 1.55% annually of the average daily value of your contract allocated to the Variable Portfolios. There are investment charges on amounts invested in the Variable Portfolios. If you elect optional features available under the contract we may charge additional fees for these features. A separate withdrawal charge schedule applies to each Purchase Payment. The amount of the withdrawal charge declines over time. After a Purchase Payment has been in the contract for three complete years, withdrawal charges no longer apply to that Purchase Payment. Please see the FEE TABLE, PURCHASING A WM DIVERSIFIED STRATEGIES(III) VARIABLE ANNUITY and EXPENSES below. ACCESS TO YOUR MONEY: You may withdraw money from your contract during the Accumulation Phase. If you do so, earnings are deemed to be withdrawn first. You will pay income taxes on earnings and untaxed contributions when you withdraw them. Payments received during the Income Phase are considered partly a return of your original investment. A federal tax penalty may apply if you make withdrawals before age 59 1/2. As noted above, a withdrawal charge may apply. Please see ACCESS TO YOUR MONEY and TAXES below. OPTIONAL LIVING BENEFITS: You may elect one of the optional living benefits available under your contract. For an additional fee, these features are designed to protect a portion of your investment in the event your contract value declines due to unfavorable investment performance during the Accumulation Phase and before a death benefit is payable. See OPTIONAL LIVING BENEFITS below. DEATH BENEFIT: A death benefit feature is available under the contract to protect your Beneficiaries in the event of your death during the Accumulation Phase. Optional enhanced death benefits are also available. Please see DEATH BENEFITS below. INCOME OPTIONS: When you are ready to begin taking income, you can choose to receive income payments on a variable basis, fixed basis or a combination of both. You may also chose from five different income options, including an option for income that you cannot outlive. Please see INCOME OPTIONS below. INQUIRIES: If you have questions about your contract call your financial representative or contact us at AIG SunAmerica Life Annuity Service Center P.O. Box 54299 Los Angeles, California 90054-0299. Telephone Number: (877) 311-WMVA (9682). See Appendix E for state contract availability and/or variations of certain features and benefits. THE COMPANY OFFERS SEVERAL DIFFERENT VARIABLE ANNUITY CONTRACTS TO MEET THE DIVERSE NEEDS OF OUR INVESTORS. OUR CONTRACTS MAY PROVIDE DIFFERENT FEATURES, BENEFITS AND PROGRAMS OFFERED AT DIFFERENT FEES AND EXPENSES. WHEN WORKING WITH YOUR FINANCIAL REPRESENTATIVE TO DETERMINE THE BEST PRODUCT TO MEET YOUR NEEDS, YOU SHOULD CONSIDER AMONG OTHER THINGS, WHETHER THE FEATURES OF THIS CONTRACT AND THE RELATED FEES PROVIDE THE MOST APPROPRIATE PACKAGE TO HELP YOU MEET YOUR RETIREMENT SAVINGS GOALS. IF YOU WOULD LIKE MORE INFORMATION REGARDING HOW MONEY IS SHARED AMONGST OUR BUSINESS PARTNERS, INCLUDING BROKER-DEALERS THROUGH WHICH YOU MAY PURCHASE A VARIABLE ANNUITY, SEE THE PAYMENTS IN CONNECTION WITH DISTRIBUTION OF THE CONTRACT SECTION UNDER OTHER INFORMATION. PLEASE READ THE PROSPECTUS CAREFULLY FOR MORE DETAILED INFORMATION REGARDING THESE AND OTHER FEATURES AND BENEFITS OF THE CONTRACT, AS WELL AS THE RISKS OF INVESTING. 5 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FEE TABLES - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU WILL PAY AT THE TIME THAT YOU BUY THE CONTRACT, TRANSFER CASH VALUE BETWEEN INVESTMENT OPTIONS OR SURRENDER THE CONTRACT. IF APPLICABLE, YOU MAY ALSO BE SUBJECT TO STATE PREMIUM TAXES. MAXIMUM OWNER TRANSACTION EXPENSES MAXIMUM WITHDRAWAL CHARGE (AS A PERCENTAGE OF EACH PURCHASE PAYMENT)(1)............................................... 7%
Transfer Fee......... $25 per transfer after the first 15 transfers in any contract year.
THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU MAY PAY PERIODICALLY DURING THE TIME THAT YOU OWN THE CONTRACT, NOT INCLUDING UNDERLYING FUND EXPENSES WHICH ARE OUTLINED IN THE NEXT SECTION. CONTRACT MAINTENANCE CHARGE $35 each year SEPARATE ACCOUNT ANNUAL EXPENSES (DEDUCTED FROM THE AVERAGE DAILY ENDING NET ASSET VALUE ALLOCATED TO THE VARIABLE PORTFOLIO) Mortality Risk Charge.............................. 1.05% Expense Risk Charge................................ 0.35% Distribution Expense Charge........................ 0.15% Optional Enhanced Death Benefit Fee(3)............. 0.15% Optional Earnings Advantage Fee(3)................. 0.25% TOTAL SEPARATE ACCOUNT ANNUAL EXPENSES................................ 1.95% ====
ADDITIONAL OPTIONAL FEATURE FEE You may elect only one of the following optional features: Diversified Strategies Income Rewards or Capital Protector described below. OPTIONAL DIVERSIFIED STRATEGIES INCOME REWARDS FEE (CALCULATED AS A PERCENTAGE OF YOUR PURCHASE PAYMENTS RECEIVED IN THE FIRST 90 DAYS ADJUSTED FOR WITHDRAWALS)
ANNUALIZED CONTRACT YEAR FEE(4) - ------------- -------------- 0-7............................................... 0.65% 8-10.............................................. 0.45% 11+............................................... none
OPTIONAL CAPITAL PROTECTOR FEE (CALCULATED AS A PERCENTAGE OF YOUR CONTRACT VALUE MINUS PURCHASE PAYMENTS RECEIVED AFTER THE 90TH DAY SINCE YOU PURCHASED YOUR CONTRACT)
ANNUALIZED CONTRACT YEAR FEE(5) - ------------- -------------- 0-5............................................... 0.65% 6-10.............................................. 0.45% 11+............................................... none
FOOTNOTES TO FEE TABLE: (1) Withdrawal Charge Schedule (as a percentage of each Purchase Payment) declines over 3 years as follows: YEARS:...................................................... 1 2 3 4+ 7% 6% 6% 0%
(2) The contract maintenance fee may be waived if contract value is $50,000 or more. (3) The Optional Enhanced Death Benefit offers a choice of one of two optional enhanced death benefits. Earnings Advantage is also an optional enhanced death benefit feature. If elected, the fee for each chosen feature is an annualized charge that is deducted daily from your net asset value. If you do not elect either enhanced death benefit option, your total separate account annual expenses would be 1.55%. (4) The Diversified Strategies Income Rewards feature is an optional guaranteed minimum withdrawal benefit. The fee is deducted from your contract value at the end of the first quarter following election and quarterly thereafter. (5) The Capital Protector feature is an optional guaranteed minimum accumulation benefit. The fee is deducted from your contract value at the end of the first quarter following election and quarterly thereafter. THE FOLLOWING SHOWS THE MINIMUM AND MAXIMUM TOTAL OPERATING EXPENSES CHARGED BY THE UNDERLYING FUNDS OF THE TRUSTS, BEFORE ANY WAIVERS OR REIMBURSEMENTS THAT YOU MAY PAY PERIODICALLY DURING THE TIME THAT YOU OWN THE CONTRACT. MORE DETAIL CONCERNING THE UNDERLYING FUNDS' EXPENSES IS CONTAINED IN THE PROSPECTUS FOR EACH OF THE TRUSTS. PLEASE READ THEM CAREFULLY BEFORE INVESTING. PORTFOLIO EXPENSES
TOTAL ANNUAL UNDERLYING FUND EXPENSES MINIMUM MAXIMUM - ------------------------------------- ------- ------- (expenses that are deducted from Underlying Funds of the Trusts, including management fees, other expenses and service (12b-1) fees, if applicable)...................... 0.79% 1.68%
6 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- MAXIMUM AND MINIMUM EXPENSE EXAMPLES - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- These examples are intended to help you compare the cost of investing in the contract with the cost of investing in other variable annuity contracts. These costs include owner transaction expenses, the contract maintenance fee if any, separate account annual expenses, available optional feature fees and Underlying Fund expenses. The examples assume that you invest $10,000 in the contract for the time periods indicated; that your investment has a 5% return each year; and you incur the maximum and minimum fees and expenses of the Underlying Fund. Although your actual costs may be higher or lower, based on these assumptions, your costs at the end of the stated period would be: MAXIMUM EXPENSE EXAMPLES (ASSUMING MAXIMUM SEPARATE ACCOUNT EXPENSES OF 1.95% (INCLUDING THE OPTIONS ESTATE REWARDS (0.15%) AND OPTIONAL EARNINGS ADVANTAGE (0.25%)) AND INVESTMENT IN AN UNDERLYING FUND WITH TOTAL EXPENSES OF 1.68%) (1) If you surrender your contract at the end of the applicable time period and you elect the optional Diversified Strategies Income Rewards, 0.65% for years 0-5, 0.45% for years 6-10:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------------------------------------- - ------------------------------------- $1,135 $1,913 $2,203 $4,421 - ------------------------------------- - -------------------------------------
(2) If you annuitize your contract at the end of the applicable time period:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------------------------------------- - ------------------------------------- $326 $995 $1,688 $3,531 - ------------------------------------- - -------------------------------------
(3) If you do not surrender your contract and you elect the optional Diversified Strategies Income Rewards, 0.65% for years 0-5, 0.45% for years 6-10:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------------------------------------- - ------------------------------------- $435 $1,313 $2,203 $4,421 - ------------------------------------- - -------------------------------------
MINIMUM EXPENSE EXAMPLES (ASSUMING MINIMUM SEPARATE ACCOUNT EXPENSES OF 1.55% AND INVESTMENT IN AN UNDERLYING FUND WITH TOTAL EXPENSES OF 0.79%) (1) If you surrender your contract at the end of the applicable time period and you do not elect any optional features:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------------------------------------- - ------------------------------------- $943 $1,347 $1,277 $2,730 - ------------------------------------- - -------------------------------------
(2) If you annuitize your contract at the end of the applicable time period:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------------------------------------- - ------------------------------------- $237 $730 $1,250 $2,676 - ------------------------------------- - -------------------------------------
(3) If you do not surrender your contract and do not elect any optional benefits or features:
1 YEAR 3 YEARS 5 YEARS 10 YEARS - ------------------------------------- - ------------------------------------- $243 $747 $1,277 $2,730 - ------------------------------------- - -------------------------------------
EXPLANATION OF FEE TABLES AND EXAMPLES 1. The purpose of the Fee Table and Expense Examples is to show you the various fees and expenses you would incur directly and indirectly by investing in this variable annuity contract. The Fee Table and Expense Examples represent both fees of the separate account as well as the maximum and minimum total annual Underlying Fund operating expenses. We converted the contract maintenance fee to a percentage (0.05%). The actual impact of the contract maintenance fee may differ from this percentage and may be waived for contract values over $50,000. Additional information on the Underlying Fund fees can be found in the Trust prospectuses. 2. In addition to the stated assumptions, the Examples also assume that no transfer fees were imposed. Although premium taxes may apply in certain states, they are not reflected in the Expense Examples. 3. If you elected other optional features, your expenses would be lower than those shown in these Expense Examples. The optional living benefit fees are not calculated as a percentage of your daily net asset value but on other calculations more fully described in the prospectus. THESE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESSER THAN THOSE SHOWN. CONDENSED FINANCIAL INFORMATION APPEARS IN THE CONDENSED FINANCIAL INFORMATION APPENDIX OF THIS PROSPECTUS. 7 THE WM DIVERSIFIED STRATEGIES(III) VARIABLE ANNUITY - -------------------------------------------------------------------------------- When you purchase a variable annuity, a contract exists between you and an insurance company. You are the owner of the contract. The contract provides three main benefits: - Tax Deferral: This means that you do not pay taxes on your earnings from the contract until you withdraw them. - Death Benefit: If you die during the Accumulation Phase, the insurance company pays a death benefit to your Beneficiary. - Guaranteed Income: If elected, you receive a stream of income for your lifetime, or another available period you select. Tax-qualified retirement plans (e.g., IRAs, 401(k) or 403(b) plans) defer payment of taxes on earnings until withdrawal. If you are considering funding a tax-qualified retirement plan with an annuity, you should know that an annuity does not provide any additional tax deferral treatment of earnings beyond the treatment provided by the tax-qualified retirement plan itself. However, annuities do provide other features and benefits, which may be valuable to you. You should fully discuss this decision with your financial representative. This variable annuity was developed to help you contribute to your retirement savings. This variable annuity works in two stages: the Accumulation Phase and the Income Phase. Your contract is in the Accumulation Phase during the period when you make payments into the contract. The Income Phase begins after the specified waiting period when you start taking income payments. The contract is called a "variable" annuity because it allows you to invest in Variable Portfolios which, like mutual funds, have different investment objectives and performance. You can gain or lose money if you invest in these Variable Portfolios. The amount of money you accumulate in your contract depends on the performance of the Variable Portfolios in which you invest. The Fixed Accounts, if available, earn interest at a rate set and guaranteed by the Company. If you allocate money to the Fixed Accounts, the amount of money that accumulates in the contract depends on the total interest credited to the particular Fixed Accounts in which you invest. For more information on investment options available under this contract, SEE INVESTMENT OPTIONS BELOW. This annuity is designed to assist in contributing to retirement savings of investors whose personal circumstances allow for a long-term investment time horizon. As a function of the Internal Revenue Code ("IRC"), you may be assessed a 10% federal tax penalty on any withdrawal made prior to your reaching age 59 1/2. Additionally, you will be charged a withdrawal charge on each Purchase Payment withdrawn prior to the end of the applicable withdrawal charge period, SEE FEE TABLES ABOVE. Because of these potential penalties, you should fully discuss all of the benefits and risks of this contract with your financial representative prior to purchase. 8 PURCHASING A WM DIVERSIFIED STRATEGIES(III) VARIABLE ANNUITY - -------------------------------------------------------------------------------- An initial Purchase Payment is the money you give us to buy a contract. Any additional money you give us to invest in the contract after purchase is a subsequent Purchase Payment. This chart shows the minimum initial and subsequent Purchase Payments permitted under your contract. These amounts depend upon whether a contract is Qualified or Non-Qualified for tax purposes.
MINIMUM MINIMUM SUBSEQUENT MINIMUM INITIAL SUBSEQUENT PURCHASE PAYMENT-- PURCHASE PAYMENT PURCHASE PAYMENT AUTOMATIC PAYMENT PLAN ---------------- ---------------- ---------------------- Qualified $ 2,000 $250 $100 Non-Qualified $10,000 $500 $100
Once you have contributed at least the minimum initial Purchase Payment, you can establish an automatic payment plan that allows you to make subsequent Purchase Payments of as little as $100. We reserve the right to require Company approval prior to accepting Purchase Payments greater than $1,000,000. For contracts owned by a non-natural owner, we reserve the right to require prior Company approval to accept Purchase Payments greater than $250,000. We reserve the right to change the amount at which pre-approval is required at any time. Subsequent Purchase Payments that would cause total Purchase Payments in all contracts issued by the Company or its affiliate, First SunAmerica Life Insurance Company, to the same owner and/or Annuitant to exceed these limits may also be subject to Company pre-approval. For any contracts that meet or exceed these dollar amount limitations, we further reserve the right to limit the death benefit amount payable in excess of contract value at the time we receive all required paperwork and satisfactory proof of death. Any limit on the maximum death benefit payable would be mutually agreed upon by you and the Company prior to purchasing the contract. We may not issue a contract to anyone age 86 or older on the contract issue date. We may not accept subsequent Purchase Payments from contract owners age 86 or older. In general, we will not issue a Qualified contract to anyone who is age 70 1/2 or older, unless it is shown that the minimum distribution required by the IRS is being made. If we learn of a misstatement of age, we reserve the right to fully pursue our remedies including termination of the contract and/or revocation of any age-driven benefits. We allow this contract to be jointly owned. We may require that the joint owners be spouses. However, the age of the older spouse is used to determine the availability of any age driven benefits. The addition of a joint owner after the contract has been issued is contingent upon prior review and approval by the Company. You may assign this contract before beginning the Income Phase by sending us a written request for an assignment. Your rights and those of any other person with rights under this contract will be subject to the assignment. We reserve the right to not recognize assignments if it changes the risk profile of the owner of the contract, as determined in our sole discretion. Please see the Statement of Additional Information for details on the tax consequences of an assignment. ALLOCATION OF PURCHASE PAYMENTS In order to issue your contract, we must receive your initial Purchase Payment and all required paperwork including Purchase Payment allocation instructions at our Annuity Service Center. We will accept initial and subsequent Purchase Payments by electronic transmission from certain broker-dealer firms. In connection with arrangements we have to transact business electronically, we may have agreements in place whereby your broker-dealer may be deemed our agent for receipt of your Purchase Payments. Provided we have received your Purchase Payment and all required paperwork by Market Close, we allocate your initial Purchase Payment within two days of receiving it. If we do not have complete information necessary to issue your contract, we will contact you. If we do not have the information necessary to issue your contract within 9 5 business days, we will send your money back to you, or ask your permission to keep your money until we get the information necessary to issue the contract. We invest your subsequent Purchase Payments in the Variable Portfolios and available Fixed Accounts according to any allocation instructions that accompany the subsequent Purchase Payment. If we receive a Purchase Payment without allocation instructions, we will invest the money according to your allocation instructions on file. SEE INVESTMENT OPTIONS BELOW. ACCUMULATION UNITS When you allocate a Purchase Payment to the Variable Portfolios, we credit your contract with Accumulation Units of the Separate Account. We base the number of Accumulation Units you receive on the unit value of the Variable Portfolio as of the day we receive your money if we receive it before Market Close, or on the next business day's unit value if we receive your money after Market Close. The value of an Accumulation Unit goes up and down based on the performance of the Variable Portfolios. We calculate the value of an Accumulation Unit each day that the NYSE is open as follows: 1. We determine the total value of money invested in a particular Variable Portfolio; 2. We subtract from that amount all applicable contract charges; and 3. We divide this amount by the number of outstanding Accumulation Units. We determine the number of Accumulation Units credited to your contract by dividing the Purchase Payment by the Accumulation Unit value for the specific Variable Portfolio. EXAMPLE: We receive a $25,000 Purchase Payment from you on Wednesday. You allocate the money to Variable Portfolio A. We determine that the value of an Accumulation Unit for Variable Portfolio A is $11.10 at Market Close on Wednesday. We then divide $25,000 by $11.10 and credit your contract on Wednesday night with 2,252.2523 Accumulation Units for Variable Portfolio A. RIGHT TO EXAMINE OR FREE LOOK You may cancel your contract within ten days after receiving it (or longer if required by state law). We call this a "free look." To cancel, you must mail the contract along with your free look request to our Annuity Service Center at P.O. Box 54299, Los Angeles, California 90054-0299. If you decide to cancel your contract during the free look period, generally we will refund to you the value of your contract on the day we receive your request. Certain states require us to return your Purchase Payments upon a free look request. Additionally, all contracts issued as an IRA require the full return of Purchase Payments upon a free look. If your contract was issued in a state requiring return of Purchase Payments or as an IRA, and you cancel your contract during the free look period, we return the greater of (1) your Purchase Payments; or (2) the value of your contract. With respect to those contracts, we reserve the right to put your money in the Money Market Variable Portfolio during the free look period. If we place your money in the Money Market Variable Portfolio during the free look period, we will allocate your money according to your instructions at the end of the applicable free look period. EXCHANGE OFFERS From time to time, we may offer to allow you to exchange an older variable annuity issued by the Company or one of its affiliates, for a newer product with more current features and benefits also issued by the Company or one of its affiliates. Such an exchange offer will be made in accordance with applicable state and federal securities and insurance rules and regulations. We will provide the specific terms and conditions of any such exchange offer at the time the offer is made. 10 EXCHANGE OFFER FROM WM ADVANTAGE VARIABLE ANNUITY ISSUED BY AMERICAN GENERAL LIFE INSURANCE COMPANY TO WM DIVERSIFIED STRATEGIES(III) VARIABLE ANNUITY Certain owners of the WM Advantage variable annuity issued by AIG SunAmerica Life's affiliate American General Life Insurance Company ("Advantage Contract") may have the opportunity to exchange the Advantage Contract for a newer variable annuity issued by AIG SunAmerica Life Assurance Company. The newer annuity being offered in this Exchange Offer is the WM Diversified Strategies(III) variable annuity, described in this prospectus; however, all Variable Portfolios may not be available for exchanged assets. This Exchange Offer is only made to Advantage Contract owners whose Advantage Contracts are completely out of the surrender charge period at the time of the exchange. Upon purchasing the WM Diversified Strategies(III) contract in exchange for the Advantage Contract, surrender charges will not apply to the exchanged values in the new contract and will be waived on new Purchase Payments made into the WM Diversified Strategies(III) variable annuity. We will pay lower compensation to financial representatives on sales of WM Diversified Strategies(III) that are part of this Exchange Offer. For a comparison of the features and benefits of the Advantage Contract to the WM Diversified Strategies(III) contract, please see the Exchange Offer Appendix. INVESTMENT OPTIONS - -------------------------------------------------------------------------------- VARIABLE PORTFOLIOS The Variable Portfolios invest in the Underlying Funds of the Trusts. Additional Variable Portfolios may be available in the future. The Variable Portfolios are only available through the purchase of certain insurance contracts. The Trusts serve as the underlying investment vehicles for other variable annuity contracts issued by the Company and other affiliated and unaffiliated insurance companies. Neither the Company nor the Trusts believe that offering shares of the Trusts in this manner disadvantages you. The Trusts are monitored for potential conflicts. The Trusts may have other Underlying Funds in addition to those listed here that are not available for investment under this contract. The Variable Portfolios along with their respective advisers are listed below: ANCHOR SERIES TRUST (CLASS 2) AIG SunAmerica Asset Management Corp. ("AIG SAAMCo"), an indirect wholly-owned subsidiary of AIG, is the investment adviser and Wellington Management Company, LLP is the subadviser to Anchor Series Trust ("AST"). SUNAMERICA SERIES TRUST (CLASS 2) AIG SAAMCo is the investment adviser and various managers are the subadvisers to SunAmerica Series Trust ("SAST"). VAN KAMPEN LIFE INVESTMENT TRUST (CLASS II) Van Kampen Asset Management is the investment adviser to the Van Kampen Life Investment Trust ("VKT"). 11 WM VARIABLE TRUST (CLASS 2) WM Advisors, Inc. is the investment advisor to the WM Variable Trust ("WMVT"). STRATEGIC ASSET MANAGEMENT PORTFOLIOS Flexible Income Portfolio WM Advisors, Inc. WMVT Conservative Balanced Portfolio WM Advisors, Inc. WMVT Balanced Portfolio WM Advisors, Inc. WMVT Conservative Growth Portfolio WM Advisors, Inc. WMVT Strategic Growth Portfolio WM Advisors, Inc. WMVT EQUITY FUNDS Technology Portfolio* Van Kampen SAST Global Equities Portfolio Alliance Capital Management, L.P. SAST REIT Fund WM Advisors, Inc. WMVT Equity Income Fund WM Advisors, Inc. WMVT Growth & Income Fund WM Advisors, Inc. WMVT West Coast Equity Fund WM Advisors, Inc. WMVT Mid Cap Stock Fund WM Advisors, Inc. WMVT Growth Fund Salomon Brothers Asset Management, Inc. WMVT Janus Capital Management LLC, and OppenheimerFunds, Inc. Small Cap Growth Fund Delaware Management Company and WMVT Oberweis Asset Management, Inc. Small Cap Value** WM Advisors, Inc. WMVT International Growth Fund Capital Guardian Trust Company WMVT MFS Mid-Cap Growth Portfolio Massachusetts Financial Services Company SAST Capital Appreciation Portfolio Wellington Management Company, LLP AST Alliance Growth Portfolio Alliance Capital Management L.P. SAST Van Kampen LIT Comstock Portfolio*** Van Kampen/Van Kampen Asset Management VKT FIXED-INCOME FUNDS Short Term Income Fund WM Advisors, Inc. WMVT U.S. Government Securities Fund WM Advisors, Inc. WMVT Income Fund WM Advisors, Inc. WMVT Money Market Fund WM Advisors, Inc. WMVT
- --------------- * Morgan Stanley Investment Management, Inc., the subadviser for the Technology SAST Portfolio, does business in certain instances using the name Van Kampen. ** Available on or about July 1, 2005. *** An equity fund seeking capital growth and income. YOU SHOULD READ THE PROSPECTUSES FOR THE TRUSTS CAREFULLY. THESE PROSPECTUSES CONTAIN DETAILED INFORMATION ABOUT THE PORTFOLIOS, INCLUDING EACH UNDERLYING FUND'S INVESTMENT OBJECTIVE AND RISK FACTORS. FIXED ACCOUNT OPTIONS Your contract may offer Fixed Accounts for varying guarantee periods. A Fixed Account is an account in which you invest money and earn a fixed rate of return. A Fixed Account may be available for differing lengths of time (such as 1, 3, or 5 years). Each guarantee period may have different guaranteed interest rates. We guarantee that the interest rate credited to amounts allocated to any available Fixed Account guarantee periods will never be less than the minimum guaranteed interest rate specified in your contract. Once the rate is established, it will not change for the duration of the guarantee period. We determine which, if any, guarantee periods will be offered at any time in our sole discretion, unless state law requires us to do otherwise. Please check with your financial representative regarding the availability of Fixed Accounts. 12 There are three categories of interest rates for money allocated to the Fixed Accounts. The applicable rate is guaranteed until the corresponding guarantee period expires. With each category of interest rate, your money may be credited a different rate as follows: - INITIAL RATE: The rate credited to any portion of the initial Purchase Payment allocated to a Fixed Account. - CURRENT RATE: The rate credited to any portion of a subsequent Purchase Payment allocated to a Fixed Account. - RENEWAL RATE: The rate credited to money transferred from a Fixed Account or a Variable Portfolio into a Fixed Account and to money remaining in a Fixed Account after expiration of a guarantee period. When a guarantee period ends, you may leave your money in the same Fixed Account or you may reallocate your money to another Fixed Account or to the Variable Portfolios. If you do not want to leave your money in the same Fixed Account, you must contact us within 30 days after the end of the guarantee period and provide us with new allocation instructions. WE DO NOT CONTACT YOU. IF YOU DO NOT CONTACT US, YOUR MONEY WILL REMAIN IN THE SAME FIXED ACCOUNT WHERE IT WILL EARN INTEREST AT THE RENEWAL RATE THEN IN EFFECT FOR THAT FIXED ACCOUNT. If available, you may systematically transfer interest earned in available Fixed Accounts into any of the Variable Portfolios on certain periodic schedules offered by us. Systematic transfers may be started, changed or terminated at any time by contacting our Annuity Service Center. Check with you financial representative about the current availability of this service. All Fixed Accounts may not be available in your state. At any time we are crediting the minimum guaranteed interest rate specified in your contract, we reserve the right to restrict your ability to make transfers and Purchase Payments into the Fixed Accounts. DOLLAR COST AVERAGING FIXED ACCOUNTS You may invest initial and/or subsequent Purchase Payments in the dollar cost averaging ("DCA") Fixed Accounts, if available. The minimum Purchase Payment that you must invest for the 6-month DCA Fixed Account is $600 and for the 12-month DCA Fixed Account is $1,200. Purchase Payments less than these minimum amounts will automatically be allocated to the Variable Portfolios according to your instructions or your current allocation instruction on file. DCA Fixed Accounts credit a fixed rate of interest and can only be elected to facilitate a DCA program. SEE DOLLAR COST AVERAGING PROGRAM BELOW for more information. Interest is credited to amounts allocated to the DCA Fixed Accounts while your money is transferred to the Variable Portfolios over certain specified time frames. The interest rates applicable to the DCA Fixed Accounts may differ from those applicable to any other available Fixed Account but will never be less than the minimum guaranteed interest rate specified in your contract. However, when using a DCA Fixed Account, the annual interest rate is paid on a declining balance as you systematically transfer your money to the Variable Portfolios. Therefore, the actual effective yield will be less than the stated annual crediting rate. We reserve the right to change the availability of DCA Fixed Accounts offered, unless state law requires us to do otherwise. DOLLAR COST AVERAGING PROGRAM The DCA program allows you to invest gradually in the Variable Portfolios at no additional cost. Under the program, you systematically transfer a specified dollar amount or percentage of contract value from a Variable Portfolio, Fixed Account or DCA Fixed Account ("source account") to any other Variable Portfolio ("target account"). Transfers may occur on certain periodic schedules such as monthly or weekly. You may change the frequency to other available options at any time by notifying us in writing. The minimum transfer amount under the DCA program is $100 per transaction, regardless of the source account. Fixed accounts are not available as target accounts for the DCA program. If available, you may systematically transfer interest earned in available Fixed Accounts into any of the Variable Portfolios on certain periodic schedules offered by us. You may change or terminate these systematic transfers by 13 contacting our Annuity Service Center. Check with your financial representative about the current availability of this service. We may also offer DCA Fixed Accounts as source accounts exclusively to facilitate the DCA program for a specified time period. The DCA Fixed Account only accepts initial or subsequent Purchase Payments. You may not make a transfer from a Variable Portfolio or Fixed Account into a DCA Fixed Account. You may terminate the DCA program at any time. If you terminate the DCA program and money remains in the DCA Fixed Accounts, we transfer the remaining money according to your current allocation instructions on file. The DCA program is designed to lessen the impact of market fluctuations on your investment. However, the DCA program can neither guarantee a profit nor protect your investment against a loss. When you elect the DCA program, you are continuously investing in securities fluctuating at different price levels. You should consider your tolerance for investing through periods of fluctuating price levels. EXAMPLE: Assume that you want to move $750 each quarter from one Variable Portfolio to another Variable Portfolio over six months. You set up a DCA program and purchase Accumulation Units at the following values:
MONTH ACCUMULATION UNIT UNITS PURCHASED ----- ----------------- --------------- 1 $ 7.50 100 2 $ 5.00 150 3 $10.00 75 4 $ 7.50 100 5 $ 5.00 150 6 $ 7.50 100
