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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13

Commission file number 0-23625

ANNUITY AND LIFE RE (HOLDINGS), LTD.

Registrant’s telephone number, including area code (441) 296-7667

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

      Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     Yes o          No x

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes x          No o

      As of June 28, 2002, the aggregate market value of Common Shares, $1.00 par value, held by non-affiliates was $452,453,802.

      As of March 12, 2003, 26,106,328 Common Shares, $1.00 par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE.

      Certain information required by Items 10, 11, 12 and 13 is incorporated by reference into Part III hereof from the registrant’s proxy statement for its 2003 Annual Meeting of Shareholders, which is expected to be filed with the Securities and Exchange Commission within 120 days of the close of the registrant’s fiscal year ended December 31, 2002.

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PART I

Overview

      Annuity and Life Re (Holdings), Ltd. was incorporated on December 2, 1997 under the laws of Bermuda. We provide annuity and life reinsurance to select insurers and reinsurers through our wholly-owned subsidiaries: Annuity and Life Reassurance, Ltd., which is licensed under the insurance laws of Bermuda as a long term insurer; and Annuity and Life Re America, Inc., an insurance holding company based in the United States, and its subsidiary, Annuity and Life Reassurance America, Inc., a life insurance company authorized to conduct business in over 40 states of the United States and the District of Columbia. We acquired Annuity and Life Reassurance America on June 1, 2000.

      As discussed in greater detail elsewhere in this report, our company encountered significant difficulties during the year ended December 31, 2002. In addition to reporting a significant operating loss for the year, we did not have sufficient available cash and investments at December 31, 2002 to post collateral to satisfy all of our obligations under certain of our reinsurance treaties. Since that date, certain of our cedents have asserted that we must satisfy additional substantial collateral requirements, bringing the total asserted collateral requirements of our cedents to approximately $140 million in excess of amounts we currently have posted. We are currently analyzing these asserted collateral requirements and have not concluded that such amounts are in fact required to be posted as collateral under the relevant reinsurance contracts. In addition, we are also attempting to address a request from a letter of credit provider to collateralize or return approximately $45 million of outstanding letters of credit issued on our behalf. In an effort to meet or reduce our collateral requirements and improve our liquidity, we have novated, terminated or negotiated the recapture of several of our annuity and life reinsurance contracts, including our annuity reinsurance contract with The Ohio National Life Insurance Company, which was our second largest annuity reinsurance contract, and certain of our more profitable life reinsurance contracts.

      While we plan to continue to receive premiums and pay claims under our remaining reinsurance treaties, we have ceased to write new reinsurance agreements and have notified our existing clients that we will not be accepting any new business under existing treaties on their current terms. We do not anticipate resuming to write new reinsurance agreements in the foreseeable future. Our plans for the future involve attempting to meet or reduce the additional collateral requirements of our ceding companies by continuing to negotiate the recapture, retrocession, novation or sale of certain of our reinsurance agreements, but there can be no assurance that we will be able to negotiate favorable terms for such transactions. We have also instituted substantial premium rate increases on all of our non-guaranteed premium yearly renewable term contracts that remain in force. There can be no assurance that our plans will be sufficient to improve our operations or liquidity. If we are not successful in implementing our plans, or if those plans are insufficient, we will not be able to satisfy our obligations in 2003 and will likely be required to liquidate our business if we cannot successfully pursue any other strategic alternative. For a more detailed discussion of certain factors that could materially and adversely affect our financial condition and results of operations, including, among other things, the possible delisting of our common shares from the New York Stock Exchange, please see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Forward-Looking Statements.

      In light of the foregoing, the discussion of our results of operations for the year ended December 31, 2002 presented in this report is not likely to be indicative of our future operating results.

The Reinsurance Business

      The business of reinsurance generally consists of reinsurers, such as Annuity and Life Re, entering into contractual arrangements (known as treaties) with primary insurers (known as ceding companies or cedents) whereby the reinsurer agrees to indemnify the ceding company for all or a portion of the risks associated with an underlying insurance policy in exchange for a reinsurance premium payable to the reinsurer. Reinsurers also may enter into retrocessional reinsurance arrangements with other reinsurers, which operate in a manner

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      Reinsurance agreements may be written on an automatic treaty basis or facultative basis. An automatic treaty provides for a ceding company to cede contractually agreed-upon risks on identified types of business that meet established criteria to a reinsurer and binds that reinsurer to accept such risks without obtaining further approval from that reinsurer. Facultative reinsurance is the reinsurance of individual risks, which allows a reinsurer the opportunity to analyze and separately underwrite a risk before agreeing to accept the risk. Both automatic treaty and facultative reinsurance may be written on either a quota share basis, where a percentage of each risk in the reinsured class of risk is assumed by the reinsurer from the ceding company, or on an excess of retention basis, where the amount of risk in excess of the ceding company’s retention is reinsured. Under either basis, premiums are paid to the reinsurer in proportion to the risk assumed by the reinsurer.

