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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

VESTA INSURANCE GROUP, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Registrant’s telephone number, including area code:

(205) 970-7000

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

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

None

INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH) AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.    YES  x    NO  ¨

INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K (§229.405 OF THIS CHAPTER) IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT’S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K.  x

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED BY EXCHANGE ACT RULE 12B-2).    YES  x    NO  ¨

THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE REGISTRANT AS OF JUNE 30, 2003: $ 82,059,538

THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT’S COMMON STOCK, AS OF March 12, 2004, 2004 is 36,065,811.

DOCUMENTS INCORPORATED BY REFERENCE

PORTIONS OF THE VESTA INSURANCE GROUP, INC. PROXY STATEMENT FOR ITS 2004 ANNUAL MEETING OF STOCKHOLDERS

ARE INCORPORATED BY REFERENCE INTO PART III HEREOF.

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Special Note Regarding Forward-Looking Statements

Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning Vesta or its business, whether expressed or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1996. Forward-looking statements are based on assumptions and opinions concerning a variety of known and unknown risks, including but not necessarily limited to reinsurance recoverables, financial strength ratings, natural disasters and other catastrophic events, increased competition, changes in availability and cost of reinsurance, changes in governmental regulations, and general economic conditions, as well as other risks more completely described in Vesta’s filings with the Securities and Exchange Commission, including exhibit 99.1 to this Report on Form 10-K. If any of these assumptions or opinions proves incorrect, any forward-looking statements made on the basis of such assumptions or opinions may also prove materially incorrect in one or more respects.

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PART I

Item 1. Business

Business Overview

As used in this Annual Report, unless the context otherwise requires, the terms “Vesta,” “we,” and “our” refer to Vesta Insurance Group, Inc., a Delaware corporation, and its subsidiaries, collectively.

Vesta is a holding company whose principal assets are investments in the capital stock of a group of insurance companies that constitute the Vesta Insurance Group. Vesta was incorporated in Delaware on July 9, 1993 as the holding company for the property and casualty insurance subsidiaries of Torchmark Corporation. In November 1993, we completed an initial public offering of our common stock, with Torchmark retaining 25% of our shares. Torchmark divested its holdings of our shares in June 2000. Vesta’s common shares are traded on the New York Stock Exchange under the symbol “VTA”.

Today, we conduct business in three areas of the personal insurance industry: (1) standard property and casualty; (2) non-standard automobile; and (3) life. We report the financial information of these three areas of personal insurance according to five business segments: (1) standard property-casualty insurance; (2) non-standard agency; (3) non-standard underwriting; (4) life insurance; and (5) corporate and other. We conduct our principle operations through Vesta Fire Insurance Corporation, a wholly-owned subsidiary domesticated in Illinois. In 2003, Vesta’s consolidated revenue was approximately $617.7 million.

We formerly participated in the commercial and assumed reinsurance markets, but exited these business lines in 1999 and 2000, respectively, to pursue our current strategy of doing business in the personal insurance markets. In 2002, we also exited from the health insurance and consulting markets. In our consolidated financial statements, we have segregated the reporting for these discontinued operations for all periods presented. For information concerning discontinued operations, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report and Note R to our consolidated financial statements.

Our largest business segment in terms of revenues is the standard property-casualty segment, where we underwrite or sell personal automobile and residential property insurance through approximately 2,525 independent insurance sales agencies. In 2003, the standard property-casualty segment generated approximately $313.1 million of revenue, or approximately 50.7% of consolidated revenue.

In the non-standard auto business, we operate as both an agency and a non-standard underwriting insurer. Non-standard personal automobile insurance policies provide coverage to drivers who find it difficult to obtain insurance from standard insurance companies due to a number of factors, including lack of prior insurance, failure to maintain continuous coverage, age, driving record or because they have limited financial resources. We currently offer products and services in selected target markets within 11 states in the Midwest, Southwest and Southeast regions of the United States. In our non-standard agency segment, our revenue consists of commissions and fees related to the sale of insurance products. In the non-standard underwriting segment, our revenue consists of risk-bearing premiums and policy fees. Since entering the non-standard auto business late in 2000, we have completed several acquisitions that have contributed to significant revenue growth in each of these segments. In 2003, our agency segment generated approximately $145.9 million of commission and fee-based revenue, or approximately 20.4% of aggregate revenue, before eliminations. In 2003, our non-standard underwriting segment generated approximately $192.3 million of revenue, or approximately 31.1% of consolidated revenue.

With respect to both standard and non-standard property-casualty insurance underwriting, key measures of performance are the combined and surplus leverage ratios. The combined ratio reflects the total expenses associated with our underwriting operations (including loss costs, loss adjustment expenses and other unallocated operating expenses) as a percentage of total earned premium and policy fees during the same period. The following table sets forth, for the years indicated, the combined ratios for our property-casualty business lines:

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Selected Operational Ratios for Property-Casualty Business

The surplus leverage ratio reflects the underwriting operations’ net written premiums relative to statutory surplus at the end of the period. Our net premiums written to statutory surplus ratios as of December 31 2003, 2002, and 2001 was 2.17, 2.73, and 1.21, respectively.