You paid an average price of only $6.67 per Accumulation Unit over six months, while the average market price actually was $7.08. By investing an equal amount of money each month, you automatically buy more Accumulation Units when the market price is low and fewer Accumulation Units when the market price is high. This example is for illustrative purposes only. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE DCA PROGRAM AT ANY TIME. TRANSFERS DURING THE ACCUMULATION PHASE Subject to our rules, restrictions and policies, during the Accumulation Phase you may transfer funds between the Variable Portfolios and/or any available Fixed Accounts by telephone or through the Company's website (http://www.aigsunamerica.com) or in writing by mail or facsimile. All transfer instructions submitted via facsimile must be sent to (818) 615-1543, otherwise they will not be considered received by us. We may accept transfers by telephone or the Internet unless you tell us not to on your contract application. When receiving instructions over the telephone or the Internet, we follow procedures we have adopted to provide reasonable assurance that the transactions executed are genuine. Thus, we are not responsible for any claim, loss or expense from any error resulting from instructions received over the telephone or the Internet. If we fail to follow our procedures, we may be liable for any losses due to unauthorized or fraudulent instructions. Any transfer request will be priced as of the day it is confirmed in good order by us if the request is processed before Market Close. If the transfer request is processed after Market Close, the request will be priced as of the next business day. Funds already in your contract cannot be transferred into the DCA Fixed Accounts. You must transfer at least $100 per transfer. If less than $100 remains in any Variable Portfolio after a transfer, that amount must be transferred as well. *** 14 TRANSFER POLICIES We do not want to issue this variable annuity contract to contract owners engaged in trading strategies that seek to benefit from short-term price fluctuations or price inefficiencies in the Variable Portfolios of this product ("Short-Term Trading") and we discourage Short-Term Trading as more fully described below. However, we cannot always anticipate if a potential contract owner intends to engage in Short-Term Trading. Short-Term Trading may create risks that may result in adverse effects on investment return of an Underlying Fund. Such risks may include, but are not limited to: (1) interference with the management and planned investment strategies of an Underlying Fund and/or (2) increased brokerage and administrative costs due to forced and unplanned fund turnover; both of which may dilute the value of the shares in the Underlying Fund and reduce value for all investors in the Variable Portfolio. In addition to negatively impacting the contract owner, a reduction in contract value may also be harmful to annuitants and/or beneficiaries. We have adopted the following administrative procedures to discourage Short-Term Trading. We charge for transfers in excess of 15 in any contract year. Currently, the fee is $25 for each transfer exceeding this limit. Transfers resulting from your participation in the DCA or Asset Rebalancing programs are not counted towards the number of free transfers per contract year. In addition to charging a fee when you exceed 15 transfers as described in the preceding paragraph, all transfer requests in excess of 5 transfers within a rolling six-month look-back period must be submitted by United States Postal Service first-class mail ("U.S. Mail") for twelve months from the date of your 5th transfer request ("Standard U.S. Mail Policy"). For example, if you made a transfer on February 15, 2004 and within the previous six months (from August 15, 2003 forward) you made 5 transfers including the February 15th transfer, then all transfers made for twelve months after February 15, 2004 must be submitted by U.S. Mail (from February 16, 2004 through February 15, 2005). We will not accept transfer requests sent by any other medium except U.S. Mail during this 12-month period. Transfer requests required to be submitted by U.S. Mail can only be cancelled by a written request sent by U.S. Mail with the appropriate paperwork received prior to the execution of the transfer. All transfers made on the same day prior to Market Close are considered one transfer request. Transfers resulting from your participation in the DCA or Asset Rebalancing programs are not included for the purposes of determining the number of transfers before applying the Standard U.S. Mail Policy. We apply the Standard U.S. Mail Policy uniformly and consistently to all contract owners except for omnibus group contracts as described below. We believe that the Standard U.S. Mail Policy is a sufficient deterrent to Short-Term Trading and we do not conduct any additional routine monitoring. However, we may become aware of transfer patterns among the Variable Portfolios and/or available Fixed Accounts which reflect what we consider to be Short-Term Trading or otherwise detrimental to the Variable Portfolios but have not yet triggered the limitations of the Standard U.S. Mail Policy described above. If such transfer activity cannot be controlled by the Standard U.S. Mail Policy, we may require you to adhere to our Standard U.S. Mail prior to reaching the specified number of transfers ("Accelerated U.S. Mail Policy"). To the extent we become aware of Short-Term Trading activities which cannot be reasonably controlled by the Standard U.S. Mail Policy or the Accelerated U.S. Mail Policy, we also reserve the right to evaluate, in our sole discretion, whether to impose further limits on the number and frequency of transfers you can make, impose minimum holding periods and/or reject any transfer request or terminate your transfer privileges. We will notify you in writing if your transfer privileges are terminated. In addition, we reserve the right to not accept transfers from a third party acting for you and not to accept preauthorized transfer forms. . Some of the factors we may consider when determining whether to accelerate the Standard U.S. Mail Policy, reject or impose other conditions on transfer privileges include: (1) the number of transfers made in a defined period; (2) the dollar amount of the transfer; (3) the total assets of the Variable Portfolio involved in the transfer and/or transfer requests that represent a significant portion of the total assets of the Variable Portfolio; 15 (4) the investment objectives and/or asset classes of the particular Variable Portfolio involved in your transfers; (5) whether the transfer appears to be part of a pattern of transfers to take advantage of short-term market fluctuations or market inefficiencies; and/or (6) other activity, as determined by us, that creates an appearance, real or perceived, of Short-Term Trading. Notwithstanding the administrative procedures above, there are limitations on the effectiveness of these procedures. Our ability to detect and/or deter Short-Term Trading is limited by operational systems and technological limitations. We cannot guarantee that we will detect and/or deter all Short-Term Trading. To the extent that we are unable to detect and/or deter Short-Term Trading, the Variable Portfolios may be negatively impacted as described above. Additionally, the Variable Portfolios may be harmed by transfer activity related to other insurance companies and/or retirement plans or other investors that invest in shares of the Underlying Fund. You should be aware that the design of our administrative procedures involves inherently subjective decisions, which we attempt to make in a fair and reasonable manner consistent with the interests of all owners of this contract. We do not enter into agreements with contract owners whereby we permit or intentionally disregard Short-Term Trading. The Standard and Accelerated U.S. Mail Policies are applied uniformly and consistently to contract owners utilizing third party trading services/strategies performing asset allocation services for a number of contract owners at the same time. You should be aware that such third party trading services may engage in transfer activities that can also be detrimental to the Variable Portfolios. These transfer activities may not be intended to take advantage of short-term price fluctuations or price inefficiencies. However, such activities can create the same or similar risks to Short-Term Trading and negatively impact the Variable Portfolios as described above. Omnibus group contracts may invest in the same Underlying Funds available in your contract but on an aggregate, not individual basis. Thus, we have limited ability to detect Short-Term Trading in omnibus group contracts and the Standard U.S. Mail Policy does not apply to these contracts. Our inability to detect Short-Term Trading may negatively impact the Variable Portfolios as described above. WE RESERVE THE RIGHT TO MODIFY THE POLICIES AND PROCEDURES DESCRIBED IN THIS SECTION AT ANY TIME. To the extent that we exercise this reservation of rights, we will do so uniformly and consistently unless we disclose otherwise. For information regarding transfers during the Income Phase, SEE INCOME OPTIONS BELOW. ASSET ALLOCATION REBALANCING PROGRAM Market fluctuations may cause the percentage of your investment in the Variable Portfolios to differ from your original allocations. Under the Automatic Asset Rebalancing program, your investments in the Variable Portfolios are periodically rebalanced to return your allocations to their original percentages for no additional charge. Automatic Asset Rebalancing typically involves shifting a portion of your money out of a Variable Portfolio with a higher return into a Variable Portfolio with a lower return. At your request, rebalancing occurs on a quarterly, semiannual or annual basis. EXAMPLE OF AUTOMATIC ASSET REBALANCING PROGRAM: Assume that you want your initial Purchase Payment split between two Variable Portfolios. You want 50% in a bond Variable Portfolio and 50% in a growth Variable Portfolio. Over the next calendar quarter, the bond market does very well while the stock market performs poorly. At the end of the calendar quarter, the bond Variable Portfolio now represents 60% of your holdings because it has increased in value and the growth Variable Portfolio represents 40% of your holdings. If you chose quarterly rebalancing, on the last day of that quarter, we would sell some of your Accumulation Units in the bond Variable Portfolio to bring its holdings back to 50% and use the money to buy more Accumulation Units in the growth Variable Portfolio to increase those holdings to 50%. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE AUTOMATIC ASSET REBALANCING PROGRAM AT ANY TIME. 16 VOTING RIGHTS The Company is the legal owner of the Trusts' shares. However, when an Underlying Fund solicits proxies in conjunction with a shareholder vote, we must obtain your instructions on how to vote those shares. We vote all of the shares we own in proportion to your instructions. This includes any shares we own on our own behalf. Should we determine that we are no longer required to comply with these rules, we will vote the shares in our own right. SUBSTITUTION, ADDITION OR DELETION OF VARIABLE PORTFOLIOS We may, subject to any applicable law, make certain changes to the Variable Portfolios offered in your contract. We may, in our sole discretion, offer new Variable Portfolios or stop offering existing Variable Portfolios. New Variable Portfolios may be made available to existing contract owners and Variable Portfolios may be closed to new or subsequent Purchase Payments, transfers or allocations as we determine appropriate. In addition, we may also liquidate the shares of any Variable Portfolio, substitute the shares of one Underlying Fund for another and/or merge Underlying Funds. This would occur for various reasons, such as a determination that a Underlying Fund is no longer an appropriate investment for the contract due to continuing substandard performance; changes to the portfolio manager, investment objectives, risks and strategies; or changes in federal or state laws. To the extent required by the Investment Company Act of 1940, we may be required to obtain your approval through a proxy vote or SEC approval, prior to a substitution of shares of an Underlying Fund. We will notify you in writing of any proxies or substitutions that affect the Variable Portfolios offered in your contract. ACCESS TO YOUR MONEY - -------------------------------------------------------------------------------- You can access money in your contract by making a partial withdrawal and/or by receiving income payments during the Income Phase. See INCOME OPTIONS below. Generally, we deduct a withdrawal charge applicable to any partial or total withdrawal before the end of the withdrawal charge period and a MVA if a withdrawal comes from certain Fixed Accounts. If you made a total withdrawal, we also deduct premium taxes if applicable and a contract maintenance fee. SEE EXPENSES BELOW. FREE WITHDRAWAL PROVISION Your contract provides for a free withdrawal amount each year. A free withdrawal amount is the portion of your contract that we allow you to take out each year without being charged a withdrawal charge. HOWEVER, UPON A FUTURE TOTAL WITHDRAWAL OF YOUR CONTRACT, IF WITHDRAWAL CHARGES ARE STILL APPLICABLE, ANY PREVIOUS FREE WITHDRAWALS WOULD BE SUBJECT TO A WITHDRAWAL CHARGE. Purchase Payments in excess of your free withdrawal amount, that are withdrawn prior to the end of the withdrawal schedule, will result in payment of a withdrawal charge. The amount of the withdrawal charge and how it applies are discussed more fully in EXPENSES below. You should consider, before purchasing this contract, the effect this withdrawal charge will have on your investment if you need to withdraw more money than the free withdrawal amount. You should fully discuss this decision with your financial representative. To determine your free withdrawal amount and your withdrawal charge, we refer to two special terms: "penalty free earnings" and the "total invested amount." The penalty-free earnings amount is your contract value less your total invested amount. The total invested amount is the total of all Purchase Payments less portions of prior withdrawals that reduce your total invested amount as follows: - Free withdrawals in any year that were in excess of your penalty-free earnings and were based on the portion of the total invested amount that was no longer subject to withdrawal charges at the time of the withdrawal; and - Any prior withdrawals (including withdrawal charges applicable to those withdrawals) of the total invested amount on which you already paid a withdrawal charge. 17 When you make a withdrawal, we deduct it from penalty-free earnings first, then from the total invested amount on a first-in, first-out basis. This means that you can also access your Purchase Payments, which are no longer subject to a withdrawal charge before those Purchase Payments, which are still subject to the withdrawal charge. During the first year after we issue your contract, your free withdrawal amount is the greater of: (1) your penalty-free earnings; or (2) if you are participating in the Systematic Withdrawal program, a total of 10% of your total invested amount. After the first contract year, you can take out the greater of the following amounts each year: (1) your penalty-free earnings and any portion of your total invested amount no longer subject to a withdrawal charge; or (2) 10% of the portion of your total invested amount that has been in your contract for at least one year. We calculate withdrawal charges due on a total withdrawal on the day after we receive your request and your contract. We return your contract value less any applicable fees and charges. The withdrawal charge percentage is determined by the age of the Purchase Payment remaining in the contract at the time of the withdrawal. For the purpose of calculating the withdrawal charge, any prior free withdrawal is not subtracted from the total Purchase Payments still subject to withdrawal charges. For example, you make an initial Purchase Payment of $100,000. For purposes of this example we will assume a 0% growth rate over the life of the contract and no subsequent Purchase Payments. In contract year 2, you take out your maximum free withdrawal of $10,000. After that free withdrawal your contract value is $90,000. In the 3rd contract year, you request a total withdrawal of your contract. We will apply the following calculation: A-(B x C)=D, where: A=Your contract value at the time of your request for withdrawal ($90,000) B=The amount of your Purchase Payments still subject to withdrawal charge ($100,000) C=The withdrawal charge percentage applicable to the age of each Purchase Payment (assuming 5% is the applicable percentage) [B x C=$5,000] D=Your full contract value ($85,000) available for total withdrawal Under most circumstances, the partial withdrawal minimum is $1,000. We require that the value left in any Variable Portfolio or Fixed Accounts be at least $100, after the withdrawal and your total contract value must be at least $500. You must send a written withdrawal request. For withdrawals of $500,000 and more, you must submit a signature guarantee at the time of your request. Unless you provide us with different instructions, partial withdrawals will be made pro rata from each Variable Portfolio and the Fixed Account in which your contract is invested. IN THE EVENT THAT A PRO RATA PARTIAL WITHDRAWAL WOULD CAUSE THE VALUE OF ANY VARIABLE PORTFOLIO OR FIXED ACCOUNT INVESTMENT TO BE LESS THAN $100, WE WILL CONTACT YOU TO OBTAIN ALTERNATE INSTRUCTIONS ON HOW TO STRUCTURE THE WITHDRAWAL. Withdrawals made prior to age 59 1/2 may result in a 10% IRS penalty tax. SEE TAXES BELOW. Under certain Qualified plans, access to the money in your contract may be restricted. We may be required to suspend or postpone the payment of a withdrawal for any period of time when: (1) the NYSE is closed (other than a customary weekend and holiday closings); (2) trading with the NYSE is restricted; (3) an emergency exists such that disposal of or determination of the value of shares of the Variable Portfolios is not reasonably practicable; (4) the SEC, by order, so permits for the protection of contract owners. Additionally, we reserve the right to defer payments for a withdrawal from a Fixed Account, for up to six months. 18 SYSTEMATIC WITHDRAWAL PROGRAM During the Accumulation Phase, you may elect to receive periodic income payments under the Systematic Withdrawal program for no additional charge. Under the program, you may choose to take monthly, quarterly, semi-annual or annual payments from your contract. Electronic transfer of these withdrawals to your bank account is also available. The minimum amount of each withdrawal is $100. There must be at least $500 remaining in your contract at all times. Withdrawals may be taxable and a 10% federal penalty tax may apply if you are under age 59 1/2. A withdrawal charge and/or MVA may apply. The program is not available to everyone. Please check with our Annuity Service Center which can provide the necessary enrollment forms. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE SYSTEMATIC WITHDRAWAL PROGRAM AT ANY TIME. MINIMUM CONTRACT VALUE Where permitted by state law, we may terminate your contract if both of the following occur: (1) your contract is less than $500 as a result of withdrawals; and (2) you have not made any Purchase Payments during the past three years. We will provide you with sixty days written notice that your contract is being terminated. At the end of the notice period, we will distribute the contract's remaining value to you. OPTIONAL LIVING BENEFITS - -------------------------------------------------------------------------------- YOU MAY ELECT ONE OF THE OPTIONAL LIVING BENEFITS DESCRIBED BELOW. THESE FEATURES ARE DESIGNED TO PROTECT A PORTION OF YOUR INVESTMENT IN THE EVENT YOUR CONTRACT VALUE DECLINES DUE TO UNFAVORABLE INVESTMENT PERFORMANCE DURING THE ACCUMULATION PHASE AND BEFORE A DEATH BENEFIT IS PAYABLE. PLEASE SEE THE DESCRIPTIONS BELOW FOR DETAILED INFORMATION. DIVERSIFIED STRATEGIES INCOME REWARDS What is Diversified Strategies Income Rewards? Diversified Strategies Income Rewards is an optional living benefit feature. If you elect this feature, for which you will be charged an annualized fee, after a specified waiting period, you are guaranteed to receive withdrawals over a minimum number of years that in total equal Purchase Payments made in the first 90 days adjusted for withdrawals during that period (the "Benefit"), even if the contract value falls to zero. Diversified Strategies Income Rewards may offer protection in the event your contract value declines due to unfavorable investment performance. Diversified Strategies Income Rewards has rules and restrictions that are discussed more fully below. What options are currently available? Three options are currently available under this feature. The available options, referred to as the Step-Up Options, provide a guaranteed minimum withdrawal amount over a minimum number of years equal to at least your initial Purchase Payment (adjusted for withdrawals) with an opportunity to receive a 10%, 20% or 50% step-up amount. If you take withdrawals prior to the Benefit Availability Date (as defined in the table below), the Benefit will be reduced and you may not receive a step-up amount depending on the option selected. Each option and its components are fully described below. You should read each option carefully and discuss the feature with your financial representative before electing an option. How and when can I elect the feature? You may only elect the feature at the time of contract issue and must choose one of the options discussed below. You may not change the option after election. You cannot elect the feature if you are age 81 or older on the contract issue date. Generally, once you elect the feature, it cannot be cancelled. Diversified Strategies Income Rewards cannot be elected if you elect the Capital Protector feature. SEE CAPITAL PROTECTOR BELOW. Diversified Strategies Income Rewards may not be available in your state or through the 19 broker-dealer with which your financial representative is affiliated. Please check with your financial representative for availability. How is the Benefit calculated? In order to determine the Benefit's value, we calculate each of the components as described below. The Benefit's components and value may vary depending on the option you choose. The earliest date you may begin taking withdrawals under the Benefit is the BENEFIT AVAILABILITY DATE. Each one-year period beginning on the contract issue date and ending on the day before the contract anniversary date is considered a BENEFIT YEAR. The table below is a summary of the three Step-Up Options we are currently offering:
- --------------------------------------------------------------------------------------------------------------------------------- MINIMUM WITHDRAWAL PERIOD* (IF MAXIMUM ANNUAL MAXIMUM ANNUAL WITHDRAWAL WITHDRAWAL AMOUNT TAKEN OPTION BENEFIT AVAILABILITY DATE STEP-UP AMOUNT AMOUNT+ PERCENTAGE EACH YEAR) - --------------------------------------------------------------------------------------------------------------------------------- 1 3 years following 10%* of Withdrawal 10% of Withdrawal 11 years contract Benefit Base Benefit Base issue date - --------------------------------------------------------------------------------------------------------------------------------- 2 5 years following 20%* of Withdrawal 10% of Withdrawal 12 years contract Benefit Base Benefit Base issue date - --------------------------------------------------------------------------------------------------------------------------------- 3 10 years following 50%** of Withdrawal 10% of Withdrawal 15 years contract Benefit Base Benefit Base issue date - ---------------------------------------------------------------------------------------------------------------------------------
* You will not receive a Step-Up Amount if you elect Options 1 or 2 and take a withdrawal prior to the Benefit Availability Date. The Minimum Withdrawal Period for Options 1 and 2 will be 10 years if you do not receive a Step-Up Amount. ** If you elect Option 3 and take a withdrawal prior to the Benefit Availability Date, you will receive a reduced Step-Up Amount of 30% of the Withdrawal Benefit Base. The Minimum Withdrawal Period will be 13 years if you receive a reduced Step-Up Amount. + For contract holders subject to annual required minimum distributions, the Maximum Annual Withdrawal Amount for this contract will be the greater of: (1) the amount indicated in the table above; or (2) the annual required minimum distribution amount. Required minimum distributions may reduce your Minimum Withdrawal Period. How are the components for the Step-Up Options calculated? First, we determine the ELIGIBLE PURCHASE PAYMENTS, which include the amount of Purchase Payments made to the contract up to the 90th day after your contract issue date, adjusted for any withdrawals in the same proportion that the withdrawal reduced the contract value on the date of the withdrawal. Second, we determine the WITHDRAWAL BENEFIT BASE, On the Benefit Availability Date, the Withdrawal Benefit Base equals the sum of all Eligible Purchase Payments. Third, we determine a STEP-UP AMOUNT, if any, which is calculated as a specified percentage (listed in the table above) of the Withdrawal Benefit Base on the Benefit Availability Date. If you elect Option 1 or 2, you will not receive a Step-Up Amount if you take any withdrawals prior to the Benefit Availability Date. If you elect Option 3, the Step-Amount will be reduced to 30% of the Withdrawal Benefit Base if you take any withdrawals prior to the Benefit Availability Date. The Step-Up Amount is not considered a Purchase Payment and cannot be used in calculating any other benefits, such as death benefits, contract values or annuitization value. Fourth, we determine a STEPPED-UP BENEFIT BASE, which is the total amount available for withdrawal under the feature and is used to calculate the minimum time period over which you may take withdrawals under the feature. The Stepped-Up Benefit Base equals the Withdrawal Benefit Base plus the Step-Up Amount, if any. Fifth, we determine the MAXIMUM ANNUAL WITHDRAWAL AMOUNT, which is a stated percentage (listed in the table above) of the Withdrawal Benefit Base and represents the maximum amount of withdrawals that are available under this feature each Benefit Year after the Benefit Availability Date. 20 Finally, we determine the MINIMUM WITHDRAWAL PERIOD, which is the minimum period over which you may take withdrawals under the feature. The Minimum Withdrawal Period is calculated by dividing the Stepped-Up Benefit Base by the Maximum Annual Withdrawal Amount. What is the fee for Diversified Strategies Income Rewards? The annualized Diversified Strategies Income Rewards fee will be assessed as a percentage of the Withdrawal Benefit Base. The fee will be deducted quarterly from your contract value starting on the first quarter following the contract issue date and ending upon the termination of the feature. If your contract value falls to zero before the feature has been terminated, the fee will no longer be assessed. We will not assess the quarterly fee if you surrender or annuitize before the end of a quarter.
CONTRACT YEAR ANNUALIZED FEE - ------------- -------------- 0-7 years 0.65% of Withdrawal Benefit Base 8-10 years 0.45% of Withdrawal Benefit Base 11+ none
What are the effects of withdrawals on the Step-Up Options? The Benefit amount, Maximum Annual Withdrawal Amount and Minimum Withdrawal Period may change over time as a result of withdrawal activity. Withdrawals after the Benefit Availability Date equal to or less than the Maximum Annual Withdrawal Amount generally reduce the Benefit by the amount of the withdrawal. Withdrawals in excess of the Maximum Annual Withdrawal Amount will reduce the Benefit in the same proportion that the contract value was reduced at the time of the withdrawal. This means if investment performance is down and contract value is reduced, withdrawals greater than the Maximum Annual Withdrawal Amount will result in a greater reduction of the Benefit. The impact of withdrawals and the effect on each component of Diversified Strategies Income Rewards are further explained through the calculations below: WITHDRAWAL BENEFIT BASE: Withdrawals prior to the Benefit Availability Date reduce the Withdrawal Benefit Base in the same proportion that the contract value was reduced at the time of the withdrawal. Withdrawals prior to the Benefit Availability Date also eliminate any Step-Up Amount for Options 1 and 2 and reduce the Step-Up Amount to 30% of the Withdrawal Benefit Base for Option 3. Withdrawals after the Benefit Availability Date will not reduce the Withdrawal Benefit Base until the sum of withdrawals after the Benefit Availability Date exceeds the Step-Up Amount. Thereafter, any withdrawal or portion of a withdrawal that exceeds the Step-Up Amount will reduce the Withdrawal Benefit Base as follows: (1) If the withdrawal does not cause total withdrawals in the Benefit Year to exceed the Maximum Annual Withdrawal Amount, the Withdrawal Benefit Base will be reduced by the amount of the withdrawal, or (2) If the withdrawal causes total withdrawals in the Benefit Year to exceed the Maximum Annual Withdrawal Amount, the Withdrawal Benefit Base is reduced to the lesser of (a) or (b), where: a. is the Withdrawal Benefit Base immediately prior to the withdrawal minus the amount of the withdrawal, or; b. is the Withdrawal Benefit Base immediately prior to the withdrawal minus the amount of the withdrawal that makes total withdrawals for the Benefit Year equal to the current Maximum Annual Withdrawal Amount, and further reduced in the same proportion that the contract value was reduced by the amount of the withdrawal that exceeds the Maximum Annual Withdrawal Amount. STEPPED-UP BENEFIT BASE: Since withdrawals prior to the Benefit Availability Date eliminate any Step-Up Amount for Options 1 and 2, the Stepped-Up Benefit Base will be equal to the Withdrawal Benefit Base if you take withdrawals prior to the Benefit Availability Date. For Option 3, if you take withdrawals prior to the Benefit Availability Date, the Stepped-Up Benefit Base will be equal to the Withdrawal Benefit Base plus the reduced Step-Up Amount which will be 30% of the Withdrawal Benefit Base, adjusted for such withdrawals. 21 If you do not take withdrawals prior to the Benefit Availability Date, you will receive the entire Step-Up Amount and the Stepped-Up Benefit Base will equal the Withdrawal Benefit Base plus the Step-Up Amount. After the Benefit Availability Date, any withdrawal that does not cause total withdrawals in a Benefit Year to exceed the Maximum Annual Withdrawal Amount will reduce the Stepped-Up Benefit Base by the amount of the withdrawal. After the Benefit Availability Date, any withdrawal that causes total withdrawals in a Benefit Year to exceed the Maximum Annual Withdrawal Amount (in that Benefit Year) reduces the Stepped-Up Benefit Base to the lesser of (a) or (b), where: a. is the Stepped-Up Benefit Base immediately prior to the withdrawal minus the amount of the withdrawal, or; b. is the Stepped-Up Benefit Base immediately prior to the withdrawal minus the amount of the withdrawal that makes total withdrawals for the Benefit Year equal to the current Maximum Annual Withdrawal Amount, and further reduced in the same proportion that the contract value was reduced by the amount of the withdrawal that exceeds the Maximum Annual Withdrawal Amount. MAXIMUM ANNUAL WITHDRAWAL AMOUNT: If the sum of withdrawals in a Benefit Year does not exceed the Maximum Annual Withdrawal Amount for that Benefit Year, the Maximum Annual Withdrawal Amount does not change for the next Benefit Year. If total withdrawals in a Benefit Year exceed the Maximum Annual Withdrawal Amount, the Maximum Annual Withdrawal Amount will be recalculated at the start of the next Benefit Year. The new Maximum Annual Withdrawal Amount will equal the Stepped-Up Benefit Base on that Benefit Year anniversary divided by the Minimum Withdrawal Period on that Benefit Year anniversary. The new Maximum Annual Withdrawal Amount may be lower than your previous Maximum Annual Withdrawal Amounts. MINIMUM WITHDRAWAL PERIOD: After each withdrawal, a new Minimum Withdrawal Period is calculated. If total withdrawals in a Benefit Year are less than or equal to the current Maximum Annual Withdrawal Amount, the new Minimum Withdrawal Period equals the Stepped-Up Benefit Base after the withdrawal, divided by the current Maximum Annual Withdrawal Amount. During any Benefit Year in which the sum of withdrawals exceeds the Maximum Annual Withdrawal Amount, the new Minimum Withdrawal Period equals the Minimum Withdrawal Period calculated at the end of the prior Benefit Year reduced by one year. CONTRACT VALUE: Any withdrawal under the Benefit reduces the contract value by the amount of the withdrawal. THE DIVERSIFIED STRATEGIES INCOME REWARDS EXAMPLES APPENDIX PROVIDES EXAMPLES OF THE EFFECTS OF WITHDRAWALS ON THE DIVERSIFIED STRATEGIES INCOME REWARDS FEATURE. What happens if my contract value is reduced to zero? If the contract value is zero but the Stepped-Up Benefit Base is greater than zero, a Benefit remains payable under the feature. However, the contract and its other features and benefits will be terminated once the contract value equals zero. Once the contract is terminated, you may not make subsequent Purchase Payments and no death benefit or future annuitization payments are available. Therefore, under adverse market conditions, withdrawals taken under the Benefit may reduce the contract value to zero eliminating any other benefits of the contract. To receive your remaining Benefit, you may select one of the following options: 1. Lump sum distribution of the actuarial present value as determined by us, of the total remaining guaranteed withdrawals; or 2. the current Maximum Annual Withdrawal Amount, paid equally on a quarterly, semi-annual or annual frequency as selected by you until the Stepped-Up Benefit Base equals zero; or 3. any payment option mutually agreeable between you and us. 22 If you do not select a payment option, the remaining Benefit will be paid as the current Maximum Annual Withdrawal Amount on a quarterly basis. What happens to Diversified Strategies Income Rewards upon a spousal continuation? A Continuing Spouse may elect to continue or cancel the feature and its accompanying fee. The components of the feature will not change as a result of a spousal continuation. SEE SPOUSAL CONTINUATION BELOW. Can my non-spousal beneficiary elect to receive any remaining withdrawals under Diversified Strategies Income Rewards upon my death? If the Stepped-Up Benefit Base is greater than zero when the original owner dies, and the contract value equals zero and therefore no death benefit is payable, a non-spousal Beneficiary may elect to continue receiving any remaining withdrawals under the feature. The components of the feature will not change. If the Stepped-Up Benefit Base and the contract value are greater than zero, a non-spousal Beneficiary must make a death claim under the contract provisions which terminates the Benefit. SEE DEATH BENEFITS BELOW. Can Diversified Strategies Income Rewards be cancelled? Once you elect the feature, you may not cancel it. The feature automatically terminates upon the occurrence of one of the following: 1. Stepped-Up Benefit Base is equal to zero; or 2. Annuitization of the contract; or 3. Full surrender of the contract; or 4. Death benefit is paid; or 5. Upon a spousal continuation, the Continuing Spouse elects not to continue the contract with the feature. We reserve the right to terminate the feature if withdrawals in excess of Maximum Annual Withdrawal Amount in any Benefit Year reduce the Stepped-Up Benefit Base by 50% or more. Important Information Diversified Strategies Income Rewards is designed to offer protection of your initial investment in the event of a significant market down turn. Diversified Strategies Income Rewards may not guarantee an income stream based on all Purchase Payments made into your contract nor does it guarantee any investment gains. Diversified Strategies Income Rewards does not guarantee a withdrawal of any subsequent Purchase Payments made after the 90th day following the contract issue date. This feature also does not guarantee lifetime income payments. You may never need to rely on Diversified Strategies Income Rewards if your contract performs within a historically anticipated range. However, past performance is no guarantee of future results. Withdrawals under the feature are treated like any other withdrawal for the purpose of reducing the contract value, free withdrawal amounts and all other benefits, features and conditions of your contract. If you need to take withdrawals or are required to take required minimum distributions ("RMD") under the Internal Revenue Code ("IRC") from this contract prior to the Benefit Availability Date, you should know that such withdrawals may negatively impact the value of the Benefit. As noted above, your Stepped-Up Benefit Base will be reduced if you take withdrawals before the Benefit Availability Date. Any withdrawals taken under this feature or under the contract may be subject to a 10% IRS tax penalty if you are under age 59 1/2 at the time of the withdrawal. For information about how the feature is treated for income tax purposes, you should consult a qualified tax advisor concerning your particular circumstances. If you set up RMDs and have elected this feature, your distributions must be automated and will not be recalculated on an annual basis. We reserve the right at the time your contract is issued to limit the maximum Eligible Purchase Payments to $1 million. For prospectively issued contracts, we reserve the right to limit the investment options available under the contract if you elect this Diversified Strategies Income Rewards feature. 23 WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE DIVERSIFIED STRATEGIES INCOME REWARDS FEATURE (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME FOR PROSPECTIVELY ISSUED CONTRACTS. CAPITAL PROTECTOR What is Capital Protector? Capital Protector is an optional living benefit offered on your contract. If you elect this feature, you will be charged an annualized fee. At the end of 10 full contract years ("Waiting Period"), the feature makes a one-time adjustment ("Benefit") so that your contract will be worth at least the amount of your guaranteed Purchase Payment(s) as specified below (less adjustments for withdrawals). Capital Protector offers protection in the event that your contract value declines due to unfavorable investment performance. How and when can I elect the feature? You may only elect this feature at the time your contract is issued, so long as the Waiting Period ends before your Latest Annuity Date. You cannot elect the feature if you are age 81 or older on the contract issue date. Capital Protector is not available if you elect Diversified Strategies Income Rewards. SEE DIVERSIFIED STRATEGIES INCOME REWARDS ABOVE. Capital Protector may not be available in your state or through the broker-dealer with which your financial representative is affiliated. Please check with your financial representative for availability. Can Capital Protector be cancelled? Generally, this feature and its corresponding charge cannot be cancelled or terminated prior to the end of the Waiting Period. The feature terminates automatically following the end of the Waiting Period. In addition, the feature will no longer be available and no Benefit will be paid if a death benefit is paid or if the contract is fully surrendered or annuitized before the end of the Waiting Period. How is the Benefit calculated? The Benefit is a one-time adjustment to your contract in the event that your contract value at the end of the Waiting Period ("Benefit Date") is less than the Purchase Payments made, as follows:
PERCENTAGE OF PURCHASE PAYMENTS TIME ELAPSED SINCE INCLUDED IN THE THE CONTRACT ISSUE DATE BENEFIT CALCULATION - ----------------------- ------------------------------- 0-90 days 100% 91 days + 0%
The benefit calculation is equal to your Benefit Base, as defined below, minus your contract value on the Benefit Date. If the resulting amount is positive, you will receive a Benefit under the feature. If the resulting amount is negative, you will not receive a Benefit. Your Benefit Base is equal to (a) minus (b) where: (a) is the Purchase Payments received on or after the contract issue date multiplied by the applicable percentages in the table above, and; (b) is an adjustment for all withdrawals and applicable fees and charges made subsequent to the contract issue date, in an amount proportionate to the amount by which the withdrawal decreased the contract value at the time of the withdrawal. What is the fee for Capital Protector? The annualized charge will be deducted from your contract value on a quarterly basis throughout the Waiting Period, beginning at the end of the first contract quarter following the contract issue date and up to and including 24 on the Benefit Date. Once the feature is terminated, as discussed above, the charge will no longer be deducted. We will also not assess the quarterly fee if you surrender or annuitize before the end of the quarter.