      The treaties that we have written that are still in force are generally in the form of yearly renewable term, coinsurance, modified coinsurance or coinsurance funds withheld. Under yearly renewable term, we share only in the mortality risk for which we receive a premium. In coinsurance, modified coinsurance and coinsurance funds withheld arrangements, we generally share proportionately in all or a portion of the risks inherent in the underlying policies, including mortality, persistency and fluctuations in investment results. Under such agreements, we agree to indemnify the primary insurer for all or a portion of the risks associated with the underlying insurance policies in exchange for a proportionate share of premiums. Coinsurance differs from modified coinsurance and coinsurance funds withheld with respect to ownership of the assets supporting the reserves. Under our coinsurance arrangements, ownership of these assets is transferred to us, whereas, in modified coinsurance and coinsurance funds withheld arrangements, the ceding company retains ownership of these assets, but we share in the investment income and risk associated with the assets.

      Certain of our remaining reinsurance treaties provide for recapture rights, permitting the ceding company to reassume all or a portion of the risk ceded to us after an agreed-upon period of time (generally 10 years for our life reinsurance treaties), subject to certain other conditions. Some of our reinsurance treaties allow the ceding company to recapture the ceded risk if we fail to maintain a specified rating or if other financial conditions relating to us are not satisfied. Our current ratings are below the specified ratings in such treaties, and we have had certain treaties recaptured as a result of the ratings downgrades we have experienced. We are also seeking to negotiate the recapture of certain treaties, as we did in 2002, to reduce or eliminate the collateral requirements associated with those treaties. Recapture of business previously ceded does not affect earned premiums paid to us prior to the recapture of such business and may involve the payment to us of a recapture fee. Nevertheless, we may be obligated to return unearned premiums, or pay other penalties, and we may also have to liquidate assets in order to return the assets supporting the reserve liabilities. In addition, we would no longer be entitled to receive the premiums paid by the policyholders underlying the recaptured business and would likely be required to accelerate the amortization of any unamortized deferred acquisition costs associated with business that is recaptured, which was the case with certain treaties recaptured during 2002. These recaptures have had an adverse impact on our reported earnings, and additional recaptures will likely further reduce our earnings in future periods.

Risks Reinsured

      We have historically written reinsurance predominantly on a direct basis with primary life insurance companies and other reinsurers. Our remaining reinsurance treaties are generally for traditional life reinsurance and annuity reinsurance, which expose us to the following categories of risks: (i) mortality, (ii) investment, (iii) persistency (or lapse) and (iv) expense.

      Mortality risk is the risk that death claims differ from what we expect. With respect to our life segment, a greater frequency or higher average size of death claims than we expected can cause us to pay greater death benefits, adversely affecting the profitability of our reinsurance contracts. Even if the total death benefits paid over the life of our contracts do not exceed the expected amount, unexpected timing of deaths can cause us to

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      We are subject to investment risk with respect to our own investments and with respect to the assets held and managed by our ceding companies or others under our modified coinsurance and coinsurance funds withheld arrangements. Our investments, which primarily consist of investment grade fixed income securities, are subject to interest rate and credit risk. Significant changes in interest rates expose us to the risk of earning less income during periods when interest rates are falling, or realizing losses if we are forced to sell securities during periods when interest rates are rising. We are also subject to prepayment risk on certain securities in our investment portfolio, including mortgage-backed securities and collateralized mortgage obligations, which generally prepay faster during periods of falling interest rates as the underlying mortgage loans are repaid and refinanced by borrowers in order to take advantage of lower interest rates. During periods when interest rates have risen or are rising, the rate of prepayments on these types of securities will decelerate, effectively extending maturities and increasing the potential for losses.

      As of December 31, 2002, our cedents had approximately $1.4 billion in assets that were held and managed by or for them under our modified coinsurance and coinsurance funds withheld arrangements. Of those assets, approximately $366 million is related to our annuity reinsurance agreement with Ohio National, which was terminated in the first quarter of 2003. While we do not own the assets that are held under modified coinsurance or coinsurance funds withheld arrangements, they are used to fund our obligations under our annuity reinsurance contracts. We record a receivable called “Funds withheld at interest” based on the amounts due to us under these contracts and are exposed to the risks associated with the securities in which the assets supporting the receivable are invested. Those assets are primarily invested in fixed income securities and, with respect to our annuity reinsurance contract with Transamerica Occidental Life Insurance Company, in convertible bonds. The fixed income securities in which the assets are invested are subject to risks similar to those described above with respect to our own investments. The value of convertible bonds in which these assets are invested is a function of their investment value (determined by comparing their yield with the yields of other securities of comparable maturity and quality that do not have a conversion privilege) and their conversion value (their market value if converted into the underlying common stock). The investment value of convertible bonds is influenced by changes in interest rates, with investment value declining as interest rates increase and increasing as interest rates decline, and by the credit standing of the issuer and other factors. The conversion value of convertible bonds is determined by the market price of the underlying common stock. If the conversion price is above the market value of the underlying common stock, the price of the convertible bonds is governed principally by their investment value. To the extent the market price of the underlying common stock approaches or exceeds the conversion price, the price of the convertible bonds will be increasingly influenced by their conversion value. Consequently, the value of convertible bonds may be influenced by changes in the equity markets.