Our net premiums written to statutory surplus ratio as of December 31, 2003 does not reflect the impact on statutory surplus from the $55.8 million litigation and arbitration settlement charge related to the 1997 20 percent whole account quota share that, for statutory reporting purposes, will be recorded in 2004. See “Business Strategy and Recent Developments” for additional discussion of the impact of these charges to our statutory surplus.

In our life insurance segment, we acquire and administer traditional life insurance products, universal life products, fixed rate annuities, pension contracts and other products. In 2003, our life insurance segment generated revenue, excluding realized gains, of approximately $42.3 million, or approximately 6.9% of consolidated revenue, excluding realized gains.

Our corporate and other business segment is primarily comprised of (1) investment income related to our property-casualty underwriting operations; (2) corporate interest expense; (3) general corporate operating expenses; and (4) realized gains and losses from the sale of investment securities or the repurchases of our own debt securities at a discount.

A more detailed discussion of each of our business segments is included later in this report.

As a holding company for 12 insurance subsidiaries, we hold certificates of authority to write various types of personal insurance in all 50 states and the District of Columbia. All of our insurance companies are subject to regulation by governmental agencies in the states in which we conduct business. For more information, please refer to the “Regulation” section of this report.

Each of the insurers we manage has been assigned a rating of “B” by the A.M. Best Company. For more information, please refer to the “A.M. Best” section of this report.

Our Internet address is www.vesta.com and the investor relations section of our web site is located at www.vesta.com/vta/ir_vta.htm. We make available free of charge, on or through the investor relations section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on 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 we electronically file such material with, or furnish it to, the Securities and Exchange Commission. The investor relations section of our web site also contains information concerning purchases and sales of our equity securities by our executive officers and directors.

The investor relations section of our web site also contains a corporate governance page where we have posted our charters for our Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee, our Corporate Governance Guidelines, a Code of Ethics for Senior Financial Officers and a Code of Business Conduct and Ethics governing our directors, officers and employees. These documents are available in print upon request of any shareholder to our Investor Relations Department. Within the time period required by the SEC and the New York Stock Exchange, we will post on our web site any amendment to our Code of Ethics for Senior Financial Officers or our Code of Business Conduct and Ethics, and any waiver granted under either of those codes applicable to our directors, executive officers or senior financial officers.

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Business Strategy and Recent Developments

In recent years, the domestic insurance industry has been impacted by economic distress in the U.S. economy, a general decline in interest rates, capital losses following the September 11, 2001 tragedy, the adverse impact of scandals involving major U.S. corporations and the financial collapse of numerous companies. Insurance companies have responded to these challenging issues in a number of ways, including raising premium rates, discontinuing coverage in certain lines of business and terminating business activities within various states. Although these factors have created voids in various sectors of the general insurance markets, the environment of rapid industry transformation has created opportunities for financially viable insurance companies to provide underwriting and other services in various niche markets.

Since 1998, Vesta has faced a number of challenges. In addition to the above-mentioned factors, we have been challenged by changes in key management, modifications to the financial strength ratings of various subsidiaries and extensive litigation and arbitrations primarily related to a restatement in 1998 of our financial results for 1997 and prior periods. During this same time, we have pursued a strategy (1) to grow our market share in certain capacity constrained niche markets in the standard property-casualty business, (2) to exit certain states in which current results and projected future results do not fit our overall growth strategy, and (3) to participate in profitable opportunities in other industry segments such as the non-standard automobile business and life insurance business. We have also endeavored to streamline operations and divest business lines that were less profitable or did not complement our strategy.

As noted above, we have been involved in litigation and arbitration with various parties related to a restatement of our financial results for 1997 and prior periods. The Company received an arbitration panel ruling on March 1, 2004 that resulted in the recording in the 2003 consolidated financial statements a charge of $65.9 million related to our 1997 20 percent quota share treaty (as discussed in the “Reinsurance Arbitrations” section on page 6) and other reinsurance balances. We believe that the conclusion of these matters brings closure to the significant uncertainties created in that era and ends a difficult period in Vesta’s history and will enable management to focus on improving long-term profitability and capital.