CONTRACT YEAR ANNUALIZED CHARGE* - ------------- ------------------ 0-5 0.65% 6-10 0.45% 11+ none
* As a percentage of your contract value minus Purchase Payments received after the 90th day since the purchase of your contract. The amount of this charge is subject to change at any time for prospectively issued contracts. What happens to Capital Protector upon a Spousal Continuation? If your spouse chooses to continue this contract upon your death, this feature cannot be terminated. The Waiting Period starts from the original issue date. The corresponding Benefit Date will not change as a result of a spousal continuation. SEE SPOUSAL CONTINUATION BELOW. Important Information Capital Protector may not guarantee a return of all of your Purchase Payments. If you plan to add subsequent Purchase Payments over the life of your contract, you should know that Capital Protector would not protect the majority of those payments. Since Capital Protector may not guarantee a return of all Purchase Payments at the end of the Waiting Period, it is important to realize that subsequent Purchase Payments made into the contract may decrease the value of the Benefit. For example, if near the end of the Waiting Period your Benefit Base is greater than your contract value, and you then make a subsequent Purchase Payment that causes your contract value to be larger than your Benefit Base on your Benefit Date, you will not receive any Benefit even though you have paid for Capital Protector throughout the Waiting Period. You should discuss making subsequent Purchase Payments with your financial representative as such activity may reduce the value of the Benefit. We will allocate any benefit amount contributed to the contract value on the Benefit Date to the Money Market Variable Portfolio. Any Benefit paid is not considered a Purchase Payment for purposes of calculating other benefits or features of your contract. Benefits based on earnings, will continue to define earnings as the difference between contract value and Purchase Payments adjusted for withdrawals. For information about how the Benefit is treated for income tax purposes, you should consult a qualified tax advisor for information concerning your particular circumstances. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE CAPITAL PROTECTOR (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME FOR PROSPECTIVELY ISSUED CONTRACTS. DEATH BENEFIT - -------------------------------------------------------------------------------- If you die during the Accumulation Phase of your contract, we pay a death benefit to your Beneficiary. You must select a death benefit option at the time you purchase your contract. Once selected, you cannot change your death benefit option. You should discuss the available options with your financial representative to determine which option is best for you. We do not pay a death benefit if you die after you switch to the Income Phase. In that case, your Beneficiary would receive any remaining guaranteed income payments in accordance with the income option you selected. SEE INCOME OPTIONS BELOW. You designate your Beneficiary who will receive any death benefit payments. You may change the Beneficiary at any time, unless you previously made an irrevocable Beneficiary designation. If your contract is jointly owned, the surviving joint owner is the sole beneficiary. 25 We calculate and pay the death benefit when we receive all required paperwork and satisfactory proof of death. All death benefit calculations discussed below are as of the date we receive paperwork and satisfactory proof of death. We consider the following satisfactory proof of death: 1. a certified copy of the death certificate; or 2. a certified copy of a decree of a court of competent jurisdiction as to the finding of death; or 3. a written statement by a medical doctor who attended the deceased at the time of death; or 4. any other proof satisfactory to us. If the Beneficiary is the spouse of a deceased owner, he or she can elect to continue the Contract. SEE SPOUSAL CONTINUATION BELOW. If a Beneficiary does not elect a specific form of pay out, within 60 days of our receipt of all required paperwork and satisfactory proof of death, we pay a lump sum death benefit to the Beneficiary. A Beneficiary may also elect to continue the contract and take the death benefit amount in a series of payments based upon the Beneficiary's life expectancy under the Extended Legacy program described below, subject to the applicable Internal Revenue Code distribution requirements. Payments must begin under the selected Income Option or the Extended Legacy program no later than the first anniversary of your death for non-qualified contracts or December 31st of the year following the year of your death for IRAs. Your Beneficiary cannot participate in the Extended Legacy program if your Beneficiary has already elected another settlement option. Beneficiaries who do not begin taking payments within these specified time periods will not be eligible to elect an Income Option or participate in the Extended Legacy program. EXTENDED LEGACY PROGRAM AND BENEFICIARY CONTINUATION OPTIONS The Extended Legacy program can allow a Beneficiary to take the death benefit amount in the form of income payments over a longer period of time with the flexibility to withdraw more than the IRS required minimum distribution if they wish. The contract continues in the original owner's name for the benefit of the Beneficiary. A Beneficiary may elect to continue the contract and take the death benefit amount in a series of payments based upon the Beneficiary's life expectancy under the Extended Legacy program described below, subject to the applicable Internal Revenue Code distribution requirements. Payments under the selected income option must begin or under the Extended Legacy program no later than the first anniversary of your death for non-qualified contracts or December 31st of the year following the year of your death for IRAs. Beneficiaries who do not begin taking payments within these specified time periods will not be eligible to elect an income option or participate in the Extended Legacy program. Your Beneficiary cannot participate in the Extended Legacy program if your Beneficiary has already elected another payout option. The Extended Legacy program allows the Beneficiary to take distributions in the form of a series of payments similar to the required minimum distributions under an IRA. Generally, IRS required minimum distributions must be made at least annually over a period not to exceed the Beneficiary's life expectancy as determined in the calendar year after your death. A Beneficiary may withdraw all or a portion of the contract value at any time, name their own beneficiary to receive any remaining unpaid interest in the contract in the event of their death and make transfers among investment options. If the contract value is less than the death benefit amount as of the date we receive satisfactory proof of death and all required paperwork, we will increase the contract value by the amount which the death benefit exceeds contract value. Participation in the program may impact certain features of the contract that are detailed in the Death Claim Form. Please see your financial representative for additional information. Other Beneficiary Continuation Options Alternatively to the Extended Legacy program, the Beneficiary may also elect to receive the death benefit under a 5-year option. The Beneficiary may take withdrawals as desired, but the entire contract value must be distributed by the fifth anniversary of your death for Non-qualified contracts or by December 31st of the year containing the fifth anniversary of your death for IRAs. For IRAs, the 5-year option is not available if the date of death is after 26 the required beginning date for distributions (April 1 of the year following the year the owner reaches the age of 70 1/2). Please consult your tax advisor regarding tax implications and your particular circumstances. DEFINED TERMS The term "Net Purchase Payment" is used frequently in describing the death benefit payable. Net Purchase Payment is an on-going calculation. It does not represent a contract value. We define Net Purchase Payments as Purchase Payments less an adjustment for each withdrawal. If you have not taken any withdrawals from your contract, Net Purchase Payments equals total Purchase Payments into your contract. To calculate the adjustment amount for the first withdrawal made under the contract, we determine the percentage by which the withdrawal reduced the contract value. For example, a $10,000 withdrawal from a $100,000 contract is a 10% reduction in value. This percentage is calculated by dividing the amount of each withdrawal (and any applicable fees and charges) by the contract value immediately before taking the withdrawal. The resulting percentage is then multiplied by the amount of the total Purchase Payments and subtracted from the amount of the total Purchase Payments on deposit at the time of the withdrawal. The resulting amount is the initial Net Purchase Payment. To arrive at the Net Purchase Payment calculation for subsequent withdrawals, we determine the percentage by which the contract value is reduced, by taking the amount of the withdrawal in relation to the contract value immediately before the withdrawal. We then multiply the Net Purchase Payment calculation as determined prior to the withdrawal, by this percentage. We subtract that result from the Net Purchase Payment calculation as determined prior to the withdrawal to arrive at all subsequent Net Purchase Payment calculations. The term "withdrawals" as used in describing the death benefit options is defined as withdrawals and the fees and charges applicable to those withdrawals. If you purchased your contract on or after March 14, 2005, the following death benefits are available: STANDARD DEATH BENEFIT If your contract is issued prior to your 83rd birthday, the standard death benefit is the greater of: 1. Contract value; or 2. Net Purchase Payments received prior to your 86th birthday. If the contract is issued on or after your 83rd birthday but prior to your 86th birthday, the standard death benefit on your contract is the greater of: 1. Contract value; or 2. The lesser of: a. Net Purchase Payments received prior to your 86th birthday; or b. 125% of contract value. OPTIONAL ENHANCED DEATH BENEFIT(S) You may elect one of the optional enhanced death benefits below, for an additional fee, which may provide greater protection for your beneficiaries. You must choose either Option 1 or Option 2 at the time you purchase your contract and you cannot change your election at any time. The annualized fee for the enhanced death benefit is 0.15% of the average daily net asset value of the contract. 27 OPTION 1 -- ACCUMULATION OPTION If the contract is issued prior to your 75th birthday, the death benefit is the greatest of: 1. Contract value; or 2. Net Purchase Payments, compounded at 3% annual growth rate to the earlier of your 75th birthday or on date of death plus Net Purchase Payments received after your 75th birthday but prior to your 86th birthday; or 3. Contract value on the seventh contract anniversary, adjusted for withdrawals since the seventh contract anniversary in the same proportion that the contract value was reduced on the date of such withdrawal, plus Net Purchase Payments received after the seventh contract anniversary but prior to your 86th birthday. The Accumulation Option can only be elected prior to your 75th birthday. OPTION 2 -- MAXIMUM ANNIVERSARY VALUE OPTION If the contract is issued prior to your 83rd birthday, the death benefit is the greatest of: 1. Contract value; or 2. Net Purchase Payments received prior to your 86th birthday; or 3. Maximum anniversary value on any contract anniversary prior to your 83rd birthday. The anniversary values equal the contract value on a contract anniversary plus any Purchase Payments since that anniversary but prior to your 86th birthday; and adjusted for any withdrawals since that contract anniversary in the same proportion that the withdrawal reduced the contract value on the date of the withdrawal. The Maximum Anniversary Value option can only be elected prior to your 83rd birthday. If you die on or after your 90th birthday, the Standard Death Benefit may provide more value to your beneficiaries than the Maximum Anniversary Value option. Under the Maximum Anniversary Value option, if you die on or after your 90th birthday the death benefit is equal to your contract value. However, if you had elected the Standard Death Benefit option and you die on or after your 90th birthday, your beneficiaries would receive the greater of contract value or Net Purchase Payments received prior to your 86th birthday. Further, there is no additional charge for the Standard Death Benefit and there is an additional charge for the Maximum Anniversary Value option. You should discuss the death benefit options with your financial representative prior to making an election. If you purchased your contract prior to March 14, 2005, please see the Statement of Additional Information for the death benefits applicable to your contract. OPTIONAL EARNINGS ADVANTAGE Earnings Advantage benefit, an optional feature of your contract, may increase the death benefit amount if you have earnings in your contract at the time of death. In order to elect Earnings Advantage, you must have also elected one of the optional enhanced death benefits described above. If you elect this feature, we will deduct daily a fee of 0.25% of your average daily net asset value allocated to the Variable Portfolios. Earnings Advantage is not available if you are age 81 or older at the time we issue your contract. You must elect Earnings Advantage at the time we issue your contract and you may not terminate or change this election. A Continuing Spouse cannot continue the contract with Earnings Advantage if they are age 81 or older on the Continuation Date. See SPOUSAL CONTINUATION section of the prospectus. Furthermore, Earnings Advantage benefit is not payable after the Latest Annuity Date. You may pay for the Earnings Advantage feature and your beneficiary may never receive the benefit if you live past the Latest Annuity Date. We will add a percentage of your contract earnings (the "Earnings Advantage Percentage"), subject to a maximum dollar amount (the "Maximum Earnings Advantage Benefit"), to the death benefit payable. The 28 contract year of your death will determine the Earnings Advantage Percentage and the Maximum Earnings Advantage Benefit. The table below provides the details if we issue your contract prior to your 70th birthday:
- ------------------------------------------------------------------------------------------------------------------ EARNINGS ADVANTAGE MAXIMUM CONTRACT YEAR OF DEATH PERCENTAGE EARNINGS ADVANTAGE PERCENTAGE - ------------------------------------------------------------------------------------------------------------------ Years 0 - 4 25% of Earnings 40% of Net Purchase Payments - ------------------------------------------------------------------------------------------------------------------ Years 5 - 9 40% of Earnings 65% of Net Purchase Payments* - ------------------------------------------------------------------------------------------------------------------ Years 10+ 50% of Earnings 75% of Net Purchase Payments* - ------------------------------------------------------------------------------------------------------------------
The table below provides the details if we issue your contract on or after your 70th birthday but prior to your 81st birthday:
- ------------------------------------------------------------------------------------------------------------------ EARNINGS ADVANTAGE MAXIMUM CONTRACT YEAR OF DEATH PERCENTAGE EARNINGS ADVANTAGE PERCENTAGE - ------------------------------------------------------------------------------------------------------------------ All contract Years 25% of Earnings 40% of Net Purchase Payments* - ------------------------------------------------------------------------------------------------------------------
* Purchase Payments received after the 5th contract anniversary must remain in the contract for at least 6 full months to be included as part of Net Purchase Payments for the purpose of the Maximum Earnings Advantage benefit. What is the Contract Year of Death? Contract Year of Death is the number of full 12 month periods during which you have owned your contract ending on the date of death. Your Contract Year of Death is used to determine the Earnings Advantage Percentage and Maximum Estate Plus Benefit as indicated in the table above. What is the Earnings Advantage Percentage? We determine the Earnings Advantage benefit using the Estate Plus Percentage, as indicated on the table above, which is a specified percentage of the earnings in your contract at the time of your death. For the purpose of this calculation, earnings equals contract value minus Net Purchase Payments as of the date of your death. If there are no earnings in your contract at the time of your death, the amount of your Earnings Advantage benefit will be zero. What is the Maximum Earnings Advantage Benefit? The Earnings Advantage benefit is subject to a maximum dollar amount. The maximum Earnings Advantage Benefit is equal to a specified percentage of your Net Purchase Payments, as indicated in the table above. Earnings Advantage may not be available in your state or through the broker-dealer with which your financial representative is affiliated. Contact your financial representative for information regarding availability. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE EARNINGS ADVANTAGE (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME FOR PROSPECTIVELY ISSUED CONTRACTS. SPOUSAL CONTINUATION If you are the original owner of the contract and the Beneficiary is your spouse, your spouse may elect to continue the contract after your death. The spouse becomes the new owner ("Continuing Spouse"). Generally, the contract and its elected features, if any, remain the same. The Continuing Spouse is subject to the same fees, charges and expenses applicable to the original owner of the contract. A spousal continuation can only take place upon the death of the original owner of the contract. Upon a spouse's continuation of the contract, we will contribute to the contract value an amount by which the death benefit that would have been paid to the beneficiary upon the death of the original owner, exceeds the 29 contract value ("Continuation Contribution"), if any. We calculate the Continuation Contribution as of the date of the original owner's death. We will add the Continuation Contribution as of the date we receive both the Continuing Spouse's written request to continue the contract and proof of death of the original owner in a form satisfactory to us ("Continuation Date"). If a Continuation Contribution is added to the contract value, the age of the Continuing Spouse on the Continuation Date and on the date of the Continuing Spouse's death will be used in determining any future death benefits under the Contract. The Continuation Contribution is not considered a Purchase Payment for the purposes of any other calculations except as explained in Appendix B. To the extent that the Continuing Spouse invests in the Variable Portfolios, they will be subject to investment risk as was the original owner. Generally, the Continuing Spouse cannot change any contract provisions as the new owner. However, on the Continuation Date, the Continuing Spouse may terminate the original owner's election of the Estate Rewards and the available death benefit will be the Standard Death Benefit. The Continuing Spouse cannot elect to continue Earnings Advantage without also continuing the Estate Rewards. If a Continuing Spouse is age 81 or older on the Continuation Date, then the death benefit will be the contract value. We will terminate Estate Rewards if the Continuing Spouse is 81 or older on the Continuation Date. If Estate Rewards is continued and the Continuing Spouse dies after the latest Annuity Date, and the 5% Accumulation option was selected, the death benefit will be the Standard Death Benefit. If the Maximum Anniversary value option was selected and the Continuing Spouse lives to age 90 or older, the death benefit will be the contract value. However, if death occurs before the latest annuity date, the Continuing Spouse will still benefit from the Earnings Advantage. Generally, the age of the Continuing Spouse on the Continuation Date (if any Continuation Contribution has been made) and on the date of the Continuing Spouse's death will be used in determining any future death benefits under the Contract. If no Continuation Contribution has been made to the contract on the Continuation Date, the age of the spouse on the date of the original contract issue will be used to determine any age-driven benefits. SEE THE DEATH BENEFITS FOLLOWING SPOUSAL CONTINUATION APPENDIX FOR A DISCUSSION OF THE DEATH BENEFIT CALCULATIONS AFTER A SPOUSAL CONTINUATION. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE SPOUSAL CONTINUATION PROVISION (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME FOR PROSPECTIVELY ISSUED CONTRACTS. EXPENSES - -------------------------------------------------------------------------------- There are fees and expenses associated with your contract which reduce your investment return. We will not increase the contract level fees, such as mortality and expense charges or withdrawal charges for the life of your contract. Underlying Fund fees may increase or decrease. Some states may require that we charge less than the amounts described below. SEPARATE ACCOUNT CHARGES The mortality and expense risk charge and distribution expense charge is 1.55% annually of the average daily ending net asset value allocated to the Variable Portfolios. This charge compensates the Company for the mortality and expense risk and the costs of contract distribution assumed by the Company. Generally, the mortality risks assumed by the Company arise from its contractual obligations to make income payments after the Annuity Date and to provide a death benefit. The expense risk assumed by the Company is that the costs of administering the contracts and the Separate Account will exceed the amount received from the administrative fees and charges assessed under the contract. If these charges do not cover all of our expenses, we will pay the difference. Likewise, if these charges exceed our expenses, we will keep the difference. The mortality and expense risk charge is expected to result in a profit. Profit may be used for any legitimate cost or expense including supporting distribution, depending upon market conditions. SEE PAYMENTS IN CONNECTION WITH DISTRIBUTION OF THE CONTRACT BELOW. 30 WITHDRAWAL CHARGES The contract provides a free withdrawal amount every year. SEE ACCESS TO YOUR MONEY ABOVE. You may incur a withdrawal charge if you take a withdrawal in excess of the free withdrawal amount and/or if you fully surrender your contract. We apply a withdrawal charge against each Purchase Payment you contribute to the contract. After a Purchase Payment has been in the contract for [921 TO COME] complete years, a withdrawal charge no longer applies to that Purchase Payment. The withdrawal charge percentage declines each year a Purchase Payment is in the contract. The withdrawal charge schedule is as follows:
YEAR 1 2 3 4 - ----------------- ---- ---- ---- ---- Withdrawal Charge 7% 6% 6% 0%
When calculating the withdrawal charge, we treat withdrawals as coming first from the Purchase Payments that have been in your contract the longest. However, for tax purposes, your withdrawals are considered as coming from earnings first, then Purchase Payments. SEE ACCESS TO YOUR MONEY ABOVE. Whenever possible, we deduct the withdrawal charge from the money remaining in your contract. If you fully surrender your contract value, we deduct any applicable withdrawal charges from the amount surrendered. We will not assess a withdrawal charge when we pay a death benefit, contract fees and/or when you switch to the Income Phase. Withdrawals made prior to age 59 1/2 may result in tax penalties. SEE TAXES BELOW. UNDERLYING FUND EXPENSES Investment Management Fees The Separate Account purchases shares of the Underlying Funds. The Accumulation Unit value for each Variable Portfolio reflects the investment management fees and other expenses of the Underlying Funds. 12b-1 Fees Shares of certain Trusts may be subject to fees imposed under a servicing plan adopted by that Trust pursuant to Rule 12b-1 of the Investment Company Act of 1940. There is an annualized 0.15% fee applicable to the Anchor and SunAmerica Series Trust portfolios and 0.25% for the Van Kampen Life Investment Trust and WM Variable Trust this amount is generally used to pay financial intermediaries for services provided over the life of the contract. SEE FEE TABLE ABOVE. FOR MORE DETAILED INFORMATION ON THESE UNDERLYING FUND FEES, REFER TO THE PROSPECTUSES FOR THE TRUSTS. CONTRACT MAINTENANCE FEE During the Accumulation Phase, we deduct a contract maintenance fee of $35 from your contract once per year on your contract anniversary. This charge compensates us for the cost of administering your contract. We will deduct the contract maintenance fee on a pro-rata basis from your contract value on your contract anniversary. If you withdraw your entire contract value, we will deduct the contract maintenance fee from that withdrawal. If your contract value is $50,000 or more on your contract anniversary date, we are currently waiving this fee. This waiver is subject to change without notice. TRANSFER FEE Generally, we permit 15 free transfers between investment options each contract year. We charge you $25 for each additional transfer that contract year. SEE TRANSFERS DURING THE ACCUMULATION PHASE ABOVE. 31 OPTIONAL DIVERSIFIED STRATEGIES INCOME REWARDS FEE The annualized Diversified Strategies Income Rewards fee will be assessed as a percentage of the Withdrawal Benefit Base. The fee will be deducted quarterly from your contract value starting on the first quarter following the contract issue date and ending upon the termination of the feature. If your contract value falls to zero before the feature has been terminated, the fee will no longer be assessed. We will not assess the quarterly fee if you surrender or annuitize before the end of a quarter. The fee is as follows:
CONTRACT YEAR ANNUALIZED FEE - ------------- -------------- 0-7 years 0.65% of Withdrawal Benefit Base 8-10 years 0.45% of Withdrawal Benefit Base 11+ none
OPTIONAL CAPITAL PROTECTOR FEE The annualized Capital Protector fee is calculated as a percentage of your contract value minus Purchase Payments received after the 90th day since contract issue date. If you elect the feature, the charge is deducted at the end of the first contract quarter and quarterly thereafter from your contract value. The fee is as follows:
CONTRACT YEAR ANNUALIZED FEE - ------------- -------------- 0-5 0.65% 6-10 0.45% 11+ none
OPTIONAL ENHANCED DEATH BENEFIT FEE The fee for the optional enhanced death benefit is 0.15% of the average daily ending net asset value allocated to the Variable Portfolio. OPTIONAL EARNINGS ADVANTAGE FEE The fee for Earnings Advantage is 0.25% of the average daily ending net asset value allocated to the Variable Portfolio. PREMIUM TAX Certain states charge the Company a tax on Purchase Payments up to a maximum of 3.5%. We deduct these premium tax charges when you fully surrender your contract or begin the Income Phase. In the future, we may deduct this premium tax at the time you make a Purchase Payment or upon payment of a death benefit. INCOME TAXES We do not currently deduct income taxes from your contract. We reserve the right to do so in the future. REDUCTION OR ELIMINATION OF FEES, EXPENSES AND ADDITIONAL AMOUNTS CREDITED Sometimes sales of contracts to groups of similarly situated individuals may lower our fees and expenses. We reserve the right to reduce or waive certain fees and expenses when this type of sale occurs. In addition, we may also credit additional amounts to contracts sold to such groups. We determine which groups are eligible for this treatment. Some of the criteria we evaluate to make a determination are size of the group; amount of expected Purchase Payments; relationship existing between us and the prospective purchaser; length of time a group of contracts is expected to remain active; purpose of the purchase and whether that purpose increases the likelihood that our expenses will be reduced; and/or any other factors that we believe indicate that fees and expenses may be reduced. 32 The Company may make such a determination regarding sales to its employees, it affiliates' employees and employees of currently contracted broker-dealers; its registered representatives; and immediate family members of all of those described. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE ANY SUCH DETERMINATION OR THE TREATMENT APPLIED TO A PARTICULAR GROUP AT ANY TIME. INCOME OPTIONS - -------------------------------------------------------------------------------- ANNUITY DATE During the Income Phase, the money in your Contract is used to make regular income payments to you. You may switch to the Income Phase any time after your second contract anniversary. You select the month and year in which you want income payments to begin. The first day of that month is the Annuity Date. You may change your Annuity Date, so long as you do so at least seven days before the income payments are scheduled to begin. Once you begin receiving income payments, you cannot change your Income Option. Except as discussed under Option 5, once you begin receiving income payments, you cannot otherwise access your money through a withdrawal or surrender. Other pay out options may be available. Contact our Annuity Service Center for more information. Income payments must begin on or before your 95th birthday or on your tenth contract anniversary, whichever occurs later. If you do not choose an Annuity Date, your income payments will automatically begin on this date (latest Annuity Date). Certain states may require your income payments to start earlier. If the Annuity Date is past your 85th birthday, your contract could lose its status as an annuity under Federal tax laws. This may cause you to incur adverse tax consequences. In addition, certain Qualified contracts require you to take minimum distributions after you reach age 70 1/2. SEE TAXES BELOW. INCOME OPTIONS Currently, this Contract offers five Income Options. Other annuity options may be available. Please check with the Annuity Service Center for details. If you elect to receive income payments but do not select an option, your income payments will be made in accordance with Option 4 for a period of 10 years. For income payments selected for joint lives, we pay according to Option 3. We base our calculation of income payments on the life of the Annuitant and the annuity rates set forth in your contract. As the contract owner, you may change the Annuitant at any time prior to the Annuity Date. You must notify us if the Annuitant dies before the Annuity Date and then designate a new Annuitant. OPTION 1 - LIFE INCOME ANNUITY This option provides income payments for the life of the Annuitant. Income payments stop when the Annuitant dies. OPTION 2 - JOINT AND SURVIVOR LIFE ANNUITY This option provides income payments for the life of the Annuitant and for the life of another designated person. Upon the death of either person, we will continue to make income payments during the lifetime of the survivor. Income payments stop whenever the survivor dies. OPTION 3 - JOINT AND 100% SURVIVOR LIFE ANNUITY WITH 10 OR 20 YEAR PERIOD CERTAIN This option is similar to Option 2 above, with an additional guarantee of payments for at least 10 or 20 years. If the Annuitant and the Survivor die before all of the payments have been made, the remaining payments are made to the Beneficiary under your Contract. 33 OPTION 4 - LIFE ANNUITY WITH 10 OR 20 YEAR PERIOD CERTAIN This option is similar to Option 1 above. In addition, this option provides a guarantee that income payments will be made for at least 10 or 20 years. You select the number of years. If the Annuitant dies before all guaranteed income payments are made, the remaining income payments go to the Beneficiary under your Contract. OPTION 5 - INCOME FOR A SPECIFIED PERIOD This option provides income payments for a guaranteed period ranging from 5 to 30 years. If the Annuitant dies before all the guaranteed income payments are made, the remaining income payments are made to the Beneficiary under your contract. Additionally, if variable income payments are elected under this option, you (or the Beneficiary under the contract if the Annuitant dies prior to all guaranteed payments being made) may redeem the contract value (in full or in part) after the Annuity Date. The amount available upon such redemption would be the discounted present value of any remaining guaranteed payments. The value of an Annuity Unit, regardless of the option chosen, takes into account the mortality and expense risk charge. Since Option 5 does not contain an element of mortality risk, no benefit is derived from this charge. We make income payments on a monthly, quarterly, semi-annual or annual basis. You instruct us to send you a check or to have the payments direct deposited into your bank account. If state law allows, we distribute annuities with a contract value of $5,000 or less in a lump sum. Also, if the selected income option results in annuity payments of less than $50 per payment, we may decrease the frequency of the payments, state law allowing. ALLOCATION OF ANNUITY PAYMENTS You can choose income payments that are fixed, variable or both. If payments are fixed, AIG SunAmerica Life guarantees the amounts of each payment. If the payments are variable, the amounts are not guaranteed. They will go up and/or down based upon the performance of the Variable Portfolio(s) in which you invest. FIXED OR VARIABLE INCOME PAYMENTS Unless otherwise elected, if at the date when income payments begin you are invested in the Variable Portfolio(s) only, your income payments will be variable and your money is only in fixed accounts at that time, your income payments will be fixed in amount. If you are invested in both fixed and variable options at the time you begin the Income Phase, a portion of your income payments will be fixed and a portion will be variable, unless otherwise elected. INCOME PAYMENTS Your income payments will vary if you are invested in the Variable Portfolio(s) after the Annuity date depending on four factors: - for life options, your age when payments begin, and in most states, if a Non-Qualified Contract, your gender; - the value of your contract in the Variable Portfolio(s) on the Annuity Date; - the 3.5% assumed investment rate ("AIR") for variable income payments used in the annuity table for the contract; and; - the performance of the Variable Portfolio(s) in which you are invested during the time you receive income payments. If you are invested in both the fixed account options and the Variable Portfolio(s) after the Annuity Date, the allocation of funds between the fixed accounts and Variable Portfolio(s) also impacts the amount of your annuity payments. The value of variable income payments, if elected, is based on the assumed AIR of 3.5% compounded annually. Variable income payments generally increase or decrease from one income payment date to the next based upon 34 the performance of the applicable Variable Portfolios. If the performance of the Variable Portfolios selected is equal to the AIR, the income payments will remain constant. If performance of Variable Portfolios is greater than the AIR, the income payments will increase and if it is less than the AIR, the income payments will decline. TRANSFERS DURING THE INCOME PHASE During the Income Phase, one transfer per month is permitted between the Variable Portfolios. No other transfers are allowed during the Income Phase. DEFERMENT OF PAYMENTS We may defer making fixed payments for up to six months, or less if required by law. Interest is credited to you during the deferral period. Please read the Statement of Additional Information, available upon request, for a more detailed discussion of the income options. See also ACCESS TO YOUR MONEY above for a discussion of when payments from a Variable Portfolio may be suspended or postponed. TAXES - -------------------------------------------------------------------------------- NOTE: THE BASIC SUMMARY BELOW ADDRESSES BROAD FEDERAL TAXATION MATTERS, AND GENERALLY DOES NOT ADDRESS STATE TAXATION ISSUES OR QUESTIONS. IT IS NOT TAX ADVICE. WE CAUTION YOU TO SEEK COMPETENT TAX ADVICE ABOUT YOUR OWN CIRCUMSTANCES. WE DO NOT GUARANTEE THE TAX STATUS OF YOUR ANNUITY. TAX LAWS CONSTANTLY CHANGE; THEREFORE, WE CANNOT GUARANTEE THAT THE INFORMATION CONTAINED HEREIN IS COMPLETE AND/OR ACCURATE. WE HAVE INCLUDED AN ADDITIONAL DISCUSSION REGARDING TAXES IN THE STATEMENT OF ADDITIONAL INFORMATION. ANNUITY CONTRACTS IN GENERAL The Internal Revenue Code ("IRC") provides for special rules regarding the tax treatment of annuity contracts. Generally, taxes on the earnings in your annuity contract are deferred until you take the money out. Qualified retirement investments that satisfy specific tax and ERISA requirements automatically provide tax deferral regardless of whether the underlying contract is an annuity, a trust, or a custodial account. Different rules apply depending on how you take the money out and whether your contract is Qualified or Non-Qualified. If you do not purchase your contract under a pension plan, a specially sponsored employer program or an individual retirement account, your contract is referred to as a Non-Qualified contract. A Non-Qualified contract receives different tax treatment than a Qualified contract. In general, your cost in a Non-Qualified contract is equal to the Purchase Payments you put into the contract. You have already been taxed on the cost basis in your contract. If you purchase your contract under a pension plan, a specially sponsored employer program or as an individual retirement account, your contract is referred to as a Qualified contract. Examples of qualified plans or arrangements are: Individual Retirement Accounts ("IRAs"), Roth IRAs, Tax-Sheltered Annuities (referred to as 403(b) contracts), plans of self-employed individuals (often referred to as H.R. 10 Plans or Keogh Plans) and pension and profit sharing plans, including 401(k) plans. Typically, for employer plans and tax-deductible IRA contributions, you have not paid any tax on the Purchase Payments used to buy your contract and therefore, you have no cost basis in your contract. However, you normally will have cost basis in a Roth IRA, and you may have cost basis in a traditional IRA or in another Qualified Contract. TAX TREATMENT OF DISTRIBUTIONS--NON-QUALIFIED CONTRACTS If you make a partial or total withdrawal from a Non-Qualified contract, the IRC treats such a withdrawal as first coming from the earnings and then as coming from your Purchase Payments. Purchase payments made prior to August 14, 1982, however, are an important exception to this general rule, and for tax purposes are treated as being distributed before the earnings on those contributions. If you annuitize your contract, a portion of each income payment will be considered, for tax purposes, to be a return of a portion of your Purchase Payment(s). Any portion 35 of each income payment that is considered a return of your Purchase Payment will not be taxed. Withdrawn earnings are treated as income to you and are taxable. The IRC provides for a 10% penalty tax on any earnings that are withdrawn other than in conjunction with the following circumstances: (1) after reaching age 59 1/2; (2) when paid to your Beneficiary after you die; (3) after you become disabled (as defined in the IRC); (4) when paid in a series of substantially equal periodic payments calculated over your life or for the joint lives of you and your Beneficiary for a period of 5 years or attainment of age 59 1/2, whichever is longer; (5) under an immediate annuity; or (6) which are attributable to Purchase Payments made prior to August 14, 1982. TAX TREATMENT OF DISTRIBUTIONS--QUALIFIED CONTRACTS (INCLUDING GOVERNMENTAL 457(b) ELIGIBLE DEFERRED COMPENSATION PLANS) Generally, you have not paid any taxes on the Purchase Payments used to buy a Qualified contract. As a result, with certain limited exceptions, any amount of money you take out as a withdrawal or as income payments is taxable income. In the case of certain Qualified contracts, the IRC further provides for a 10% penalty tax on any taxable withdrawal or income payment paid to you other than in conjunction with the following circumstances: (1) after reaching age 59 1/2; (2) when paid to your Beneficiary after you die; (3) after you become disabled (as defined in the IRC); (4) in a series of substantially equal periodic payments calculated over your life or for the joint lives of you and your Beneficiary, that begins after separation from service with the employer sponsoring the plan and continued for a period of 5 years until you attain age 59 1/2, whichever is longer; (5) to the extent such withdrawals do not exceed limitations set by the IRC for deductible amounts paid during the taxable year for medical care; (6) to fund higher education expenses (as defined in the IRC; only from an IRA); (7) to fund certain first-time home purchase expenses (only from an IRA); (8) when you separate from service after attaining age 55 (does not apply to an IRA); (9) when paid for health insurance, if you are unemployed and meet certain requirements; and (10) when paid to an alternate payee pursuant to a qualified domestic relations order (does not apply to IRAs). This 10% penalty tax does not apply to withdrawals or income payments from governmental 457(b) eligible deferred compensation plans, except to the extent that such withdrawals or income payments are attributable to a prior rollover to the plan (or earnings thereon) from another plan or arrangement that was subject to the 10% penalty tax. The IRC limits the withdrawal of an employee's voluntary Purchase Payments from a Tax-Sheltered Annuity (TSA). Withdrawals can only be made when an owner: (1) reaches age 59 1/2; (2) severs employment with the employer; (3) dies; (4) becomes disabled (as defined in the IRC); or (5) experiences a financial hardship (as defined in the IRC). In the case of hardship, the owner can only withdraw Purchase Payments. Additional plan limitations may also apply. Amounts held in a TSA annuity contract as of December 31, 1988 are not subject to these restrictions. Qualifying transfers of amounts from one TSA contract to another TSA contract under section 403(b) or to a custodial account under section 403(b)(7), and qualifying transfers to a state defined benefit plan to purchase service credits, are not considered distributions, and thus are not subject to these withdrawal limitations. If amounts are transferred from a custodial account described in Code section 403(b)(7) to this contract the transferred amount will retain the custodial account withdrawal restrictions. Withdrawals from other Qualified Contracts are often limited by the IRC and by the employer's plan. MINIMUM DISTRIBUTIONS Generally, the IRC requires that you begin taking annual distributions from qualified annuity contracts by April 1 of the calendar year following the later of (1) the calendar year in which you attain age 70 1/2 or (2) the calendar year in which you separate from service from the employer sponsoring the plan. If you own an IRA, you must begin taking distributions when you attain age 70 1/2. If you own more than one TSA, you may be permitted to take your annual distributions in any combination from your TSAs. A similar rule applies if you own more than one IRA. However, you cannot satisfy this distribution requirement for your TSA contract by taking a distribution from an IRA, and you cannot satisfy the requirement for your IRA by taking a distribution from a TSA. You may be subject to a surrender charge on withdrawals taken to meet minimum distribution requirements, if the withdrawals exceed the contract's maximum penalty free amount. 36 Failure to satisfy the minimum distribution requirements may result in a tax penalty. You should consult your tax advisor for more information. You may elect to have the required minimum distribution amount on your contract calculated and withdrawn each year under the automatic withdrawal option. You may select monthly, quarterly, semiannual, or annual withdrawals for this purpose. This service is provided as a courtesy and we do not guarantee the accuracy of our calculations. Accordingly, we recommend you consult your tax advisor concerning your required minimum distribution. You may terminate your election for automated minimum distribution at any time by sending a written request to our Annuity Service Center. We reserve the right to change or discontinue this service at any time. The IRS issued regulations, effective January 1, 2003, regarding required minimum distributions from qualified annuity contracts. One of the regulations effective January 1, 2006 will require that the annuity contract value used to determine required minimum distributions include the actuarial value of other benefits under the contract, such as optional death benefits. This regulation does not apply to required minimum distributions made under an irrevocable annuity income option. Generally, we are currently awaiting further clarification from the IRS on this regulation, including how the value of such benefits is determined. You should discuss the effect of these new regulations with your tax advisor. TAX TREATMENT OF DEATH BENEFITS Any death benefits paid under the contract are taxable to the Beneficiary. The rules governing the taxation of payments from an annuity contract, as discussed above, generally apply whether the death benefits are paid as lump sum or annuity payments. Estate taxes may also apply. Certain enhanced death benefits may be purchased under your contract. Although these types of benefits are used as investment protection and should not give rise to any adverse tax effects, the IRS could take the position that some or all of the charges for these death benefits should be treated as a partial withdrawal from the contract. In that case, the amount of the partial withdrawal may be includible in taxable income and subject to the 10% penalty if the owner is under 59 1/2. If you own a Qualified contract and purchase these enhanced death benefits, the IRS may consider these benefits "incidental death benefits." The IRC imposes limits on the amount of the incidental death benefits allowable for Qualified contracts. If the death benefit(s) selected by you are considered to exceed these limits, the benefit(s)could result in taxable income to the owner of the Qualified contract. Furthermore, the IRC provides that the assets of an IRA (including a Roth IRA) may not be invested in life insurance, but may provide, in the case of death during the Accumulation Phase, for a death benefit payment equal to the greater of Purchase Payments or Contract Value. This contract offers death benefits, which may exceed the greater of Purchase Payments or Contract Value. If the IRS determines that these benefits are providing life insurance, the contract may not qualify as an IRA (including Roth IRAs). You should consult your tax advisor regarding these features and benefits prior to purchasing a contract. CONTRACTS OWNED BY A TRUST OR CORPORATION A Trust or Corporation ("Non-Natural Owner") that is considering purchasing this contract should consult a tax advisor. Generally, the IRC does not treat a Non-Qualified contract owned by a non-natural owner as an annuity contract for Federal income tax purposes. The non-natural owner pays tax currently on the contract's value in excess of the owner's cost basis. However, this treatment is not applied to a contract held by a trust or other entity as an agent for a natural person nor to contracts held by Qualified Plans. See the SAI for a more detailed discussion of the potential adverse tax consequences associated with non-natural ownership of a non-qualified annuity contract. GIFTS, PLEDGES AND/OR ASSIGNMENTS OF A CONTRACT If you transfer ownership of your Non-Qualified contract to a person other than your spouse (or former spouse incident to divorce) as a gift you will pay federal income tax on the contract's cash value to the extent it exceeds your cost basis. The recipient's cost basis will be increased by the amount on which you will pay federal taxes. In 37 addition, the IRC treats any assignment or pledge (or agreement to assign or pledge) of any portion of a Non-Qualified contract as a withdrawal. See the SAI for a more detailed discussion regarding potential tax consequences of gifting, assigning, or pledging a Non-Qualified contract. The IRC prohibits Qualified annuity contracts including IRAs from being transferred, assigned or pledged as security for a loan. This prohibition, however, generally does not apply to loans under an employer-sponsored plan (including loans from the annuity contract) that satisfy certain requirements, provided that: (a) the plan is not an unfunded deferred compensation plan; and (b) the plan funding vehicle is not an IRA. DIVERSIFICATION AND INVESTOR CONTROL The IRC imposes certain diversification requirements on the underlying investments for a variable annuity. We believe that the management of the Underlying Funds monitors the Funds so as to comply with these requirements. To be treated as a variable annuity for tax purposes, the underlying investments must meet these requirements. The diversification regulations do not provide guidance as to the circumstances under which you, and not the Company, would be considered the owner of the shares of the Variable Portfolios under your Non-Qualified Contract, because of the degree of control you exercise over the underlying investments. This diversification requirement is sometimes referred to as "investor control." It is unknown to what extent owners are permitted to select investments, to make transfers among Variable Portfolios or the number and type of Variable Portfolios owners may select from. If any guidance is provided which is considered a new position, then the guidance should generally be applied prospectively. However, if such guidance is considered not to be a new position, it may be applied retroactively. This would mean that you, as the owner of the Non-qualified Contract, could be treated as the owner of the underlying Variable Portfolios. Due to the uncertainty in this area, we reserve the right to modify the contract in an attempt to maintain favorable tax treatment. These investor control limitations generally do not apply to Qualified Contracts, which are referred to as "Pension Plan Contracts" for purposes of this rule, although the limitations could be applied to Qualified Contracts in the future. OTHER INFORMATION - -------------------------------------------------------------------------------- THE SEPARATE ACCOUNT The Company established the Separate Account, Variable Separate Account, under Arizona law on January 1, 1996 when it assumed the Separate Account, originally established under California law on June 25, 1981. The Separate Account is registered with the SEC as a unit investment trust under the Investment Company Act of 1940, as amended. The Company owns the assets in the Separate Account. However, the assets in the Separate Account are not chargeable with liabilities arising out of any other business conducted by the Company. Income gains and losses (realized and unrealized) resulting from assets in the Separate Account are credited to or charged against the Separate Account without regard to other income gains or losses of the Company. THE GENERAL ACCOUNT Money allocated to any Fixed Accounts goes into the Company's general account. The general account consists of all of the company's assets other than assets attributable to a Separate Account. All of the assets in the general account are chargeable with the claims of any of the Company's contract holders as well as all of its creditors. The general account funds are invested as permitted under state insurance laws. The Company has a support agreement in effect between the Company and its ultimate parent company, American International Group, Inc. ("AIG"), and the Company's insurance policy obligations are guaranteed by American Home Assurance Company, a subsidiary of AIG. See the Statement of Additional Information for more information regarding these arrangements. 38 REGISTRATION STATEMENTS Registration statements under the Securities Act of 1933, as amended, related to the contracts offered by this prospectus are on file with the SEC. This prospectus does not contain all of the information contained in the registration statements and exhibits. For further information regarding the Separate Account, the Company and its general account, the Variable Portfolios and the contract, please refer to the registration statements and exhibits. PAYMENTS IN CONNECTION WITH DISTRIBUTION OF THE CONTRACT Payments to Broker-Dealers Registered representatives of broker-dealers sell the contract. We pay commissions to the broker-dealers for the sale of your contract ("Contract Commissions"). There are different structures by which a broker-dealer can choose to have their Contract Commissions paid. For example, as one option, we may pay upfront Contract Commission only, that may be up to a maximum 6.0% of each Purchase Payment you invest (which may include promotional amounts). Another option may be a lower upfront Contract Commission on each Purchase Payment, with a trail commission of up to a maximum 1.50% of contract value annually. Generally, the higher the upfront commissions, the lower the trail and vice versa. We pay Contract Commissions directly to the broker-dealer with whom your registered representative is affiliated. Registered representatives may receive a portion of these amounts we pay in accordance with any agreement in place between the registered representative and his/her broker-dealer firm. We may pay broker-dealers support fees in the form of additional cash or non-cash compensation. These payments may be intended to reimburse for specific expenses incurred or may be based on sales, certain assets under management, longevity of assets invested with us or a flat fee. These payments may be consideration for, among other things, product placement/preference, greater access to train and educate the firm's registered representatives about our products, our participation in sales conferences and educational seminars and allowing broker-dealers to perform due diligence on our products. The amount of these fees may be tied to the anticipated level of our access in that firm. We enter into such arrangements in our discretion and we may negotiate customized arrangements with firms, including affiliated and non-affiliated broker-dealers based on various factors. We do not deduct these amounts directly from your Purchase Payments. We anticipate recovering these amounts from the fees and charges collected under the contract. Contract commissions and other support fees may influence the way that a broker-dealer and its registered representatives market the contracts and service customers who purchase the contracts and may influence the broker-dealer and its registered representatives to present this contract over others available in the market place. You should discuss with your broker-dealer and/or registered representative how they are compensated for sales of a contract and/or any resulting real or perceived conflicts of interest. WM Funds Distributor, 1201 Third Avenue, 22nd Floor, Seattle, Washington 98101, distributes the contracts. WM Funds Distributor is a registered as a broker-dealer under the Exchange Act of 1934 and a member of the National Association of Securities Dealers, Inc. No underwriting fees are paid in connection with the distribution of the contracts. Payments We Receive In addition to amounts received pursuant to established 12b-1 Plans from the Underlying Funds, we receive compensation of up to 0.50% annually based on assets under management from certain Trusts' investment advisers or their affiliates for services related to the availability of the Underlying Funds in the contract. We receive such payments in connection with each of the Trusts available in this Contract. Such amounts received from our affiliate, AIG SAAMCo, are paid pursuant to a profit sharing agreement and is not expected to exceed 0.50%. Furthermore, certain investment advisers and/or subadvisers may help offset the costs we incur for training to support sales of the Underlying Funds in the contract. 39 ADMINISTRATION We are responsible for the administrative servicing of your contract. Please contact our Annuity Service Center at (877) 311-WMVA (9682), if you have any comment, question or service request. We send out transaction confirmations and quarterly statements. During the Accumulation Phase, you will receive confirmation of transactions within your contract. Transactions made pursuant to contractual or systematic agreements, such as dollar cost averaging, may be confirmed quarterly. Purchase Payments received through the automatic payment plan or a salary reduction arrangement, may also be confirmed quarterly. For all other transactions, we send confirmations immediately. It is your responsibility to review these documents carefully and notify us of any inaccuracies immediately. We investigate all inquiries. To the extent that we believe we made an error, we retroactively adjust your contract, provided you notify us within 30 days of receiving the transaction confirmation or quarterly statement. Any other adjustments we deem warranted are made as of the time we receive notice of the error. LEGAL PROCEEDINGS There are no pending legal proceedings affecting the Separate Account. The Company and its subsidiaries are parties to various kinds of litigation incidental to their respective business operations. In management's opinion, these matters are not material in relation to the financial position of the Company with the exception of the matter disclosed below. A purported class action captioned Nitika Mehta, as Trustee of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case 04L0199, was filed on April 5, 2004 in the Circuit Court, Twentieth Judicial District in St. Clair County, Illinois. The action has been transferred to and is currently pending in the United States District Court for the District of Maryland, Case No. 04-md-15863, as part of a Multi-District Litigation proceeding. The lawsuit alleges certain improprieties in conjunction with alleged market timing activities. The probability of any particular outcome cannot be reasonably estimated at this time. AIG has announced that it has delayed filing its Annual Report on Form 10-K for the year ended December 31, 2004 to allow AIG's Board of Directors and new management adequate time to complete an extensive review of AIG's books and records. The review includes issues arising from pending investigations into non-traditional insurance products and certain assumed reinsurance transactions by the Office of the Attorney General for the State of New York and the Securities and Exchange Commission and from AIG's decision to review the accounting treatment of certain additional items. Circumstances affecting AIG can have an impact on the Company. For example, the recent downgrades and ratings actions taken by the major rating agencies with respect to AIG resulted in corresponding downgrades and ratings actions being taken with respect to the Company's ratings. Accordingly, we can give no assurance that any further changes in circumstances for AIG will not impact us. 40 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AIG SUNAMERICA LIFE ASSURANCE COMPANY - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AIG SunAmerica Life Assurance Company (the "Company") was incorporated as Anchor National Life Insurance Company under the laws of the State of Arizona on April 12, 1965 while the Company changed its name to AIG SunAmerica Life Assurance Company on January 24, 2002. The Company continued to do business as Anchor National Life Insurance Company until February 28, 2003, after which time it began doing business under its new name, AIG SunAmerica Life Assurance Company. 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 has no employees; however, employees of AIGRS and other affiliates of the Company perform various services for the Company. AIGRS had approximately 1,900 employees at December 31, 2004, approximately 1,100 of whom perform services for the Company as well as for certain of its affiliates. The Company's primary activities are retirement services, herein discussed as annuity operations and asset management operations. The annuity operations consist of the sale and administration of deposit-type insurance contracts, such as variable and fixed annuity contracts, universal life insurance contracts and guaranteed investment contracts ("GICs"). The asset management operations are conducted by the Company's registered investment advisor subsidiary, AIG SunAmerica Asset Management Corp ("SAAMCo"), and its wholly owned distributor, AIG SunAmerica Capital Services, Inc. ("SACS"), and its wholly owned servicing administrator, AIG SunAmerica Fund Services, Inc. ("SFS"). See Note 13 of Notes to the Consolidated Financial Statements for operating results by segment. The Company ranks among the largest U.S. issuers of variable annuity contracts. The Company distributes its products and services through an extensive network of independent broker-dealers, full-service securities firms and financial institutions. In prior years, GICs were marketed directly to banks, municipalities, asset management firms and direct plan sponsors and through intermediaries, such as managers or consultants servicing these groups. In addition to distributing its variable annuity products through its nine affiliated broker-dealers, the Company distributes its products through a vast network of independent broker-dealers, full-service securities firms and financial institutions. In total, more than 84,000 independent sales representatives are appointed to sell the Company's annuity products. The Company's nine affiliated broker-dealers are among the largest networks of registered representatives in the nation. Sales through affiliated broker-dealers accounted for approximately a quarter of the Company's total annuity sales in 2004. 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 51 million to 69 million from 1994 to 2003, making this age group the fastest-growing segment of the U.S. population. Between 1994 and 2003, annual industry premiums from fixed and variable annuities increased from $155 billion to $267 billion. Benefiting from continued strong growth of the retirement savings 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 life operations on the sale of variable annuity contracts. In recent years, the Company has enhanced its marketing efforts and expanded its offerings of fee-based variable annuity contracts. Variable accounts within the Company's variable annuity business entail no portfolio credit risk and requires significantly less capital support than the fixed accounts of variable annuity contracts ("Fixed Options"), which generate net investment income. F-1 The following table shows the Company's investment income, net realized investment losses and fee income for the year ended December 31, 2004 by primary product line or service: NET INVESTMENT AND FEE INCOME
AMOUNT PERCENT PRIMARY PRODUCT OR SERVICE --------- -------- ----------------------------------------- (IN THOUSANDS, EXCEPT FOR PERCENTAGES) Fee income: Variable annuity policy fees, net of reinsurance.......... $369,141 42.2% Variable annuity contracts Asset management fees..................................... 89,569 10.2 Asset management Universal life policy fees, net of reinsurance............ 33,899 3.9 Universal life products Surrender charges......................................... 26,219 3.0 Fixed and variable annuity contracts Other fees................................................ 15,753 1.8 Asset management -------- ----- Total fee income.......................................... 534,581 61.1 Investment income........................................... 363,594 41.6 Fixed annuity contracts and Fixed Options Net realized investment losses.............................. (23,807) (2.7) Fixed annuity contracts and Fixed Options -------- ----- Total net investment and fee income......................... $874,368 100.0% ======== =====
ANNUITY OPERATIONS - SEPARATE ACCOUNT The annuity operations principally engaged in the business of issuing variable annuity contracts directed to the market for tax-deferred, long-term savings products. It also administers closed blocks of fixed annuity contracts, universal life insurance contracts and GICs directed to the institutional marketplace. The Company's variable annuity products offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as Fixed Options. The Company earns fees on the amounts earned in variable account options of its variable annuity products held in separate accounts and net investment income on the Fixed Options held in the general account. Variable annuity contracts offer retirement planning features similar to those offered by fixed annuity contracts, but differ in that the contract holder'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 contract holder. Because the investment risk is generally borne by the customer in all but the Fixed Options, these products require significantly less capital support than fixed annuity contracts. At December 31, 2004, variable product liabilities were $26.04 billion, of which $22.61 billion were held in separate accounts and $3.43 billion were the liabilities of the Fixed Options, held in the Company's general account. The Company's variable annuity products incorporate incentives, surrender charges and/or other restrictions to encourage persistency. At December 31, 2004, 71% of the Company's variable annuity liabilities held in 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 2004 was approximately $74,000. ANNUITY OPERATIONS - GENERAL ACCOUNT The Company's general account obligations are fixed-rate products, principally Fixed Options, but also including fixed annuity contracts, GICs and universal life insurance contracts ("Fixed-Rate Products") issued in prior years. The Fixed Options provide interest rate guarantees of certain periods ranging up to ten years. Although the Company's annuity contracts remain in force an average of seven to ten years, approximately 77% of the reserves for fixed annuity contracts and Fixed Options, as well as the universal life insurance contracts, reprice annually at discretionary rates determined by the Company subject to a minimum rate guarantee ranging from 1.5% to 4.0%, 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. In prior years, the Company augmented its retail annuity business with the sale of institutional products. At December 31, 2004, the Company had $211.4 million of fixed-maturity, variable-rate GIC obligations that reprice periodically based upon certain defined indices and $3.9 million of fixed-maturity, fixed-rate GICs. The Company designs its Fixed-Rate Products and conducts its investment operations in order to closely match the duration and cash flows of the assets in its investment portfolio to its fixed-rate 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-Rate Products incorporate incentives, surrender charges and other restrictions in order to encourage F-2 persistency. Approximately 77% of the Company's reserves for Fixed-Rate Products had incentives, surrender penalties and/or other restrictions at December 31, 2004. INVESTMENT OPERATIONS The Company believes a portfolio principally composed of fixed-rate investments that generate predictable rates of return should back its liabilities for Fixed-Rate Products. 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 an affiliate 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." ASSET MANAGEMENT OPERATIONS Effective January 1, 2004, the Parent contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, SAAMCo, which in turn has two wholly owned subsidiaries: SACS and SFS. Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary of the Company. This contribution increased the Company's shareholder's equity by $150,653,000. Assets, liabilities and shareholder's equity at December 31, 2003 were restated to include $190,605,000, $39,952,000 and $150,653,000, respectively, of SAAMCo balances. Similarly, the results of operations and cash flows have been restated for the years ended December 31, 2003 and 2002 for the addition and subtraction to pretax income of $16,345,000 and $4,464,000, respectively, to reflect the SAAMCo activity. The asset management operations are conducted by the Company's registered investment advisor subsidiary, SAAMCo, and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS. These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, serving as investment advisor to certain variable investment portfolios offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. 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 an 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 contract, deposits of securities for the benefit of contract holders, 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 contract holders rather than security holders. 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, 2004. The federal government does not directly regulate the business of insurance, however, the Company, its subsidiaries and its products are governed by federal agencies, including the Securities and Exchange Commission ("SEC"), the Internal Revenue Service and the self-regulatory organization, National Association of Securities Dealers, Inc. ("NASD"). 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 the F-3 Employee Retirement Income Security Act 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, among other items, after-hours trading, short-term trading (sometimes referred to as market timing), suitability, revenue sharing arrangements and greater transparency regarding compensation arrangements. There are several rule proposals pending at the SEC, the NASD and on a federal level, which, if passed, could have an impact on the business of the Company and/or its subsidiaries. COMPETITION The businesses conducted by the Company are highly competitive. The Company competes with other life insurers, and also competes for customers' 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 2003, net annuity premiums written among the top 100 companies ranged from approximately $79 million to approximately $20 billion annually. The Company together with its affiliates ranked third 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. AVAILABLE INFORMATION AIG SunAmerica Life Assurance Company (the "Company") files annual, quarterly, and current reports and other information with the Securities and Exchange Commission (the "SEC"). The SEC maintains a website that contains annual, quarterly, and current reports and other information that issuers (including the Company) file electronically with the SEC. The SEC's website is http://www.sec.gov. Additionally, any materials the Company files with the SEC may be read and copied at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company does not maintain a website. The Company makes available free of charge, Annual Reports on Form 10-K, Quarterly Reports of Form 10-Q and Current Reports of Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such materials are electronically filed with, or furnished to the SEC. SECURITIES AND EXCHANGE COMMISSION POSITION ON INDEMNIFICATION Indemnification for liabilities arising under the 1933 Act is provided to the Company's officers, directors and controlling persons. The SEC has advised that it believes such indemnification is against public policy under the Securities Act and unenforceable. If a claim for indemnification against such liabilities (other than for payment of expenses incurred or paid by its directors, officers or controlling persons in the successful defense of any legal action) is asserted by a director, officer or controlling person of the Company in connection with the securities registered under this prospectus, the Company will submit to a court with jurisdiction to determine whether the indemnification is against public policy under the Act. The Company will be governed by final judgment of the issue. However, if in the opinion of the Company's counsel this issue has been determined by controlling precedent, the Company will not submit the issue to a court for determination. DESCRIPTION OF PROPERTY The Company's executive offices and its principal office are in leased premises at 1 SunAmerica Center, Los Angeles, California 90067. The Company, through an affiliate, also leases office space in Woodland Hills, California and Jersey City, New Jersey. The Company believes that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of its businesses. F-4 SELECTED FINANCIAL DATA The following selected financial data of the Company should be read in conjunction with the consolidated 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. The following selected financial date of the Company for years prior to December 31, 2004 have been restated as if the contribution of SAAMCo and its related subsidiaries were effective as of the earliest period reported below. The following amounts include only the subsidiaries of SAAMCo as of December 31, 2004.