      We are also subject to investment risk based on the difference between the interest rates earned on the investments managed by us or our ceding companies and the credited interest rates paid under policies reinsured by us. Both rising and declining interest rates can affect the income we derive from these interest rate spreads. During periods in which prevailing market interest rates are falling, any new investments made in fixed income securities to replace investments that mature or are prepaid will likely bear lower interest rates,

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      We also reinsure policies providing a guaranteed minimum income benefit that entitle a policyholder to purchase a lifetime annuity payment stream after the expiration of a stipulated waiting period. We are subject to investment risk to the extent that investment returns on the assets supporting the liabilities under these policies are not sufficient to fund the payment stream the policyholder is entitled to receive. However, because the annuity purchase rates applicable to the guaranteed minimum income benefits are often less favorable than prevailing annuity purchase rates when the underlying policy annuitizes, policyholders may receive a preferable stream of annuity payments using the actual account value at prevailing annuity purchase rates as opposed to utilizing the predetermined guaranteed minimum income benefit purchase rate under the policy. To the degree this occurs, any difference in annuity purchase rates will offset the investment risk.

      We may use interest rate swaps and other financial instruments as tools to mitigate the effects of asset/liability mismatches or the effect of interest rate changes on our balance sheet. At December 31, 2002, we were party to two interest rate swap agreements with an aggregate notional value of $67 million. These swap agreements were terminated on January 13, 2003. In general, however, we have not hedged our investment risk, but we may do so in the future.

      Persistency or lapse risk is the risk that policyholders maintain their policies for different periods of time than expected. This includes policy surrenders and policy lapses. Surrenders are the voluntary termination of a policy by the policyholder, while lapses are the termination of the policy due to non-payment of premium. Surrender and lapse rates that are higher than what we assumed when pricing a contract can cause us to increase the rate of amortization of our deferred acquisition costs for the annuity policies and certain types of life insurance that we reinsure, which would adversely affect our results of operations. If the actual surrender and lapse rates remain too high for too long, as was the case in 2001 and 2002 with our annuity reinsurance contract with Transamerica, we may conclude that the contract will be unprofitable over its expected lifetime, and we would be required to further write down our deferred acquisition costs. Surrenders also usually involve the return of the policy’s cash surrender value to the policyholder, which reduces the asset base on which we earn investment income and, in some cases, premiums. In addition, with respect to our Transamerica contract, a surrendering policyholder is entitled to a guaranteed minimum interest rate on his or her invested premiums, and we are required to pay our proportionate share of any shortfall between that guaranteed amount and the actual value of the policyholder’s account. We have been required to make significant minimum interest guarantee payments under this contract, as discussed below. During periods in which the financial markets are falling, increases in partial surrenders under certain reinsurance policies do not reduce the guaranteed minimum death benefits we are obligated to pay by the same proportion by which the premiums supporting the guaranteed minimum death benefit obligations are reduced. The risk of partial surrenders impacting our guaranteed minimum death benefit obligations may have an effect on the profitability of our largest contract reinsuring such benefits.

      Certain of our life reinsurance products provide level premiums to us for a fixed period of time, typically 10 to 20 years. The premiums we receive on these level premium contracts are expected to exceed the death

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      Expense risk is the risk that our actual expenses will be higher than we anticipated, or that our operations are less efficient than anticipated.

Business Written

      The following table sets forth selected information for the indicated periods concerning our insurance operations:

Policy Revenues, Insurance In Force and Annuity Reinsurance Deposits

(1)

The information presented for the year ended December 31, 2002 does not reflect the effects of the termination, novation and recapture of several of our reinsurance agreements, except that Insurance in force does reflect the effect of a transaction with XL Life Ltd, a subsidiary of XL Capital Ltd, a related party, that was completed on December 31, 2002. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Pro Forma Effects of Recent Transactions for a discussion of the effects of these transactions.

     In 2002, we began to separately track the results of our life and annuity operations in segments. Please refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Segment Results and Note 13 to our consolidated financial statements for more detailed information.

      Our life reinsurance segment is the reinsurance of ordinary life insurance, primarily for mortality risks. Ordinary life reinsurance generally is the reinsurance of individual term life insurance policies, whole life insurance policies and joint and survivor insurance policies on yearly renewable term basis. In addition, we reinsure the mortality risk portion of universal life insurance policies, variable universal life insurance policies and variable life insurance policies.