While we experienced significant and profitable growth in various personal lines business during the years 2000 through 2002, we also experienced significant declines in our property and casualty subsidiaries’ statutory capital and surplus during the same period. These declines in capital and surplus during this period were primarily attributable to less favorable arbitration awards and changes in estimates of disputed reinsurance recoverable balances, reserve strengthening in our discontinued commercial and assumed reinsurance segments and increased policy acquisition costs associated with significant premium growth. This decline in statutory surplus coupled with our significant growth in premium written is the primary reason that A.M. Best Company adjusted the financial strength ratings of our property and casualty subsidiaries from B+ (Very Good) to B (Fair) in March of 2003. During 2003, we reversed these two trends by stabilizing our growth rate for premiums written relative to 2002 and growing our statutory surplus. However, the impact from the occurrence of an $18.3 million net catastrophe loss resulting from a series of hailstorms in Texas and the Southeastern United States during the second quarter of 2003 resulted in a dampening of our improvement in statutory capital. See the “Regulatory Guidelines” section on page 6 for factors that negatively impact our statutory surplus on an ongoing basis.

Since the March 2003 A.M. Best downgrade, we have not experienced a significant negative impact in our core insurance operations. However, the level of our statutory surplus as of December 31, 2003, as discussed below, could lead to further negative adjustments in our A.M. Best ratings. We currently intend to consummate two transactions in order to strengthen our capital, each of which are discussed below under the heading “Anticipated Capital Transactions,” but we are unable to predict whether A.M. Best will refrain from taking any negative rating actions pending the consummation of these transactions. If we are unable to retain or improve our A.M. Best rating, we may ultimately experience deterioration in selected portions of our property and casualty premium volume, which could adversely impact our financial results, the degree to which management is unable to quantify.

In an effort to strengthen our capital position, we began a capital evaluation in March of 2003. The capital evaluation included concluding initiatives determined in 2002 as well as an analysis of the possible divestiture of certain of our businesses, including our life and property-casualty operations. The capital evaluation was conducted throughout 2003 and resulted in certain initiatives. One such initiative was the conclusion of our marketing of our health operations, which resulted in the divestiture of these operations. We completed the divestiture of our health insurance operations in the third quarter of 2003 with the sale of Aegis Financial Corporation (Aegis), the holding company for our health insurance line of business. Additionally, we began the process of combining our non-standard auto operations with our non-standard agency operations in the third quarter of 2003. Effective December 31, 2003, we completed the combination of our non-standard auto underwriting operations with our non-standard agency operations under a distinct holding company, Affirmative Insurance Holdings, Inc. Prior to December 31, 2003, all of our non-standard personal automobile insurance policies were issued by various insurance company subsidiaries and reinsured by Vesta Fire pursuant to an

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internal 100% quota share reinsurance contract. Effective December 31, 2003, we transferred to Affirmative Insurance Holdings, Inc. 100% of the stock of two insurance company subsidiaries – Affirmative Insurance Company and its wholly owned subsidiary Insura Property and Casualty Insurance Company – in exchange for additional shares of Affirmative’s common stock. Also effective December 31, 2003, we restructured our internal reinsurance to effectively transfer to Affirmative Insurance Company and Insura all of our non-standard personal automobile insurance policies in force as of December 31, 2003 as well as any new and renewal non-standard personal automobile insurance policies issued by our insurance company subsidiaries and produced by Affirmative’s underwriting agencies on or subsequent to December 31, 2003. We believe that combining these operations under a distinct holding company will enable us to (i) seek separate financial strength ratings for our non-standard auto underwriting operations and (ii) to raise capital independently from Vesta. We expect to file a registration statement relating to a proposed initial public offering of securities of Affirmative Insurance Holdings, Inc. in March 2004.

Reinsurance

In order to improve our statutory surplus during 2003 and into 2004, we increased our utilization of quota share reinsurance. Specifically, we entered into a 50% quota share agreement (“2003 50% Quota Share Agreement”), effective September 30, 2003, on our residential property book of business in the states of Alabama, Alaska, Arizona, California, Connecticut, Florida, Hawaii, Massachusetts, New Jersey, New York, Pennsylvania, Rhode Island, South Carolina, Tennessee, and West Virginia (“Continuing States”), representing the states in which we intend to continue to write new property and casualty business. Effective December 1, 2003, we added our residential property book of business in Texas to the 2003 50% Quota Share Agreement, which had been previously reinsured under a separate treaty covering only residential property business in Texas (“2002 50% Quota Share Agreements”).

We also increased the use of reinsurance for our non-standard auto book of business in order to strengthen our statutory surplus. Effective January 1, 2004, we entered into two quota share reinsurance agreements with unaffiliated reinsurers with various cession percentages, which provide us with an option to cede less of the business produced by our affiliated underwriting agencies to these reinsurers in the last two quarters of 2004. For a more detailed discussion of the standard property-casualty and non-standard auto quota share agreements, see our discussion captioned “Reinsurance” on page 21.