YEARS ENDED DECEMBER 31, ---------------------------------------------------- 2004 2003 2002 2001 2000 -------- -------- -------- -------- -------- (IN THOUSANDS) Results of Operations Revenues: Fee income, net of reinsurance.............................. $534,581 $427,091 $444,002 $481,945 $549,970 Investment income........................................... 363,594 402,923 387,355 370,198 398,168 Net realized investment losses.............................. (23,807) (30,354) (65,811) (59,784) (15,177) -------- -------- -------- -------- -------- Total revenues............................................ 874,368 799,660 765,546 792,359 932,961 Benefits and Expenses: Interest expense............................................ 222,749 240,213 238,129 244,614 264,493 Amortization of bonus interest.............................. 10,357 19,776 16,277 11,938 3,824 General and administrative expenses......................... 131,612 119,093 115,210 99,232 138,955 Amortization of deferred acquisition costs and other deferred expenses......................................... 157,650 160,106 222,484 208,378 154,183 Annual commissions.......................................... 64,323 55,661 58,389 58,278 56,473 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 17,766 15,716 17,566 19,914 Guaranteed minimum death benefits, net of reinsurance recoveries................................................ 58,756 63,268 67,492 17,839 614 -------- -------- -------- -------- -------- Total benefits & expenses................................. 662,867 675,883 733,697 657,845 638,456 -------- -------- -------- -------- -------- Pretax income before cumulative effect of accounting change.................................................... 211,501 123,777 31,849 134,514 294,505 Income tax expense.......................................... 6,410 30,247 160 21,824 94,400 -------- -------- -------- -------- -------- Net income before cumulative effect of accounting change.... 205,091 93,530 31,689 112,690 200,105 -------- -------- -------- -------- -------- Cumulative effect of accounting change, net of tax.......... (62,589) -- -- (10,342) -- -------- -------- -------- -------- -------- Net Income.................................................. $142,502 $ 93,530 $ 31,689 $102,348 $200,105 ======== ======== ======== ======== ========
In 2004, the Company adopted AICPA Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts ("SOP 03-1"), which was recorded as a cumulative effect of accounting change. (See Note 2 of Notes to Consolidated Financial Statements). F-5 In 2001, the Company adopted EITF 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" and Statement of Financial Accounting Standard 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), which were recorded as a cumulative effect of accounting change.
DECEMBER 31, ------------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS) Financial Position Investments and cash.................................. $ 7,125,986 $ 7,124,633 $ 7,248,324 $ 6,294,148 $ 5,249,827 Variable annuity assets held in separate accounts..... 22,612,451 19,178,796 14,758,642 18,526,413 20,393,820 Deferred acquisition costs and other deferred expenses............................................ 1,606,870 1,505,328 1,436,802 1,419,498 1,286,456 Other assets.......................................... 150,708 162,970 309,221 258,446 177,468 ----------- ----------- ----------- ----------- ----------- Total Assets.......................................... $31,496,015 $27,971,727 $23,752,989 $26,498,505 $27,107,571 =========== =========== =========== =========== =========== Reserves for fixed annuity and fixed accounts of variable annuity contracts.......................... $ 3,948,158 $ 4,274,329 $ 4,285,098 $ 3,498,917 $ 2,778,229 Reserves for universal life insurance contracts....... 1,535,905 1,609,233 1,676,073 1,738,493 1,832,667 Reserves for guaranteed investment contracts.......... 215,331 218,032 359,561 483,861 610,672 Variable annuity liabilities related to separate accounts............................................ 22,612,451 19,178,796 14,758,642 18,526,413 20,393,820 Other payables and accrued liabilities................ 1,172,594 794,031 831,138 839,032 268,201 Subordinated notes payable to affiliates.............. -- 40,960 40,960 47,960 55,119 Deferred income taxes................................. 257,532 242,556 341,935 211,242 81,989 Shareholder's equity.................................. 1,754,044 1,613,790 1,459,582 1,152,587 1,086,874 ----------- ----------- ----------- ----------- ----------- Total Liabilities and Shareholder's Equity............ $31,496,015 $27,971,727 $23,752,989 $26,498,505 $27,107,571 =========== =========== =========== =========== ===========
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 AIG SunAmerica Life Assurance Company (the "Company") for the years ended December 31, 2004 ("2004"), 2003 ("2003") and 2002 ("2002") 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 and profitability of the Company's activities. 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. CRITICAL ACCOUNTING POLICIES The Company considers its most critical accounting policies those policies with respect to valuation of certain financial instruments, amortization of deferred acquisition costs ("DAC") and other deferred expenses and the reserve for guaranteed benefits. 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. F-6 Valuation of Certain Financial Instruments: Gross unrealized losses on debt and equity securities available for sale amounted to $27.1 million at December 31, 2004. 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 investments in debt and 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 $813.0 million at December 31, 2004 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 the Company 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 and Other Deferred Expenses: Policy acquisition costs include commissions and other costs that vary with, and are primarily related to, the production or acquisition of new business. Such costs are deferred and amortized over the estimated lives of the annuity contracts. Approximately 81% of the amortization of DAC and other deferred expenses was attributed to policy acquisition costs deferred by the annuity operations and 19% was attributed to the distribution costs deferred by the asset management operations. For the annuity operations, the Company amortizes DAC and other deferred expenses 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, the growth rate of the separate account assets (with respect to variable options of the variable annuity contracts) or general account assets (with respect to fixed annuity contracts, Fixed Options and universal life insurance contracts) supporting these obligations, costs of providing contract guarantees and the level of expenses necessary to administer the policies. The Company adjusts amortization of DAC and other deferred expenses (a "DAC unlocking") when current or estimates of future gross profits to be realized from its annuity contracts are revised as more fully described below. Substantially all of the DAC balance attributed to annuity operations at December 31, 2004 related to variable annuity contracts. DAC amortization on annuities is impacted by surrender rates, claims costs, and the actual and assumed future growth rate of the assets supporting the Company's obligations under annuity policies. With respect to Fixed Options, the growth rate depends on the yield on the general account assets supporting those annuity contracts. With respect to the variable options of the variable annuity contracts, the growth rate depends on the performance of the investment options available under the annuity contract and the allocation of assets among these various investment options. The assumption the Company uses for the long-term annual net growth rate of the separate account assets in the determination of DAC amortization with respect to its variable annuity contracts is 10% (the "long-term growth rate assumption"). The Company uses a "reversion to the mean" methodology that allows it to maintain this 10% long-term growth rate assumption, while also giving consideration to the effect of short-term swings in the equity markets. For example, if performance was 15% during the first year following the introduction of a product, the DAC model would assume that market returns for the following five years (the "short-term growth rate assumption") would be approximately 9%, resulting in an average annual growth rate of 10% during the life of the product. Similarly, following periods of below 10% performance, the model will assume a short-term growth rate higher than 10%. A DAC unlocking will occur if management deems the short-term growth rate assumption (i.e., the growth rate required to revert to the mean 10% growth rate over a five-year period) to be unreasonable. The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. For the asset management operations, the Company defers distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or a contingent deferred sales charge feature (collectively, "Distribution Fee Revenue"). These costs are amortized on a straight-line basis, adjusted for redemptions, over a period ranging from one year to eight years depending on share class. The carrying value of the deferred asset is subject to continuous review based on projected Distribution Fee Revenue. Amortization of deferred distribution costs is increased if at any reporting period the value of the deferred amount exceeds the projected Distribution Fee Revenue. The projected Distribution Fee Revenue is impacted by estimated future withdrawal rates and the rates of market return. Management uses historical activity to estimate future withdrawal rates and average annual performance of the equity markets to estimate the rates of market return. F-7 Reserve for Guaranteed Benefits: Pursuant to the adoption of Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1") which was adopted on January 1, 2004, the Company is required to recognize a liability for guaranteed minimum death benefits and other guaranteed benefits. In calculating the projected liability, five thousand stochastically generated investment performance scenarios were developed using the Company's best estimates. These assumptions included, among others, mean equity return and volatility, mortality rates and lapse rates. The estimation of cash flow and the determination of the assumptions used require judgment, which can, at times, be subjective. Several of the guaranteed benefits are sensitive to equity market conditions. The Company uses the purchase of reinsurance and capital market hedging strategies to mitigate the risk of paying benefits in excess of account values as a result of significant downturns in equity markets. Risk mitigation may or may not reduce the volatility of net income resulting from equity market volatility. Reinsurance or hedges are secured when the cost is less than the risk reduction. The Company expects to use either additional reinsurance or capital market hedges for risk mitigation on an opportunistic basis. Despite the purchase of reinsurance or hedges, the reinsurance or hedge secured may be inadequate to completely offset the effects of changes in equity markets. BUSINESS SEGMENTS Effective January 1, 2004, SunAmerica Life Insurance Company (the "Parent"), the parent of the Company, contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo"), which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") and AIG SunAmerica Fund Services, Inc. ("SFS"). This contribution increased the Company's shareholder's equity by approximately $150.7 million (see Note 1 of Notes to Consolidated Financial Statements). Effective January 1, 2004, the Company's earnings include the asset management operations of SAAMCo, SACS and SFS. Prior year results have been restated to account for this contribution as if it had occurred at the beginning of the earliest period presented. The Company has two business segments: annuity operations and asset management operations. The annuity operations consist of the sale and administration of deposit-type insurance contracts, such as variable and fixed annuity contracts, universal life insurance contracts and guaranteed investment contracts. The Company focuses primarily on the marketing of variable annuity products. The variable annuity products offer investors a broad spectrum of fund alternatives, with a choice of investment managers, as well as Fixed Options. The Company earns fee income on amounts invested in the variable account options and net investment spread on the Fixed Options. The asset management operations are conducted by the Company's registered investment advisor subsidiary, SAAMCo, and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS. These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, servicing as investment advisor to certain variable investment portfolios offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. RESULTS OF OPERATIONS NET INCOME totaled $142.5 million in 2004, compared with $93.5 million in 2003 and $31.7 million in 2002. CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX reflected the adoption of SOP 03-1 on January 1, 2004. The Company recorded a loss of $62.6 million, net of tax, which is recognized in the consolidated statement of income and comprehensive income as a cumulative effect of accounting change for the year ended December 31, 2004. PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $211.5 million in 2004, compared with $123.8 million in 2003 and $31.8 million in 2002. The increase in 2004 compared to 2003 was primarily due to higher variable annuity policy fee and asset management fee income, partially offset by lower investment income and higher general and administrative and other expenses. The increase in 2003 compared to 2002 was primarily due to reductions in net realized investment losses and amortization of DAC and other expenses. INCOME TAX EXPENSE totaled $6.4 million in 2004, $30.2 million in 2003 and $0.2 million in 2002 representing effective tax rates of 3%, 24% and 1%, respectively. The tax expense in 2004 included the benefit of $39.7 million resulting from the reduction of the prior year tax liability based on additional information becoming available. Excluding this benefit the effective tax rate is 22% in 2004. The unusually low effective tax rate for 2002 is due primarily to the lower relative pretax income without corresponding reductions in permanent tax differences. See Note 11 of the Notes to Consolidated Financial Statements for a reconciliation of income tax expense to the federal statutory rate. F-8 ANNUITY OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $176.9 million in 2004, compared with $98.7 million in 2003 and $27.7 million in 2002. The increase in 2004 compared to 2003 was primarily due to higher variable annuity policy fee income and lower amortization of deferred acquisition costs and other deferred expenses partially offset by higher general and administrative and other expenses. The increase in 2003 compared to 2002 was primarily due to lower net realized investment losses and improved net investment income as customers allocated more dollars to the fixed rate portion of variable annuity contracts. NET INVESTMENT SPREAD, a non-GAAP measure, represents investment income less interest credited to Fixed-Rate Products is a key measurement used by the Company in evaluating the profitability of its annuity business. Investment income includes income earned on invested assets, as well as the mark-to-market on both purchased derivatives and embedded derivatives inherent in certain product guarantees. 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 investments pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities". In the calculation of average invested assets, the Company excludes collateral received from a securities lending program, which is offset by a securities lending payable in the same amount. 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 an affiliate to administer the program. An analysis of net investment spread and a reconciliation to pretax income before cumulative effect of accounting change is presented in the following table:
YEARS ENDED DECEMBER 31, --------------------------------- 2004 2003 2002 --------- --------- --------- (IN THOUSANDS) Investment income........................................... $ 362,631 $ 398,304 $ 377,556 Interest credited to fixed annuity contracts and Fixed Options................................................... (140,889) (153,636) (142,973) Interest credited to universal life insurance contracts..... (73,745) (76,415) (80,021) Interest credited to guaranteed investment contracts........ (6,034) (7,534) (11,267) --------- --------- --------- Net investment spread....................................... 141,963 160,719 143,295 Net realized investment losses.............................. (24,100) (30,354) (65,811) Fee income, net of reinsurance.............................. 429,259 344,908 358,983 Amortization of bonus interest.............................. (10,357) (19,776) (16,277) General and administrative expenses......................... (93,188) (83,013) (79,287) Amortization of DAC and other deferred expenses............. (126,142) (137,130) (171,583) Annual commissions.......................................... (64,323) (55,661) (58,389) Claims on UL contracts, net of reinsurance recoveries....... (17,420) (17,766) (15,716) Guaranteed benefits, net of reinsurance recoveries.......... (58,756) (63,268) (67,492) --------- --------- --------- Pretax income before cumulative effect of accounting change.................................................... $ 176,936 $ 98,659 $ 27,723 ========= ========= =========
Net investment spread totaled $142.0 million in 2004, compared to $160.7 million in 2003 and $143.3 million in 2002. These amounts equal 2.28% on average invested assets (computed on a daily basis) of $6.22 billion in 2004, 2.37% on average invested assets of $6.66 billion in 2003 and 2.41% on average invested assets of $6.09 billion in 2002. The decrease in net investment spread in 2004 from 2003 reflected results from lower average invested assets as discussed below and reinvesting in the historically low prevailing interest rate environment that has persisted throughout 2003 and 2004. The increase in net investment spread in 2003 from 2002 resulted from substantial growth in average invested assets and effective management of interest crediting rates to offset lower yields available on invested assets. F-9 The components of net investment spread were as follows:
YEARS ENDED DECEMBER 31, --------------------------------------- 2004 2003 2002 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Net investment spread....................................... $ 141,963 $ 160,719 $ 143,295 Average invested assets..................................... 6,216,792 6,656,360 6,086,517 Average interest-bearing liabilities........................ (5,942,627) (6,407,102) (5,962,521) Yield on average invested assets............................ 5.83% 5.98% 6.20% Rate paid on average interest-bearing liabilities........... 3.71 3.71 3.93 ----------- ----------- ----------- Difference between yield and interest rate paid............. 2.12% 2.27% 2.27% =========== =========== =========== Net investment spread as a percentage of average invested assets.................................................... 2.28% 2.41% 2.35% =========== =========== ===========
The decline in average invested assets resulted primarily from net exchanges from Fixed Options into the separate accounts of variable annuity contracts, partially offset by new deposits of Fixed Options. Deposits of Fixed Options and renewal deposits on its universal life insurance contracts totaled $1.41 billion 2004, $1.58 billion in 2003 and $1.78 billion in 2002, and are primarily deposits for the Fixed Options. Deposits of Fixed Options represent 24% in 2004, 27% in 2003 and 34% in 2002, of the related reserve balances at the beginning of the respective periods. Net investment spread includes the effect of income earned or interest paid on the difference between average invested assets and average interest-bearing liabilities. Average invested assets exceeded average interest-bearing liabilities by $274.2 million in 2004, compared with $249.3 million in 2003 and $124.0 million in 2002. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities was 2.12% in 2004 and 2.27% in 2003 and 2.27% in 2002. Investment income (and the related yields on average invested assets) totaled $362.6 million (5.83%) in 2004, compared with $398.3 million (5.98%) in 2003 and $377.6 million (6.20%) in 2002. The decrease in the investment yield primarily reflects the reinvesting in the historically low prevailing interest rate environment that has persisted throughout 2002, 2003 and 2004, as well as a $4.3 million reduction in income from the mark to market of the S&P 500 put options and the guaranteed minimum account value and guaranteed minimum withdrawal benefit embedded derivatives in 2004. Excluding the impact of the put options and embedded derivatives, investment income would have been $361.6 million (5.82%) and $393.0 million (5.90%) in 2004 and 2003, respectively. Expenses incurred to manage the investment portfolio amounted to $2.5 million in 2004, $2.3 million in 2003 and $2.4 million in 2002. These expenses are included as a reduction of investment income in the consolidated statement of income and comprehensive income. Interest expense (and the related rate paid on average interest-bearing liabilities) totaled $220.7 million (3.71%) in 2004, $237.6 million (3.71%) in 2003 and $234.3 million (3.93%) in 2002. Interest-bearing liabilities averaged $5.94 billion during 2004, $6.41 billion during 2003 and $5.96 billion during 2002. NET REALIZED INVESTMENT LOSSES totaled $24.1 million in 2004, $30.4 million in 2003 and $65.8 million in 2002 and include impairment writedowns of $21.1 million, $54.1 million and $57.3 million, respectively. Thus, net realized losses from sales and redemptions of investments totaled $3.0 million in 2004, compared with net realized gains of $23.7 million in 2003 and net realized losses of $8.5 million in 2002. The Company sold or redeemed invested assets, principally bonds and notes, aggregating $1.97 billion in 2004, $2.21 billion in 2003 and $1.60 billion in 2002. 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 0.05%, 0.36% and 0.14% of average invested assets for 2004, 2003 and 2002, 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 $21.1 million, $54.1 million and $57.3 million of provisions principally applied to bonds in 2004, 2003 and 2002, respectively. Impairment writedowns represent 0.34%, 0.81% and 0.96% of average invested assets in the respective periods. For the five years ended December 31, 2004, impairment writedowns as a percentage of average invested assets have ranged from 0.34% to 1.27% and have averaged 0.75%. 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. F-10 VARIABLE ANNUITY POLICY FEES, NET OF REINSURANCE are generally based on the market value of assets in the separate accounts supporting variable annuity contracts. Such fees totaled $369.1 million in 2004, $281.4 million in 2003 and $286.9 million in 2002 and are net of reinsurance premiums of $28.6 million, $30.8 million and $22.5 million, respectively. The increased fees in 2004 compared to 2003 primarily reflect the improved equity market conditions in 2004 and the latter part of 2003, and the resulting favorable impact on market values of the assets in the separate accounts. The decreased fees in 2003 as compared to 2002 reflected increased reinsurance premiums. Variable annuity policy fees represent 1.8%, 1.7% and 1.7% of average variable annuity assets in 2004, 2003 and 2002, respectively. Variable annuity assets averaged $20.41 billion, $16.32 billion and $16.45 billion during the respective periods. Variable annuity deposits, which exclude deposits allocated to the Fixed Options, totaled $2.65 billion in 2004, $1.73 billion in 2003 and $1.18 billion in 2002. These amounts represent 14%, 12% and 6% of variable annuity reserves at the beginning of the respective periods. The increase in variable annuity deposits in 2004 and 2003 reflected increased demand for variable annuity products due to the improved equity market conditions in 2004 and the latter part of 2003. Transfers from the Fixed Options to the separate accounts 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 the Fixed Options) ("Variable Annuity Product Sales") amounted to $4.01 billion, $3.27 billion and $2.92 billion in 2004, 2003 and 2002, respectively. Such sales primarily reflect those of the Company's Polaris and Seasons families of variable annuity products. The Company's variable annuity products are primarily multi-manager variable annuities that offer investors a choice of several variable funds as well as up to seven fixed funds, depending on the product. The increase in Variable Annuity Product Sales in 2004 and 2003 reflects the generally improved equity market conditions in 2004 and the latter part of 2003. 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"). With respect to all reinsurance agreements, 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. Due to the high credit ratings and periodic monitoring of these ratings of the reinsurers, such risks are considered to be minimal. UNIVERSAL LIFE INSURANCE POLICY FEES, NET OF REINSURANCE amounted to $33.9 million in 2004, $35.8 million in 2003 and $36.3 million in 2002 and are net of reinsurance premiums of $34.3 million, $33.7 million and $34.1 million, respectively. Universal life insurance policy 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 insurance contracts as part of the acquisition of business from MBL Life Assurance Corporation on December 31, 1998 and does not actively market such contracts. Such fees represent 2.20%, 2.23% and 2.17% of average reserves for universal life insurance contracts in the respective periods. SURRENDER CHARGES on variable annuity and universal life insurance contracts totaled $26.2 million in 2004, $27.7 million in 2003 and $32.5 million in 2002. 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. GENERAL AND ADMINISTRATIVE EXPENSES totaled $93.2 million in 2004, $83.0 million in 2003 and $79.3 million in 2002. The increase in 2004 results from higher information technology costs and payroll related expenses resulting from the servicing of a larger block of annuity contracts. 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 AND OTHER DEFERRED EXPENSES totaled $126.1 million in 2004, compared with $137.1 million in 2003 and $171.6 million in 2002. DAC amortization in 2003 reflected a declining market which led to higher DAC amortization (i.e. impairments on specific products) during the first nine months of 2003 and is partially offset by an $18.0 million DAC unlocking. The higher amortization in 2002 was primarily related to lower estimates of future gross profits on variable annuity contracts compared to the prior years in light of the downturn in the equity markets in 2002, and additional variable annuity product sales over the last twelve months and the subsequent amortization of related deferred commissions and other direct selling costs. ANNUAL COMMISSIONS totaled $64.3 million in 2004, compared with $55.7 million in 2003 and $58.4 million in 2002. Annual commissions generally 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. The vast majority of the Company's average balances of its variable annuity products are currently subject to such annual commissions. F-11 CLAIMS ON UNIVERSAL LIFE CONTRACTS, NET OF REINSURANCE RECOVERIES totaled $17.4 million in 2004, compared with $17.8 million in 2003 and $15.7 million in 2002 (net of reinsurance recoveries of $34.2 million in 2004, $34.0 million in 2003 and $29.2 million in 2002). The change in such claims resulted principally from changes in mortality experience and the reinsurance recoveries there on. GUARANTEED BENEFITS, NET OF REINSURANCE RECOVERIES on variable annuity contracts totaled $58.8 million in 2004, compared with $63.3 million in 2003 and $67.5 million in 2002 and are net of reinsurance recoveries of $2.7 million, $8.0 million and $8.4 million, respectively. These guaranteed benefits consist primarily of guaranteed minimum death benefits as well as immaterial amounts of earnings enhancement benefits and guaranteed minimum income benefits. These guarantees are described in more detail in the following paragraphs. The decrease during 2004 reflects the generally improved equity market conditions in 2004 and the latter part of 2003. Downturns in the equity markets could increase these expenses. Guaranteed minimum death benefits ("GMDB") are issued on a majority of the Company's variable annuity products. GMDB provides that, upon the death of a contract holder, the contract holder's beneficiary will receive the greater of (1) the contract holder's account value, or (2) a guaranteed minimum death benefit that varies by product and election by the contract holder. The Company bears the risk that death claims following a decline in the debt and equity markets may exceed contract holder account balances and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. On January 1, 2004, the Company recorded a liability for guaranteed benefits including GMDB (see Note 2 of Notes to Consolidated Financial Statements) pursuant to adoption of a new accounting standard, SOP 03-1. Earnings enhancement benefit ("EEB") is a feature the Company offers on certain variable annuity products. For contract holders who elect the feature, the EEB provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The Company bears the risk that account values following favorable performance of the financial markets will result in greater EEB death claims and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. Guaranteed minimum income benefit ("GMIB") is a feature the Company offers on certain variable annuity products. This feature provides a minimum fixed annuity payment guarantee for those contract holders who choose to receive fixed lifetime annuity payments after a seven, nine, or ten-year waiting period in their deferred annuity contracts. The Company bears the risk that the performance of the financial markets will not be sufficient for accumulated contract holder account balances to support GMIB benefits and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. As there is a waiting period to annuitize using the GMIB, there are no policies eligible to receive this benefit at December 31, 2004. The Company has eliminated offering a GMIB feature that guarantees a return in excess of the amount to be annuitized in order to mitigate its exposure. Guaranteed minimum account value ("GMAV") is a feature the Company offers on certain variable annuity products in the third quarter of 2002. If available and elected by the contract holder at the time of contract issuance, this feature guarantees that the account value under the contract will at least equal the amount of the deposits invested during the first ninety days of the contract, adjusted for any subsequent withdrawals, at the end of a ten-year waiting period. The Company bears the risk that protracted under-performance of the financial markets could result in GMAV benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The Company purchased put options on the S&P 500 index to partially offset this risk. Changes in the market value of both the GMAV benefit and the put options are recorded in investment income in the accompanying consolidated statement of income and comprehensive income. Guaranteed minimum withdrawal benefit ("GMWB") is a feature the Company began offering on certain variable annuity products in May of 2004. If available and elected by the contract holder at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days adjusted for any subsequent withdrawals ("Eligible Premium"). These guaranteed annual withdrawals of up to 10% of Eligible Premium are available after either a three-year or a five-year waiting period, as elected by the contract holder at the time of contract issuance, without reducing the future amounts guaranteed. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will realize an additional 10% or 20%, respectively, of Eligible Premium after all other amounts guaranteed under this benefit have been paid. The Company bears the risk that protracted under-performance of the financial markets could result in GMWB benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. The Company purchased put options on the S&P 500 index to partially offset this risk. Changes in the market value of both the GMWB benefit and the put options are recorded in investment income in the accompanying consolidated statement of income and comprehensive income. F-12 Management expects substantially all of the Company's near-term exposure to guaranteed benefits will relate to GMDB and EEB. As sales of products with other guaranteed benefits increase, the Company expects these other guarantees to have an increasing impact on operating results, under current hedging strategies. ASSET MANAGEMENT OPERATIONS PRETAX INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE totaled $34.6 million in 2004, compared to $25.1 million in 2003 and $4.1 million in 2002. The increases in 2004 from 2003 resulted from the impact of higher average asset base and higher margin on account servicing fees, partially offset by increased amortization of DAC and other deferred expenses. The increase in 2003 from 2002 resulted from decreased amortization of DAC and other deferred expenses. ASSET MANAGEMENT FEES, which include investment advisory fees and 12b-1 distribution fees, are based on the market value of assets managed by SAAMCo in its mutual funds and certain variable annuity portfolios. Such fees totaled $89.6 million on average assets managed of $9.65 billion in 2004, $66.7 million on average assets managed of $8.15 billion in 2003 and $66.4 million on average assets managed of $7.64 billion in 2002. The increase in asset management fees is primarily the result of a higher average asset base and higher margin on account servicing fees. Mutual fund sales, excluding sales of money market accounts and private accounts, totaled $2.14 billion in 2004, compared to $2.23 billion in 2003 and $1.67 billion in 2002. Redemptions of mutual funds, excluding redemptions of money market accounts, amounted to $1.56 billion in 2004, $1.55 billion in 2003 and $1.55 billion in 2002, which represent 20%, 25% and 25%, respectively, of average related mutual fund assets. The 4% decrease in mutual fund sales in 2004 compared to 2003 primarily reflects generally difficult equity market conditions in the second and third quarters of 2004. The increase in sales in 2003 principally reflects increasing demand for equity products, due to generally improved equity market conditions in the latter part of 2003. GENERAL AND ADMINISTRATIVE EXPENSES totaled $38.4 million in 2004, $36.1 million in 2003 and $35.9 million in 2002. General and administrative expenses increased in 2004 due primarily to higher employee-related costs. AMORTIZATION OF DEFERRED ACQUISITION COSTS AND OTHER DEFERRED EXPENSES includes amortization of distribution costs that totaled $31.5 million in 2004, compared with $23.0 million in 2003 and $35.9 million in 2002. The increased amortization in 2004 was primarily due to additional mutual fund sales and amortization of the deferred commissions thereon. In 2002, amortization of deferred acquisition costs and other deferred expenses included additional amortization of $24.2 million, resulting from certain distribution costs whose carrying value exceeded projected revenue. CAPITAL RESOURCES AND LIQUIDITY SHAREHOLDER'S EQUITY increased to $1.75 billion at December 31, 2004 from $1.61 billion at December 31, 2003 due to $142.5 million of net income and $49.1 million of capital contribution from Parent partially offset by a $49.1 million tax effect on a distribution of investment and a $2.5 million dividend to the Parent. F-13 INVESTMENTS AND CASH at December 31, 2004 totaled $7.13 billion, compared with $7.14 billion at December 31, 2003. The Company's invested assets are managed by an affiliate. The following table summarizes the Company's portfolio of bonds, notes and redeemable preferred stocks (the "Bond Portfolio") and other investments and cash at December 31, 2004 and 2003:
DECEMBER 31, 2004 DECEMBER 31, 2003 ----------------------- ----------------------- FAIR PERCENT OF FAIR PERCENT OF VALUE PORTFOLIO VALUE PORTFOLIO ---------- ---------- ---------- ---------- BOND PORTFOLIO: (IN THOUSANDS, EXCEPT FOR PERCENTAGES) U.S. government securities.................................. $ 30,300 0.4% $ 24,292 0.3% Mortgage-backed securities.................................. 956,567 13.4 1,191,817 16.7 Securities of public utilities.............................. 332,038 4.7 365,150 5.1 Corporate bonds and notes................................... 2,902,829 40.8 2,697,142 37.9 Redeemable preferred stocks................................. 21,550 0.3 22,175 0.3 Other debt securities....................................... 917,743 12.9 1,205,224 16.9 ---------- ----- ---------- ----- Total Bond Portfolio........................................ 5,161,027 72.5 5,505,800 77.2 Mortgage loans.............................................. 624,179 8.7 716,846 10.1 Common stocks............................................... 4,902 0.1 727 0.0 Cash and short-term investments............................. 201,117 2.8 133,105 1.9 Securities lending collateral............................... 883,792 12.4 514,145 7.2 Other invested assets....................................... 250,969 3.5 254,010 3.6 ---------- ----- ---------- ----- Total investments and cash.................................. $7,125,986 100.0% $7,124,633 100.0% ========== ===== ========== =====
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 72% of the Company's total investment portfolio at December 31, 2004, had an aggregate fair value that was $153.2 million greater than its amortized cost at December 31, 2004, compared with $154.6 million at December 31, 2003. At December 31, 2004, the Bond Portfolio had an aggregate fair value of $5.16 billion and an aggregate amortized cost of $5.01 billion. At December 31, 2004, the Bond Portfolio (excluding $21.6 million of redeemable preferred stocks) included $4.50 billion of bonds rated by Standard & Poor's ("S&P"), Moody's Investors Service ("Moody's") or Fitch ("Fitch") and $638.1 million of bonds rated by the National Association of Insurance Commissioners ("NAIC") or the Company pursuant to statutory ratings guidelines established by the NAIC. At December 31, 2004, approximately $4.75 billion of the Bond Portfolio was investment grade, including $986.8 million of mortgage-backed securities ("MBS") and U.S. government/agency securities. At December 31, 2004, the Bond Portfolio included $386.4 million of bonds that were not investment grade. These non-investment-grade bonds accounted for approximately 1% of the Company's total assets and approximately 5% 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 to decline. At December 31, 2004, the Company's non-investment-grade bond portfolio consisted of 171 issues with no single issuer representing more than 10% of the total non-investment-grade portfolio. These non-investment-grade securities are comprised of bonds spanning 10 industries with 19%, 16%, 16% and 10% concentrated in telecommunications, utilities, financial services and noncyclical consumer products industries, respectively. No other industry concentration constituted more than 10% of these assets. F-14 The table below summarizes the Company's rated bonds by rating classification as of December 31, 2004. RATED BONDS BY RATING CLASSIFICATION
ISSUES RATED BY ISSUES NOT RATED BY S&P/MOODY'S/FITCH S&P/MOODY'S/FITCH, BY NAIC CATEGORY TOTAL - ------------------------------------------ ------------------------------------- ------------------------------------------ S&P/MOODY'S/FITCH AMORTIZED ESTIMATED NAIC AMORTIZED ESTIMATED AMORTIZED ESTIMATED PERCENT OF TOTAL CATEGORY(1) COST FAIR VALUE CATEGORY(2) COST FAIR VALUE COST FAIR VALUE INVESTED ASSETS - ----------------- ---------- ---------- ------------ --------- ---------- ---------- ---------- ---------------- (DOLLARS IN THOUSANDS) AAA+ to A- (Aaa to A3) [AAA to A-] $2,888,647 $2,964,803 1 $266,034 $270,334 $3,154,681 $3,235,137 45.40% BBB+ to BBB- (Baa to Baa3) [BBB+ to BBB-] 1,203,109 1,233,692 2 276,973 284,221 1,480,082 1,517,913 21.30% BB+ to BB- (Bal to Ba3) [BB+ to BB-] 133,070 138,091 3 36,371 36,462 169,441 174,553 2.45% B+ to B- (Bl to B3) [B+ to B-] 129,347 140,699 4 11,600 11,524 140,947 152,223 2.14% CCC+ to CCC- (Caal to Caa3) [CCC+ to CCC-] 18,954 19,353 5 7,305 6,695 26,259 26,048 0.37% CC to D (Ca to C) [CC to D] 1,842 4,722 6 14,476 28,880 16,318 33,602 0.47% ---------- ---------- -------- -------- ---------- ---------- TOTAL RATED ISSUES $4,374,969 $4,501,360 $612,759 $638,116 $4,987,728 $5,139,476 ========== ========== ======== ======== ========== ==========
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 $131.5 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; (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. F-15 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 sale. As a result of these policies, the Company recorded pretax impairment writedowns of $21.1 million, $54.1 million and $57.3 million in 2004, 2003 and 2002, respectively. No individual impairment loss, net of DAC and taxes, during the year exceeded 10% of the Company's net income for the year ended December 31, 2004. 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, 2004, the fair value of the Company's Bond Portfolio aggregated $5.16 billion. Of this aggregate fair value, approximately 0.03% 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 DAC and decreases in income taxes. At December 31, 2004, approximately $3.91 billion, at amortized cost, of the Bond Portfolio had a fair value of $4.09 billion resulting in an aggregate unrealized gain of $180.3 million. At December 31, 2004, approximately $1.10 billion, at amortized cost, of the Bond Portfolio had a fair value of $1.07 billion resulting in an aggregate unrealized loss of $27.1 million. No single issuer accounted for more than 10% of unrealized losses. Approximately 36%, 15% and 11% of unrealized losses were from the financial services, transportation and noncyclical consumer products industries, respectively. No other industry accounted for more than 10% of unrealized losses. The amortized cost of the Bond Portfolio in an unrealized loss position at December 31, 2004, by contractual maturity, is shown below.