      Our annuity reinsurance segment is the reinsurance of general account fixed deferred annuities, general account payout annuity obligations and certain ancillary risks arising from variable annuities. With respect to the general account fixed annuities we reinsure, our agreements generally relate to individual general account single premium deferred annuity policies, which either involve the tax-deferred accumulation of interest on a single premium paid by the policyholder (accumulation phase policies) or are annuities that pay fixed amounts periodically to policyholders over a fixed period of time or their lives (payout phase policies). Accumulation phase policies are subject primarily to investment risk and persistency (lapse) risk, while

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      All of the fixed annuity products we reinsure have minimum interest guarantee provisions required under state law that entitle the policyholder to a specified minimum annual return over the life of the policy. These lifetime guarantees are typically 3% to 3.5% annually. Further, policyholders are typically guaranteed interest rates in excess of the state required minimums for the initial year of the policy. After the expiration of the period in which the crediting rate is guaranteed, the primary insurer has the discretionary ability to adjust the crediting rate annually to any rate at or above the guaranteed minimum rate required under state law. Policyholders are typically permitted to withdraw all or a part of their premium paid, plus an accumulation amount equal to the accrued interest credited to the account, subject to the assessment of a surrender charge for withdrawals in excess of specified limits. Certain policies reinsured by us guarantee the policyholder a crediting rate beyond the initial policy year, including those policies that were covered by our annuity reinsurance contract with Ohio National, which was terminated in the first quarter of 2003.

      Under our Transamerica annuity reinsurance contract, the minimum interest guarantee provisions take effect when the policyholder dies, his or her policy annuitizes or his or her policy is surrendered. Our aggregate minimum interest guarantee exposure under this contract equals our proportionate share of the amount by which each policyholder’s premiums deposited compounded at the minimum guarantee interest rate exceeds the policyholder’s actual account value at the date of surrender. The actual account value is calculated after expenses are deducted from the gross investment returns and such expenses generally accrue at a rate of approximately 2.75% of the assets annually. Our minimum interest guarantee exposure is calculated on a policyholder-by-policyholder basis. The amount by which the value of certain policyholder accounts exceeds the minimum guarantee amount with respect to those accounts does not offset our exposure to the amount by which the value of other policyholder accounts is less than the minimum guarantee amount with respect to such other accounts. This exposure generally arises during periods in which investment returns fall near or below the minimum guaranteed rate, as has occurred in recent years.

      If we conclude that we are exposed to minimum interest guarantees under a reinsurance agreement, we then estimate the expected minimum interest guarantee payments that we may be required to make by projecting the anticipated future investment performance of the assets supporting the policyholder accounts and by applying projected surrender, annuitization and mortality assumptions to the exposed amounts. These expected future payments are utilized in determining the amount of the deferred acquisition cost asset we can carry on our balance sheet. Because we assume that the investment performance of the underlying assets will exceed the minimum guaranteed interest rate on the underlying annuity policies over their life, we anticipate that any minimum interest guarantee exposure we have will decrease over time. The amount of expected minimum interest guarantee payments is therefore dependent upon our estimate of the number of policyholders that will annuitize or surrender their policy or die prior to the value of the underlying assets increasing to a level where it equals or exceeds the policyholders’ minimum guarantee amounts. If our assumptions for investment returns prove to be inaccurate, or if lapse rates exceed our assumptions, we may be required to make additional minimum interest guarantee payments and record additional charges, which would adversely impact our earnings. Our minimum interest guarantee exposure can increase during any period in which the actual investment performance of the underlying assets less expenses lags the minimum guaranteed interest rate.

      We also reinsure certain guarantees associated with variable annuity contracts, including guaranteed minimum death benefits, enhanced earnings benefits and guaranteed minimum income benefits. Under contracts with a guaranteed minimum death benefit, a policyholder’s beneficiary is entitled upon the policyholder’s death to receive the greater of the policyholder’s account value or a guaranteed minimum benefit payment. The majority of the policies underlying the guaranteed minimum death benefit contracts we reinsure are written on a “ratchet” basis, which means that the guaranteed minimum death benefit payable to the policyholder’s beneficiary equals the highest policyholder account value achieved over the course of the contract, as measured annually on each anniversary date of the policy until the policyholder reaches the attained age under the policy (typically 80 years of age). Other guaranteed minimum death benefit policies are written on a “roll-up” basis, which means that the guaranteed minimum death benefit equals the

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      We have two large contracts reinsuring guaranteed minimum death benefits. As of December 31, 2002, the guaranteed minimum death benefit amount at risk (i.e., the amount by which guaranteed death benefits exceed related account values) under our largest such contract was approximately $1.07 billion. Also as of December 31, 2002, the guaranteed minimum death benefit amount at risk under the other such contract was approximately $160 million. These amounts are an aggregate measure of our exposure to guaranteed minimum death benefits assuming all the policyholders died on December 31, 2002. Our expected liability for future guaranteed minimum death benefit payments, based on our mortality assumptions, is substantially less. Because the premium paid to the ceding company under our largest such reinsurance agreement, and to us under that reinsurance agreement, is derived from asset-based charges levied against the account value, there may be circumstances during periods of reduced performance in the financial markets when we could be under compensated for reinsuring the guaranteed minimum death benefit. Under our largest such reinsurance agreement, we are subject to additional risks beyond those described above when the underlying policies are partially surrendered. Unlike the policies underlying the other such reinsurance contract, the policies underlying our largest such agreement provide that the guaranteed minimum death benefit is not proportionally reduced when a policyholder withdraws some, but not all, of the policy value (a partial surrender), but rather is reduced on a dollar for dollar basis. As a result, partial surrenders of those underlying policies reduce the account value from which we derive our revenues without reducing our exposure to the death benefit in excess of the account value. We are, in effect, paid less for the same amount of risk. However, under that same reinsurance agreement, the maximum amount of guaranteed minimum death benefit payments we would have to make in a calendar year would be limited to no more than 2% of the average aggregate account values of all of the underlying policyholders in that calendar year. Any partial surrenders of the underlying policies will reduce the aggregate account values and may lower the amount of payments we could be required to make. The account values would, however, have to decline substantially for the 2% cap to have any meaningful effect on the amount of our current exposure.