Reinsurance Arbitrations

As noted above, we have been involved in litigation and arbitration with various parties related to a restatement of our financial results for 1997 and prior periods. One such arbitration relates our 1997 20 percent whole account quota share treaty with NRMA Insurance Limited (“NRMA”), Alfa Mutual Insurance Company (“Alfa”) and Dorinco Reinsurance Company (“Dorinco”). As described further in Item 3 “Legal Proceedings” and Note G to our consolidated financial statements, the panel hearing our arbitration with NRMA regarding the 1997 20 percent whole account quota share issued a ruling on March 1, 2004 in favor of NRMA. As a result, we recorded a pre-tax charge of $33.5 million in the fourth quarter of 2003 related to this ruling. We considered the NRMA ruling in our evaluation of the recoverability of other amounts due us from the other participants on the same reinsurance treaty as well as another, unrelated treaty. Although there are distinct facts and circumstances underlying and affecting our disputes with those other participants, for financial reporting purposes, we concluded that those amounts may not ultimately be collected. Accordingly, we recorded an additional pre-tax charge of $32.4 million in the fourth quarter of 2003, $30.1 million of which was related to other balances recoverable from ALFA and Dorinco.

On March 4, 2004, we filed a motion to vacate the NRMA arbitration award in U.S. District Court. Additionally, the recording of the charge in our consolidated financial statements does not impact our intentions to continue to actively arbitrate the ALFA and Dorinco matters, the resolution to which we believe will not occur before 2005.

Regulatory Guidelines

Our insurance companies must file annual statutory based financial information by February 28^th of each year. Our most recent filings were submitted prior to receipt of the above arbitration ruling and indicated statutory surplus of $203.8 million as of December 31, 2003. However, this level of surplus will be immediately impacted in the first quarter of 2004 by $55.8 million resulting from charges related to our 1997 20 percent whole account quota share and other disputed reinsurance treaties, which was recorded as a charge of $65.9 million in the fourth quarter of 2003 for GAAP financial reporting purposes. Although the statutory and GAAP charges related to the same reinsurance arbitrations and disputes, the statutory charges vary from the GAAP charges due to the recording of valuation allowances in prior periods in accordance with statutory reporting guidelines that are not required for GAAP financial reporting. With the recording of these charges, we will no longer have negative exposure related to the 1997 20 percent whole account quota share from a statutory surplus basis.

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We believe that this $55.8 million statutory charge could result in our statutory surplus falling below the “company action” level as defined by the NAIC. In the event an insurance company’s statutory surplus falls below company action level, regulations require that the company submit a plan that details management’s proposed actions to increase statutory surplus. Although we are not currently required to submit such a plan, we believe the actions contemplated below under the caption, “Anticipated Transactions” would adequately address our statutory surplus needs.

Based on our statutory surplus level at December 31, 2003, we had four NAIC Insurance Regulatory Information System (“IRIS”) ratios that unfavorably varied from the normal range. We submitted a plan to the Illinois Department of Insurance detailing our plan to resolve these variances, including requesting dividends from other insurance company subsidiaries as well as the liquidation of certain non-qualifying investments. The Illinois Department of Insurance is aware of these variances and, as of March 12, 2004, has not suggested any corrective action.

The charge we have incurred associated with the 1997 20 percent whole account quota share could result in additional unfavorable IRIS ratio variances. In the event that additional IRIS ratios fall outside of the favorable range, we will update and submit our year-end plan.

Anticipated Capital Transactions and Results of Continuing Operations

In addition to the sale of our health insurance operations, the increased use of reinsurance, and the segregation of our non-standard auto operations in anticipation of an initial public offering, we executed a definitive agreement on March 12, 2004 to sell American Founders Financial Corporation (“AFFC”), our life insurance subsidiary, for a total purchase price of approximately $63.5 million, consisting of $25 million in cash at closing and a promissory note in the amount of approximately $38.5 million. The note will bear a floating interest rate of LIBOR plus 200 basis points and will be repaid over a six-year term, with the interest payments only in the first year and the principal repayments in five equal annual payments thereafter. The note will be secured by a pledge of the stock of both AFFC and all capital stock and surplus debentures issued by AFFC’s immediate subsidiary, Laurel Life Insurance Company, which owns 100% of the capital stock of American Founders Life Insurance Company. The divestiture of AFFC will not result in a significant impact to our GAAP equity, but will have a significant positive impact on our statutory surplus. We anticipate an increase in statutory surplus of approximately $19.5 million upon the closing of this transaction. Although we have executed a definitive agreement, the consummation of this transaction is subject to regulatory approval from various state departments of insurance. Such approval is beyond our control and no assurance can be given that this transaction will receive the required regulatory approval.