AMORTIZED COST -------------- (IN THOUSANDS) Due in one year or less..................................... $ 46,250 Due after one year through five years....................... 422,237 Due after five years through ten years...................... 389,073 Due after ten years......................................... 243,973 ---------- Total....................................................... $1,101,533 ==========
F-16 The aging of the Bond Portfolio in an unrealized loss position at December 31, 2004 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 ------------------------------- ------------------------------ ------------------------------ AMORTIZED UNREALIZED AMORTIZED UNREALIZED AMORTIZED UNREALIZED MONTHS COST LOSS ITEMS COST LOSS ITEMS COST LOSS ITEMS - ------ ---------- ---------- ----- --------- ---------- ----- --------- ---------- ----- (DOLLARS IN THOUSANDS) Investment Grade Bonds 0-6 $ 455,818 $ (4,128) 73 $ -- $ -- -- $ -- $ -- -- 7-12 387,123 (6,808) 57 -- -- -- -- -- -- >12 171,695 (7,108) 22 17,477 (4,046) 3 -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $1,014,636 $(18,044) 152 $17,477 $(4,046) 3 $ -- $ -- -- ========== ======== === ======= ======= ==== ==== ===== ==== Below Investment Grade Bonds 0-6 $ 28,496 $ (1,806) 13 $ -- $ -- -- $452 $(292) 3 7-12 8,773 (489) 8 -- -- -- -- -- -- >12 31,699 (2,467) 11 -- -- -- -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $ 68,968 $ (4,762) 32 $ -- $ -- -- $452 $(292) 3 ========== ======== === ======= ======= ==== ==== ===== ==== Total Bonds 0-6 $ 484,314 $ (5,934) 86 $ -- $ -- -- $452 $(292) 3 7-12 395,896 (7,297) 65 -- -- -- -- -- -- >12 203,394 (9,575) 33 17,477 (4,046) 3 -- -- -- ---------- -------- --- ------- ------- ---- ---- ----- ---- Total $1,083,604 $(22,806) 184 $17,477 $(4,046) 3 $452 $(292) 3 ========== ======== === ======= ======= ==== ==== ===== ==== TOTAL ------------------------------- AMORTIZED UNREALIZED MONTHS COST LOSS ITEMS - ------ ---------- ---------- ----- (DOLLARS IN THOUSANDS) Investment Grade Bonds 0-6 $ 455,818 $ (4,128) 73 7-12 387,123 (6,808) 57 >12 189,172 (11,154) 25 ---------- -------- --- Total $1,032,113 $(22,090) 155 ========== ======== === Below Investment Grade Bonds 0-6 $ 28,948 $ (2,098) 16 7-12 8,773 (489) 8 >12 31,699 (2,467) 11 ---------- -------- --- Total $ 69,420 $ (5,054) 35 ========== ======== === Total Bonds 0-6 $ 484,766 $ (6,226) 89 7-12 395,896 (7,297) 65 >12 220,871 (13,621) 36 ---------- -------- --- Total $1,101,533 $(27,144) 190 ========== ======== ===
In 2004, the pretax realized losses incurred with respect to the sale of fixed-rate securities in the Bond Portfolio was $12.6 million. The aggregate fair value of securities sold was $140.3 million, which was approximately 92% of amortized cost. The average period of time that securities sold at a loss during 2004 were trading continuously at a price below amortized cost was approximately 21 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 fair value of these securities at December 31, 2004 was approximately $813.0 million. 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. 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. 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 $277.2 million at December 31, 2004. Secured Loans are senior to subordinated debt and equity and are secured by assets of the issuer. At December 31, 2004, Secured Loans consisted of $190.1 million of privately traded securities and $87.1 million of publicly traded securities. These Secured Loans are composed of loans to 59 borrowers spanning 10 industries, with 26%, 18%, 15%, 12% and 11% from the utilities, telecommunications, transportation, noncyclical consumer products and cyclical consumer products industries, respectively. No other industry 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. F-17 MORTGAGE LOANS aggregated $624.2 million at December 31, 2004 and consisted of 100 commercial first mortgage loans with an average loan balance of approximately $6.2 million, collateralized by properties located in 30 states. Approximately 32% of this portfolio was office, 17% was manufactured housing, 17% was multifamily residential, 11% was industrial, 11% was hotels, and 12% was other types. At December 31, 2004, approximately 27%, 11% and 10% of this portfolio were secured by properties located in California, Michigan and Massachusetts, respectively. No more than 10% of this portfolio was secured by properties located in any other single state. At December 31, 2004, 13 mortgage loans have an outstanding balance of $10 million or more, which collectively aggregated approximately 45% of this portfolio. At December 31, 2004, approximately 42% of the mortgage loan portfolio consisted of loans with balloon payments due before January 1, 2008. During 2004 and 2003, loans delinquent by more than 90 days, foreclosed loans and structured loans have not been significant in relation to the total mortgage loan portfolio. Substantially all of the mortgage loan portfolio has been originated by the Company under its 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 Company's underwriting standards, the Company believes that it has prudently managed the risk attributable to its mortgage loan portfolio while maintaining attractive yields. SECURITIES LENDING COLLATERAL totaled $883.8 million at December 31, 2004, compared to $514.1 million at December 31, 2003, and consisted of cash collateral invested in highly rated short-term securities received in connection with the Company's securities lending program. The increase in securities lending collateral in 2004 results from increased demand for securities in the Company's portfolio. 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 in an effort to minimize the risks of interest rate fluctuations and disintermediation (i.e. the risk of being forced to sell investments during unfavorable market conditions). 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 incentives, surrender charges and/or other restrictions in order to encourage persistency. Approximately 77% of the Company's reserves for Fixed-Rate Products had surrender penalties or other restrictions at December 31, 2004. 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 and cash flows of the fixed-rate assets to that of its fixed-rate liabilities. The fixed-rate assets in the Company's asset-liability modeling include: cash and short-term investments; bonds, notes and redeemable preferred stocks; mortgage loans; policy loans; and investments in limited partnerships that invest primarily in fixed-rate securities. At December 31, 2004, these assets had an aggregate fair value of $6.17 billion with an option-adjusted duration of 3.2 years. The Company's fixed-rate liabilities include Fixed Options, as well as universal life insurance, fixed annuity and GIC contracts. At December 31, 2004, these liabilities had an aggregate fair value (determined by discounting future contractual cash flows by related market rates of interest) of $5.54 billion with an option-adjusted duration of 3.6 years. The Company's potential exposure due to a relative 10% decrease in prevailing interest rates from its December 31, 2004 levels is a loss of approximately $0.3 million, representing an 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 years 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 F-18 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 and these differences may be material. A significant portion of the Company's fixed annuity contracts (including the Fixed Options) 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. 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 the earlier discussion under "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 2004, 2003 and 2002 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:
2004 2003 2002 ---- ---- ---- AVERAGE 10-YEAR U.S. TREASURY BOND RATE:.................... 4.26% 4.01% 4.61% AIG SunAmerica Life Assurance Company: Average yield on Bond Portfolio........................... 5.66 5.75 6.23 Rate paid on average interest-bearing liabilities......... 3.71 3.71 3.93
Since the Company's investing strategy is to hold fixed-rate assets for long-term investment, the Company's average yield tends to trail movements in the average U.S. treasury yield. For further discussion on average yield on the bond portfolio and the rate paid on average interest-bearing liabilities, see discussion on "Investment Spread." As a component of its asset-liability management strategy, the Company may utilize interest rate swap agreements ("Swap Agreements") to match assets more closely to liabilities. Swap Agreements exchange interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) with a counterparty, based on an underlying principal balance (notional principal) to hedge against interest rate changes. 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. No Dollar Roll Repos were outstanding at December 31, 2004. The Company also seeks to provide liquidity by investing in MBS. MBS are generally investment-grade securities collateralized by large pools of mortgage loans. MBS 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 and Swap Agreements is counterparty risk. The Company believes, however, that the counterparties to its Dollar Roll Repos and Swap Agreements 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. In addition to counterparty risk, Swap Agreements also have interest rate risk. However, the Company's Swap Agreements are intended to hedge variable-rate assets or liabilities. The primary risk associated with MBS 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 least quarterly to determine whether specific investments should be placed on a nonaccrual 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 F-19 value of the underlying collateral. For investments in partnerships, management reviews the financial statements and other information provided by the general partners. The carrying values of investments that are determined to have declines in value that are other than temporary are reduced to net realizable 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 $40.1 million of bonds at December 31, 2004, and constituted approximately 0.6% of total invested assets. At December 31, 2003, defaulted investments totaled $49.6 million of bonds, which constituted approximately 0.7% 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, reverse repurchase agreement capacity on invested assets and, if required, proceeds from invested asset sales. The Company's liquidity is primarily derived from operating cash flows from annuity operations. At December 31, 2004, approximately $4.09 billion of the Bond Portfolio had an aggregate unrealized gain of $180.3 million, while approximately $1.07 billion of the Bond Portfolio had an aggregate unrealized loss of $27.1 million. In addition, the Company's investment portfolio currently provides approximately $44.0 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 Fixed-Rate Products 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 interest rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its Fixed-Rate Products. 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. 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 The Company has six agreements outstanding in which it has provided liquidity support for certain short-term securities of municipalities and non-profit organizations by agreeing to purchase such securities in the event there is no other buyer in the short-term marketplace. In return the Company receives a fee. In addition, the Company guarantees the payment of these securities upon redemption. The maximum liability under these guarantees at December 31, 2004 is $195.4 million. These commitments have contractual maturity dates in 2005. Related to each of these agreements are participation agreements with the Parent, under which the Parent will share in $62.6 million of these liabilities in exchange for a proportionate percentage of the fees received under these agreements. The Internal Revenue Service examined the transactions underlying these commitments, including the Company's role in the transactions. The examination did not result in a material loss to the Company. At December 31, 2004, the Company held reserves for GICs with maturity dates as follows: $186.5 million in 2005 and $28.8 million in 2024. F-20 RECENTLY ISSUED ACCOUNTING STANDARDS In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts." (For further discussion see Note 2 of Notes to Consolidated Financial Statements.) CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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. DIRECTORS AND OFFICERS Directors are elected for one year terms at the annual meeting of the shareholder. They receive no additional compensation for serving as directors. The board of directors elects executive officers to one year terms subject to removal at the board's discretion. The directors and principal officers of AIG SunAmerica Life Assurance Company (the "Company") as of March 31, 2005 are listed below, together with information as to their ages, dates of election and principal business occupations during the last five years (if other than their present business occupations).
YEAR ASSUMED OTHER POSITIONS AND OTHER BUSINESS EXPERIENCE NAME AGE PRESENT POSITION POSITION WITHIN LAST FIVE YEARS FROM-TO - ---- --- ---------------------- -------- --------------------------------------------- --------- Jay S. Wintrob*.......... 48 Chairman and Chief 2001 Chief Executive Officer, AIGRS, SunAmerica 2001- Executive Officer Life Insurance Company ("SALIC") and First 2001- SunAmerica Life Insurance Company ("FSA") President, FSA 2001- President, AIGRS 2000- Chief Operating Officer, AIGRS 1998-2000 Vice Chairman, AIGRS (Joined AIGRS in 1987) 1995-2000 James R. Belardi*........ 48 Senior Vice President 1994 President, SALIC 2002- Executive Vice President, AIGRS (Joined AIGRS 1995- in 1986) Marc H. Gamsin*.......... 49 Senior Vice President 1999 Executive Vice President, AIGRS 2001- Senior Vice President, SALIC and FSA 1999- Executive Vice President SunAmerica 1998- Investments, Inc. N. Scott Gillis*......... 51 Senior Vice President 2003 Chief Financial Officer, AIGRS, SALIC and FSA 2003- and Chief Financial Senior Vice President, AIGRS 2002- Officer Controller, AIGRS 2000- Vice President, AIGRS (Joined AIGRS in 1985) 1998-2002 Jana W. Greer*........... 53 President 2002 Executive Vice President, AIGRS 2001- President, SunAmerica Retirement Markets, 1996- Inc. 1994- Senior Vice President, SALIC and FSA 1992-2000 Senior Vice President, AIGRS (Joined AIGRS in 1974) Michael J. Akers......... 55 Senior Vice President 2003 Chief Actuary, AIGRS 2003- Senior Vice President, SALIC and FSA 2003- Senior Vice President, AIGRS 2002- Senior Vice President and Chief Actuary, The 1999-2002 Variable Annuity Life Insurance Company Christine A. Nixon....... 40 Senior Vice President, 2003 Senior Vice President, General Counsel and 2003- General Counsel and Secretary, SALIC and FSA Secretary Chief Compliance Officer, AIGRS 2003 Secretary and Deputy Chief Legal Counsel, 2002- AIGRS 2000- Vice President, AIGRS (Joined AIGRS in 1993) 1997-2000 Associate General Counsel, AIGRS Gregory M. Outcalt....... 42 Senior Vice President 2000 Vice President, SunAmerica Investments, Inc. 2002- Senior Vice President, SALIC and FSA (Joined 2000- AIGRS in 1986) DIRECTOR NAME SINCE - ---- -------- Jay S. Wintrob*.......... 1990 James R. Belardi*........ 1990 Marc H. Gamsin*.......... 2000 N. Scott Gillis*......... 2000 Jana W. Greer*........... 1993 Michael J. Akers......... -- Christine A. Nixon....... -- Gregory M. Outcalt....... --
F-21
YEAR ASSUMED OTHER POSITIONS AND OTHER BUSINESS EXPERIENCE NAME AGE PRESENT POSITION POSITION WITHIN LAST FIVE YEARS FROM-TO - ---- --- ---------------------- -------- --------------------------------------------- --------- Stewart Polakov.......... 45 Senior Vice President 2003 Senior Vice President and Controller, FSA and 2003- and Controller SALIC Vice President, SALIC and FSA (Joined AIGRS 1997-2003 in 1991) Edwin R. Raquel.......... 47 Senior Vice President 1995 Senior Vice President and Chief Actuary, 1995- and Chief Actuary SALIC and FSA (Joined AIGRS in 1990) Mallary L. Reznik........ 36 Vice President 2005 Vice President, FSA 2005- Associate General Counsel, AIGRS 1998- Stephen J. Stone......... 46 Vice President 2005 Vice President, FSA 2005- Senior Portfolio Manager, Allstate Insurance 1989-2004 Company Edward T. Texeria........ 40 Vice President 2003 Vice President, SALIC and FSA 2003- Assistant Controller, AIGRS 2003- Assistant Controller, SALIC and FSA 2000-2003 Senior Manager, Assurance and Advisory 1994-2000 Business Services, Ernst & Young LLP DIRECTOR NAME SINCE - ---- -------- Stewart Polakov.......... -- Edwin R. Raquel.......... -- Mallary L. Reznik........ -- Stephen J. Stone......... -- Edward T. Texeria........ --
- --------------- * Also serves as a director The Company does not have an audit committee and relies on the Audit Committee of the Board of Directors of AIG. EXECUTIVE COMPENSATION The Company's executive officers provide services for the Company, its subsidiaries and, for certain officers, its affiliates. Allocations have been made to the Company and its subsidiaries based upon each individual's time devoted to his or her duties for the Company and its subsidiaries. All compensation information provided under this Item 11 is based on these allocations. The following table sets forth allocable compensation awarded to, earned by or paid to the Company's chief executive officer and four other most highly compensated executive officers for the years ended December 31, 2004, 2003 and 2002: SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ANNUAL COMPENSATION --------------------------- ---------------------------------- SECURITIES NAME AND OTHER ANNUAL UNDERLYING LTIP ALL OTHER SICO LTIP PRINCIPAL POSITION YEAR SALARY BONUS(1) COMPENSATION OPTIONS (#)(2) PAYOUTS(3) COMPENSATION(4) AWARDS(5) - ------------------ ---- -------- -------- ------------ -------------- ---------- --------------- --------- Jay S. Wintrob............ 2004 $ 84,500 $104,000 $21,580 6,500 $194,526 $ 5,068 $341,484 Chief Executive Officer 2003 86,125 71,500 18,330 10,400 183,365 3,041 -- 2002 316,050 215,600 56,840 19,600 719,992 2,467,413 907,088 Jana W. Greer............. 2004 329,648 517,634 -- 6,762 417,973 18,109 695,051 President 2003 318,000 371,353 -- 10,560 327,366 17,208 -- 2002 220,789 111,250 -- 4,005 363,902 2,014,889 556,054 Peter A. Harbeck.......... 2004 254,567 442,500 -- 7,500 364,920 14,475 531,927 President & Chief Executive 2003 331,250 390,000 -- 13,000 389,782 18,950 -- Officer, Asset Management 2002 223,269 160,000 50,000 6,500 444,581 1,512,950 590,070 N. Scott Gillis........... 2004 69,863 65,138 -- 1,782 36,437 5,360 170,217 Senior Vice President and 2003 69,317 58,050 -- 3,240 24,726 6,448 -- Chief Financial Officer 2002 61,027 71,750 -- 2,460 49,230 169,465 104,361 Christine A. Nixon........ 2004 92,250 50,840 -- 2,009 20,997 7,558 64,619 Senior Vice President, General 2003 89,038 39,600 -- 3,600 15,860 7,889 -- Counsel and Secretary 2002 46,142 27,900 -- 1,395 14,839 65,863 57,387
- --------------- (1) Amounts represent year-end and bonuses paid quarterly pursuant to a quarterly bonus program sponsored by AIG and marketing incentives. (2) Amounts represent the number of shares of common stock of AIG subject to options granted during the year indicated. (3) Amounts shown represent payments under the Company's 2000 and 2001 Five-Year Deferred Bonus Plans. Awards were granted under these plans in 2000 and 2001 and additional grants are not anticipated. Each award pays out in 20% installments over five years of continued employment. The last installment is to be paid in 2006. (4) Amounts shown primarily represent Company matching contributions under the 401(k) Plan and the Executive Savings Plan. Additionally, the 2002 amounts shown for Mr. Wintrob, Ms. Greer, Mr. Harbeck, Mr. Gillis and Ms. Nixon include allocated retention bonuses awarded in connection with the acquisition of SunAmerica Inc. by AIG consummated on January 1, 1999. F-22 (5) The SICO LTIP awards were granted by Starr International Company, Inc. pursuant to its Deferred Compensation Profit Participation Plan (the "SICO Plan"). The following table summarizes certain information with respect to the allocable portion of grants of options to purchase AIG common stock which were granted during 2004 to the individuals named in the Summary Compensation Table. OPTION GRANTS IN 2004
POTENTIAL REALIZABLE VALUE* PERCENTAGE OF AT ASSUMED ANNUAL RATES OF NUMBER OF TOTAL OPTIONS STOCK APPRECIATION FOR SECURITIES GRANTED TO AIG EXERCISE OPTION TERM DATE OF UNDERLYING EMPLOYEES PRICE PER EXPIRATION ---------------------------- NAME GRANT OPTIONS(1) DURING 2004(2) SHARE DATE 5 PERCENT(3) 10 PERCENT(4) - ---- ---------- ---------- -------------- --------- ---------- ------------ ------------- Jay S. Wintrob................. 12/16/2004 6,500 0.19% $64.47 12/16/14 $263,510 $667,875 Jana W. Greer.................. 12/16/2004 6,762 0.20% 64.47 12/16/14 274,131 694,795 Peter A. Harbeck............... 12/16/2004 7,500 0.22% 64.47 12/16/14 304,050 770,625 N. Scott Gillis................ 12/16/2004 1,782 0.05% 64.47 12/16/14 72,242 183,101 Christine A. Nixon............. 12/16/2004 2,009 0.06% 64.47 12/16/14 81,445 206,425
- --------------- * Options would have no realizable value if there were no appreciation or if there were depreciation from the price at which options were granted. (1) All options relate to shares of common stock of AIG and were granted pursuant to AIG's Amended and Restated 1999 Stock Option Plan at an exercise price equal to the fair market value of such stock at the date of grant. The option grants in 2004 provide that 25 percent of the options granted on any date become exercisable on each anniversary date in each of the successive four years and expire ten years from the date of grant. (2) It is impractical to determine the percent the grant represents of total options granted to the Company's employees, since the Company has no employees. The percentage is provided with regard to options granted to employees of AIG and its subsidiaries. (3) The appreciated price per share at 5 percent is $105.01 per share. (4) The appreciated price per share at 10 percent is $167.22 per share. The following table summarizes certain information with respect to the allocable exercise of options to purchase AIG common stock during 2004 by the individuals named in the Summary Compensation Table and the allocable unexercised options to purchase AIG common stock held by such individuals at December 31, 2004 based on the allocations described above. AGGREGATED OPTION EXERCISES DURING THE YEAR ENDED DECEMBER 31, 2004 AND DECEMBER 31, 2004 OPTION VALUES
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT SHARES DECEMBER 31, 2004 DECEMBER 31, 2004(2) ACQUIRED ON VALUE --------------------------- --------------------------- NAME EXERCISE REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ----------- ----------- ------------- ----------- ------------- Jay S. Wintrob............................ 21,101 $1,368,055 95,143 21,288 $ 4,474,328 $98,683 Jana W. Greer............................. 53,023 3,315,702 259,354 61,642 11,565,498 87,719 Peter A. Harbeck.......................... 14,428 710,616 57,373 45,471 1,464,499 94,203 N. Scott Gillis........................... 1,144 50,969 12,170 8,937 275,270 30,452 Christine A. Nixon........................ 3,549 203,628 12,983 9,364 377,754 34,657
- --------------- (1) Aggregate market value on date of exercise (closing sale price as reported in the New York Stock Exchange Composite Transactions Report) less aggregate exercise price. (2) Aggregate market value on December 31, 2004 (closing sale price as reported in the New York Stock Exchange Composite Transactions Report) less aggregate exercise price. F-23 The following table summarizes certain information with respect to benefits granted under the SICO Plan which were granted during 2002 (with respect to the 2003-2004 period) to the individuals named in the Summary Compensation Table. SICO LONG-TERM INCENTIVE PLANS(1)
NUMBER UNIT AWARD ESTIMATED NAME OF UNITS PERIOD FUTURE PAYOUTS - ---- -------- ---------- ---------------- Jay S. Wintrob.............................................. 325 Two years 5,200 shares Jana W. Greer............................................... 882 Two years 10,584 shares Peter A. Harbeck............................................ 675 Two years 8,100 shares N. Scott Gillis............................................. 216 Two years 2,592 shares Christine A. Nixon.......................................... 123 Two years 984 shares
- --------------- (1) Awards represent grants of units under the SICO Plan with respect to the two-year period from January 1, 2003 through December 31, 2004. The SICO Plan contains neither threshold amounts nor maximum payout limitations. The number of shares of AIG common stock, if any, allocated to a unit for the benefit of a participant in the SICO Plan is primarily dependent upon two factors: the growth in future earnings of AIG during the unit award period and the book value of AIG at the end of the award period. Prior to earning the right to payout, the participant is not entitled to any equity interest with respect to such shares, and the shares are subject to forfeiture under certain conditions, including but not limited to the participant's voluntary termination of employment with AIG or its subsidiaries prior to normal retirement age other than by death or disability. EMPLOYEE BENEFIT PLANS The Company participates in several employee benefit plans sponsored by AIG. RETIREMENT PLANS: The American International Group, Inc. Retirement Plan (the "AIG Plan") is a non-contributory, qualified, defined benefit plan. For employees of AIGRS and its subsidiaries, the formula equals .925% times Average Final Compensation (defined as the average annual compensation, which includes base pay and sales commissions, subject to limitations for certain highly compensated employees imposed by law, during the three consecutive years in the last ten years of credited service affording the highest such average) up to 150% of the employee's "covered compensation" (the average of the Social Security Wage Bases during the 35 years preceding the Social Security retirement age), plus 1.425% times Average Final Compensation in excess of 150% of the employee's "covered compensation" times years of credited service up to 35 years; plus 1.425% times Average Final Compensation times years of credited service in excess of 35 years but limited to 44 years. AIG also has in place the AIG Excess Retirement Income Plan ("AIG Excess Plan") for employees participating in the AIG Plan whose benefits under the AIG Plan are limited by applicable tax laws. The AIG Excess Plan provides benefits in excess of the AIG Plan benefits determined as if the benefit under the AIG Plan has been calculated without the limitations imposed by applicable tax laws. The AIG Excess Plan is a nonqualified, unfunded plan. AIG also has approved a Supplemental Executive Retirement Plan ("AIG SERP") which provides annual benefits to certain employees of AIGRS and its subsidiaries, not to exceed 60% of Average Final Compensation, that accrue at a rate of 2.4% of Average Final Compensation for each year of service or fraction thereof for each full month of active employment. The benefit payable under the AIG SERP is reduced by payments from the AIG Plan, the AIG Excess Plan, Social Security and any payments from a qualified pension plan of a prior employer. F-24 Annual amounts of normal retirement pension commencing at normal retirement age of 65 based upon Average Final Compensation and credited service under the AIG Plan and the AIG Excess Plan are illustrated in the following table: ESTIMATED ANNUAL PENSION AT AGE 65
AVERAGE FINAL COMPENSATION 10 YEARS 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS 40 YEARS - ------------- -------- -------- -------- -------- -------- -------- ---------- $ 125,000 $ 14,341 $ 21,512 $ 28,682 $ 35,853 $ 43,024 $ 50,194 $ 59,100 $ 150,000 17,904 26,856 35,807 44,759 53,711 62,663 73,350 $ 175,000 21,466 32,199 42,932 53,666 64,399 75,132 87,600 $ 200,000 25,029 37,543 50,057 62,572 75,086 87,600 101,850 $ 225,000 28,591 42,887 57,182 71,478 85,774 100,069 116,100 $ 250,000 32,154 48,231 64,307 80,384 96,461 112,538 130,350 $ 300,000 39,279 58,918 78,557 98,197 117,836 137,475 158,850 $ 375,000 49,966 74,949 99,932 124,916 149,899 174,882 201,600 $ 400,000 53,529 80,293 107,057 133,822 160,586 187,350 215,850 $ 500,000 67,779 101,668 135,557 169,447 203,336 237,225 272,850 $ 750,000 103,404 155,106 206,807 258,509 310,211 361,913 415,350 $1,000,000 139,029 208,543 278,057 347,572 417,086 486,600 557,850 $1,200,000 167,529 251,293 335,057 418,822 502,586 586,350 671,850 $1,400,000 196,029 294,043 392,057 490,072 588,086 686,100 785,850 $1,600,000 224,529 336,793 449,057 561,322 673,586 785,850 899,850 $1,800,000 253,029 379,543 506,057 632,572 759,086 885,600 1,013,850 $2,000,000 281,529 422,293 563,057 703,822 844,586 985,350 1,127,850
Each of the individuals named in the Summary Compensation Table have 2.0 years of credited service (under both plans) through December 31, 2004. Pensionable salary includes the regular salary paid by AIG and its subsidiaries and does not include amounts attributable to supplementary bonuses or overtime pay. For such named individuals, pensionable salary allocable to the Company during 2004 was as follows: Mr. Wintrob - $84,500; Ms. Greer - $329,648; Mr. Harbeck - $339,423; Mr. Gillis - $69,863; and Ms. Nixon - $92,250. Employees of AIGRS and its subsidiaries participate in the American International Group, Inc. Incentive Savings Plan (the "Incentive Savings Plan"), a 401(k) plan established by AIG which includes salary reduction contributions by employees and matching contributions. Matching contributions vary based on the number of years the employee has been employed. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Board of Directors of the Company does not have a Compensation Committee. Compensation decisions regarding the Chief Executive Officer are made by AIG. Compensation decisions regarding other executive officers are made by the Chief Executive Officer. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The Company is an indirect wholly owned subsidiary of American International Group, Inc. The number of shares of AIG common stock beneficially owned as of January 31, 2005, by directors, executive officers named in the Summary Compensation Table (as set forth in Item 11) and directors and executive officers as a group were as follows:
AIG COMMON STOCK -------------------- AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP DIRECTOR OR EXECUTIVE OFFICER (1)(2)(3)(5) - ----------------------------- -------------------- Jay S. Wintrob(4)........................................... 2,087,506 James R. Belardi............................................ 861,222 Marc H. Gamsin.............................................. 140,616 N. Scott Gillis............................................. 47,439 Jana W. Greer............................................... 304,877 Peter A. Harbeck............................................ 132,846 Christine A. Nixon.......................................... 33,003 All Directors and Executive Officers as a Group............. 3,607,509
F-25 - --------------- (1) The number of shares of AIG common stock owned by each individual and by all directors and executive officers as a group represents less than 1% of the outstanding shares of AIG common stock. (2) The number of shares of AIG common stock shown includes shares with respect to which the individual shares voting and investment power as follows: Mr. Belardi - 237 shares with his spouse; Ms. Greer - 39,105 shares with co-trustee. (3) The number of shares of AIG common stock shown includes shares subject to options which may be exercised within 60 days as follows: Mr. Wintrob - 741,870; Mr. Belardi - 305,397; Ms. Greer - 265,772; Mr. Gillis - 46,575; Mr. Gamsin - 140,216; Mr. Harbeck - 78,122; Ms. Nixon - 32,790; and all directors and executive officers as a group - 1,610,742. (4) Mr. Wintrob holds equity securities of C.V. Starr & Co., Inc. of 750 shares of Common Stock and 3,750 shares of various series of Preferred Stock. (5) The number of shares of AIG common stock shown excludes the following shares owned by members of the named individual's immediate family as to which such individual has disclaimed beneficial ownership: Mr. Wintrob - 4,009 shares held by various family members. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS During 2004, the Company paid cash dividends to its shareholder aggregating $2.5 million and received a capital contribution of 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo") (formerly SunAmerica Asset Management Corp.) which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica Fund Services, Inc. ("SFS") (formerly SunAmerica Fund Services, Inc.). This capital contribution increased the Company's equity by $150,653,000. Beginning in 2004, the Company and its subsidiaries are included in the consolidated federal income tax return of its ultimate parent, AIG. The Company is a party to a written agreement (the "Tax Sharing Agreement") with AIG setting forth the manner in which the total consolidated U.S. Federal income tax is allocated to each entity that joins in the consolidated return. The Tax Sharing Agreement provides that AIG agrees not to charge us a greater portion of the consolidated tax liability than would have been paid by us had the Company filed a separate federal income tax return. Additionally, AIG agrees to reimburse the Company for any tax benefits arising out of net losses or tax credits, if any, within ninety days after the filing of the consolidated federal income tax return for the year in which such losses or tax credits are utilized by AIG. The Company paid commissions totaling $60,674,000 in 2004 to nine affiliated broker-dealers: Royal Alliance Associates, Inc.; SunAmerica Securities, Inc.; Advantage Capital Corporation; FSC Services Corporation; Sentra Securities Corporation; Spelman & Co., Inc.; VALIC Financial Advisors; American General Equity Securities Corporation and American General Securities Inc. These affiliated broker-dealers distribute a significant portion of the Company's variable annuity products amounting to approximately 23% of deposits in 2004. Of the Company's mutual fund sales, approximately 25% were distributed by these affiliated broker-dealers in 2004. On February 1, 2004, SAAMCo entered into an administrative services agreement with FSA whereby SAAMCo will pay to FSA a fee based on a percentage of all assets invested through FSA's variable annuity products in exchange for services performed. SAAMCo is the investment advisor for certain trusts that serve as investment options for FSA's variable annuity products. Amounts incurred by the Company under this agreement totaled $1,537,000 in 2004. On October 1, 2001, SAAMCo entered into two administrative services agreements with business trusts established by its affiliate, The Variable Annuity Life Insurance Company ("VALIC"), whereby the trust pays to SAAMCo a fee based on a percentage of average daily net assets invested through VALIC's annuity products in exchange for services performed. Amounts earned by SAAMCo under this agreement totaled $9,074,000 in 2004 and are net of certain administrative costs incurred by VALIC of $2,593,000. Pursuant to a cost allocation agreement, the Company purchases administrative, investment management, accounting, legal, marketing and data processing services from the Parent, AIGRS and AIG. The allocation of such costs for investment management services is based on the level of assets under management. The allocation of costs for other services is based on estimated levels of usage, transactions or time incurred in providing the respective services. Amounts paid for such services totaled $148,554,000 in 2004. The majority of the Company's invested assets are managed by an affiliate of the Company. The investment management fees incurred were $3,712,000 in 2004. Additionally, the Company incurred $1,113,000 of management fees to an affiliate of the Company to administer its securities lending program for 2004. F-26 FINANCIAL STATEMENTS The consolidated financial statements of AIG SunAmerica Life Assurance Company which are included in this prospectus should be considered only as bearing on the ability AIG SunAmerica Life to meet its obligations with respect to amounts allocated to the fixed investment options and with respect to the death and other living benefits and our assumption of the mortality and expense risks and the risks that withdrawal charge will not be sufficient to cover the cost of distributing the contracts. They should not be considered as bearing on the investment performance of the variable Portfolios. The value of the variable Portfolios is affected primarily by the performance of the underlying investments. F-27 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholder of AIG SunAmerica Life Assurance Company: In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income and comprehensive income and of cash flows, in all material respects, the financial position of AIG SunAmerica Life Assurance Company (the "Company"), an indirect wholly owned subsidiary of American International Group, Inc., at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards 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 consolidated financial statements, the Company changed its method of accounting and reporting for certain nontraditional long-duration contracts in 2004. PricewaterhouseCoopers LLP Los Angeles, California April 15, 2005 F-28 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED BALANCE SHEET
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Assets Investments and cash: Cash and short-term investments........................... $ 201,117 $ 133,105 Bonds, notes and redeemable preferred stocks available for sale, at fair value (amortized cost: December 31, 2004, $5,007,868; December 31, 2003, $5,351,183).............. 5,161,027 5,505,800 Mortgage loans............................................ 624,179 716,846 Policy loans.............................................. 185,958 200,232 Mutual funds.............................................. 6,131 21,159 Common stocks available for sale, at fair value (cost: December 31, 2004, $4,876; December 31, 2003, $635)..... 4,902 727 Real estate............................................... 20,091 22,166 Securities lending collateral............................. 883,792 514,145 Other invested assets..................................... 38,789 10,453 ----------- ----------- Total investments and cash................................ 7,125,986 7,124,633 Variable annuity assets held in separate accounts........... 22,612,451 19,178,796 Accrued investment income................................... 73,769 74,647 Deferred acquisition costs.................................. 1,349,089 1,268,621 Other deferred expenses..................................... 257,781 236,707 Income taxes currently receivable from Parent............... 9,945 15,455 Receivable from brokers for sales of securities............. 161 -- Goodwill.................................................... 14,038 14,038 Other assets................................................ 52,795 58,830 ----------- ----------- Total Assets................................................ $31,496,015 $27,971,727 =========== ===========
See accompanying notes to consolidated financial statements. F-29 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED BALANCE SHEET (Continued)
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Liabilities and Shareholder's Equity Reserves, payables and accrued liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 3,948,158 $ 4,274,329 Reserves for universal life insurance contracts........... 1,535,905 1,609,233 Reserves for guaranteed investment contracts.............. 215,331 218,032 Reserves for guaranteed benefits.......................... 76,949 12,022 Securities lending payable................................ 883,792 514,145 Due to affiliates......................................... 21,655 19,289 Payable to brokers........................................ -- 1,140 Other liabilities......................................... 190,198 247,435 ----------- ----------- Total reserves, payables and accrued liabilities.......... 6,871,988 6,895,625 Variable annuity liabilities related to separate accounts... 22,612,451 19,178,796 Subordinated notes payable to affiliates.................... -- 40,960 Deferred income taxes....................................... 257,532 242,556 ----------- ----------- Total liabilities........................................... 29,741,971 26,357,937 ----------- ----------- Shareholder's equity: Common stock.............................................. 3,511 3,511 Additional paid-in capital................................ 758,346 709,246 Retained earnings......................................... 919,612 828,423 Accumulated other comprehensive income.................... 72,575 72,610 ----------- ----------- Total shareholder's equity................................ 1,754,044 1,613,790 ----------- ----------- Total Liabilities and Shareholder's Equity.................. $31,496,015 $27,971,727 =========== ===========
See accompanying notes to consolidated financial statements. F-30 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Revenues: Fee income: Variable annuity policy fees, net of reinsurance........ $369,141 $281,359 $286,919 Asset management fees................................... 89,569 66,663 66,423 Universal life insurance fees, net of reinsurance....... 33,899 35,816 36,253 Surrender charges....................................... 26,219 27,733 32,507 Other fees.............................................. 15,753 15,520 21,900 -------- -------- -------- Total fee income...................................... 534,581 427,091 444,002 Investment income........................................... 363,594 402,923 387,355 Net realized investment losses.............................. (23,807) (30,354) (65,811) -------- -------- -------- Total revenues.............................................. 874,368 799,660 765,546 ======== ======== ======== Benefits and Expenses: Interest expense: Fixed annuity and fixed accounts of variable annuity contracts............................................... 140,889 153,636 142,973 Universal life insurance contracts........................ 73,745 76,415 80,021 Guaranteed investment contracts........................... 6,034 7,534 11,267 Subordinated notes payable to affiliates.................. 2,081 2,628 3,868 -------- -------- -------- Total interest expense...................................... 222,749 240,213 238,129 Amortization of bonus interest.............................. 10,357 19,776 16,277 General and administrative expenses......................... 131,612 119,093 115,210 Amortization of deferred acquisition costs and other deferred expenses......................................... 157,650 160,106 222,484 Annual commissions.......................................... 64,323 55,661 58,389 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 17,766 15,716 Guaranteed minimum death benefits, net of reinsurance recoveries................................................ 58,756 63,268 67,492 -------- -------- -------- Total benefits and expenses................................. 662,867 675,883 733,697 ======== ======== ======== Pretax Income Before Cumulative Effect of Accounting Change.................................................... 211,501 123,777 31,849 Income tax expense.......................................... 6,410 30,247 160 -------- -------- -------- Net Income Before Cumulative Effect of Accounting Change.... 205,091 93,530 31,689 Cumulative effect of accounting change, net of tax.......... (62,589) -- -- -------- -------- -------- Net Income.................................................. $142,502 $ 93,530 $ 31,689 ======== ======== ======== Other Comprehensive Income (Loss), Net of Tax: Net unrealized gains (losses) on debt and equity securities available for sale identified in the current period less related amortization of deferred acquisition costs and other deferred expenses....................... $(20,487) $ 67,125 $ 20,358 Less reclassification adjustment for net realized losses included in net income.................................. 19,263 19,194 52,285 Net unrealized gains (losses) on foreign currency......... 1,170 -- -- Change related to cash flow hedges........................ -- -- (2,218) Income tax (benefit) expense.............................. 19 (30,213) (24,649) -------- -------- -------- Other Comprehensive Income (Loss)........................... (35) 56,106 45,776 -------- -------- -------- Comprehensive Income........................................ $142,467 $149,636 $ 77,465 ======== ======== ========