      The following table summarizes key attributes of our exposure under our contracts reinsuring guaranteed minimum death benefits as of December 31, 2002:

      Policies with the enhanced earnings benefit provide that if a policyholder dies prior to the maturity date of his or her policy, the issuer of the policy will pay the policyholder’s beneficiary the death benefit otherwise payable under the policy plus an additional amount generally equal to 25% to 40% of the actual increase in the

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      We have one contract reinsuring guaranteed minimum income benefits. Policies providing a guaranteed minimum income benefit entitle a policyholder to purchase a lifetime annuity payment stream after the expiration of a stipulated waiting period of at least 7 years based upon the initial premium paid by the policyholder compounded at a predetermined rate, usually 3% to 6%, depending on the age of the policyholder. The annuity purchase rate used to calculate the income stream the policyholder is entitled to receive is a predetermined rate. We are subject to investment risk to the extent that investment returns on the assets supporting the liabilities under these policies are not sufficient to fund the payment stream the policyholder is entitled to receive. However, because the annuity purchase rates applicable to the guaranteed minimum income benefits are often less favorable than prevailing annuity purchase rates when the underlying policy annuitizes, policyholders may receive a preferable stream of annuity payments using the actual account value at prevailing annuity purchase rates as opposed to utilizing the predetermined guaranteed minimum income benefit purchase rate under the policy. To the degree this occurs, any difference in annuity purchase rates will offset the investment risk. Because none of the guaranteed minimum income benefit policies we reinsure have reached the end of the stipulated waiting period, we cannot estimate accurately the effect the unfavorable annuity purchase rates will have on policyholders’ desire to utilize this benefit under various market conditions. The earliest date on which policyholders can elect to annuitize is in 2004.

      The following table summarizes key attributes of our exposure under our contracts reinsuring guaranteed minimum income benefits as of December 31, 2002:

Underwriting

      We currently are not writing new reinsurance treaties or accepting any additional business under existing treaties on their current terms. Our reinsurance policies, including those that remain in force, were written in accordance with underwriting guidelines that we developed with the objective of controlling the risks of our reinsurance policies as well as determining appropriate pricing levels. As our business and staff grew, we incorporated peer review procedures to enhance our pricing and risk management controls. These guidelines may be amended from time to time in response to changing industry conditions, market developments, changes in technology and other factors.

      In implementing our underwriting guidelines, we determined whether to assume any particular reinsurance business by considering many factors, including the type of risks to be covered, actuarial evaluations, historical performance data for the cedent and the industry as a whole, the cedent’s retention, the product to be reinsured, pricing assumptions, underwriting standards, reputation and financial strength of the cedent, the likelihood of establishing a long term relationship with the cedent and the market share of the cedent. Pricing of our reinsurance products was based on actuarial and investment models which incorporated a number of client specific factors including mortality, expenses, demographics, persistency and investment returns, and macroeconomic factors, such as inflation, industry regulation, taxation and capital requirements.

      The majority of our remaining life and annuity reinsurance agreements were written on an automatic treaty quota share basis with a focus on large blocks of business where the underlying policies met our underwriting criteria. We also have a small number of facultative reinsurance arrangements with primary insurers with whom we had entered into automatic treaty reinsurance business. We generally required ceding companies to retain at least 10% of every life insurance risk reinsured and we generally limited our own net liability on any single-life risk to $1,000,000.

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      The reinsurance agreements typically remain in force for the life of the underlying policies reinsured. However, some agreements allow the ceding company to recapture (reassume) all or a portion of the risk formerly ceded to us subject to certain conditions. Recapture features were considered when we underwrote the reinsurance agreements.

Transamerica Contract

      Our largest annuity reinsurance contract, which was effective as of September 30, 1998, is with Transamerica Occidental Life Insurance Company. The contract is a retrocessional reinsurance arrangement covering VisionMark fixed annuity products issued by IL Annuity and Insurance Company. Since the middle of 1999 through 2002, the surrender rate of the VisionMark policies has been higher than we had anticipated when pricing the reinsurance contract. We made numerous requests to Transamerica to address the surrender problem with IL Annuity, but the problem has remained unresolved. Although we had previously increased the rate of amortization of our deferred acquisition costs associated with this contract in light of the higher than expected surrender rates, during 2001, we initiated a review of the recoverability of the deferred acquisition costs associated with this contract utilizing revised assumptions for lapse rates and expected future returns on invested assets due to poor financial market performance. This review ultimately resulted in $46,115,000 of write downs of deferred acquisition costs in 2001 and, as a result of a high level of surrenders by policyholders coupled with continued poor investment performance of the premiums paid by the holders of policies underlying this contract, a further write down of $27,474,000 in 2002.