We believe that the divestiture of AFFC and a public offering of securities by Affirmative Insurance Holdings, Inc. will improve our statutory capital and surplus significantly and position us to realize the economic potential of our standard property-casualty business. However, as noted previously, the consummation of these transactions involves regulatory approval and other factors that are beyond our control. As such, we continue to evaluate our current capital position and methods by which we can improve our overall capital strength. The most significant factor that we look to in evaluating our future capital improvement opportunities, other than our sale of the non-standard auto and life business, is our core standard property-casualty results. We believe that our standard property-casualty operations over the past 12 months demonstrate the earnings potential of our strategy of focusing on capacity constrained states. Excluding the $18.3 million catastrophe loss in the second quarter, which represents the single largest catastrophe loss in our company’s history, our standard property-casualty segment would have generated a pre-tax operating income of $15.4 million during 2003, equating to a combined ratio of 95.3%. Regardless of whether we are able to consummate the sale of American Founders or the initial public offering of our non-standard auto operations, we believe that these results, coupled with the consistent earnings of our life and non-standard auto and agency segments, will provide us with future earnings at levels that will enable us to improve our overall capital position.

Elsewhere in this document, we discuss the business and results of operations of our non-standard auto agency, non-standard auto underwriting and life insurance segments. Readers should be aware that our anticipated capital transactions discussed previously would involve the discontinuation of our life insurance segment and a change in the significance of the results of our non-standard agency and non-standard underwriting segments and the manner in which we account for those results.

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Business Segments

We report financial and other information according to five business segments: (1) standard property-casualty; (2) non-standard agency; (3) non-standard underwriting; (4) life insurance; and (5) corporate and other. All information included in this section should be read in conjunction with “Management’s Discussion and Analysis Financial Condition and Results of Operations” and related notes to the consolidated financial statements as presented elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2003.

Standard Property-Casualty Insurance Segment

Based upon revenue generated in 2003, our largest segment is the standard property-casualty segment. In this segment, we underwrite or sell standard residential property, automobile and miscellaneous insurance products to targeted markets. Our standard property-casualty products are offered through a network of 2,525 independent insurance agencies located in 16 states in the U.S.

The following table presents the source of gross premium written in our standard property-casualty segment (in thousands, except percentages):

Standard Property - Casualty Segment

Gross Written Premium

Year Ended December 31

Our standard property-casualty segment can be separated into two categories: (1) underwriting only residential property insurance in capacity constrained states; and (2) underwriting residential property and automobile insurance in states where we can profitably offer both products through independent agents.

Residential property

Through various subsidiaries, Vesta provides residential property insurance that we generally categorize into four geographic areas:

In recent years, our growth in residential property underwriting has primarily occurred in catastrophe-exposed states with capacity constraints that offer high margin potential. As a result, we have focused on increasing our presence in Florida, Texas, Hawaii, South Carolina, New York, New Jersey and Massachusetts.

Our strategy in these catastrophe-exposed states is to optimize our portfolio of business through the integration of catastrophic risk management and underwriting. Our residential property management team utilizes a rigorous practice of continuously modeling our portfolio to maintain a geographically dispersed book of business. Using multiple catastrophe models, we strive to minimize our probable maximum loss from any single catastrophe event. When a geographic region gets out of balance from the production of new or renewal business, we seek to redistribute the risk by stopping production in over-concentrated zip codes.

In states that do not have capacity constraints – Alabama, Connecticut, Pennsylvania, Rhode Island, Tennessee, West Virginia – we strive to build effective relationships with our independent agencies.

Florida and Texas business – In 2001, we acquired Florida Select, a historically profitable insurance provider located in Florida. Florida Select’s customer base was comprised primarily of former customers of the Florida Residential Property and Casualty Joint Underwriting Association (“JUA”), a state-sponsored insurer created by the Florida Legislature following

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Hurricane Andrew in 1992. Florida Select was established in response to an incentive program designed to encourage private carriers to assume policies from the JUA. Florida Select was one of the first companies to assume policies from the JUA and has operated profitably since its inception. Florida Select generates new business through a wholly-owned subsidiary, Florida Select Insurance Agency, Inc.

Our residential property business in Texas is written by our subsidiary, Texas Select Lloyds Insurance Company. Since the second half of 2001, we have substantially increased our volume of insurance premiums written in Texas. The primary reason for the increase was the decision by several major insurance providers to discontinue providing new coverage in Texas because of potential exposure to claims associated with mold damage. Concurrent with Vesta’s entry into the market, a dramatic decrease in the number of providers in Texas created opportunity for us to gain new homeowners’ customers. We believe that our lack of historical business is a competitive advantage in Texas, as we have avoided current exposure to mold problems resulting from old claims. Our policies contain a mold endorsement, which limits our mold exposure only to sudden and accidental water losses that occur during the term of our policy. In 2003, our net written premium in Florida and Texas declined to $131 million from $186 million in 2002 because of our increased usage of reinsurance, including our 2002 and 2003 50% quota share agreements.

In developing new homeowners’ business, we have taken measures to minimize exposure to mold claims. We implemented procedures which limit our exposure to mold claims on all new and renewal policies written in Texas unless policyholders purchase additional coverage.