See accompanying notes to consolidated financial statements. F-31 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, ------------------------------------- 2004 2003 2002 --------- ----------- ----------- (IN THOUSANDS) Cash Flow from Operating Activities: Net income.................................................. $ 142,502 $ 93,530 $ 31,689 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of accounting change, net of tax........ 62,589 -- -- Interest credited to: Fixed annuity and fixed accounts of variable annuity contracts.............................................. 140,889 153,636 142,973 Universal life insurance contracts...................... 73,745 76,415 80,021 Guaranteed investment contracts......................... 6,034 7,534 11,267 Net realized investment losses............................ 23,807 30,354 65,811 Accretion of net discounts on investments................. (1,277) (9,378) (2,412) Loss on other invested assets............................. 572 2,859 3,932 Amortization of deferred acquisition costs and other expenses................................................ 168,007 179,882 238,761 Acquisition costs deferred................................ (246,033) (212,251) (204,833) Other expenses deferred................................... (62,906) (70,158) (77,602) Depreciation of fixed assets.............................. 1,619 1,718 860 Provision for deferred income taxes....................... 49,337 (129,591) 106,044 Change in: Accrued investment income............................... 878 679 13,907 Other assets............................................ 4,416 (12,349) 4,736 Income taxes currently payable to/receivable from Parent................................................. 5,157 148,898 (43,629) Due from/to affiliates.................................. 2,366 (36,841) (7,743) Other liabilities....................................... 7,485 10,697 (7,143) Other, net................................................ 2,284 14,885 10,877 --------- ----------- ----------- Net Cash Provided by Operating Activities................... 381,471 250,519 367,516 --------- ----------- ----------- Cash Flows from Investing Activities: Purchases of: Bonds, notes and redeemable preferred stocks.............. (964,705) (2,078,310) (2,403,362) Mortgage loans............................................ (31,502) (44,247) (128,764) Other investments, excluding short-term investments....... (33,235) (20,266) (65,184) Sales of: Bonds, notes and redeemable preferred stocks.............. 383,695 1,190,299 849,022 Other investments, excluding short-term investments....... 22,283 12,835 825 Redemptions and maturities of: Bonds, notes and redeemable preferred stocks.............. 898,682 994,014 615,798 Mortgage loans............................................ 125,475 67,506 82,825 Other investments, excluding short-term investments....... 10,915 72,970 114,347 --------- ----------- ----------- Net Cash Provided By (Used in) Investing Activities......... $ 411,608 $ 194,801 $ (934,493) ========= =========== ===========
See accompanying notes to consolidated financial statements. F-32 AIG SUNAMERICA LIFE ASSURANCE COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
YEARS ENDED DECEMBER 31, -------------------------------------- 2004 2003 2002 ----------- ----------- ---------- (IN THOUSANDS) Cash Flow from Financing Activities: Deposits received on: Fixed annuity and fixed accounts of variable annuity contracts............................................... $ 1,360,319 $ 1,553,000 $1,731,597 Universal life insurance contracts........................ 45,183 45,657 49,402 Net exchanges from the fixed accounts of variable annuity contracts................................................. (1,332,240) (1,108,030) (503,221) Withdrawal payments on: Fixed annuity and fixed accounts of variable annuity contracts............................................... (458,052) (464,332) (529,466) Universal life insurance contracts........................ (69,185) (61,039) (68,444) Guaranteed investment contracts........................... (8,614) (148,719) (135,084) Claims and annuity payments, net of reinsurance, on: Fixed annuity and fixed accounts of variable annuity contracts............................................... (108,691) (109,412) (98,570) Universal life insurance contracts........................ (105,489) (111,380) (100,995) Net receipt from (repayments of) other short-term financings................................................ (41,060) 14,000 -- Net payment related to a modified coinsurance transaction... (4,738) (26,655) (30,282) Capital contribution received from Parent................... -- -- 200,000 Dividends paid to Parent.................................... (2,500) (12,187) (10,000) ----------- ----------- ---------- Net Cash (Used in) Provided by Financing Activities......... (725,067) (429,097) 504,937 ----------- ----------- ---------- Net Increase (Decrease) in Cash and Short-term Investments............................................... 68,012 16,223 (62,040) Cash and Short-term Investments at Beginning of Period...... 133,105 116,882 178,922 ----------- ----------- ---------- Cash and Short-term Investments at End of Period............ $ 201,117 $ 133,105 $ 116,882 =========== =========== ========== Supplemental Cash Flow Formation: Interest paid on indebtedness............................... $ 2,081 $ 2,628 $ 3,868 =========== =========== ========== Net income taxes (received) paid to Parent.................. $ (47,749) $ 10,989 $ 5,856 =========== =========== ==========
See accompanying notes to consolidated financial statements. F-33 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AIG SunAmerica Life Assurance Company (formerly Anchor National Life Insurance Company) (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, retirement services and asset management. The Company is an Arizona-domiciled life insurance company principally engaged in the business of writing variable annuity contracts directed to the market for tax-deferred, long-term savings products. The Company changed its name to AIG SunAmerica Life Assurance Company on January 24, 2002. The Company continued to do business as Anchor National Life Insurance Company until February 28, 2003, at which time it began doing business under its new name. Effective January 1, 2004, the Parent contributed to the Company 100% of the outstanding capital stock of its consolidated subsidiary, AIG SunAmerica Asset Management Corp. ("SAAMCo") (formerly SunAmerica Asset Management Corp.) which in turn has two wholly owned subsidiaries: AIG SunAmerica Capital Services, Inc. ("SACS") (formerly SunAmerica Capital Services, Inc.) and AIG SunAmerica Fund Services, Inc. ("SFS") (formerly SunAmerica Fund Services, Inc.). Pursuant to this contribution, SAAMCo became a direct wholly owned subsidiary of the Company. Assets, liabilities and shareholder's equity at December 31, 2003 were restated to include $190,605,000, $39,952,000 and $150,653,000, respectively, of SAAMCo balances. Similarly, the results of operations and cash flows for the years ended December 31, 2003 and 2002 have been restated for the addition and subtraction to pretax income of $16,345,000 and $4,464,000 to reflect the SAAMCo activity. Prior to this capital contribution to the Company, SAAMCo distributed certain investments with a tax effect of $49,100,000 which was indemnified by its then parent, SALIC. See Note 10 of the Notes to Consolidated Financial Statements. SAAMCo and its wholly owned distributor, SACS, and its wholly owned servicing administrator, SFS, are included in the Company's asset management segment (see Note 13). These companies earn fee income by managing, distributing and administering a diversified family of mutual funds, managing certain subaccounts offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios. 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. Products for the annuity operations and asset management operations are marketed through affiliated and independent broker-dealers, full-service securities firms and financial institutions. One independent selling organization in the annuity operations represented 24.8% of deposits in the year ended December 31, 2004, 14.6% of deposits in the year ended December 31, 2003 and 11.9% of deposits in the year ended December 31, 2002. No other independent selling organization was responsible for 10% or more of deposits for any such period. One independent selling organization in the asset management operations represented 16.0% of deposits in the year ended December 31, 2004 and 10.8% of deposits in the year ended December 31, 2003. No other independent selling organization was responsible for 10% or more of deposits for any such period. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION: The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the amounts reported in the financial F-34 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) statements and the accompanying notes. Actual results could differ from those estimates. Certain prior period items have been reclassified to conform to the current period's presentation. INVESTMENTS: Cash and short-term investments primarily include cash, commercial paper, money market investments and short-term bank 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 deferred acquisition costs, deferred other expenses and income tax, are credited or charged directly to the accumulated other comprehensive income or loss component of shareholder's equity. Bonds, notes, redeemable preferred stocks and common stocks are reduced to estimated net fair value when declines in such values 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. Mutual funds consist of seed money for mutual funds used as investment vehicles for the Company's variable annuity separate accounts and is carried at market value. Real estate is carried at the lower of cost or net realizable value. 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 fair value of securities pledged under the securities lending agreement were $862,481,000 and $502,885,000 as of December 31, 2004 and 2003, respectively, and represents securities included in bonds, notes and redeemable preferred stocks available for sale caption in the consolidated balance sheet as of December 31, 2004 and 2003, respectively. The Company receives primarily cash collateral in an amount in excess of the market value of the securities loaned. The affiliated lending agent 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 consolidated statement of income and comprehensive income. Other invested assets consist principally of investments in limited partnerships and put options on the S&P 500 index purchased to partially offset the risk of Guaranteed Minimum Account Value ("GMAV") benefits and Guaranteed Minimum Withdrawal ("GMWB") benefits (see Note 7). Limited partnerships are carried at cost. The put options do not qualify for hedge accounting and accordingly are marked to market and changes in market value are recorded through investment income. Realized gains and losses on the sale of investments are recognized in operations 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 consolidated statement of income and comprehensive income. Impairments writedowns totaled $21,050,000, $54,092,000 and $57,273,000 in the years ending December 31, 2004, 2003 and 2002. DERIVATIVE FINANCIAL INSTRUMENTS: Derivative financial instruments primarily used by the Company include interest rate swap agreements and put options on the S&P 500 index entered into to partially offset the risk of certain guarantees of annuity contract values. The Company is neither a dealer nor a trader in derivative financial instruments. F-35 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) The Company recognizes all derivatives in the consolidated balance sheet at fair value. Hedge accounting requires a high correlation between changes in fair values or cash flows of the derivative financial instrument and the specific item being hedged, both at inception and throughout the life of the hedge. For fair value hedges, gains and losses in the fair value of both the derivative and the hedged item attributable to the risk being hedged are recognized in earnings. For cash flow hedges, to the extent the hedge is effective, gains and losses in the fair value of both the derivative and the hedged item attributable to the risk being hedged are recognized as component of accumulated other comprehensive income in shareholder's equity. Any ineffective portion of cash flow hedges is reported in investment income. On the date a derivative contract is entered into, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet. Interest rate swap agreements convert specific investment securities from a floating-rate to a fixed-rate basis, or vice versa, and hedge against the risk of declining rates on anticipated security purchases. Interest rate swaps in which the Company agrees to pay a fixed rate and receive a floating rate are accounted for as fair value hedges. Interest rate swaps in which the Company agrees to pay a floating rate and receive a fixed rate are accounted for as cash flow hedges. The difference between amounts paid and received on swap agreements is recorded as an adjustment to investment income or interest expense, as appropriate, on an accrual basis over the periods covered by the agreements. The related amount payable to or receivable from counterparties is included in other liabilities or other assets. The Company issues certain variable annuity products that offer an optional GMAV and GMWB living benefit. If elected by the contract holder at the time of contract issuance, the GMAV feature guarantees that the account value under the contract will equal or exceed the amount of the initial principal invested, adjusted for withdrawals, at the end of a ten-year waiting period. If elected by the contract holder at the time of contract issuance, the GMWB feature guarantees an annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days, adjusted for any subsequent withdrawals. There is a separate charge to the contract holder for these features. The Company bears the risk that protracted under-performance of the financial markets could result in GMAV and GMWB benefits being higher than the underlying contract holder account balance and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. Under Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities"("FAS 133"), the GMAV and GMWB benefits are considered embedded derivatives that are bifurcated and marked to market and recorded in other liabilities in the consolidated balance sheet. Changes in the market value of the estimated GMAV and GMWB benefits are recorded through investment income. DEFERRED ACQUISITION COSTS ("DAC"): Policy acquisition costs are deferred and amortized over the estimated lives of the annuity and universal life insurance contracts. Policy acquisition costs include commissions and other costs that vary with, and are primarily related to, the production or acquisition of new business. DAC is amortized based on a percentage of expected gross profits ("EGPs") over the life of the underlying contracts. EGPs are computed based on assumptions related to the underlying contracts, including their anticipated duration, the growth rate of the separate account assets (with respect to variable options of the variable annuity contracts) or general account assets (with respect to fixed options of variable annuity contracts ("Fixed Options") and universal life insurance contracts) supporting the annuity obligations, costs of providing for contract guarantees and the level of expenses necessary to maintain the contracts. The Company adjusts amortization of DAC and other deferred expenses (a "DAC unlocking") when estimates of future gross profits to be realized from its annuity contracts are revised. The assumption for the long-term annual net growth of the separate account assets used by the Company in the determination of DAC amortization with respect to its variable annuity contracts is 10% (the "long-term growth rate assumption"). The Company uses a "reversion to the mean" methodology that allows the Company to maintain this 10% long-term growth rate assumption, while also giving consideration to the effect of short-term swings in the equity markets. For example, if performance were 15% during the first year following the introduction of a product, the DAC model would assume that market returns for the following five years (the "short-term growth rate assumption") would approximate 9%, resulting in an average annual growth rate of 10% during the life of the product. Similarly, following periods of below 10% F-36 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) performance, the model will assume a short-term growth rate higher than 10%. A DAC unlocking will occur if management deems the short-term growth rate (i.e., the growth rate required to revert to the mean 10% growth rate over a five-year period) to be unreasonable. The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. As debt 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 debt and equity securities available for sale which is a component of accumulated other comprehensive income (loss) and is credited or charged directly to shareholder's equity. 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 amortization expense on the consolidated statement of income and comprehensive income. OTHER DEFERRED EXPENSES: The annuity operations currently offers enhanced crediting rates or bonus payments to contract holders on certain of its products. Such amounts are deferred and amortized over the life of the contract using the same methodology and assumptions used to amortize DAC. The Company previously deferred these expenses as part of DAC and reported the amortization of such amounts as part of DAC amortization. Upon implementation of Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1"), the Company reclassified $155,695,000 of these expenses from DAC to other deferred expenses, which is reported on the consolidated balance sheet. The prior period consolidated balance sheet and consolidated statements of income and comprehensive income presentation has been reclassified to conform to the new presentation. See Recently Issued Accounting Standards below. The asset management operations defer distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or contingent deferred sales charge feature (collectively, "Distribution Fee Revenue"). The Company amortizes these deferred distribution costs on a straight-line basis, adjusted for redemptions, over a period ranging from one year to eight years depending on share class. Amortization of these deferred distribution costs is increased if at any reporting period the value of the deferred amount exceeds the projected Distribution Fee Revenue. The projected Distribution Fee Revenue is impacted by estimated future withdrawal rates and the rates of market return. Management uses historical activity to estimate future withdrawal rates and average annual performance of the equity markets to estimate the rates of market return. The Company reviews the carrying value of other deferred expenses on at least an annual basis. Management considers estimated future gross profit margins as well as expected mortality, interest earned, credited rates, persistency, withdrawal rates, rates of market return 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 policy fees in the consolidated statement of income and comprehensive income. GOODWILL: Goodwill amounted to $14,038,000 (net of accumulated amortization of $18,838,000) at December 31, 2004 and 2003. In accordance with Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), the Company assesses goodwill for impairment on an annual basis, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of the impairment, if any. The Company has evaluated goodwill for impairment as of December 31, 2004 and 2003, and has determined that no impairment provision is necessary. RESERVES FOR FIXED ANNUITY CONTRACTS, FIXED ACCOUNTS OF VARIABLE ANNUITY CONTRACTS, UNIVERSAL LIFE INSURANCE CONTRACTS AND GICS: Reserves for fixed annuity, Fixed Options, universal life insurance and GIC contracts are accounted for in accordance with Statement of Financial Accounting Standards No. 97, F-37 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) "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). 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 consolidated statement of income and comprehensive income, as they are recorded directly to contract holders' liabilities upon receipt. RESERVES FOR GUARANTEED BENEFITS: Reserves for guaranteed minimum death benefits ("GMDB"), earnings enhancement benefit and guaranteed minimum income benefits are accounted for in accordance with SOP 03-1. See Recently Issued Accounting Standards below. FEE INCOME: Fee income includes variable annuity policy fees, asset management fees, universal life insurance fees, commissions and surrender charges. Variable annuity policy fees are generally based on the market value of assets in the separate accounts supporting the variable annuity contracts. Asset management fees include investment advisory fees and 12b-1 distribution fees and are based on the market value of assets managed in mutual funds and certain variable annuity portfolios by SAAMCo. Universal life insurance policy fees consist of mortality charges, up-front fees earned on deposits received and administrative fees, net of reinsurance premiums. Surrender charges are assessed on withdrawals occurring during the surrender charge period. All fee income is recorded as income when earned with net retained commissions are recognized as income on a trade date basis. INCOME TAXES: Prior to the 2004, the Company was included in a consolidated federal income tax return with its Parent. Also, prior to 2004, SAAMCO, SFS and SACS were included in a separate consolidated federal income tax return with their parent, Saamsun Holdings Corporation. Beginning in 2004, all of these companies are included in the consolidated federal income tax return of their ultimate parent, AIG. Income taxes have been calculated as if each entity files 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 July 2003, the American Institute of Certified Public Accountants issued SOP 03-1. This statement was effective as of January 1, 2004, and requires the Company to recognize a liability for GMDB and certain living benefits related to its variable annuity contracts, account for enhanced crediting rates or bonus payments to contract holders and modifies certain disclosures and financial statement presentations for these products. In addition, SOP 03-1 addresses the presentation and reporting of separate accounts and the capitalization and amortization of certain other expenses. The Company reported for the first quarter of 2004 a one-time cumulative accounting charge upon adoption of $62,589,000 ($96,291,000 pre-tax) to reflect the liability and the related impact of DAC and reinsurance as of January 1, 2004. 3. INVESTMENTS The amortized cost and estimated fair value of bonds, notes and redeemable preferred stocks by major category follow:
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) At December 31, 2004: U.S. government securities.................................. $ 28,443 $ 30,300 Mortgage-backed securities.................................. 926,274 956,567 Securities of public utilities.............................. 321,381 332,038 Corporate bonds and notes................................... 2,797,943 2,902,829 Redeemable preferred stocks................................. 20,140 21,550 Other debt securities....................................... 913,687 917,743 ---------- ---------- Total..................................................... $5,007,868 $5,161,027 ========== ==========
F-38 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued)
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) At December 31, 2003: U.S. government securities.................................. $ 22,393 $ 24,292 Mortgage-backed securities.................................. 1,148,452 1,191,817 Securities of public utilities.............................. 352,998 365,150 Corporate bonds and notes................................... 2,590,254 2,697,142 Redeemable preferred stocks................................. 21,515 22,175 Other debt securities....................................... 1,215,571 1,205,224 ---------- ---------- Total..................................................... $5,351,183 $5,505,800 ========== ==========
At December 31, 2004, bonds, notes and redeemable preferred stocks included $386,426,000 that were not rated investment grade. These non-investment-grade securities are comprised of bonds spanning 10 industries with 19%, 16%, 16% and 10% concentrated in telecommunications, utilities, financial institutions and noncyclical consumer products industries, respectively. No other industry concentration constituted more than 10% of these assets. At December 31, 2004, mortgage loans were collateralized by properties located in 30 states, with loans totaling approximately 27%, 11% and 10% of the aggregate carrying value of the portfolio secured by properties located in California, Michigan and Massachusetts, respectively. No more than 10% of the portfolio was secured by properties in any other single state. At December 31, 2004, the carrying value, which approximates its estimated fair value, of all investments in default as to the payment of principal or interest totaled $40,051,000 of bonds. As a component of its asset and liability management strategy, the Company utilizes interest rate swap agreements to match assets more closely to liabilities. Interest rate swap agreements exchange interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) with a counterparty, based on an underlying principal balance (notional principal) to hedge against interest rate changes. The Company typically utilizes swap agreements to create a hedge that effectively converts floating-rate assets and liabilities to fixed-rate instruments. At December 31, 2004, $10,505,000 of bonds, at amortized cost, were on deposit with regulatory authorities in accordance with statutory requirements. At December 31, 2004, no investments in any one entity or its affiliates exceeded 10% of the Company's shareholder's equity. The amortized cost and estimated fair value of bonds, notes and redeemable preferred stocks by contractual maturity, as of December 31, 2004, follow:
AMORTIZED ESTIMATED COST FAIR VALUE ---------- ---------- (IN THOUSANDS) Due in one year or less..................................... $ 278,939 $ 281,954 Due after one year through five years....................... 2,076,145 2,138,574 Due after five years through ten years...................... 1,299,345 1,339,499 Due after ten years......................................... 427,165 444,433 Mortgage-backed securities.................................. 926,274 956,567 ---------- ---------- Total..................................................... $5,007,868 $5,161,027 ========== ==========
Actual maturities of bonds, notes and redeemable preferred stocks may differ from those shown above due to prepayments and redemptions. F-39 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued) Gross unrealized gains and losses on bonds, notes and redeemable preferred stocks by major category follow:
GROSS GROSS UNREALIZED UNREALIZED GAINS LOSSES ---------- ---------- (IN THOUSANDS) At December 31, 2004: U.S. government securities.................................. $ 1,857 $ -- Mortgage-backed securities.................................. 32,678 (2,385) Securities of public utilities.............................. 11,418 (761) Corporate bonds and notes................................... 118,069 (13,183) Redeemable preferred stocks................................. 1,410 -- Other debt securities....................................... 14,871 (10,815) -------- -------- Total..................................................... $180,303 $(27,144) ======== ========
GROSS GROSS UNREALIZED UNREALIZED GAINS LOSSES ---------- ---------- (IN THOUSANDS) At December 31, 2003: U.S. government securities.................................. $ 1,898 $ -- Mortgage-backed securities.................................. 46,346 (2,980) Securities of public utilities.............................. 13,467 (1,315) Corporate bonds and notes................................... 127,996 (21,108) Redeemable preferred stocks................................. 660 -- Other debt securities....................................... 24,366 (34,713) -------- -------- Total..................................................... $214,733 $(60,116) ======== ========
Gross unrealized gains on equity securities aggregated $26,000 at December 31, 2004 and $112,000 at December 31, 2003. There were no unrealized losses on equity securities at December 31, 2004 and gross unrealized losses on equity securities aggregated $20,000 at December 31, 2003. The following tables summarize 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, 2004 and 2003.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ----------------------------- ----------------------------- ------------------------------- FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSS ITEMS VALUE LOSS ITEMS VALUE LOSS ITEMS -------- ---------- ----- -------- ---------- ----- ---------- ---------- ----- (DOLLARS IN THOUSANDS) December 31, 2004 Mortgage-backed securities............... $125,589 $ (1,282) 23 $ 40,275 $ (1,103) 9 $ 165,864 $ (2,385) 32 Securities of public utilities................ 46,249 (761) 9 0 0 0 46,249 (761) 9 Corporate bonds and notes.................... 487,923 (7,418) 86 87,194 (5,765) 15 575,117 (13,183) 101 Other debt securities...... 207,378 (4,062) 36 79,782 (6,753) 12 287,160 (10,815) 48 -------- -------- --- -------- -------- -- ---------- -------- --- Total.................... $867,139 $(13,523) 154 $207,251 $(13,621) 36 $1,074,390 $(27,144) 190 ======== ======== === ======== ======== == ========== ======== ===
F-40 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued)
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL ----------------------------- ---------------------------- ----------------------------- FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSS ITEMS VALUE LOSS ITEMS VALUE LOSS ITEMS -------- ---------- ----- ------- ---------- ----- -------- ---------- ----- December 31, 2003 Mortgage-backed securities..... $180,559 $ (2,882) 49 $13,080 $ (98) 6 $193,639 $ (2,980) 55 Securities of public utilities.................... 67,626 (1,315) 8 -- -- -- 67,626 (1,315) 8 Corporate bonds and notes...... 276,373 (17,086) 54 30,383 (4,022) 5 306,756 (21,108) 59 Other debt securities.......... 302,230 (33,951) 54 41,523 (762) 5 343,753 (34,713) 59 -------- -------- --- ------- ------- -- -------- -------- --- Total........................ $826,788 $(55,234) 165 $84,986 $(4,882) 16 $911,774 $(60,116) 181 ======== ======== === ======= ======= == ======== ======== ===
Realized investment gains and losses on sales of investments are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Bonds, Notes and Redeemable Preferred Stocks: Realized gains............................................ $ 12,240 $ 30,896 $ 25,013 Realized losses........................................... (12,623) (11,818) (32,865) Common Stocks: Realized gains............................................ 5 561 -- Realized losses........................................... (247) (117) (169)
The sources and related amounts of investment income are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Short-term investments...................................... $ 2,483 $ 1,363 $ 5,447 Bonds, notes and redeemable preferred stocks................ 293,258 321,493 305,480 Mortgage loans.............................................. 50,825 53,951 55,417 Partnerships................................................ 417 (478) 12,344 Policy loans................................................ 17,130 15,925 18,796 Real estate................................................. (202) (331) (276) Other invested assets....................................... 2,149 13,308 (7,496) Less: investment expenses................................... (2,466) (2,308) (2,357) -------- -------- -------- Total investment income................................... $363,594 $402,923 $387,355 ======== ======== ========
Investment income was attributable to the following products:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Fixed annuity contracts..................................... $ 34,135 $ 37,762 $ 41,856 Variable annuity contracts.................................. 222,660 239,863 201,766 Guaranteed investment contracts............................. 13,191 20,660 28,056 Universal life insurance contracts.......................... 92,645 100,019 105,878 Asset management............................................ 963 4,619 9,799 -------- -------- -------- Total..................................................... $363,594 $402,923 $387,355 ======== ======== ========
4. FAIR VALUE OF FINANCIAL INSTRUMENTS The 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 F-41 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) assets (including its real estate investments and other invested assets except for partnerships) 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 INSTRUMENTS: 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 that 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. POLICY LOANS: Carrying value is considered a reasonable estimate of fair value. MUTUAL FUNDS: Fair value is considered to be the market value of the underlying securities. COMMON STOCKS: Fair value is based principally on independent pricing services, broker quotes and other independent information. PARTNERSHIPS: Fair value of partnerships that invest in debt and equity securities is based upon the fair value of the net assets of the partnerships as determined by the general partners. VARIABLE ANNUITY ASSETS HELD IN SEPARATE ACCOUNTS: Variable annuity assets are carried at the market value of the underlying securities. RESERVES FOR FIXED ANNUITY AND FIXED ACCOUNTS OF VARIABLE 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. RESERVES FOR GUARANTEED INVESTMENT CONTRACTS: Fair value is based on the present value of future cash flows at current pricing rates. SECURITIES LENDING COLLATERAL/PAYABLE: Carrying value is considered to be a reasonable estimate of fair value. 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. SUBORDINATED NOTES TO/FROM AFFILIATES: Fair value is estimated based on the quoted market prices for similar issues. F-42 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) The estimated fair values of the Company's financial instruments at December 31, 2004 and 2003 compared with their respective carrying values, are as follows:
CARRYING FAIR VALUE VALUE ----------- ----------- (IN THOUSANDS) December 31, 2004: Assets: Cash and short-term investments........................... $ 201,117 $ 201,117 Bonds, notes and redeemable preferred stocks.............. 5,161,027 5,161,027 Mortgage loans............................................ 624,179 657,828 Policy loans.............................................. 185,958 185,958 Mutual funds.............................................. 6,131 6,131 Common stocks............................................. 4,902 4,902 Partnerships.............................................. 1,084 1,084 Securities lending collateral............................. 883,792 883,792 Put options hedging guaranteed benefits................... 37,705 37,705 Variable annuity assets held in separate accounts......... 22,612,451 22,612,451 Liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 3,948,158 $ 3,943,265 Reserves for guaranteed investment contracts.............. 215,331 219,230 Securities lending payable................................ 883,792 883,792 Variable annuity liabilities related to separate accounts................................................ 22,612,451 22,612,451
CARRYING FAIR VALUE VALUE ----------- ----------- (IN THOUSANDS) December 31, 2003: Assets: Cash and short-term investments........................... $ 133,105 $ 133,105 Bonds, notes and redeemable preferred stocks.............. 5,505,800 5,505,800 Mortgage loans............................................ 716,846 774,758 Policy loans.............................................. 200,232 200,232 Mutual funds.............................................. 21,159 21,159 Common stocks............................................. 727 727 Partnerships.............................................. 1,312 1,685 Securities lending collateral............................. 514,145 514,145 Put options hedging guaranteed benefits................... 9,141 9,141 Variable annuity assets held in separate accounts......... 19,178,796 19,178,796 Liabilities: Reserves for fixed annuity and fixed accounts of variable annuity contracts....................................... $ 4,274,329 $ 4,225,329 Reserves for guaranteed investment contracts.............. 218,032 223,553 Securities lending payable................................ 514,145 514,145 Variable annuity liabilities related to separate accounts................................................ 19,178,796 19,178,796 Subordinated note payable to affiliate.................... 40,960 40,960
F-43 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. DEFERRED ACQUISITION COSTS The following table summarizes the activity in deferred acquisition costs:
YEARS ENDED DECEMBER 31, ------------------------- 2004 2003 ----------- ----------- (IN THOUSANDS) Balance at beginning of year................................ $1,268,621 $1,224,101 Acquisition costs deferred.................................. 246,033 212,250 Effect of net unrealized gains (losses) on securities....... 267 (30,600) Amortization charged to income.............................. (126,142) (137,130) Cumulative effect of SOP 03-1............................... (39,690) -- ---------- ---------- Balance at end of year...................................... $1,349,089 $1,268,621 ========== ==========
6. OTHER DEFERRED EXPENSES The annuity operations defer enhanced crediting rates or bonus payments to contract holders on certain of its products ("Bonus Payments"). The asset management operations defer distribution costs that are directly related to the sale of mutual funds that have a 12b-1 distribution plan and/or contingent deferred sales charge feature. The following table summarizes the activity in these deferred expenses:
BONUS DISTRIBUTION PAYMENTS COSTS TOTAL -------- ------------ -------- (IN THOUSANDS) Year Ended December 31, 2004 Balance at beginning of year................................ $155,695 $ 81,012 $236,707 Expenses deferred........................................... 36,732 26,174 62,906 Effect of net unrealized gains (losses) on securities....... 33 -- 33 Amortization charged in income.............................. (10,357) (31,508) (41,865) -------- -------- -------- Balance at end of year...................................... $182,103 $ 75,678 $257,781 ======== ======== ======== Year Ended December 31, 2003 Balance at beginning of year................................ $140,647 $ 72,054 $212,701 Expenses deferred........................................... 38,224 31,934 70,158 Effect of net unrealized gains (losses) on securities....... (3,400) -- (3,400) Amortization charged in income.............................. (19,776) (22,976) (42,752) -------- -------- -------- Balance at end of year...................................... $155,695 $ 81,012 $236,707 ======== ======== ========
7. GUARANTEED BENEFITS The Company issues variable annuity contracts for which the investment risk is generally borne by the contract holder, except with respect to amounts invested in the Fixed Options. For many of the Company's variable annuity contracts, the Company offers contractual guarantees in the event of death, at specified dates during the accumulation period, upon certain withdrawals or at annuitization. Such benefits are referred to as GMDB, GMAV, GMWB and guaranteed minimum income benefits ("GMIB"), respectively. The Company also issues certain variable annuity products that offer an optional earnings enhancement benefit ("EEB") feature that provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The assets supporting the variable portion of variable annuity contracts are carried at fair value and reported as summary total "variable annuity assets held in separate accounts" with an equivalent summary total reported for liabilities. Amounts assessed against the contract holders for mortality, administrative, other services and certain features are included in variable annuity policy fees, net of reinsurance, in the consolidated statement of income and comprehensive income. Changes in liabilities for minimum guarantees are included in guaranteed benefits, net of reinsurance, in the consolidated statement of income and comprehensive income. Separate account net investment income, net investment gains and losses and the related liability charges are offset within the same line item in the consolidated statement of income and comprehensive income. F-44 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) The Company offers GMDB options that guarantee for virtually all contract holders, that upon death, the contract holder's beneficiary will receive the greater of (1) the contract holder's account value, or (2) a guaranteed minimum death benefit that varies by product and election by policy owner. The GMDB liability is determined each period end by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to guaranteed benefits, net of reinsurance recoveries, if actual experience or other evidence suggests that earlier assumptions should be revised. EEB is a feature the Company offers on certain variable annuity products. For contract holders who elect the feature, the EEB provides an additional death benefit amount equal to a fixed percentage of earnings in the contract, subject to certain maximums. The Company bears the risk that account values following favorable performance of the financial markets will result in greater EEB death claims and that the fees collected under the contract are insufficient to cover the costs of the benefit to be provided. If available and elected by the contract holder, GMIB provides a minimum fixed annuity payment guarantee after a seven, nine or ten-year waiting period. As there is a waiting period to annuitize using the GMIB, there are no policies eligible to receive this benefit at December 31, 2004. The GMIB liability is determined each period end by estimating the expected value of the annuitization benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to guaranteed benefits, net of reinsurance recoveries, if actual experience or other evidence suggests that earlier assumptions should be revised. GMAV is a feature offered on certain variable annuity products. If available and elected by the contract holder at the time of contract issuance, GMAV guarantees that the account value under the contract will at least equal the amount of deposits invested during the first ninety days, adjusted for any subsequent withdrawals, at the end of a ten-year waiting period. The Company purchases put options on the S&P 500 index to partially offset this risk. GMAVs are considered to be derivatives under FAS 133, and are recognized at fair value in the consolidated balance sheet and through investment income in the consolidated statement of income and comprehensive income. GMWB is a feature offered on certain variable annuity products. If available and elected by the contract holder at the time of contract issuance, this feature provides a guaranteed annual withdrawal stream, regardless of market performance, equal to deposits invested during the first ninety days adjusted for any subsequent withdrawals ("Eligible Premium"). These guaranteed annual withdrawals of up to 10% of Eligible Premium are available after either a three-year or a five-year waiting period as elected by the contract holder at time of contract issuance, without reducing the future amounts guaranteed. If no withdrawals have been made during the waiting period of three or five years, the contract holder will realize an additional 10% or 20%, respectively, of Eligible Premium after all other amounts guaranteed under this benefit have been paid. GMWBs are considered to be derivatives under FAS 133 and are recognized at fair value in the consolidated balance sheet and through investment income in the consolidated statement of income and comprehensive income. F-45 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) Details concerning the Company's guaranteed benefit exposures as of December 31, 2004 are as follows:
HIGHEST SPECIFIED RETURN OF NET ANNIVERSARY ACCOUNT DEPOSITS PLUS A VALUE MINUS MINIMUM WITHDRAWALS POST RETURN ANNIVERSARY --------------- ------------------- (DOLLARS IN MILLIONS) In the event of death (GMDB and EEB): Account value............................................. $ 12,883 $12,890 Net amount at risk(a)..................................... $ 933 $ 1,137 Average attained age of contract holders.................. 67 64 Range of guaranteed minimum return rates.................. 0%-5% 0% At annuitization (GMIB): Account value............................................. $ 6,942 Net amount at risk(b)..................................... $ 3 Weighted average period remaining until earliest 3.8 Years annuitization........................................... Range of guaranteed minimum return rates.................. 0%-6.5% Accumulation at specified date (GMAV): Account value............................................. $ 1,533 Net amount at risk(c)..................................... $ -- Weighted average period remaining until guaranteed 9.0 Years payment................................................. Annual withdrawals at specified date (GMWB): Account value............................................. $ 294 Net amount at risk(d)..................................... $ -- Weighted average period remaining until expected payout... 13.9 Years
------------------- (a) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value, net of reinsurance, if all contract holders died at the same balance sheet date. The net amount at risk does not take into account the effect of caps and deductibles from the various reinsurance treaties. (b) Net amount at risk represents the present value of the expected annuitization payments at the expected annuitization dates in excess of the present value of the expected account value at the expected annuitization dates, net of reinsurance. (c) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value, if all contract holders reached the specified date at the same balance sheet date. (d) Net amount at risk represents the guaranteed benefit exposure in excess of the current account value if all contract holders exercise the maximum withdrawal benefits at the same balance sheet date. If no withdrawals have been made during the waiting period of 3 or 5 years, the contract holder will realize an additional 10% or 20% of Eligible Premium, respectively, after all other amounts guaranteed under this benefit have been paid. The additional 10% or 20% enhancement increases the net amount at risk by $26.3 million and is payable no sooner than 13 or 15 years from contract issuance for the 3 or 5 year waiting periods, respectively. The following summarizes the reserve for guaranteed benefits, net of reinsurance, on variable contracts reflected in the general account:
(IN THOUSANDS) Balance at January 1, 2004 before reinsurance(e)............ $ 92,873 Guaranteed benefits incurred................................ 61,472 Guaranteed benefits paid.................................... (49,947) -------- Balance at December 31, 2004 before reinsurance............. 104,398 Less reinsurance.......................................... (27,449) -------- Balance at December 31, 2004, net of reinsurance............ $ 76,949 ========
(e) Includes amounts from the one-time cumulative accounting change resulting from the adoption of SOP 03-1. F-46 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. GUARANTEED BENEFITS (Continued) The following assumptions and methodology were used to determine the reserve for guaranteed benefits at December 31, 2004: - Data used was 5,000 stochastically generated investment performance scenarios. - Mean investment performance assumption was 10%. - Volatility assumption was 16%. - Mortality was assumed to be 64% of the 75-80 ALB table. - Lapse rates vary by contract type and duration and range from 0% to 40%. - The discount rate was approximately 8%. 8. REINSURANCE Reinsurance contracts do not relieve the Company from its obligations to contract holders. 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. The Company has no reinsurance recoverable or related concentration of credit risk greater than 10% of shareholder's equity. Variable policy fees are net of reinsurance premiums of $28,604,000, $30,795,000 and $22,500,000 in 2004, 2003 and 2002, respectively. Universal life insurance fees are net of reinsurance premiums of $34,311,000, $33,710,000 and $34,098,000 in 2004, 2003 and 2002, respectively. The Company has a reinsurance treaty under which the Company retains no more than $100,000 of risk on any one insured life in order to limit the exposure to loss on any single insured. Reinsurance recoveries recognized as a reduction of claims on universal life insurance contracts amounted to $34,163,000, $34,036,000 and $29,171,000 in 2004, 2003 and 2002, respectively. Guaranteed benefits were reduced by reinsurance recoveries of $2,716,000, $8,042,000 and $8,362,000 in 2004, 2003 and 2002, respectively. 9. COMMITMENTS AND CONTINGENT LIABILITIES The Company has six agreements outstanding in which it has provided liquidity support for certain short-term securities of municipalities and non-profit organizations by agreeing to purchase such securities in the event there is no other buyer in the short-term marketplace. In return the Company receives a fee. In addition, the Company guarantees the payment of these securities upon redemption. The maximum liability under these guarantees at December 31, 2004 is $195,442,000. These commitments have contractual maturity dates in 2005. Related to each of these agreements are participation agreements with the Parent under which the Parent will share in $62,590,000 of these liabilities in exchange for a proportionate percentage of the fees received under these agreements. The Internal Revenue Service has completed its examinations into the transactions underlying these commitments, including the Company's role in the transactions. The examination did not result in a material loss to the Company. At December 31, 2004, the Company has commitments to purchase a total of approximately $10,000,000 of asset- backed securities in the ordinary course of business. The expiration dates of these commitments are as follows: $2,000,000 in 2005 and $8,000,000 in 2007. Various federal, state and other regulatory agencies are reviewing certain transactions and practices of the Company and its subsidiaries in connection with industry-wide and other inquiries. In the opinion of the Company's management, based on the current status of these inquiries, it is not likely that any of these inquiries will have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows of the Company. Various lawsuits against the Company and its subsidiaries have arisen in the ordinary course of business. Contingent liabilities arising from litigation, income taxes and regulatory and other matters are not considered material in relation to the consolidated financial position, results of operations or cash flows of the Company. F-47 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENT LIABILITIES (Continued) On April 5, 2004, a purported class action captioned Nitika Mehta, as Trustee of the N.D. Mehta Living Trust vs. AIG SunAmerica Life Assurance Company, Case 04L0199, was filed in the Circuit Court, Twentieth Judicial District in St. Clair County, Illinois. The lawsuit alleges certain improprieties in conjunction with alleged market timing activities. The probability of any particular outcome cannot be reasonably estimated at this time. The Company cannot estimate a range because the litigation has not progressed beyond the preliminary stage. 10. SHAREHOLDER'S EQUITY The Company is authorized to issue 4,000 shares of its $1,000 par value Common Stock. At December 31, 2004 and 2003, 3,511 shares were outstanding. Changes in shareholder's equity are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Additional Paid-in Capital: Beginning balances........................................ $709,246 $709,246 $509,246 Capital contributions by Parent........................... 49,100 -- 200,000 -------- -------- -------- Ending balances........................................... $758,346 $709,246 $709,246 ======== ======== ======== Retained Earnings: Beginning balances........................................ $828,423 $730,321 $669,103 Net income................................................ 142,502 93,530 31,689 Dividends paid to Parent.................................. (2,500) (12,187) (10,000) Adjustment for tax benefit of distributed subsidiary...... 287 16,759 39,529 Tax effect on a distribution of investment................ (49,100) -- -- -------- -------- -------- Ending balances........................................... $919,612 $828,423 $730,321 ======== ======== ======== Accumulated Other Comprehensive Income (Loss): Beginning balances........................................ $ 72,610 $ 16,504 $(29,272) Change in net unrealized gains (losses) on debt securities available for sale...................................... (1,459) 118,725 98,718 Change in net unrealized gains (losses) on equity securities available for sale........................... (65) 1,594 (1,075) Change in net unrealized gains on foreign currency........ 1,170 -- -- Change in adjustment to deferred acquisition costs and other deferred expenses................................. 300 (34,000) (25,000) Net change related to cash flow hedges.................... -- -- (2,218) Tax effects of net changes................................ 19 (30,213) (24,649) -------- -------- -------- Ending balances........................................... $ 72,575 $ 72,610 $ 16,504 ======== ======== ========
Gross unrealized gains (losses) on fixed maturity and equity securities included in accumulated other comprehensive income are as follows:
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Gross unrealized gains...................................... $180,329 $214,845 Gross unrealized losses..................................... (27,144) (60,136) Unrealized gain on foreign currency......................... 1,170 -- Adjustment to DAC and other deferred expenses............... (42,700) (43,000) Deferred income taxes....................................... (39,080) (39,099) -------- -------- Accumulated other comprehensive income...................... $ 72,575 $ 72,610 ======== ========
On October 30, 2002, the Company received a capital contribution of $200,000,000 in cash from the Parent. F-48 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. SHAREHOLDER'S EQUITY (Continued) Dividends that the Company may pay to its shareholder in any year without prior approval of the Arizona Department of Insurance are limited by statute. The maximum amount of dividends which can be paid to shareholders of insurance companies domiciled in the state of Arizona without obtaining the prior approval of the Insurance Commissioner is limited to the lesser of either 10% of the preceding year's statutory surplus or the preceding year's statutory net gain from operations if, after paying the dividend, the Company's capital and surplus would be adequate in the opinion of the Arizona Department of Insurance. Accordingly, the maximum amount of dividends that can be paid to stockholder in the year 2005 without obtaining prior approval is $83,649,000. Dividends of $2,500,000 were paid in 2004. Prior to the capital contribution of SAAMCo to the Company, SAAMCo paid dividends to its parent, SunAmerica Life Insurance Company, of $12,187,000 and $10,000,000 in 2003 and 2002, respectively. Under statutory accounting principles utilized in filings with insurance regulatory authorities, the Company's net income totaled $99,288,000 for the year ended December 31, 2004, net income of $89,071,000 and net loss of $180,737,000 for the years ended December 31, 2003 and 2002, respectively. The Company's statutory capital and surplus totaled $840,001,000 at December 31, 2004 and $602,348,000 at December 31, 2003. 11. INCOME TAXES The components of the provisions for income taxes on pretax income consist of the following:
YEARS ENDED DECEMBER 31, ------------------------------- 2004 2003 2002 -------- -------- --------- (IN THOUSANDS) Current expense (benefit)................................... $(42,927) $127,655 $(105,369) Deferred expense (benefit).................................. 49,337 (97,408) 105,529 -------- -------- --------- Total income tax expense.................................... $ 6,410 $ 30,247 $ 160 ======== ======== =========
Income taxes computed at the United States federal income tax rate of 35% and income tax expenses reflected in statement of income and comprehensive income provided differ as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2004 2003 2002 -------- -------- -------- (IN THOUSANDS) Amount computed at statutory rate........................... $ 74,025 $ 43,322 $ 11,147 Increases (decreases) resulting from: State income taxes, net of federal tax benefit............ 4,020 2,273 (567) Dividends received deduction.............................. (19,058) (15,920) (10,117) Tax credits............................................... (4,000) -- -- Adjustment to prior year tax liability(a)................. (39,730) -- -- Other, net................................................ (8,847) 572 (303) -------- -------- -------- Total income tax expense.................................. $ 6,410 $ 30,247 $ 160 ======== ======== ========
------------------ (a) In 2004, the Company revised its estimate of tax contingency amount for prior year based on additional information that became available. Under prior federal income tax law, one-half of the excess of a life insurance company's income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as "policyholders' surplus". At December 31, 2004, the Company had approximately $14,300,000 of policyholders' surplus on which no deferred tax liability has been recognized, as federal income taxes are not required unless this amount is distributed as a dividend or recognized under other specified conditions. The American Jobs Creation Act of 2004 modified federal income tax law to allow life insurance companies to distribute amounts from policyholders' surplus during 2005 and 2006 without incurring federal income tax on the distributions. The Company eliminated its policyholders' surplus balance in January 2005. At December 31, 2004, the Company had net operating carryforwards, capital loss carryforwards and tax credit carryforwards for Federal income tax purposes of $15,515,000, $63,774,000 and $44,604,000, respectively, arising from F-49 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. INCOME TAXES (Continued) affordable housing investments no longer owned by SAAMCo. Such carryforwards expire in 2018, 2006 to 2008 and 2018, respectively. 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 liability for deferred income taxes are as follows:
DECEMBER 31, DECEMBER 31, 2004 2003 ------------ ------------ (IN THOUSANDS) Deferred Tax Liabilities: Deferred acquisition costs and other deferred expenses...... $ 432,868 $ 473,387 State income taxes.......................................... 10,283 5,744 Other liabilities........................................... 15,629 350 Net unrealized gains on debt and equity securities available for sale.................................................. 39,080 39,098 --------- --------- Total deferred tax liabilities.............................. 497,860 518,579 --------- --------- Deferred Tax Assets: Investments................................................. (28,915) (25,213) Contract holder reserves.................................... (122,691) (158,112) Guaranty fund assessments................................... (3,402) (3,408) Deferred income............................................. (5,604) (3,801) Other assets................................................ (1,068) (7,446) Net operating loss carryforward............................. (5,430) -- Capital loss carryforward................................... (22,321) (20,565) Low income housing credit carryforward...................... (44,604) (36,600) Partnership income/loss..................................... (6,293) (20,878) --------- --------- Total deferred tax assets................................... (240,328) (276,023) --------- --------- Deferred income taxes....................................... $ 257,532 $ 242,556 ========= =========
The Company has concluded that the deferred tax asset will be fully realized and no valuation allowance is necessary. 12. RELATED-PARTY MATTERS As of December 31, 2004, subordinated notes payable to affiliates were paid off except for accrued interest totaling $460,000 which is included in other liabilities on the consolidated balance sheet. On February 15, 2004, the Company entered into a short-term financing arrangement with the Parent whereby the Company has the right to borrow up to $500,000,000 from the Parent and vice versa. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On February 15, 2004, the Company entered into a short-term financing arrangement with its affiliate, First SunAmerica Life Insurance Company ("FSA"), whereby the Company has the right to borrow up to $15,000,000 from FSA and vice versa. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On December 19, 2001, the Company entered into a short-term financing arrangement with AIGRS whereby AIGRS has the right to borrow up to $500,000,000. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On December 19, 2001, the Company entered into a short-term financing arrangement with SunAmerica Investments, Inc. ("SAII"), whereby SAII has the right to borrow up to $500,000,000 from the Company. Any advances made under this agreement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. F-50 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. RELATED-PARTY MATTERS (Continued) On September 26, 2001, the Company entered into a short-term financing arrangement with AIGRS. Under the terms of this agreement, the Company has immediate access of up to $500,000,000. Any advances made under this arrangement must be repaid within 30 days. There were no balances outstanding under this agreement at December 31, 2004. On September 26, 2001, the Company entered into a short-term financing arrangement with SAII, whereby the Company has the right to borrow up to $500,000,000. Any advances made under this agreement must be repaid within 30 days. At December 31, 2004 and 2003, the Company owed $0 and $14,000,000, respectively, under this agreement, which was included in due to affiliates. On October 31, 2003, the Company became a party to an existing credit agreement under which the Company agreed to make loans to AIG in an aggregate amount of up to $60,000,000. This commitment expires on October 28, 2005. There were no balances outstanding under this agreement at December 31, 2004. For the years ended December 31, 2004, 2003 and 2002, the Company paid commissions totaling $60,674,000, $51,716,000 and $59,058,000, respectively, to nine affiliated broker-dealers: Royal Alliance Associates, Inc.; SunAmerica Securities, Inc.; Advantage Capital Corporation; FSC Services Corporation; Sentra Securities Corporation; Spelman & Co., Inc.; VALIC Financial Advisors; American General Equity Securities Corporation and American General Securities Inc. These affiliated broker-dealers distribute a significant portion of the Company's variable annuity products amounting to approximately 23%, 24% and 31% of deposits for each of the respective years. Of the Company's mutual fund sales, approximately 25%, 23% and 28% were distributed by these affiliated broker-dealers for the years ended December 31, 2004, 2003 and 2002, respectively. On February 1, 2004, SAAMCo entered into an administrative services agreement with FSA whereby SAAMCo will pay to FSA a fee based on a percentage of all assets invested through FSA's variable annuity products in exchange for services performed. SAAMCo is the investment advisor for certain trusts that serve as investment options for FSA's variable annuity products. Amounts incurred by the Company under this agreement totaled $1,537,000 in 2004 and are included in the Company's consolidated statement of income and comprehensive income. A fee of $150,000, $1,620,000 and $1,777,000 was paid under a different agreement in 2004, 2003 and 2002, respectively. On October 1, 2001, SAAMCo entered into two administrative services agreements with business trusts established by its affiliate, The Variable Annuity Life Insurance Company ("VALIC"), whereby the trust pays to SAAMCo a fee based on a percentage of average daily net assets invested through VALIC's annuity products in exchange for services performed. Amounts earned by SAAMCo under this agreement totaled $9,074,000, $7,587,000 and $7,614,000 in 2004, 2003 and 2002, respectively, and are net of certain administrative costs incurred by VALIC of $2,593,000, $2,168,000 and $2,175,000, respectively. The net amounts earned by SAAMCo are included in other fees in the consolidated statement of income and comprehensive income. The Company has a support agreement in effect between the Company and AIG (the "Support Agreement"), pursuant to which AIG has agreed that AIG will cause the Company to maintain a policyholder's surplus of not less than $1,000,000 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 obligations 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. Contract holders 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 contract holder when due, have the right to enforce the Support Agreement directly against AIG. The Company's insurance policy obligations are guaranteed by American Home Assurance Company ("American Home"), a subsidiary of AIG, and a member of an AIG intercompany pool. This guarantee is unconditional and irrevocable, and the Company's contract holders have the right to enforce the guarantee directly against American Home. While American Home does not publish financial statements, it does file statutory annual and quarterly 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 F-51 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. RELATED-PARTY MATTERS (Continued) 1934, and publishes annual reports on Form 10-K and quarterly reports on Form 10-Q, which are available from the Securities and Exchange Commission. The Company's ultimate parent, AIG, has announced that it has delayed filing its Annual Report on Form 10-K for the year ended December 31, 2004 to allow AIG's Board of Directors and new management adequate time to complete an extensive review of AIG's books and records. The review includes issues arising from pending investigations into non-traditional insurance products and certain assumed reinsurance transactions by the Office of the Attorney General for the State of New York and the SEC and from AIG's decision to review the accounting treatment of certain additional items. Circumstances affecting AIG can have an impact on the Company. For example, the recent downgrades and ratings actions taken by the major rating agencies with respect to AIG, resulted in corresponding downgrades and ratings actions being taken with respect to the Company's ratings. Accordingly, we can give no assurance that any further changes in circumstances for AIG will not impact us. While the outcome of this investigation is not determinable at this time, management believes that the ultimate outcome will not have a material adverse effect on Company operating results, cash flows or financial position. Pursuant to a cost allocation agreement, the Company purchases administrative, investment management, accounting, legal, marketing and data processing services from its Parent, AIGRS and AIG. The allocation of such costs for investment management services is based on the level of assets under management. The allocation of costs for other services is based on estimated levels of usage, transactions or time incurred in providing the respective services. Amounts paid for such services totaled $148,554,000 for the year ended December 31, 2004, $126,531,000 for the year ended December 31, 2003 and $119,981,000 for the year ended December 31, 2002. The component of such costs that relate to the production or acquisition of new business during these periods amounted to $60,183,000, $48,733,000 and $49,004,000 respectively, and is deferred and amortized as part of deferred acquisition costs. The other components of such costs are included in general and administrative expenses in the consolidated 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 $3,712,000, $3,838,000 and $3,408,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The Company incurred $1,113,000, $500,000 and $790,000 of management fees to an affiliate of the Company to administer its securities lending program for the years ended December 31, 2004, 2003 and 2002, respectively (see Note 2). In December 2003, the Company purchased an affiliated bond with a carrying value of $37,129,000. At December 31, 2004, the affiliated bond has a market value of $34,630,000. F-52 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS The Company conducts its business through two business segments, annuity operations and asset management operations. Annuity operations consists of the sale and administration of deposit-type insurance contracts, including fixed and variable annuity contracts, universal life insurance contracts and GICs. Asset management operations, which includes the managing, distributing and administering a diversified family of mutual funds, managing certain subaccounts offered within the Company's variable annuity products and providing professional management of individual, corporate and pension plan portfolios, is conducted by SAAMCo and its subsidiary and distributor, SACS, and its subsidiary and servicing administrator, SFS. Following is selected information pertaining to the Company's business segments.
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2004: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 369,141 $ -- $ 369,141 Asset management fees..................................... -- 89,569 89,569 Universal life insurance policy fees, net of reinsurance............................................. 33,899 -- 33,899 Surrender charges......................................... 26,219 -- 26,219 Other fees................................................ -- 15,753 15,753 ----------- -------- ----------- Total fee income............................................ 429,259 105,322 534,581 Investment income........................................... 362,631 963 363,594 Net realized investment gains (losses)...................... (24,100) 293 (23,807) ----------- -------- ----------- Total revenues.............................................. 767,790 106,578 874,368 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 220,668 2,081 222,749 Amortization of bonus interest.............................. 10,357 -- 10,357 General and administrative expenses......................... 93,188 38,424 131,612 Amortization of deferred acquisition costs and other deferred expenses......................................... 126,142 31,508 157,650 Annual commissions.......................................... 64,323 -- 64,323 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,420 -- 17,420 Guaranteed benefits, net of reinsurance recoveries.......... 58,756 -- 58,756 ----------- -------- ----------- Total benefits and expenses................................. 590,854 72,013 662,867 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 176,936 $ 34,565 $ 211,501 =========== ======== =========== Total assets................................................ $31,323,462 $217,155 $31,540,617 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 132 $ 132 =========== ======== ===========
F-53 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS (Continued)
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2003: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 281,359 $ -- $ 281,359 Asset management fees..................................... -- 66,663 66,663 Universal life insurance policy fees, net of reinsurance............................................. 35,816 -- 35,816 Surrender charges......................................... 27,733 -- 27,733 Other fees................................................ -- 15,520 15,520 ----------- -------- ----------- Total fee income............................................ 344,908 82,183 427,091 Investment income........................................... 398,304 4,619 402,923 Net realized investment losses.............................. (30,354) -- (30,354) ----------- -------- ----------- Total revenues.............................................. 712,858 86,802 799,660 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 237,585 2,628 240,213 Amortization of bonus interest.............................. 19,776 -- 19,776 General and administrative expenses......................... 83,013 36,080 119,093 Amortization of deferred acquisition costs and other deferred expenses......................................... 137,130 22,976 160,106 Annual commissions.......................................... 55,661 -- 55,661 Claims on universal life contracts, net of reinsurance recoveries................................................ 17,766 -- 17,766 Guaranteed benefits, net of reinsurance recoveries.......... 63,268 -- 63,268 ----------- -------- ----------- Total benefits and expenses................................. 614,199 61,684 675,883 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 98,659 $ 25,118 $ 123,777 =========== ======== =========== Total assets................................................ $27,781,457 $190,270 $27,971,727 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 2,977 $ 2,977 =========== ======== ===========
F-54 AIG SUNAMERICA LIFE ASSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. BUSINESS SEGMENTS (Continued)
ASSET ANNUITY MANAGEMENT OPERATIONS OPERATIONS TOTAL ----------- ---------- ----------- (IN THOUSANDS) Year Ended December 31, 2002: Revenues: Fee income: Variable annuity policy fees, net of reinsurance.......... $ 286,919 $ -- $ 286,919 Asset management fees..................................... -- 66,423 66,423 Universal life insurance policy fees, net of reinsurance............................................. 36,253 -- 36,253 Surrender charges......................................... 32,507 -- 32,507 Other fees................................................ 3,304 18,596 21,900 ----------- -------- ----------- Total fee income............................................ 358,983 85,019 444,002 Investment income........................................... 377,556 9,799 387,355 Net realized investment losses.............................. (65,811) -- (65,811) ----------- -------- ----------- Total revenues.............................................. 670,728 94,818 765,546 ----------- -------- ----------- Benefits and Expenses: Interest expense............................................ 234,261 3,868 238,129 Amortization of bonus interest.............................. 16,277 -- 16,277 General and administrative expenses......................... 79,287 35,923 115,210 Amortization of deferred acquisition costs and other deferred expenses......................................... 171,583 50,901 222,484 Annual commissions.......................................... 58,389 -- 58,389 Claims on universal life contracts, net of reinsurance recoveries................................................ 15,716 -- 15,716 Guaranteed benefits, net of reinsurance recoveries.......... 67,492 -- 67,492 ----------- -------- ----------- Total benefits and expenses................................. 643,005 90,692 733,697 ----------- -------- ----------- Pretax income before cumulative effect of accounting change.................................................... $ 27,723 $ 4,126 $ 31,849 =========== ======== =========== Total assets................................................ $23,538,832 $214,157 $23,752,989 =========== ======== =========== Expenditures for long-lived assets.......................... $ -- $ 7,297 $ 7,297 =========== ======== ===========
F-55 TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION Separate Account............................................ 2 General Account............................................. 2 Support Agreement Between the Company and AIG............... 3 Death Benefits for Contracts Issued Prior to March 14, 2005...................................................... 3 Performance Data............................................ 6 Income Protector............................................ 9 Income Payments............................................. 12 Annuity Unit Values......................................... 12 Variable Annuity Payments................................... 14 Taxes....................................................... 14 Distribution of Contracts................................... 20 Financial Statements........................................ 20
F-56 APPENDIX A - DEATH BENEFITS FOLLOWING SPOUSAL CONTINUATION - -------------------------------------------------------------------------------- The following details the death benefit options and EstatePlus benefit available upon the Continuing Spouse's death. The death benefit we will pay to the new Beneficiary chosen by the Continuing Spouse varies depending on the death benefit option elected by the original owner of the contract, and the age of the Continuing Spouse as of the Continuation Date and Continuing Spouse's date of death. The term "Continuation Net Purchase Payment" is used frequently in describing the death benefit payable upon a spousal continuation. We define Continuation Net Purchase Payment as Net Purchase Payments made as of the Continuation Date. For the purpose of calculating Continuation Net Purchase Payments, the amount that equals the contract value on the Continuation Date, including the Continuation Contribution is considered a Purchase Payment. If the Continuing Spouse makes no additional Purchase Payments or withdrawals, the Continuation Net Purchase Payments equals the contract value on the Continuation Date, including the Continuation Contribution. The term "withdrawals" as used in describing the death benefits is defined as withdrawals and the fees and charges applicable to those withdrawals. The following details the death benefit options and EstatePlus benefit upon the Continuing Spouse's death: The death benefit we will pay to the new Beneficiary chosen by the Continuing Spouse varies depending on the death benefit option elected by the original owner of the contract and the age of the Continuing Spouse as of the Continuation Date. STANDARD DEATH BENEFIT PAYABLE UPON CONTINUING SPOUSE'S DEATH If the Continuing Spouse is age 82 or younger on the Continuation Date, the death benefit will be the greater of: a. Contract value; or b. Contract value on the Continuation Date plus any Continuation Net Purchase Payments received prior to the Continuing Spouse's 86th birthday. If the Continuing Spouse is age 83-85 on the Continuation Date, the death benefit will be the greater of: a. Contract value; or b. The lesser of: (1) Contract value on the Continuation Date plus Continuation Net Purchase Payments received prior to the Continuing Spouse's 86th birthday; or (2) 125% of the contract value. If the Continuing Spouse is age 86 or older on the Continuation Date, the death benefit is equal to the contract value. ESTATE REWARDS DEATH BENEFIT PAYABLE UPON CONTINUING SPOUSE'S DEATH If Estate Rewards is applicable upon the Continuing Spouse's death, we will pay the Beneficiary the applicable death benefit under Option 1 or 2. OPTION 1 - ACCUMULATION OPTION: If the Continuing Spouse is age 74 or younger on the Continuation Date, the death benefit will be the greatest of: a. Contract value; or b. Contract value on the Continuation Date plus Continuation Net Purchase Payments, compounded at 3% annual growth rate, to the earlier of the Continuing Spouse's 75th birthday or date of death; reduced for any withdrawals made and increased by any Continuation Net Purchase Payments received A-1 after the Continuing Spouse's 75th birthday to the earlier of the Continuing Spouse's 86th birthday or date of death; or c. Contract value on the seventh contract anniversary (from the original contract issue date), reduced for withdrawals made since the seventh contract anniversary in the same proportion that the contract value was reduced on the date of such withdrawal, plus any Net Purchase Payments received between the seventh contract anniversary date but prior to the Continuing Spouse's 86th birthday. If the Continuing Spouse is age 75-82 on the Continuation Date, the death benefit will be the greatest of: a. Contract value; or b. Contract value on the Continuation Date plus any Continuation Net Purchase Payments received prior to the Continuing Spouse's 86th birthday; or c. Maximum anniversary value on any contract anniversary that occurred after the Continuation Date, but prior to the Continuing Spouse's 83rd birthday. The anniversary value for any year is equal to the contract value on the applicable contract anniversary date, plus any Purchase Payments received since that anniversary date but prior to the Continuing Spouse's 86th birthday, and reduced for any withdrawals made since that contract anniversary in the same proportion that the withdrawal reduced the contract value on the date of withdrawal. If the Continuing Spouse is age 83-85 on the Continuation Date, then the death benefit will be the Standard Death Benefit described above and the fee for the Accumulation Option will no longer be deducted as of the Continuation Date. If the Continuing Spouse is age 86 or older on the Continuation Date, the death benefit is equal to contract value. OPTION 2 - MAXIMUM ANNIVERSARY VALUE: If the Continuing Spouse is age 82 or younger on the Continuation Date, the death benefit will be the greatest of: a. Contract value; or b. Contract value on the Continuation Date plus Continuation Net Purchase Payments received prior to the Continuing Spouse's 86th birthday; or c. Maximum anniversary value on any contract anniversary that occurred after the Continuation Date, but prior to the Continuing Spouse's 83rd birthday. The anniversary value for any year is equal to the contract value on the applicable contract anniversary date after the Continuation Date, plus any Purchase Payments received since that anniversary date but prior to the Continuing Spouse's 86th birthday, and reduced for any withdrawals made since that contract anniversary in the same proportion that the withdrawal reduced the contract value on the date of withdrawal. If the Continuing Spouse is age 83-85 on the Continuation Date, the death benefit will be the Standard Death Benefit described above and the fee for the Maximum Anniversary Value option will not longer be deducted as of the Continuation Date. If the Continuing Spouse is age 86 or older on the Continuation Date or age 90 or older on the date of death, the death benefit is equal to contract value. Please see the Statement of Additional Information for a description of the death benefit calculations following a Spousal Continuation for contracts issued before March 14, 2005. EARNINGS ADVANTAGE BENEFIT FOR SPOUSAL CONTINUATION: The Earnings Advantage benefit is only available if the original owner elected Earnings Advantage and the Continuing Spouse is age 80 or younger on the Continuation Date. Earnings Advantage benefit is not payable after the Latest Annuity Date. If the Continuing Spouse had earnings in the contract at the time of his/her death, we will add a percentage of those earnings (the "Earnings Advantage Percentage"), subject to a maximum dollar amount (the "Maximum A-2 Earnings Advantage Percentage"), to the death benefit payable. The contract year of death will determine the Earnings Advantage Percentage and the Maximum Earnings Advantage Benefit. The Earnings Advantage benefit, if any, is added to the death benefit payable under the Purchase Payment Accumulation or the Maximum Anniversary option. On the Continuation Date, if the Continuing Spouse is 69 or younger, the table below shows the available Earnings Advantage benefit:
- -------------------------------------------------------------------------------------------- CONTRACT YEAR EARNINGS ADVANTAGE OF DEATH PERCENTAGE MAXIMUM EARNINGS ADVANTAGE AMOUNT - -------------------------------------------------------------------------------------------- Years 0-4 25% of Earnings 40% of Continuation Net Purchase Payments - -------------------------------------------------------------------------------------------- Years 5-9 40% of Earnings 65% of Continuation Net Purchase Payments* - -------------------------------------------------------------------------------------------- Years 10+ 50% of Earnings 75% of Continuation Net Purchase Payments* - --------------------------------------------------------------------------------------------
What is the Contract Year of Death? Contract Year of Death is the number of full 12 month periods starting on the Continuation Date and ending on the Continuing Spouse's date of death. What is the Earnings Advantage amount? We determine the Earnings Advantage amount based upon a percentage of earnings in the contract at the time of the Continuing Spouse's death. For the purpose of this calculation, earnings are defined as (1) minus (2) where (1) equals the contract value on the Continuing Spouse's date of death; (2) equals the Continuation Net Purchase Payment(s). What is the Maximum Earnings Advantage amount? The Earnings Advantage amount is subject to a maximum. The Maximum Earnings Advantage amount is a percentage of the Continuation Net Purchase Payments. The Earnings Advantage benefit will only be paid if the Continuing Spouse's date of death is prior to the Latest Annuity Date. WE RESERVE THE RIGHT TO MODIFY, SUSPEND OR TERMINATE THE SPOUSAL CONTINUATION PROVISION (IN ITS ENTIRETY OR ANY COMPONENT) AT ANY TIME. A-3 APPENDIX B -- DIVERSIFIED STRATEGIES INCOME REWARDS EXAMPLES - -------------------------------------------------------------------------------- The following examples demonstrate the operation of the Diversified Strategies Income Rewards feature: EXAMPLE 1: Assume you elect Diversified Strategies Income Rewards Option 2 and you invest a single Purchase Payment of $100,000. If you make no additional Purchase Payments and no withdrawals, your Withdrawal Benefit Base is $100,000 on the Benefit Availability Date. Your Stepped-Up Benefit Base equals Withdrawal Benefit Base plus the Step-Up Amount ($100,000 + (20% X $100,000) = $120,000). Your Maximum Annual Withdrawal Amount as of the Benefit Availability Date is 10% of your Withdrawal Benefit Base ($100,000 X 10% = $10,000). The Minimum Withdrawal Period is equal to the Stepped-Up Benefit Base divided by the Maximum Annual Withdrawal Amount, which is 12 years ($120,000/$10,000). Therefore, you may take $120,000 in withdrawals of up to $10,000 annually over a minimum of 12 years beginning on or after the Benefit Availability Date. EXAMPLE 2 - IMPACT OF WITHDRAWALS PRIOR TO THE BENEFIT AVAILABILITY DATE FOR OPTIONS 1 AND 2: Assume you elect Diversified Strategies Income Rewards Option 2 and you invest a single Purchase Payment of $100,000. You make a withdrawal of $11,000 prior to the Benefit Availability Date. Prior to the withdrawal, your contract value is $110,000. You make no other withdrawals before the Benefit Availability Date. Immediately following the withdrawal, your Withdrawal Benefit Base is recalculated by first determining the proportion by which your contract value was reduced by the withdrawal ($11,000/$110,000 = 10%). Next, we reduce your Withdrawal Benefit Base by the percentage by which the contract value was reduced by the withdrawal ($100,000 - (10% X 100,000) = $90,000). Since the Step-Up Amount is zero because a withdrawal was made prior to the Benefit Availability Date, your Stepped-Up Benefit Base on the Benefit Availability Date equals your Withdrawal Benefit Base. Therefore, the Stepped-Up Benefit Base also equals $90,000. Your Maximum Annual Withdrawal Amount is 10% of the Withdrawal Benefit Base on the Benefit Availability Date ($90,000). This equals $9,000. Therefore, you may take withdrawals of up to $9,000 annually over a minimum of 10 years ($90,000/$9,000 = 10). EXAMPLE 3 - IMPACT OF WITHDRAWALS PRIOR TO THE BENEFIT AVAILABILITY DATE FOR OPTION 3: Assume you elect Diversified Strategies Income Rewards Option 3 and you invest a single Purchase Payment of $100,000. You make a withdrawal of $11,000 prior to the Benefit Availability Date. Prior to the withdrawal, your contract value is $110,000. You make no other withdrawals before the Benefit Availability Date. Immediately following the withdrawal, your Withdrawal Benefit Base is recalculated by first determining the proportion by which your contract value was reduced by the withdrawal ($11,000/$110,000 = 10%). Next, we reduce your Withdrawal Benefit Base by the percentage by which the contract value was reduced by the withdrawal ($100,000 - (10% X 100,000) = $90,000). Since the withdrawal occurred prior to the Benefit Availability Date, your Step-Up Amount will be reduced to 30% of your Withdrawal Benefit Base ((30% X $90,000) = $27,000). Therefore, your Stepped-Up Benefit Base on the Benefit Availability Date equals the Withdrawal Benefit Base plus the Step-Up Amount (($90,000 + $27,000) = $117,000). Your Maximum Annual Withdrawal Amount is 10% of the Withdrawal Benefit Base on the Benefit Availability Date ($90,000). This equals $9,000. Therefore, you may take withdrawals of up to $9,000 annually over a minimum of 13 years ($117,000/$9,000 = 13). EXAMPLE 4 - IMPACT OF WITHDRAWALS LESS THAN OR EQUAL TO MAXIMUM ANNUAL WITHDRAWAL AMOUNT AFTER THE BENEFIT AVAILABILITY DATE: Assume you elect Diversified Strategies Income Rewards Option 2 and you invest a single Purchase Payment of $100,000. You make a withdrawal of $7,500 during the first year after the Benefit Availability Date. B-1 Because the withdrawal is less than or equal to your Maximum Annual Withdrawal Amount ($10,000), your Stepped-Up Benefit Base ($120,000) is reduced by the total dollar amount of the withdrawal ($7,500). Your new Stepped-Up Benefit Base equals $112,500. Your Maximum Annual Withdrawal Amount remains $10,000. Your new Minimum Withdrawal Period following the withdrawal is equal to the new Stepped-Up Benefit Base divided by your current Maximum Annual Withdrawal Amount, ($112,500/$10,000). Therefore, you may take withdrawals of up to $10,000 over a minimum of 11 years and 3 months. EXAMPLE 5 - IMPACT OF WITHDRAWALS IN EXCESS OF MAXIMUM ANNUAL WITHDRAWAL AMOUNT AFTER THE BENEFIT AVAILABILITY DATE: Assume you elect Diversified Strategies Income Rewards Option 2 and you invest a single Purchase Payment of $100,000. Your Withdrawal Benefit Base is $100,000 and your Stepped-Up Benefit Base is $120,000. You make a withdrawal of $15,000 during the first year after the Benefit Availability Date. Your contract value is $125,000 at the time of the withdrawal. Because the withdrawal is greater than your Maximum Annual Withdrawal Amount ($10,000), we recalculate your Stepped-Up Benefit Base ($120,000) by taking the lesser of two calculations. For the first calculation, we deduct the amount of the withdrawal from the Stepped-Up Benefit Base ($120,000 - $15,000 = $105,000). For the second calculation, we deduct the amount of the Maximum Annual Withdrawal Amount from the Stepped-Up Benefit Base ($120,000 - $10,000 = $110,000). Next, we calculate the excess portion of the withdrawal ($5,000) and determine the proportion by which the contract value was reduced by the excess portion of the withdrawal ($5,000/$125,000 = 4%). Finally we reduce $110,000 by that proportion (4%) which equals $105,600. Your Stepped-Up Benefit Base is the lesser of these two calculations or $105,000. The Minimum Withdrawal Period following the withdrawal is equal to the Minimum Withdrawal Period at the end of the prior year (12 years) reduced by one year (11 years). Your Maximum Annual Withdrawal Amount is your Stepped-Up Benefit Base divided by your Minimum Withdrawal Period ($105,000/11), which equals $9,545.45. B-2 APPENDIX C -- EXCHANGE OFFER - -------------------------------------------------------------------------------- As explained in the prospectus, an Exchange Offer is available to certain contract owners currently invested in the WM Advantage Variable Annuity to move to the WM Diversified Strategies(III) Variable Annuity, subject to our rules. The chart below highlights the material differences between the WM Advantage and WM Diversified Strategies(III) variable annuities. This material is intended as a summary to help you compare the two products. Full details about each of these features and benefits as well as other components of these products can be found in the WM Diversified Strategies(III) or WM Advantage Prospectus. You and your financial representative should review this chart and the relevant prospectuses when deciding whether this Exchange Offer would be beneficial to you.
- ------------------------------------------------------------------------------------------------------------------- FEATURE WM ADVANTAGE WM DIVERSIFIED STRATEGIES(III) - ------------------------------------------------------------------------------------------------------------------- SEPARATE ACCOUNT INSURANCE 1.40% annually of the value in the 1.55% annually of the value in the CHARGES variable investment options, subtracted variable investment options, subtracted daily. daily. - ------------------------------------------------------------------------------------------------------------------- SURRENDER CHARGES 6 years per purchase payment, declines: 3 years per purchase payment, declines: 7%, 6%, 6%, 5%, 4%, 2%, 0%. 7%, 6%, 6%, 0%.* - ------------------------------------------------------------------------------------------------------------------- ANNUAL CONTRACT FEE None $35 ($30 in North Dakota) Waived for policies with account value greater than $50,000 on the contract anniversary. - ------------------------------------------------------------------------------------------------------------------- VARIABLE INVESTMENT OPTIONS 5 Strategic Asset Management 5 Strategic Asset Management (SAM) (SAM) Portfolios portfolios 7 Equity Funds 13 Equity Portfolios 4 Fixed-Income Funds (REIT Fund not available) 4 Fixed-Income Portfolios - ------------------------------------------------------------------------------------------------------------------- FIXED ACCOUNT OPTIONS 1-, 3-, 5-year guarantee periods Available DCAFAs (If available) (See Fixed Investment Options) - ------------------------------------------------------------------------------------------------------------------- LONG TERM CARE/TERMINAL Yes None ILLNESS WAIVER - ------------------------------------------------------------------------------------------------------------------- STANDARD DEATH BENEFIT Greatest of: Greater of: - Contract Value - Net Purchase Payments compounded at 3% - Purchase Payments minus withdrawals until the earlier of death or age 75 - Maximum Anniversary Value - Contract Value - ------------------------------------------------------------------------------------------------------------------- ENHANCED DEATH BENEFIT None For a fee (.15%), a choice between two options: 1. Purchase Payment Accumulation which pays the greater of: - Net Purchase Payments compounded at 5% until the earlier of death or age 80 - Contract Value 2. Maximum Anniversary which pays the greatest of: - Net Purchase Payments - Contract Value - Maximum Anniversary Value up to age 81 Choice between these two offerings must be made at the time of purchase. - ------------------------------------------------------------------------------------------------------------------- ENHANCED BENEFICIARY None Yes (for an additional fee of .25%) Can PROTECTION only be elected if one of the Enhanced Death Benefits is elected. - ------------------------------------------------------------------------------------------------------------------- LIVING BENEFIT None For a fee (.10%) guarantees a minimum retirement income upon annuitization after at least 10 years. - -------------------------------------------------------------------------------------------------------------------
* Not applicable to contracts issued as a result of an exchange from WM Advantage to WM Diversified Strategies(III.) C-1 APPENDIX D - -------------------------------------------------------------------------------- CONDENSED FINANCIAL INFORMATION
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR ENDING ENDING ENDING ENDING ANCHOR SERIES TRUST 12/31/01 12/31/02 12/31/03 12/31/04 - -------------------------------------------------------------------------------------------------------------------------------- Capital Appreciation (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $32.095 (a) $34.794 (a) $26.448 (a) $34.395 (b) $32.095 (b) $34.852 (b) $26.392 (b) $34.180 Ending AUV....................................... (a) $34.794 (a) $26.448 (a) $34.395 (a) $36.897 (b) $34.852 (b) $26.392 (b) $34.180 (b) $36.519 Ending Number of AUs............................. (a) 386 (a) 15,211 (a) 34,580 (a) 52,568 (b) 1,795 (b) 9,564 (b) 9,532 (b) 20,734 - --------------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR ENDING ENDING ENDING ENDING SUNAMERICA SERIES TRUST 12/31/01 12/31/02 12/31/03 12/31/04 - -------------------------------------------------------------------------------------------------------------------------------- Alliance Growth (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $30.768 (a) $32.723 (a) $22.108 (a) $27.347 (b) $30.768 (b) $32.744 (b) $22.030 (b) $27.141 Ending AUV....................................... (a) $32.723 (a) $22.108 (a) $27.347 (a) $29.022 (b) $32.744 (b) $22.030 (b) $27.141 (b) $28.687 Ending Number of AUs............................. (a) 29 (a) 7,424 (a) 12,084 (a) 15,703 (b) 21 (b) 2,753 (b) 3,284 (b) 3,077 - -------------------------------------------------------------------------------------------------------------------------------- Global Equities (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $16.645 (a) $17.562 (a) $12.632 (a) $15.711 (b) $16.645 (b) $17.577 (b) $12.590 (b) $15.599 Ending AUV....................................... (a) $17.562 (a) $12.632 (a) $15.711 (a) $17.281 (b) $17.577 (b) $12.590 (b) $15.599 (b) $17.082 Ending Number of AUs............................. (a) 15 (a) 2,002 (a) 4,811 (a) 9,628 (b) 1 (b) 730 (b) 764 (b) 365 - -------------------------------------------------------------------------------------------------------------------------------- MFS Mid Cap Growth (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $12.022 (a) $13.453 (a) $6.990 (a) $9.431 (b) $12.022 (b) $13.445 (b) $6.956 (b) $9.347 Ending AUV....................................... (a) $13.453 (a) $6.990 (a) $9.431 (a) $10.579 (b) $13.445 (b) $6.956 (b) $9.347 (b) $10.443 Ending Number of AUs............................. (a) 68 (a) 7,702 (a) 32,405 (a) 37,580 (b) 52 (b) 8,548 (b) 9,886 (b) 10,611 - -------------------------------------------------------------------------------------------------------------------------------- Technology (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $3.222 (a) $3.457 (a) $1.720 (a) $2.550 (b) $3.222 (b) $3.457 (b) $1.719 (b) $2.538 Ending AUV....................................... (a) $3.457 (a) $1.720 (a) $2.550 (a) $2.443 (b) $3.457 (b) $1.719 (b) $2.538 (b) $2.422 Ending Number of AUs............................. (a) 217 (a) 30,946 (a) 108,814 (a) 81,168 (b) 3 (b) 4,971 (b) 4,969 (b) 38,945 - --------------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR ENDING ENDING ENDING ENDING WM VARIABLE TRUST 12/31/01 12/31/02 12/31/03 12/31/04 - -------------------------------------------------------------------------------------------------------------------------------- Balanced Portfolio (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $7.347 (a) $7.547 (a) $6.764 (a) $8.156 (b) $7.347 (b) $7.543 (b) $6.733 (b) $8.086 Ending AUV....................................... (a) $7.547 (a) $6.764 (a) $8.156 (a) $8.821 (b) $7.543 (b) $6.733 (b) $8.086 (b) $8.710 Ending Number of AUs............................. (a) 93,859 (a) 2,232,623 (a) 5,308,097 (a) 8,919,229 (b) 16,660 (b) 531,637 (b) 791,271 (b) 1,027,732 - -------------------------------------------------------------------------------------------------------------------------------- Conservative Balanced Portfolio (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $5.489 (a) $5.558 (a) $5.338 (a) $6.140 (b) $5.489 (b) $5.554 (b) $5.313 (b) $6.088 Ending AUV....................................... (a) $5.558 (a) $5.338 (a) $6.140 (a) $6.522 (b) $5.554 (b) $5.313 (b) $6.088 (b) $6.440 Ending Number of AUs............................. (a) 36,105 (a) 219,214 (a) 728,848 (a) 1,658,338 (b) 818 (b) 50,067 (b) 78,689 (b) 121,944 - --------------------------------------------------------------------------------------------------------------------------------
AU - Accumulation Unit AUV - Accumulation Unit Value (a) Without election of the optional enhanced death benefit features (b) With election of the optional enhanced death benefit features D-1
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR ENDING ENDING ENDING ENDING WM VARIABLE TRUST 12/31/01 12/31/02 12/31/03 12/31/04 - -------------------------------------------------------------------------------------------------------------------------------- Conservative Growth Portfolio (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $7.645 (a) $7.945 (a) $6.594 (a) $8.334 (b) $7.645 (b) $7.946 (b) $6.571 (b) $8.272 Ending AUV....................................... (a) $7.945 (a) $6.594 (a) $8.334 (a) $9.156 (b) $7.946 (b) $6.571 (b) $8.272 (b) $9.051 Ending Number of AUs............................. (a) 57,379 (a) 958,772 (a) 1,639,836 (a) 2,626,602 (b) 18,040 (b) 510,781 (b) 529,868 (b) 537,134 - -------------------------------------------------------------------------------------------------------------------------------- Equity Income Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $6.197 (a) $6.369 (a) $5.477 (a) $6.997 (b) $6.197 (b) $6.365 (b) $5.453 (b) $6.938 Ending AUV....................................... (a) $6.369 (a) $5.477 (a) $6.997 (a) $8.186 (b) $6.365 (b) $5.453 (b) $6.938 (b) $8.085 Ending Number of AUs............................. (a) 40,294 (a) 652,304 (a) 1,058,224 (a) 1,742,252 (b) 13,192 (b) 264,269 (b) 282,614 (b) 354,394 - -------------------------------------------------------------------------------------------------------------------------------- Flexible Income Portfolio (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $6.517 (a) $6.524 (a) $6.547 (a) $7.286 (b) $6.517 (b) $6.538 (b) $6.536 (b) $7.245 Ending AUV....................................... (a) $6.524 (a) $6.547 (a) $7.286 (a) $7.622 (b) $6.538 (b) $6.536 (b) $7.245 (b) $7.548 Ending Number of AUs............................. (a) 23,092 (a) 1,115,544 (a) 3,743,642 (a) 7,008,339 (b) 536 (b) 168,170 (b) 273,450 (b) 326,936 - -------------------------------------------------------------------------------------------------------------------------------- Growth & Income Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $5.849 (a) $6.016 (a) $4.661 (a) $5.806 (b) $5.849 (b) $6.013 (b) $4.637 (b) $5.752 Ending AUV....................................... (a) $6.016 (a) $4.661 (a) $5.806 (a) $6.218 (b) $6.013 (b) $4,637 (b) $5.752 (b) $6.136 Ending Number of AUs............................. (a) 4,551 (a) 150,973 (a) 285,233 (a) 368,765 (b) 13,991 (b) 87,324 (b) 93,495 (b) 109,283 - -------------------------------------------------------------------------------------------------------------------------------- Growth Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $6.791 (a) $7.150 (a) $4.847 (a) $6.148 (b) $6.791 (b) $7.137 (b) $4.823 (b) $6.092 Ending AUV....................................... (a) $7.150 (a) $4.847 (a) $6.148 (a) $6.539 (b) $7.137 (b) $4.823 (b) $6.092 (b) $6.454 Ending Number of AUs............................. (a) 3,394 (a) 64,109 (a) 103,137 (a) 122,877 (b) 41 (b) 20,860 (b) 22,069 (b) 17,131 - -------------------------------------------------------------------------------------------------------------------------------- Income Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $5.816 (a) $5.746 (a) $6.191 (a) $6.673 (b) $5.816 (b) $5.744 (b) $6.164 (b) $6.617 Ending AUV....................................... (a) $5.746 (a) $6.191 (a) $6.673 (a) $6.919 (b) $5.744 (b) $6.164 (b) $6.617 (b) $6.834 Ending Number of AUs............................. (a) 16,374 (a) 877,757 (a) 2,589,597 (a) 2,840,973 (b) 28,322 (b) 274,470 (b) 259,664 (b) 218,461 - -------------------------------------------------------------------------------------------------------------------------------- International Growth Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $4.367 (a) $4.546 (a) $3.776 (a) $5.023 (b) $4.367 (b) $4.546 (b) $3.789 (b) $5.020 Ending AUV....................................... (a) $4.546 (a) $3.776 (a) $5.023 (a) $5.605 (b) $4.546 (b) $3.789 (b) $5.020 (b) $5.578 Ending Number of AUs............................. (a) 2 (a) 15,526 (a) 21,413 (a) 35,799 (b) 2 (b) 8,188 (b) 5,405 (b) 4,877 - -------------------------------------------------------------------------------------------------------------------------------- Mid Cap Stock Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $6.186 (a) $6.645 (a) $5.855 (a) $7.347 (b) $6.186 (b) $6.642 (b) $5.829 (b) $7.285 Ending AUV....................................... (a) $6.645 (a) $5.855 (a) $7.347 (a) $8.267 (b) $6.642 (b) $5.829 (b) $7.285 (b) $8.164 Ending Number of AUs............................. (a) 4,582 (a) 64,864 (a) 130,356 (a) 210,552 (b) 940 (b) 42,438 (b) 43,115 (b) 54,478 - -------------------------------------------------------------------------------------------------------------------------------- Money Market Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $5.792 (a) $5.793 (a) $5.769 (a) $5.703 (b) $5.792 (b) $5.795 (b) $5.746 (b) $5.658 Ending AUV....................................... (a) $5.793 (a) $5.769 (a) $5.703 (a) $5.649 (b) $5.795 (b) $5.746 (b) $5.658 (b) $5.581 Ending Number of AUs............................. (a) 21,359 (a) 611,656 (a) 346,649 (a) 761,286 (b) 5,174 (b) 26,588 (b) 32,680 (b) 13,189 - --------------------------------------------------------------------------------------------------------------------------------
AU - Accumulation Unit AUV - Accumulation Unit Value (a) Without election of the optional enhanced death benefit features (b) With election of the optional enhanced death benefit features D-2
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR ENDING ENDING ENDING ENDING WM VARIABLE TRUST 12/31/01 12/31/02 12/31/03 12/31/04 - -------------------------------------------------------------------------------------------------------------------------------- Short Term Income Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $5.922 (a) $5.916 (a) $6.168 (a) $6.406 (b) $5.922 (b) $5.923 (b) $6.150 (b) $6.361 Ending AUV....................................... (a) $5.916 (a) $6.168 (a) $6.406 (a) $6.409 (b) $5.923 (b) $6.150 (b) $6.361 (b) $6.338 Ending Number of AUs............................. (a) 2,421 (a) 163,898 (a) 813,368 (a) 890,374 (b) 114 (b) 24,307 (b) 57,771 (b) 58,574 - -------------------------------------------------------------------------------------------------------------------------------- Small Cap Growth Fund (Inception Date -- 11/05/01)* Beginning AUV.................................... (a) $6.106 (a) $7.409 (a) $3.847 (a) $6.474 (b) $6.106 (b) $7.424 (b) $3.842 (b) $6.441 Ending AUV....................................... (a) $7.409 (a) $3.847 (a) $6.474 (a) $6.661 (b) $7.424 (b) $3.842 (b) $6.441 (b) $6.600 Ending Number of AUs............................. (a) 3,287 (a) 31,973 (a) 104,235 (a) 135,661 (b) 2 (b) 7,619 (b) 19,306 (b) 20,808 - -------------------------------------------------------------------------------------------------------------------------------- Strategic Growth Portfolio (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $8.331 (a) $8.763 (a) $6.853 (a) $8.959 (b) $8.331 (b) $8.774 (b) $6.834 (b) $8.898 Ending AUV....................................... (a) $8.763 (a) $6.853 (a) $8.959 (a) $9.927 (b) $8.774 (b) $6.834 (b) $8.898 (b) $9.821 Ending Number of AUs............................. (a) 9,248 (a) 197,031 (a) 477,462 (a) 902,787 (b) 1,123 (b) 28,279 (b) 38,111 (b) 76,780 - -------------------------------------------------------------------------------------------------------------------------------- U.S. Government Securities Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $5.943 (a) $5.817 (a) $6.219 (a) $6.238 (b) $5.943 (b) $5.825 (b) $6.204 (b) $6.197 Ending AUV....................................... (a) $5.817 (a) $6.219 (a) $6.238 (a) $6.363 (b) $5.825 (b) $6.204 (b) $6.197 (b) $6.296 Ending Number of AUs............................. (a) 90,321 (a) 1,433,815 (a) 1,996,843 (a) 1,569,287 (b) 3,371 (b) 100,117 (b) 144,873 (b) 104,942 - -------------------------------------------------------------------------------------------------------------------------------- West Coast Equity Fund (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $8.249 (a) $8.805 (a) $6.706 (a) $9.438 (b) $8.249 (b) $8.795 (b) $6.676 (b) $9.358 Ending AUV....................................... (a) $8.805 (a) $6.706 (a) $9.438 (a) $10.475 (b) $8.795 (b) $6.676 (b) $9.358 (b) $10.345 Ending Number of AUs............................. (a) 4,021 (a) 217,183 (a) 384,631 (a) 589,269 (b) 890 (b) 81,228 (b) 93,442 (b) 89,785 - -------------------------------------------------------------------------------------------------------------------------------- WM REIT Fund (Inception Date -- 10/01/03) Beginning AUV.................................... (a) $N/A (a) $N/A (a) $10.600 (a) $11.535 (b) $N/A (b) $N/A (b) $10.605 (b) $11.393 Ending AUV....................................... (a) $N/A (a) $N/A (a) $11.535 (a) $15.132 (b) $N/A (b) $N/A (b) $11.393 (b) $14.707 Ending Number of AUs............................. (a) N/A (a) N/A (a) 8 (a) 12,145 (b) N/A (b) N/A (b) 9 (b) 4 - --------------------------------------------------------------------------------------------------------------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FISCAL YEAR ENDING ENDING ENDING ENDING VAN KAMPEN LIFE INVESTMENT TRUST 12/31/01 12/31/02 12/31/03 12/31/04 - -------------------------------------------------------------------------------------------------------------------------------- Van Kampen LIT Comstock, Class II Shares (Inception Date -- 11/05/01) Beginning AUV.................................... (a) $9.992 (a) $10.263 (a) $8.135 (a) $10.475 (b) $9.992 (b) $10.213 (b) $8.067 (b) $10.345 Ending AUV....................................... (a) $10.263 (a) $8.135 (a) $10.475 (a) $12.112 (b) $10.213 (b) $8.067 (b) $10.345 (b) $11.914 Ending Number of AUs............................. (a) 917 (a) 46,801 (a) 89,132 (a) 125,587 (b) 6,737 (b) 88,739 (b) 101,065 (b) 109,292 - --------------------------------------------------------------------------------------------------------------------------------
AU - Accumulation Unit AUV - Accumulation Unit Value (a) Without election of the optional enhanced death benefit features (b) With election of the optional enhanced death benefit features * The Small Cap Stock Fund was renamed the Small Cap Growth Fund effective 5/3/2004. D-3 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- APPENDIX E -- STATE CONTRACT AVAILABILITY AND/OR VARIATIONS OF CERTAIN FEATURES AND BENEFITS - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------- PROSPECTUS PROVISION AVAILABILITY OR VARIATION STATES - ----------------------------------------------------------------------------------------------------------------- Transfer Privilege Any transfer over the limit of 15 will incur a $10 Pennsylvania transfer fee. Texas - ----------------------------------------------------------------------------------------------------------------- Administration Charge Contract Maintenance Fee is $30. Oregon North Dakota - ----------------------------------------------------------------------------------------------------------------- Administration Charge Will be deducted pro-rata from variable portfolios only. Oregon If premiums are allocated among fixed funds only, no Texas Administration Charge will be deducted. Washington - ----------------------------------------------------------------------------------------------------------------- Capital Protector Charge will be deducted pro-rata from variable portfolios Washington only. If premiums are allocated among fixed funds only, no Capital Protector charge will be deducted. - ----------------------------------------------------------------------------------------------------------------- Free Look Free Look period is 20 days. Idaho North Dakota Utah - ----------------------------------------------------------------------------------------------------------------- Free Look If you reside in California and are age 60 or older on California your Contract Date, the Free Look period is 30 days. - ----------------------------------------------------------------------------------------------------------------- Free Look If you cancel your contract during the Free Look period, Minnesota we return the greater of (1) your Purchase Payments; or (2) the value of your contract. - ----------------------------------------------------------------------------------------------------------------- Free Look If you cancel your contract during the Free Look period, Colorado we return the Purchase Payment(s) paid. Delaware Georgia Hawaii Idaho Iowa Kansas Louisiana Massachusetts Michigan Missouri Nebraska Nevada New Hampshire North Carolina Ohio Oklahoma Rhode Island South Carolina Utah Washington West Virginia - ----------------------------------------------------------------------------------------------------------------- Free Withdrawal Amounts DURING THE FIRST CONTRACT YEAR: Washington You may withdraw the greater of (1) your penalty-free earnings; (2) if you are participating in the Systematic Withdrawal program, a total of 10% of your total invested amount or (3) interest earnings from the amounts allocated to the fixed accounts, not previously withdrawn. AFTER THE FIRST CONTRACT YEAR: Your maximum free withdrawal amount is the greater of (1) your penalty-free earnings and any portion of your total invested amount no longer subject to a withdrawal charge; (2) 10% of the portion of your total invested amount that has been in your contract for at least one year; or (3) interest earnings from amounts allocated to the fixed accounts, no previously withdrawn. - -----------------------------------------------------------------------------------------------------------------
E-1
- ----------------------------------------------------------------------------------------------------------------- PROSPECTUS PROVISION AVAILABILITY OR VARIATION STATES - ----------------------------------------------------------------------------------------------------------------- Systematic Withdrawal Minimum withdrawal amount is $250 per withdrawal or the Oregon penalty free withdrawal amount. - ----------------------------------------------------------------------------------------------------------------- Minimum Contract Value We may terminate your contract if both the following Texas occur: (1) your contract is less than $500 as a result of withdrawals; and (2) you have not made any Purchase Payments during the past three years. We will provide you with sixty days written notice. At the end of the notice period, we will distribute the contract's remaining value to you. - ----------------------------------------------------------------------------------------------------------------- Market Value Adjustment L equal to zero Pennsylvania - ----------------------------------------------------------------------------------------------------------------- Market Value Adjustment L equal to 0.0025 Florida - ----------------------------------------------------------------------------------------------------------------- Premium Tax We do not deduct premium tax charges when you surrender New Mexico your contract or begin the Income Phase. Texas Washington - -----------------------------------------------------------------------------------------------------------------
E-2 APPENDIX F -- MARKET VALUE ADJUSTMENT ("MVA") - -------------------------------------------------------------------------------- The information in this Appendix applies only if you take money out of a FAGP with a duration longer than 1 year before the end of the guarantee period. If you take money out of any available multi-year FAGP, before the end of the guarantee period, we make an adjustment to your contract. We refer to the adjustment as a market value adjustment ("MVA"). The MVA reflects any difference in the interest rate environment between the time you place your money in the FAGP and the time when you withdraw or transfer that money. This adjustment can increase or decrease your contract value. Generally, if interest rates drop between the time you put your money into a FAGP and the time you take it out, we credit a positive adjustment to your contract. Conversely, if interest rates increase during the same period, we post a negative adjustment to your contract. You have 30 days after the end of each guarantee period to reallocate your funds without incurring any MVA. We calculate the MVA by doing a comparison between current rates and the rate being credited to you in the FAGP. For the current rate we use a rate being offered by us for a guarantee period that is equal to the time remaining in the FAGP from which you seek withdrawal (rounded up to a full number of years). If we are not currently offering a guarantee period for that period of time, we determine an applicable rate by using a formula to arrive at a number based on the interest rates currently offered for the two closest periods available. Where the MVA is negative, we first deduct the adjustment from any money remaining in the FAGP. If there is not enough money in the FAGP to meet the negative deduction, we deduct the remainder from your withdrawal. Where the MVA is positive, we add the adjustment to your withdrawal amount. If a withdrawal charge applies, it is deducted before the MVA calculation. The MVA is assessed on the amount withdrawn less any withdrawal charges. The MVA is computed by multiplying the amount withdrawn, transferred or taken under an income option by the following factor: [(1+I/(1+J+L)](N/12) -- 1 where: I is the interest rate you are earning on the money invested in the FAGP; J is the interest rate then currently available for the period of time equal to the number of years remaining in the term you initially agreed to leave your money in the FAGP; N is the number of full months remaining in the term you initially agreed to leave your money in the FAGP; and L is 0.005 (some states require a different value; see your Contract). We do not assess a MVA against withdrawals from a FAGP under the following circumstances: - If a withdrawal is made within 30 days after the end of a guarantee period; - If a withdrawal is made to pay contract fees and charges; - To pay a death benefit; and - Upon beginning an income option, if occurring on the Latest Annuity Date. EXAMPLES OF THE MVA The purpose of the examples below is to show how the MVA adjustments are calculated and may not reflect the Guarantee Periods available or Surrender Charges applicable under your contract. The examples below assume the following: (1) You made an initial Purchase Payment of $10,000 and allocated it to a FAGP at a rate of 5%; (2) You make a partial withdrawal of $4,000 when 1 1/2 years (18 months) remain in the term you initially agreed to leave your money in the FAGP (N = 18); F-1 (3) You have not made any other transfers, additional Purchase Payments, or withdrawals; and (4) You contract was issued in a state where L = 0.005. POSITIVE ADJUSTMENT, NO WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year FAGP is 3.5% and the 3-year FAGP is 4.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 4%. No withdrawal charge is reflected in this example, assuming that the Purchase Payment withdrawn falls within the free withdrawal amount. The MVA factor is = [(1+I/(1+J+0.005)](N/12) -- 1 = [(1.05)/(1.04+0.005)](18/12) -- 1 = (1.004785)(1.5) -- 1 = 1.007186 -- 1 = +0.007186 The requested withdrawal amount is multiplied by the MVA factor to determine the MVA: $4,000 X (+0.007186) = +$28.74 $28.74 represents the positive MVA that would be added to the withdrawal. NEGATIVE ADJUSTMENT, NO WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year FAGP is 5.5% and the 3-year FAGP is 6.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 6%. No withdrawal charge is reflected in this example, assuming that the Purchase Payment withdrawn falls with the free withdrawal amount. The MVA factor is = [(1+I)/(1+J+0.005)](N/12) -- 1 = [(1.05)/(1.06+0.005)](18/12) -- 1 = (0.985915)(1.5) -- 1 = 0.978948 -- 1 = -0.021052 The requested withdrawal amount is multiplied by the MVA factor to determine the MVA: $4,000 X (-0.021052) = -$84.21 $84.21 represents the negative MVA that will be deducted from the withdrawal. POSITIVE ADJUSTMENT, WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year FAGP is 3.5% and the 3-year FAGP is 4.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 4%. A withdrawal charge of 6% is reflected in this example, assuming that the Purchase Payment withdrawn exceeds the free withdrawal amount. The MVA factor is = [(1+I)/(I+J+0.005)](N/12) -- 1 = [(1.05)/(1.04+0.005)](18/12) -- 1 = (1.004785)(1.5) -- 1 = 1.007186 -- 1 = +0.007186 F-2 The requested withdrawal amount, less the withdrawal charge ($4,000 -6% = $3,760) is multiplied by the MVA factor to determine the MVA: $3,760 X (+0.007186) = +$27.02 $27.02 represents the positive MVA that would be added to the withdrawal. NEGATIVE ADJUSTMENT, WITHDRAWAL CHARGE APPLIES Assume that on the date of withdrawal, the interest rate in effect for new Purchase Payments in the 1-year FAGP is 5.5% and the 3-year FAGP is 6.5%. By linear interpolation, the interest rate for the remaining 2 years (1 1/2 years rounded up to the next full year) in the contract is calculated to be 6%. A withdrawal charge of 6% is reflected in this example, assuming that the Purchase Payment withdrawn exceeds the free withdrawal amount. The MVA factor is = [(1+I)/(I+J+0.005)](N/12) -- 1 = [(1.05)/(1.06+0.005)](18/12) -- 1 = (0.985915)(1.5) -- 1 = 0.978948 -- 1 = -0.021052 The requested withdrawal amount, less the withdrawal charge ($4,000 -6% = $3,760) is multiplied by the MVA factor to determine the MVA: $3,760 X (-0.021052) = -$79.16 $79.16 represents the negative MVA that would be deducted from the withdrawal. F-3 Part II Information Not Required in Prospectus Item 13. Other Expenses of Issuance and Distribution. The following table sets forth the expenses in connection with the issuance and distribution of the securities being registered, other than underwriting discounts and commissions. All of the amounts shown are estimates, except the SEC registration fee. SEC registration fee .......................... $12,135 Printing and engraving ........................ $50,000 Legal fees and expenses ....................... $10,000 Rating agency fees ............................ $ 7,500 Miscellaneous ................................. $10,000 Total .................................... $89,635
Item 14. Indemnification of Directors and Officers. Section 10-851 of the Arizona Corporations and Associations law permits the indemnification of directors, officers, employees and agents of Arizona corporations. Article Eight of the Company's Restated Articles of Incorporation, as amended and restated (the "Articles") and Article Five of the Company's By-Laws ("By-Laws") authorize the indemnification of directors and officers to the full extent required or permitted by the Laws of the State of Arizona, now or hereafter in force, whether such persons are serving the Company, or, at its request, any other entity, which indemnification shall include the advance of expenses under the procedures and to the full extent permitted by law. In addition, the Company's officers and directors are covered by certain directors' and officers' liability insurance policies maintained by the Company's parent. Reference is made to section 10-851 of the Arizona Corporations and Associations Law, Article Eight of the Articles, and Article Five of the By-Laws, which are incorporated herein by reference. Item 15. Recent Sales of Unregistered Securities. None Item 16. Exhibits and Financial Statements Schedules.
Exhibit No. Description (1) Underwriting Agreement ++++ (2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession ** (3) (a) Amended Articles of Incorporation Dated September 30, 2002 +++ (b) Articles of Incorporation + (c) By-Laws + (4) (a) Vista Capital Advantage Fixed and Variable Contract *** (b) Application for Contract *** (5) Opinion of Counsel re: Legality *** (6) Opinion re Discount on Capital Shares ** (7) Opinion re Liquidation Preference ** (8) Opinion re Tax Matters ** (9) Voting Trust Agreement ** (10) Material Contracts ** (11) Statement re Computation of Per Share Earnings ** (12) Statement re Computation of Ratios ** (14) Material Foreign Patents ** (15) Letter re Unaudited Financial Information ** (16) Letter re Change in Certifying Accountant ** (21) Subsidiaries of Registrant *** (23) (a) Consent of Independent Registered Public Accounting Firm * (b) Consent of Attorney *** (24) Powers of Attorney ++ (a) December, 2003 +++++ (25) Statement of Eligibility of Trustee ** (26) Invitation for Competitive Bids ** (27) Financial Data Schedule **** (28) Information Reports Furnished to State Insurance Regulatory Authority ** (29) Other Exhibits **
* Filed Herewith ** Not Applicable *** Incorporated by Reference to Post-Effective Amendment No. 3 to Registration Statement No. 33-81476 on Form S-1 filed on 12-24-97. **** Incorporated by Reference to Post-Effective Amendment No. 5 to Registration Statement No. 33-81476 on Form S-1 filed on 12-24-98. ***** Incorporated by Reference to Post-Effective Amendment No. 9 to Registration Statement No. 33-81476 on Form S-3 filed on December 19, 2000. + Incorporated by Reference to Post-Effective Amendment 17 to Registration Statement No. 33-81476 on Form S-3 filed on September 20, 2002, accession number 0000950148-02-002275. ++ Incorporated by Reference to Initial Registration Statement No. 333-103504 on Form S-3 filed on December 20, 2002, Accession Number 000095014-03-000424. +++ Incorporated by Reference to Post-Effective Amendment 1 to Registration Statement No. 333-103504 on Form S-3 filed on May 1, 2003, Accession No. 0000950148-03-001099. ++++ Incorporated by Reference to Form N-14AE Registration Statement No. 333-108115 filed on August 21, 2003, Accession No. 0000 1206774-03-000644. +++++ Incorporated by Reference to Post-Effective Amendment 3 to Registration Statement No. 333-103504 on Form S-3 filed on December 8, 2003, Accession Number 0000950148-03-002850. The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. SIGNATURES Pursuant to the requirement of the Securities Act of 1933, the Registrant has duly caused this post-effective amendment to the registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California on this 27th day of April 2005. AIG SUNAMERICA LIFE ASSURANCE COMPANY (Registrant) By: /s/ JAY S. WINTROB --------------------------------------- Jay S. Wintrob, Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacity and on the dates indicated.
SIGNATURE TITLE DATE - --------- ----- ---- JAY S. WINTROB* Chief Executive Officer, April 27, 2005 - --------------------------------- & Director Jay S. Wintrob (Principal Executive Officer) JAMES R. BELARDI* Director April 27, 2005 - --------------------------------- James R. Belardi MARC H. GAMSIN* Director April 27, 2005 - --------------------------------- Marc H. Gamsin N. SCOTT GILLIS* Senior Vice President, April 27, 2005 - --------------------------------- Chief Financial Officer & N. Scott Gillis Director (Principal Financial Officer) JANA W. GREER* Director April 27, 2005 - --------------------------------- Jana W. Greer STEWART R. POLAKOV* Senior Vice President April 27, 2005 - --------------------------------- & Controller Stewart R. Polakov (Principal Accounting Officer) * By: /s/ MALLARY L. REZNIK April 27, 2005 ---------------------------- Mallary L. Reznik Attorney-In-Fact
EXHIBIT INDEX Number Description - ------ ----------- 23(a) Consent of Independent Registered Public Accounting Firm EX-23.A 2 v08019p1exv23wa.txt EX-23.A EXHIBIT 23.(A) CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the use in the Prospectuses of the Vista Capital Advantage, the Polaris Choice II and the WM Diversified Strategies III Variable Annuities, which constitute part of this Registration Statement on Form S-1 of our report dated April 15, 2005 relating to the consolidated financial statements of AIG SunAmerica Life Assurance Company at December 31, 2004 and 2003, and for each of the three years in the period ended December 31, 2004, which appears in such Registration Statement. PricewaterhouseCoopers LLP Los Angeles, CA April 27, 2005 -----END PRIVACY-ENHANCED MESSAGE-----