      The VisionMark products are based on a total return strategy and allow the policyholder to allocate their premium payments to different asset classes within IL Annuity’s general account. The VisionMark contracts are credited with interest at rates that are guaranteed by IL Annuity. If a policyholder surrenders, a total return adjustment is made to the policyholder’s account value based upon the total return on the selected asset class within the general account assets. The effect of the total return adjustment is to adjust the policyholder’s account value to reflect actual asset performance. The total return adjustment is made for a policyholder when his or her funds are accessed upon surrender or annuitization of the policy. None of the annuity products we reinsure allow the policyholders to direct the investment of the underlying premiums. However, the VisionMark policyholders are able to select the category of assets to which the crediting rate of their policies are linked. As with the holders of other single premium deferred annuity policies, a VisionMark policyholder is guaranteed a return of premiums paid plus a guaranteed minimum interest rate of 3% to 3.5% per annum over the life of the policy. For the years ended December 31, 2000, 2001, and 2002, we paid approximately $2,800,000, $13,500,000, and $26,700,000, respectively, under our annuity reinsurance contract with Transamerica to cover our proportionate share of the shortfall that arose because the net investment returns on the assets related to these policies substantially underperformed the minimum interest guarantees for surrendered policies.

      The following table sets forth certain financial information relating to our annuity reinsurance contract with Transamerica from its inception in 1998 through December 31, 2002.

      The first column in the table is the amount of the Funds withheld at interest asset associated with the Transamerica contract that was included on our balance sheet at the end of each of the periods indicated. The Funds withheld at interest asset is a receivable equal to our portion of Transamerica’s statutory reserves related to the underlying policies. The second column sets forth our Interest sensitive contracts liability included on our balance sheet at the end of each of the periods indicated. This is our proportionate share of the liability to policyholders for their account values. The third column sets forth the value of the deferred

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      The Funds withheld at interest asset associated with the Transamerica contract has been a significant portion of our total assets since the contract’s inception, representing 70% of our total assets at December 31, 1998 and 36% of our total assets at December 31, 2002. In similar fashion, the Interest sensitive contract liability associated with the contract has been a significant portion of our total liabilities, representing 96% of our total liabilities at December 31, 1998 and 43% of our total liabilities at December 31, 2002. The deferred acquisition costs associated with the contract have declined from over 97% of our total Deferred policy acquisition costs at December 31, 1998 and 1999 to 27% of our total Deferred acquisition costs at December 31, 2002, primarily because of the extensive write downs recorded. As a result of the changes to our remaining book of business, especially the termination of our annuity reinsurance contract with Ohio National in February 2003, we expect that the assets and liabilities associated with the Transamerica contract will continue to represent a significant portion of our total assets and liabilities in future periods. We do not expect the Transamerica contract to generate significant income in future periods. However, those write downs were based on a series of complex assumptions principally related to the investment performance of the assets supporting our liabilities under the contract, as well as future lapse rates for the underlying policies. These assumed lapse rates include assumptions regarding full surrenders, partial withdrawals, annuitizations and policyholder deaths. We believe these estimates to be reasonable, but we cannot assure you that they will prove to be accurate. If such assumptions turn out to be inaccurate, we could be required to write off additional deferred acquisition costs, which would have a significant adverse impact on our net income in future periods.

Policy Benefit Liabilities and Interest Sensitive Contracts Liabilities

      Policy benefit liabilities and interest sensitive contracts liabilities comprise the majority of our financial obligations. Policy benefit liabilities for our products other than annuities are based upon our estimates of mortality, persistency, investment income and expenses, with allowances for adverse deviation. The liabilities for policy benefits established by us with respect to individual risks or classes of business may be greater or less than those established by our ceding companies due to their use of different mortality and other assumptions. Policy benefit liabilities include both mortality and morbidity claims in the process of settlement and an estimate of claims that have been incurred by our cedents but not yet reported to us. Actual experience in a particular period may be worse than assumed experience and, consequently, may adversely affect our operating results for the period. For example, our operating results for the quarter and year ended December 31, 2002 were significantly impacted by an unexpected increase in reported claim volume and average claim size during the fourth quarter.

      Policy benefit liabilities for annuities are reflected on our balance sheet as “Interest sensitive contracts liability” and are reported at the accumulated policyholder balance of these contracts.

Investments

Invested Assets

      Our investments are governed by investment guidelines established and approved by our Board of Directors. Our investment objectives are to achieve above average risk-adjusted total returns, maintain a high quality portfolio, maximize current income, maintain an adequate level of liquidity in our portfolio and match

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      Our investment securities are managed by two professional investment advisors, Alliance Capital Management Corporation and Prudential Investment Corporation, each of which manages a segment of the portfolio. Our agreement with Alliance may be terminated by either party with 30 days notice and our agreement with Prudential may be terminated by either party with 45 days notice. The performance of Alliance and Prudential and the fees associated with the arrangements are periodically reviewed by our Board of Directors.