Hawaii business – We provide residential property-casualty insurance in Hawaii principally through The Hawaiian Insurance & Guaranty Company, Ltd., a wholly-owned subsidiary. In Hawaii, we target our products to owners of higher-value residential property. Until 2000, we primarily insured dwellings against fire and other catastrophic loss. However, in 2000, the state-sponsored insurance pool that had previously provided insurance coverage for wind and hurricane loss was disbanded and we subsequently increased the scope of our products and markets to include wind and hurricane loss. In 2003, our net written premium for Hawaiian property business declined to $9 from $15 million in 2002 because of our increased usage of reinsurance.

Northeast U.S. business – In 1998, we acquired the Property Plus book of personal lines insurance from CIGNA, which primarily insures mid-to-high value residential property in the Northeast U.S. This book of business primarily insures older homes in densely populated areas. Our spread of geographic risk reflects the location of our agency force, and has resulted in a concentration of business on Long Island, New York and in the Nantuckett-Martha’s Vineyard area of Massachusetts. In 2003, our net written premium in the Northeast declined to $27 million from $48 million in 2002 primarily because of our increased usage of reinsurance.

Our standard residential property lines in Florida, Texas, Hawaii and the Northeast U.S. are exposed in catastrophic-prone locales. We have mitigated our risk of exposure to wind and hurricane losses by purchasing reinsurance coverage from the traditional reinsurance markets. For more information, please refer to the below discussion of various reinsurance programs, “Reinsurance” of this report and Note I to our financial statements of this report.

Midwest and Mid-Atlantic business – We provide homeowners insurance in the Midwest and Mid-Atlantic regions of the U.S. principally through Shelby Insurance Companies, a group of wholly owned subsidiaries we acquired in 1997. We primarily target homeowners of dwellings valued from $100,000 to $350,000. In this market we are minimally exposed to potential hurricane loss. In 2003, our net written premium in the Midwest and Mid-Atlantic regions declined to $14.7 million from $25 million in 2002 because of our increased usage of reinsurance.

Standard personal automobile

The majority of our standard auto business is underwritten by The Shelby Insurance Company and affiliates and is sold to individuals in Pennsylvania, West Virginia, Tennessee, Rhode Island, Connecticut and Alabama. We also provide standard auto insurance in Hawaii through our local subsidiary. The target market for our standard personal auto line insurance products are drivers who are older than thirty-five years of age with above-average driving records. We underwrite standard auto policies with liability limits up to $500,000.

We actively manage and re-underwrite our renewal book in a disciplined manner. Each existing policy with a loss in the past three years is reviewed for current acceptability and proper tier placement prior to future renewal offerings, dependent on individual state statute. Individual agency books of business are also reviewed separately if loss ratios exceed certain thresholds.

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Our independent agents enter the vast majority of our auto policies on our Internet platform, VIA (Vesta Internet Access). Standard underwriting tools such as motor vehicle reports, previous loss history and Additional Driver Discovery are ordered by agents to determine acceptability before submission. A series of underwriting edits and manual review ensure that all underwriting criteria are met prior to policy issuance. Our target market for the standard auto is the “M and M” account, mature drivers, multi-car risks, and multi-policy (auto and homeowners policies.) Our overall pricing strategy supports our target “M and M” account. Dependent on company or industry results, our pricing will be below a median price on target accounts and above median on non-target accounts. The primary ingredient in our pricing philosophy is that we will be disciplined to price our products to profitability even if that means sacrificing gross revenue.

Geographic Mix

The following table presents, for the year ending December 31, 2003, the principal geographic distribution of our gross premiums written in the standard property-casualty business for the ten states that generated the largest gross premiums (in thousands).

As described previously, our gross written premium for residential property business is subject to the 2003 50% quota share agreement, effective September 30, 2003, for our Continuing States, excluding Texas. The residential property business in Texas has been subject to the 2002 50% Quota Share since December 1, 2002. Upon the expiration of the 2002 50% Quota Share on November 30, 2003, the residential property business in Texas was transferred to the 2003 50% Quota Share.

In 2003, we continued the process of ceasing to write standard property-casualty business in a number of states, including Arkansas, Georgia, Illinois, Indiana, Maryland, Nevada, New Mexico, North Carolina, Ohio and Virginia (our “Discontinued States”). Combined, our total loss ratio in these exiting states had a loss ratio of approximately 95% and a combined ratio of approximately 121% in 2003. However, our premium volume and policies-in-force have declined substantially during the year and we expect to be substantially out of these states by June 2004.

Underwriting. The target market for our underwriting activities in the standard property-casualty segment are families (1) with multiple insurance policies; (2) who own more than one automobile; and (3) who live in a home valued between $100,000 and $350,000. Our underwriters utilize standard industry computer and analytical software to assist in evaluating and selecting risks and to determine the appropriate levels of insurance to retain.

Our underwriting staff also provides support to our network of independent insurance agents. We require that independent insurance agents who sell our products and services adhere to our underwriting philosophy, discipline and objectives in developing and maintaining business.

Reinsurance — exposure to catastrophic events. In the standard property-casualty segment, our greatest risk of loss is associated with property damage caused by catastrophic events such as hail storms in Texas, hurricanes and tropical storms affecting Florida, Texas, Hawaii and the Northeast U.S. These risks are seasonal, with the greatest risk existing generally between June and November of any given calendar year. Our exposure to loss from other catastrophic events, such as

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tornadoes and earthquakes is not as significant because we do not insure significant levels of property in areas traditionally affected by these types of events. Although we endeavor to reinsure a significant portion of our risk for potential catastrophic losses, there can be no assurances that losses will be maintained within the coverage limits of any reinsurance programs to which we are a party.

Our current catastrophe excess of loss reinsurance program, which covers the period July 1, 2003 to June 30, 2004, provides a maximum of $200 million of reinsurance for Hawaii risks, $110 million in Texas, and $160 million for other nationwide risks in excess of our retention of $15 million. These retention levels do not include the expenses that we would incur in the event we exceed our retention, most notably reinstatement premiums. In Florida, our current program provides $238 million of reinsurance in excess of our retention of $15 million of risk. Included in the reinsurance protection for Florida is an estimated $87.5 million of coverage in excess of $31.1 million of losses, with a 10% co-insurance requirement, from The Florida Hurricane Catastrophe Fund (FHCF). This catastrophe excess of loss reinsurance program, combined with other inuring reinsurance contracts, provides reinsurance coverage sufficient to cover the probable maximum loss, or “PML,” from a 1-in-100 year weather event based on estimates of probable losses provided by Risk Management Solutions, Inc.’s RiskLink v4.2 sp1 run with demand surge, excluding storm surge.

Reinsurance – quota share contracts. From time to time, our property-casualty companies may obtain quota share reinsurance. A quota share reinsurance treaty is a reinsurance contract that provides protection on a proportional basis. Unlike a conventional “excess of loss” reinsurance contract, where reinsurers provide coverage for certain losses in excess of specified limits, under a quota share arrangement a reinsurer shares losses and certain allocated expenses in the same percentage as it shares in premiums.

Reinsurance – per risk coverage. We also maintain property “per risk” reinsurance coverage through excess of loss of reinsurance agreements, which provide coverage above a stated amount of loss on individual risks. We utilize excess loss arrangements primarily to provide reinsurance in Florida, Texas, Hawaii and the Northeast U.S. In our property reinsurance program, our retention is $1,000,000 per loss. In our casualty excess of loss reinsurance program, our retention is $500,000 per loss occurrence.

Marketing. Our standard property-casualty products are distributed through a network of 2,525 independent insurance agencies located in 16 states across the U.S. Key elements of our marketing strategy are developing and maintaining relationships with select independent agents located in rural or suburban areas. We believe the products we offer in the standard property-casualty lines meet the needs of a wide range of customers who are served by local independent agents. These independent agents typically maintain close relationships with their customers and usually experience a high rate of retention, which reduces our overall policy acquisition costs.

We have established compensation programs to enable independent agents to earn competitive industry pay when new policies are written through our companies, and we support the agency force through advertising and promotions designed to create a high level of awareness of the local agent and our companies. We also provide the independent agents with business-to-business technology support in order to increase productivity and reduce operating expenses.

Independent insurance agents are required to comply with strict guidelines established by Vesta and have predetermined and limited authority to bind insurance coverage on our affiliated companies. Our underwriting staff reviews all coverage implemented by the independent agents and has discretion to modify or override decisions by the agency force. Because of (1) the broad base of our independent agency force; (2) the contractual limitations on the agents’ authority to bind coverage; and (3) our disciplined underwriting review process, we believe the activities and strategy with respect to our independent agency force does not present any material risks to our overall operations.

Claims. Claims costs represent actual payments made and changes in estimated future payments to be made to or on behalf of our policyholders. Claims costs include expenses required to settle all claims and losses and loss estimates for future assignments and assessments.

Claims on policies written in the Northeast, Midwest and Mid-Atlantic regions are managed by our centralized claims department. When a notice of loss is received, our claims department personnel open a claim file and establish a corresponding reserve based upon standard industry specified criteria. Claims are reviewed and payments generated by employees of Vesta, with the exception of claims related to specific products adjusted by a managing general agency (“MGA”). With respect to MGA claims, our employees periodically conduct audits to insure compliance with Vesta’s policies and procedures.

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We employ a centralized litigation staff to monitor all claims-related litigation. Our philosophy and practices are designed to emphasize prompt, fair and equitable settlement of meritorious claims. Our litigation staff also is responsible for insuring the adequacy of claim reserves and controlling claim adjustments and legal expenses.