      At December 31, 2002, our invested assets, including cash and cash equivalents, had an aggregate fair value of $306,346,337, including unrealized gains of $6,162,525. At December 31, 2002, our fixed-income portfolio was comprised of fixed income securities with a weighted average credit quality rating of “AA” and a weighted average duration of 3.8 years. The effective yield rate earned on our invested assets was approximately 5.28% for the year ended December 31, 2002. The effective yield rate equals net investment income divided by the average of our total adjusted invested assets at the end of each calendar quarter in the year ended December 31, 2002.

      Our results of operations and our financial condition are significantly affected by the performance of our investments and by changes in interest rates. During a period of declining interest rates, if our investments are prematurely sold, called, prepaid or redeemed, we may be unable to reinvest the proceeds in securities of equivalent risk with comparable rates of return. During a period of rising interest rates, the fair value of our invested assets could decline. In addition, rising interest rates could also cause disintermediation, which in turn could cause us to sell investments at prices and times when the fair values of such investments are less than their amortized cost. We believe that our traditional life insurance liabilities are not highly interest rate sensitive and, therefore, the effects of fluctuating interest rates on these liabilities are not significant. For interest sensitive liabilities, we are primarily dependent upon asset/ liability matching or other strategies to minimize the impact of changes in interest rates. If we do not appropriately match the asset management strategy to our obligations, we could sustain losses. We may use interest rate swaps and other financial instruments as tools to mitigate the effects of asset/ liability mismatches or interest rate changes on our balance sheet. In general, however, we have not hedged our investment risk, but we may do so in the future. Our results of operations are also significantly affected by the performance of assets held and managed by our ceding companies or others under modified coinsurance or coinsurance funds withheld arrangements, as discussed below under “Funds Withheld at Interest.”

Funds Withheld at Interest

      Our annuity reinsurance agreements generally cover individual single premium deferred annuity policies and are structured as modified coinsurance or coinsurance funds withheld arrangements. In these types of arrangements, the ceding company invests the premiums received from policyholders or engages an investment manager to do so, credits interest to policyholders’ accounts, processes surrenders and engages in other administrative activities. The ceding company is also required to carry reserves for these annuity policies based upon certain statutory rules in the state in which the ceding company is domiciled. The underlying investments purchased with the premiums received from policyholders support these statutory reserves.

      Historically, when a ceding company enters into an annuity reinsurance contract structured as a modified coinsurance or coinsurance funds withheld arrangement with us, a portion of the ceding company’s liability to the policyholders is ceded to us. Our remaining modified coinsurance and coinsurance funds withheld

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      At December 31, 2002, we had annuity reinsurance contracts with six ceding companies. At December 31, 2002, our Funds withheld at interest receivable related to these contracts had a carrying value of approximately $1.4 billion. Our contracts with Transamerica and Ohio National accounted for approximately 77% of our Funds withheld at interest receivable as of that date. At December 31, 2002, the assets held and managed by our ceding companies were invested in convertible bonds and fixed income securities having a weighted average credit quality of “A” and a weighted average duration of 5.3 years. In addition, at December 31, 2002 approximately 4.2% of such assets were invested in below investment grade securities. The average yield rates earned on the assets held and managed by our ceding companies was approximately 5.25% for the year ended December 31, 2002. The average yield rates earned on the invested premiums funding our annuity obligations to Transamerica and Ohio National were approximately 4.61% and 6.36%, respectively, for the year ended December 31, 2002. As noted elsewhere in this report, on February 14, 2003, we terminated our annuity reinsurance contract with Ohio National.

      For purposes of calculating the average yield rate earned on assets held and managed by our ceding companies, including Transamerica and Ohio National, we include net realized capital gains and losses as reported to us by our ceding companies. The performance of these assets depends to a great extent on the ability of the ceding company and its investment managers to make appropriate investments and match asset and liability duration exposure. If these assets do not achieve investment returns at rates sufficient to meet our obligations on the underlying policies, we could experience unexpected losses, as has happened under our annuity reinsurance agreement with Transamerica, where the minimum interest guarantees on the underlying policies have exceeded the underlying policyholder account values due to poor investment performance, and we have been forced to fund our proportionate share of the shortfall.

      Our policy has been to seek counterparties for our annuity reinsurance treaties that have strong financial strength and credit ratings. Although such ratings are assigned by independent ratings agencies and are generally regarded as reliable, there can be no assurance that they accurately reflect the financial condition of any of our counterparties. At December 31, 2002, approximately $734 million of our Funds withheld at interest receivable and $756 million of our Interest sensitive contracts liability related to our reinsurance contract with Transamerica, which is a retrocessional reinsurance arrangement covering policies issued by IL Annuity. Transamerica’s agreement with IL Annuity is also structured on a modified coinsurance basis, so IL Annuity maintains ownership and control of the assets supporting our obligations to Transamerica. As of December 31, 2002, IL Annuity has financial strength or claims paying ratings of “A” from both A.M. Best and Standard & Poor’s. As of December 31, 2002, Transamerica has financial strength or claims paying ratings of “A+,” “AA+,” “Aa3” and “AA+” from A.M. Best, Standard & Poor’s, Moody’s Ratings and Fitch Ratings, respectively. At December 31, 2002, approximately $366 million of our Funds withheld at interest receivable (net of the fair value of the embedded derivatives associated with this contract, which was an unrealized loss of $10 million) and $376 million of our Interest sensitive contracts liability related to our reinsurance contract with Ohio National. As of December 31, 2002, Ohio National has financial strength or claims paying ratings of “A+,” “AA,” and “A1” from A.M. Best, Standard & Poor’s, and Moody’s Ratings, respectively.

      Under the terms of our annuity reinsurance treaties, mutual debts and credits are offset between the counterparties to each treaty and ourselves as part of a monthly net settlement process. The terms of our annuity reinsurance treaties and applicable state insurance insolvency laws also allow us to offset mutual debts and credits between us and the counterparties to each treaty in the event of a counterparty’s insolvency. Therefore, if such counterparty were to become insolvent, we are entitled to offset our Funds withheld at

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Embedded Derivatives

      We have concluded that there are embedded derivatives within the Funds withheld at interest receivable related to certain of our annuity reinsurance contracts written on a modified coinsurance or coinsurance funds withheld basis that require bifurcation and separate accounting under Statement of Financial Accounting Standards No. 133 — Accounting for Derivative Instruments and Hedging Activities. These embedded derivatives are similar to a total return swap arrangement on the underlying assets held by our ceding companies. The fair value of these embedded derivatives is classified as part of our Funds withheld asset on our balance sheet. We have developed a cash flow model with the assistance of outside advisors to arrive at an estimate of the fair value of this total return swap that uses various assumptions regarding future cash flows under the affected annuity reinsurance contracts. The change in fair value of these embedded derivatives is recorded in our statement of operations as Net change in fair value of embedded derivatives, which is a non-cash item. The change in fair value of these embedded derivatives also impacts the emergence of expected gross profits for purposes of amortizing deferred acquisition costs associated with these contracts. The application of this accounting policy has increased the volatility of our reported earnings. While we have made an estimate of the fair value of these embedded derivatives using a model that we believe to be appropriate and based upon reasonable assumptions, the assumptions used are subjective and may require adjustment in the future. In addition, as industry standards for estimating the fair value of embedded derivatives develop, it is possible that we may modify our methodology. Changes in our assumptions and industry standards could have a significant impact on the fair value of the embedded derivatives and our reported earnings. We do not bifurcate and separately account for the embedded derivatives contained in certain of our contracts, including our Transamerica annuity reinsurance agreement and our guaranteed minimum income benefit reinsurance agreement, because we acquired those agreements prior to the transition date elected by us under FAS 133, as amended by FAS 137. Because of the nature of the assets underlying our Transamerica contract, which were roughly 65% convertible bonds at December 31, 2002, the bifurcation and separate accounting for the embedded derivatives contained in that contract would add significant volatility to our reported results. If we bifurcated and separately accounted for the embedded derivatives contained in our guaranteed minimum income benefit reinsurance agreement, it also would add volatility to our reported results.

Competition

      The reinsurance industry is highly competitive. Although we are currently not writing new reinsurance treaties or accepting any additional business under existing treaties on their current terms, we have historically

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Financial Ratings

      As of March 31, 2003, A.M. Best has assigned a financial strength rating of “B-” to Annuity and Life Reassurance and Annuity and Life Reassurance America. A.M. Best has announced that these ratings are under review with negative implications. Annuity and Life Reassurance and Annuity and Life Reassurance America have also received a “BB-” rating from Standard & Poor’s, which has placed both companies on CreditWatch with negative implications. Annuity and Life Reassurance has been rated “C” by Fitch Ratings, which also has a negative ratings outlook. These ratings represent significant downgrades from historical levels and have contributed to our inability to write new business and have adversely affected our ability to retain existing business, as certain of our cedents have chosen to recapture their reinsurance agreements as a result of these downgrades. If other cedents that currently have the right to recapture their agreements with us do so, it could adversely affect our financial condition and results of operations. In particular, we entered into a 50% quota share reinsurance treaty with a subsidiary of XL Capital Ltd in December 2002, under which XL has the right to recapture given our current ratings. Although we currently are not writing new reinsurance treaties, in the event that we are able to position ourselves to write new business in the future, we cannot provide assurance that we will be able to attract and retain new customers if our financial ratings do not improve.

Employees

      As of December 31, 2002, we had fourteen employees located in Bermuda and ten employees located in the United States.

Internet Website

      We maintain an Internet website at www.alre.bm, although the information contained on our Internet website is not part of this report. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed with, or furnished to, the Securities and Exchange Commission pursuant to Section 13(a) or 15(d) of the Securities Exchange Ac