Claims administration for polices written in Florida and Texas are outsourced to a third party administrator. The claims administration contract was in effect at the time of our acquisition of Florida Select, and we amended the contract in 2001 to include claims made on our policies written in Texas. We believe the third party providing these claims administration services is well-staffed and equipped with current technology to provide cost efficient and reliable claims administration for our Florida and Texas policies.

Systems. With the exception of policies written in Texas and Florida, policy issuance, billing, customer service and other facets of administration, are provided through a centralized policy management information system. In recent years, we have upgraded the core infrastructure and expanded the scope of this policy management information system. Administration for policies written in Florida and Texas is outsourced to a third party administrator.

We place a priority on e-commerce and have intensified resources in recent years to exploit internet-based technology. To assist the marketing and servicing capabilities of our independent agency force, we maintain internet-based programs to provide agents with the ability to quote, enter new business, perform endorsements and perform inquiries on policies, billing and claims. We have also established a network for exchange of intra-company information that provides independent agents with ready and convenient access to product, policy and claims information. We endeavor to utilize state-of-the-art electronic technology to allow the agency force to securely conduct transactions, access information and communicate with our insurance subsidiaries.

Non-Standard Underwriting

Our Products

Our non-standard insurance policies, which generally are issued for the minimum limits of liability coverage mandated by state laws, provide coverage to drivers who find it difficult to obtain insurance from standard insurance companies due to a number of factors, including lack of prior coverage, failure to maintain continuous coverage, age, prior accidents, driving violations, type of vehicle or limited financial resources. We believe that the majority of customers who purchase our non-standard personal automobile insurance policies do not qualify for standard policies because of financial reasons, such as the failure to maintain continuous coverage or the lack of flexible payment options in the standard market. Approximately 70% of the drivers who purchased our policies in 2003 had no at-fault accidents and no moving violations or tickets in the 36 months preceding the date of the quote. In general, customers in the non-standard market have higher average premiums for a comparable amount of coverage than customers who qualify for the standard market, resulting from increased loss costs and transaction expenses, partially offset by the lower severity of losses resulting from lower limits of coverage.

We offer a wide range of coverage options to meet our policyholders’ and agents’ needs. We offer both liability-only policies, as well as full coverage policies, which include first-party coverage for the insured’s vehicle. Our liability-only policies generally include:

The liability-only policies may also include personal injury protection coverage and/or medical payment coverage, depending on state statutes. These policies provide coverage for injuries without regard to fault, as well as uninsured/underinsured motorist coverage. In addition to bodily injury liability and property damage liability coverage, the full coverage policies we sell include:

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Full coverage policies may also include optional coverages such as towing, rental reimbursement and special equipment.

The policies we offer are predominantly tailored to the typical non-standard customer, whose selection of policy, in our experience, is generally determined by a combination of payment terms and price. We offer a variety of policy terms ranging from one month to one year. Our policies are designed to be priced to allow us to achieve our target underwriting margin while at the same time meeting our customers’ needs for low down payments and flexible payment plans. Our policy processing systems and payment plans enable us to offer a variety of attractive payment plans while minimizing the potential credit risk of uncollectible premium. We offer discounts for proof of having purchased automobile insurance within a prescribed prior time period, maintaining homeowners insurance, vehicle safety and anti-theft equipment, while surcharging the insured for traffic violations and accidents.

Distribution

Most of the non-standard auto policies issued by our insurance companies use the services of our affiliated underwriting agencies which perform or supervise all of the administrative functions associated with the design, sale and subsequent servicing of a non-standard personal automobile insurance policy. We discuss our underwriting agencies’ operations below under the heading “Non-Standard Agency Segment.”

Our insurance companies also issue insurance policies that are designed, distributed and serviced by unaffiliated underwriting agencies. We issue insurance policies sold through unaffiliated underwriting agencies with established customer bases in order to capture business in markets other than those targeted by our affiliated underwriting agencies. In these instances, we collect fees to compensate us both for the use of our certificates of authority to transact insurance business in selected markets as well as for assuming the risk that the unaffiliated underwriting agency will continuously and effectively administer these policies. We generally reinsure a higher percentage of this business relative to the business administered by our affiliated underwriting agencies. During 2003, we issued insurance policies through four unaffiliated underwriting agencies which in turn distributed our policies through an aggregate of approximately 3,900 independent agencies. In the year ended December 31, 2003, these four unaffiliated underwriting agencies accounted for 28.6 % of the non-standard gross premiums written by our insurance companies, and no one unaffiliated underwriting agency accounted for more than 12.6% of the gross premiums written by our insurance companies.

For the years ended December 31, 2003 and 2002 the following chart displays the premium written by our insurance companies through both affiliated and unaffiliated underwriting agencies on a gross (before reinsurance) and net (after reinsurance) basis: