UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------ FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2003 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition period from ____ to ______ Commission File Number 001-16855 SCOTTISH ANNUITY & LIFE HOLDINGS, LTD. (Exact Name of Registrant as Specified in Its Charter) Cayman Islands 98-0362785 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) P.O. Box HM 2939 Crown House, Third Floor 4 Par-la-Ville Road Hamilton HM08 Bermuda Not Applicable (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (441) 295-4451 (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No As of August 1, 2003, Registrant had 35,045,542 ordinary shares outstanding. Table of Contents PART I. FINANCIAL INFORMATION.................................................2 Item 1. Financial Statements..................................................2 Consolidated Balance Sheets - June 30, 2003 (Unaudited) and December 31, 2002............................................................2 Unaudited Consolidated Statements of Income - Three and six months ended June 30, 2003 and 2002.......................................................3 Unaudited Consolidated Statements of Comprehensive Income - Three and Six months ended June 30, 2003 and 2002.........................................4 Unaudited Consolidated Statements of Shareholders' Equity - Six months ended June 30, 2003 and 2002.......................................................5 Unaudited Consolidated Statements of Cash Flows - Six months ended June 30, 2003 and 2002.......................................................6 Notes to Unaudited Consolidated Financial Statements at June 30, 2003..........8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........................................17 Item 3. Quantitative and Qualitative Disclosures About Market Risk...........41 Item 4. Disclosure Controls and Procedures...................................41 PART II. OTHER INFORMATION....................................................42 Item 1. Legal Proceedings....................................................42 Item 2. Changes in Securities and Use of Proceeds............................42 Item 3. Defaults Upon Senior Securities......................................42 Item 4. Submission of Matters to a Vote of Securities Holders................43 Item 5. Other Information....................................................44 Item 6. Exhibits and Reports on Form 8-K.....................................44 SIGNATURES....................................................................49 i PART I. FINANCIAL INFORMATION Item 1. Financial Statements Scottish Annuity & Life Holdings, Ltd. Consolidated Balance Sheets - June 30, 2003 (Unaudited) and December 31, 2002 (Dollars in thousands) June 30, 2003 December 31, (unaudited) 2002 ---------------- ---------------- ASSETS Fixed maturity investments, available for sale, at fair value (Amortized cost $1,253,882; 2002 - $991,304)....................... $ 1,292,208 $ 1,003,946 Preferred stock, available for sale, at fair value (Cost $48,769 ). 49,711 - Investment in unit-linked securities............................... - 16,497 Cash and cash equivalents.......................................... 131,322 149,666 Other investments.................................................. 5,653 5,631 Funds withheld at interest......................................... 1,184,920 1,101,836 ---------------- ---------------- Total investments............................................. 2,663,814 2,277,576 Accrued interest receivable........................................ 14,823 11,910 Reinsurance balances and risk fees receivable...................... 81,054 39,805 Deferred acquisition costs......................................... 262,015 213,516 Amount recoverable from reinsurers................................. 18,241 22,608 Present value of in-force business................................. 14,686 18,181 Goodwill........................................................... 35,847 35,847 Fixed assets....................................................... 9,259 6,493 Other assets....................................................... 10,832 11,702 Segregated assets.................................................. 723,906 653,588 ---------------- ---------------- Total assets.................................................. $ 3,834,477 $ 3,291,226 ================ ================ LIABILITIES Reserves for future policy benefits................................ $ 477,772 $ 386,807 Interest sensitive contract liabilities............................ 1,920,223 1,567,176 Unit-linked contract liabilities................................... - 17,069 Accounts payable and accrued expenses.............................. 13,644 15,702 Reinsurance balances payable....................................... 18,497 16,348 Deferred tax liability............................................. 16,336 9,071 Current income tax payable......................................... 1,428 1,873 Long term debt..................................................... 132,500 132,500 Segregated liabilities............................................. 723,906 653,588 ---------------- ---------------- Total liabilities............................................. 3,304,306 2,800,134 ---------------- ---------------- SHAREHOLDERS' EQUITY Share capital, par value $0.01 per ordinary share:................. Issued and fully paid: 27,363,042 ordinary shares (2002 - 26,927,456)........................................... 274 269 Additional paid-in capital......................................... 421,954 416,712 Accumulated other comprehensive income............................. 34,889 13,467 Retained earnings.................................................. 73,054 60,644 ---------------- ---------------- Total shareholders' equity.................................... 530,171 491,092 ---------------- ---------------- Total liabilities and shareholders' equity.................... $ 3,834,477 $ 3,291,226 ================ ================ See Accompanying Notes to Unaudited Consolidated Financial Statements 2 Scottish Annuity & Life Holdings, Ltd. Unaudited Consolidated Statements of Income - Three and Six months ended June 30, 2003 and 2002 (Dollars in thousands, except per share data) Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- REVENUES Premiums earned.................................. $ 94,737 $ 37,628 $ 159,556 $ 68,983 Investment income, net........................... 35,941 26,136 68,245 47,867 Fee income....................................... 2,380 2,201 4,371 4,275 Realized losses.................................. (3,392) (1,606) (5,713) (3,305) ------------- ------------- ------------- ------------- Total revenues.............................. 129,666 64,359 226,459 117,820 ------------- ------------- ------------- ------------- BENEFITS AND EXPENSES Claims and other policy benefits................. 65,676 26,656 108,570 50,543 Interest credited to interest sensitive contract liabilities............................. 16,874 11,228 32,767 20,406 Acquisition costs and other insurance expenses, net.............................................. 27,884 12,040 48,539 22,869 Operating expenses............................... 8,148 6,236 16,013 10,153 Interest expense................................. 1,851 138 3,664 482 ------------- ------------- ------------- ------------- Total benefits and expenses................. 120,433 56,298 209,553 104,453 ------------- ------------- ------------- ------------- Income from continuing operations before income taxes............................................ 9,233 8,061 16,906 13,367 Income tax expense (benefit)..................... (84) 121 166 429 ------------- ------------- ------------- ------------- Income from continuing operations........... 9,317 7,940 16,740 12,938 ------------- ------------- ------------- ------------- Loss from discontinued operations................ 1,445 91 1,625 91 ------------- ------------- ------------- ------------- Net income $ 7,872 $ 7,849 $ 15,115 $ 12,847 ============= ============= ============= ============= Earnings per ordinary share from continuing operations -Basic................................ $ 0.34 $ 0.30 $ 0.62 $ 0.55 ============= ============= ============= ============= Earnings per ordinary share from continuing operations - Diluted............................. $ 0.33 $ 0.28 $ 0.59 $ 0.52 ============= ============= ============= ============= Earnings per ordinary share - Basic.............. $ 0.29 $ 0.29 $ 0.56 $ 0.55 ============= ============= ============= ============= Earnings per ordinary share -Diluted............. $ 0.28 $ 0.28 $ 0.53 $ 0.51 ============= ============= ============= ============= Dividends per ordinary share..................... $ 0.05 $ 0.05 $ 0.10 $ 0.10 ============= ============= ============= ============= Weighted average number of ordinary shares outstanding...................................... Basic....................................... 27,101,357 26,683,204 27,038,103 23,432,731 ============= ============= ============= ============= Diluted..................................... 28,587,540 28,504,230 28,371,379 24,946,671 ============= ============= ============= ============= See Accompanying Notes to Unaudited Consolidated Financial Statements 3 Scottish Annuity & Life Holdings, Ltd. Unaudited Consolidated Statements of Comprehensive Income - Three and Six months ended June 30, 2003 and 2002 (Dollars in thousands) Three months Three months Six months Six months ended June 30, ended June 30, ended ended 2003 2002 June 30, 2003 June 30, 2002 -------------- -------------- ------------- ------------- Net income .............................. $ 7,872 $ 7,849 $ 15,115 $ 12,847 -------- -------- -------- -------- Other comprehensive income, net of tax Unrealized appreciation on investments: .................... 20,409 10,752 25,476 4,878 Add: reclassification adjustment for investment losses included in net income ............................. (4,629) (1,256) (6,035) 24 -------- -------- -------- -------- Unrealized appreciation on investments net of income tax expense of $4,533; $2,100; $6,831 and $1,085 ............... 15,780 9,496 19,441 4,902 Cumulative translation adjustment ....... 2,747 3,652 2,020 2,988 Minimum pension liability adjustment .... (61) - (39) - -------- -------- -------- -------- Other comprehensive income .............. 18,466 13,148 21,422 7,890 -------- -------- -------- -------- Comprehensive income .................... $ 26,338 $ 20,997 $ 36,537 $ 20,737 ======== ======== ======== ======== See Accompanying Notes to Unaudited Consolidated Financial Statements 4 Scottish Annuity & Life Holdings, Ltd. Unaudited Consolidated Statements of Shareholders' Equity - Six months ended June 30, 2003 and 2002 (Dollars in thousands) Six months ended Six months ended June 30, 2003 June 30, 2002 ---------------- ---------------- ORDINARY SHARES: Beginning of period ............................ 26,927,456 20,144,956 Ordinary shares issued ......................... - 6,750,000 Issuance to employees on exercise of options ... 235,586 15,000 Issuance on exercise of warrants ............... 200,000 - -------------- -------------- End of period .................................. 27,363,042 26,909,956 ============== ============== SHARE CAPITAL: Beginning of period ............................ $ 269 $ 201 Ordinary shares issued ......................... - 67 Issuance to employees on exercise of options ... 3 1 Issuance on exercise of warrants ............... 2 - -------------- -------------- End of period .................................. 274 269 -------------- -------------- ADDITIONAL PAID-IN CAPITAL: Beginning of period ............................ 416,712 301,542 Ordinary shares issued ......................... - 114,284 Issuance to employees on exercise of options ... 2,244 144 Issuance on exercise of warrants .............. 2,998 - -------------- -------------- End of period .................................. 421,954 415,970 -------------- -------------- ACCUMULATED OTHER COMPREHENSIVE INCOME: Unrealized appreciation (depreciation) on investments Beginning of period ............................ 8,930 (3,626) Change in period (net of tax) .................. 19,441 4,902 -------------- -------------- End of period .................................. 28,371 1,276 -------------- -------------- Cumulative translation adjustment Beginning of period ............................ 5,908 - Change in period ............................... 2,020 2,988 -------------- -------------- End of period .................................. 7,928 2,988 -------------- -------------- Minimum pension liability adjustment Beginning of period ............................ (1,371) - Change in period ............................... (39) - -------------- -------------- End of period .................................. (1,410) - -------------- -------------- ACCUMULATED OTHER COMPREHENSIVE INCOME .............. 34,889 4,264 -------------- -------------- RETAINED EARNINGS: Beginning of period ............................ 60,644 33,165 Net income ..................................... 15,115 12,847 Dividends paid ................................. (2,705) (2,352) -------------- -------------- End of period .................................. 73,054 43,660 -------------- -------------- TOTAL SHAREHOLDERS' EQUITY .......................... $ 530,171 $ 464,163 ============== ============== See Accompanying Notes to Unaudited Consolidated Financial Statements 5 Scottish Annuity & Life Holdings, Ltd. Unaudited Consolidated Statements of Cash Flows - Six months ended June 30, 2003 and 2002 (Dollars in thousands) Six months ended Six months ended June 30, 2003 June 30, 2002 ---------------- ---------------- OPERATING ACTIVITIES Net income................................................................. $ 15,115 $ 12,847 Items not affecting cash:.................................................. Net realized losses................................................... 5,713 3,305 Amortization of investments........................................... 1,964 173 Amortization of deferred acquisition costs............................ 21,587 13,596 Amortization of present value of in-force business.................... 1,694 1,080 Changes in assets and liabilities:.................................... Accrued interest.................................................. (2,778) (685) Reinsurance balances and risk fees receivable..................... (36,904) 3,098 Deferred acquisition costs........................................ (67,929) (50,188) Deferred tax liability............................................ (391) 514 Other assets...................................................... 869 3,643 Current income tax receivable and payable......................... (445) 510 Reserves for future policy benefits............................... 92,431 (430) Interest sensitive contract liabilities, net of funds withheld at interest.......................................................... 8,928 10,046 Unit linked contract liabilities.................................. - (6,704) Accounts payable and accrued expenses............................. (3,181) (1,782) Other............................................................. (1,125) 1,752 ---------------- ---------------- Net cash provided by (used in) operating activities........................ 35,548 (9,225) ---------------- ---------------- INVESTING ACTIVITIES Purchase of fixed maturity investments..................................... (430,902) (218,605) Proceeds from sales of fixed maturity investments.......................... 60,369 71,223 Proceeds from maturity of fixed maturity investments....................... 104,615 41,677 Purchase of preferred stock ............................................... (49,726) - Proceeds from sales of preferred stock..................................... 363 - Proceeds from maturity of preferred stock.................................. 587 - Costs of acquisition of World-Wide Holdings................................ - (1,276) Purchase of fixed assets................................................... (2,774) - ---------------- ---------------- Net cash used in investing activities...................................... (317,468) (106,981) ---------------- ---------------- FINANCING ACTIVITIES Deposits to interest sensitive contract liabilities........................ 278,687 22,146 Withdrawals from interest sensitive contract liabilities................... (17,653) (12,224) Borrowings................................................................. - (42,814) Issuance of ordinary shares................................................ 5,247 114,496 Dividends paid............................................................. (2,705) (2,352) ---------------- ---------------- Net cash provided by financing activities,................................. 263,576 79,252 ---------------- ---------------- NET CHANGE IN CASH AND CASH EQUIVALENTS (18,344) (36,954) Cash and cash equivalents, beginning of period............................. 149,666 94,581 ---------------- ---------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 131,322 $ 57,627 ================ ================ See Accompanying Notes to Unaudited Consolidated Financial Statements 6 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 1. Basis of presentation Accounting Principles - The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP") and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results for the period are not necessarily indicative of the results to be expected for the entire year. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the period ended December 31, 2002. All tabular amounts are reported in thousands of United States dollars (except per share amounts). Certain prior period amounts have been reclassified to conform to the current year presentation. 2. New Accounting Pronouncements In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123". In prior years, we applied the intrinsic value-based expense provisions set forth in ABP Opinion No. 25, "Accounting for Stock Issued to Employees" and did not recognize compensation expense. Effective January 1, 2003 we have adopted the modified prospective method of fair value-based stock option expense provisions of SFAS No. 123 as amended by SFAS No. 148. This has resulted in a charge to income of $81,000 in the three and six month periods ended June 30, 2003. In May 2003, FASB approved for issuance a Statement of Position ("SOP"), "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Insurance Contracts and for Separate Accounts". This Statement of Position provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts and is effective for financial statements for fiscal years beginning after December 15, 2003. At the date of initial application of this SOP, we are required to make various determinations, such as qualification for separate account treatment, classification of securities in separate account arrangements, significance of mortality and morbidity risk, adjustments to contract holder liabilities, and adjustments to estimated gross profits as defined in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments". We do not believe the implementation of this SOP will have a material effect on our financial statements. The Derivative Implementation Group has released Statement 133 Implementation Issue No. 36, "Embedded Derivatives: Bifurcation of a Debt Instrument that Incorporates Both Interest Rate Risk and Credit Rate Risk Exposures that are Unrelated or Only Partially Related to the Creditworthiness of the Issuer of that Instrument" ("DIG B36"). DIG B36 addresses whether SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" requires bifurcation of a debt instrument into a debt host contract and an embedded derivative if the debt instrument incorporates both interest rate risk and credit risk exposures that are unrelated or only partially related to the creditworthiness of the issuer of that 7 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 instrument. Under DIG B36 modified coinsurance reinsurance agreements, where interest is determined by reference to a pool of fixed maturity assets, are arrangements containing embedded derivatives requiring bifurcation. Our funds withheld at interest, which arise under modified coinsurance agreements, are therefore considered to contain embedded derivatives requiring bifurcation. We are required to adopt DIG B36 in the quarter ending December 31, 2003. We have not yet determined the value of the related embedded derivatives in our funds withheld at interest. The market value of funds withheld at interest was $1.3 billion at June 30, 2003. 3. Discontinued operations During the quarter ended June 30, 2003 we decided to discontinue our Wealth Management operations in Luxembourg. We are in the process of transferring our Luxembourg Wealth Management business to third parties and we expect to complete the closure of this office by December 31, 2003. We have reported the results of the Luxembourg Wealth Management activities as discontinued operations. During the quarter ended June 30, 2003 losses from these operations amounted to $1.4 million ($0.05 per diluted share) in comparison with $91,000 in the prior year period. The losses recorded in the current quarter include the write down of a deferred tax asset of $349,000, which had arisen from prior year net operating losses, and estimates of severance costs and costs to close the operation. Losses incurred in respect of these operations in the six month period ended June 30, 2003 and 2002 amounted to $1.6 million ($0.06 per diluted share) and $91,000, respectively. 8 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 4. Business segments We report segments in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". Our main lines of business are Life Reinsurance North America, Life Reinsurance International and Wealth Management. The segment reporting for the lines of business is as follows: Three months ended June 30, 2003 ----------------------------------------------------------------------------------- Life Life Reinsurance Reinsurance Wealth North America International Management Other Total ------------- ------------- ------------- ------------- ------------- Premiums earned ............... $ 56,565 $ 38,172 $ - $ - $ 94,737 Investment income, net ........ 32,680 2,125 60 1,076 35,941 Fee income .................... 1,337 - 1,043 - 2,380 Realized gains (losses) ....... (3,294) (264) (8) 174 (3,392) ------------- ------------- ------------- ------------- ------------- Total revenues ................ 87,288 40,033 1,095 1,250 129,666 ------------- ------------- ------------- ------------- ------------- Claims and other policy benefits ................... 42,821 22,855 - - 65,676 Interest credited to interest sensitive contract liabilities ................ 16,874 - - - 16,874 Acquisition costs and other insurance expenses, net .... 19,815 7,690 379 - 27,884 Operating expenses ............ 2,372 3,292 193 2,291 8,148 Interest expense .............. 240 - - 1,611 1,851 ------------- ------------- ------------- ------------- ------------- Total benefits and expenses ... 82,122 33,837 572 3,902 120,433 ------------- ------------- ------------- ------------- ------------- Net income (loss) from continuing operations before income taxes $ 5,166 $ 6,196 $ 523 $ (2,652) $ 9,233 ============= ============= ============= ============= ============= 9 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 Three months ended June 30, 2002 ----------------------------------------------------------------------------------- Life Life Reinsurance Reinsurance Wealth North America International Management Other Total ------------- ------------- ------------- ------------- ------------- Premiums earned ................. $ 23,382 $ 14,246 $ - $ - $ 37,628 Investment income, net .......... 23,157 1,705 (46) 1,320 26,136 Fee income ...................... 1,316 - 885 - 2,201 Realized gains (losses) ......... 404 (2,118) - 108 (1,606) ------------- ------------- ------------- ------------- ------------- Total revenues .................. 48,259 13,833 839 1,428 64,359 ------------- ------------- ------------- ------------- ------------- Claims and other policy benefits 17,528 9,128 - - 26,656 Interest credited to interest sensitive contract liabilities 11,155 73 - - 11,228 Acquisition costs and other insurance expenses, net ...... 10,952 139 949 - 12,040 Operating expenses .............. 1,772 1,767 377 2,320 6,236 Interest expense ................ - - - 138 138 ------------- ------------- ------------- ------------- ------------- Total benefits and expenses ..... 41,407 11,107 1,326 2,458 56,298 ------------- ------------- ------------- ------------- ------------- Net income (loss) from continuing operations before income taxes $ 6,852 $ 2,726 $ (487) $ (1,030) $ 8,061 ============= ============= ============= ============= ============= Six months ended June 30, 2003 ----------------------------------------------------------------------------------- Life Life Reinsurance Reinsurance Wealth North America International Management Other Total ------------- ------------- ------------- ------------- ------------- Premiums earned ................. $ 96,025 $ 63,531 $ - $ - $ 159,556 Investment income, net .......... 62,280 3,851 94 2,020 68,245 Fee income ...................... 2,396 - 1,975 - 4,371 Realized gains (losses) ......... (5,052) (873) (8) 220 (5,713) ------------- ------------- ------------- ------------- ------------- Total revenues .................. 155,649 66,509 2,061 2,240 226,459 ------------- ------------- ------------- ------------- ------------- Claims and other policy benefits 72,226 36,344 - - 108,570 Interest credited to interest sensitive contract liabilities 32,767 - - - 32,767 Acquisition costs and other insurance expenses, net ...... 34,267 13,221 1,051 - 48,539 Operating expenses .............. 4,415 5,840 355 5,403 16,013 Interest expense ................ 477 - - 3,187 3,664 ------------- ------------- ------------- ------------- ------------- Total benefits and expenses ..... 144,152 55,405 1,406 8,590 209,553 ------------- ------------- ------------- ------------- ------------- Net income (loss) from continuing operations before income taxes $ 11,497 $ 11,104 $ 655 $(6,350) $ 16,906 ============= ============= ============= ============= ============= 10 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 Six months ended June 30, 2002 ----------------------------------------------------------------------------------- Life Life Reinsurance Reinsurance Wealth North America International Management Other Total ------------- ------------- ------------- ------------- ------------- Premiums earned ............... $ 42,530 $ 26,453 $ - $ - $ 68,983 Investment income, net ........ 42,683 3,108 (129) 2,205 47,867 Fee income .................... 2,609 - 1,666 - 4,275 Realized losses ............... (733) (2,486) - (86) (3,305) ------------- ------------- ------------- ------------- ------------- Total revenues ................ 87,089 27,075 1,537 2,119 117,820 ------------- ------------- ------------- ------------- ------------- Claims and other policy benefits ................... 33,142 17,401 - - 50,543 Interest credited to interest sensitive contract liabilities ................ 20,318 88 - - 20,406 Acquisition costs and other insurance expenses, net .... 19,675 1,674 1,513 7 22,869 Operating expenses ............ 2,697 3,454 587 3,415 10,153 Interest expense .............. - - - 482 482 ------------- ------------- ------------- ------------- ------------- Total benefits and expenses ... 75,832 22,617 2,100 3,904 104,453 ------------- ------------- ------------- ------------- ------------- Net income (loss) from continuing operations before income taxes $ 11,257 $ 4,458 $ (563) $ (1,785) $ 13,367 ============= ============= ============= ============= ============= Assets June 30, 2003 December 31, 2002 ----------------- ----------------- Life Reinsurance North America........................ $ 2,700,027 $ 2,236,089 International........................ 268,073 265,658 ----------------- ----------------- Total Life Reinsurance................... 2,968,100 2,501,747 Wealth Management........................ 762,601 681,534 Other.................................... 103,776 107,945 ----------------- ----------------- Total.................................... $ 3,834,477 $ 3,291,226 ================= ================= 11 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 5. Earnings per ordinary share The following table sets forth the computation of basic and diluted earnings per ordinary share: Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Numerator: Net income ........................ $ 7,872 $ 7,849 $ 15,115 $ 12,847 ============= ============= ============= ============= Denominator: Denominator for basic earnings per ordinary share - Weighted average number of ordinary shares....... 27,101,357 26,683,204 27,038,103 23,432,731 ============= ============= ============= ============= Effect of dilutive securities - Stock options .................. 882,360 1,055,956 821,246 926,607 - Warrants ....................... 603,823 765,070 512,030 587,333 ------------- ------------- ------------- ------------- Denominator for dilutive earnings per ordinary share 28,587,540 28,504,230 28,371,379 24,946,671 ============= ============= ============= ============= Earnings per ordinary share from continuing operations -Basic......................... $ 0.34 $ 0.30 $ 0.62 $ 0.55 ============= ============= ============= ============= Earnings per ordinary share from continuing operations - Diluted...................... $ 0.33 $ 0.28 $ 0.59 $ 0.52 ============= ============= ============= ============= Basic earnings per ordinary share.......................... $ 0.29 $ 0.29 $ 0.56 $ 0.55 ============= ============= ============= ============= Diluted earnings per ordinary share $ 0.28 $ 0.28 $ 0.53 $ 0.51 ============= ============= ============= ============= 6. Deferred acquisition costs The change in deferred acquisition costs is as follows: Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Balance beginning of period........ $ 231,414 $ 131,073 $ 213,516 $ 113,898 Expenses deferred.................. 41,325 27,028 67,929 49,688 Amortization expense............... (12,454) (8,346) (21,587) (13,596) Deferred acquisition costs on realized losses................... 1,730 709 2,157 474 ------------- ------------- ------------- ------------ Balance end of period............ $ 262,015 $ 150,464 $ 262,015 $ 150,464 ============= ============= ============= ============ 12 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 7. Due to Related Parties In the normal course of business, we enter into reinsurance contracts with Pacific Life Insurance Company in which we both assume and cede business. Amounts due to Pacific Life of $1.3 million at June 30, 2003 are included in reinsurance balances payable. Amounts due from Pacific Life of $817,000 at December 31, 2002 are included in reinsurance balances and risk fees receivable. 8. Credit Facilities During 2002, we arranged two secured credit facilities with U.S. banks totaling $100 million. Each of the credit facilities provides a combination of borrowings and letters of credit of up to $50 million. Interest rates on amounts borrowed under these facilities are LIBOR plus 45-50 basis points. These facilities expire in September 2003 but are renewable upon the agreement of both parties. At June 30, 2003 and December 31, 2002 there were no borrowings under these facilities. Outstanding letters of credit at June 30, 2003 and December 31, 2002 amounted to $27.6 million and $9.1 million, respectively. Each facility has covenants, including a consolidated net worth covenant and a maximum leverage covenant. We also have a reverse repurchase agreement with a major broker/dealer. Under this agreement, we have the ability to sell agency mortgage backed securities with the agreement to repurchase them at a fixed price, providing the dealer with a spread that equates to an effective borrowing cost linked to one-month LIBOR. This agreement is renewable monthly at the discretion of the broker/dealer. At June 30, 2003 and December 31, 2002, there were no borrowings under this agreement. 9. Long-term debt Long-term debt consists of: June 30, 2003 December 31, 2002 ------------- ----------------- 4.5% senior convertible notes due 2022......... $ 115,000 $ 115,000 Capital securities............................. 17,500 17,500 ------------- ------------ Total $ 132,500 $ 132,500 ============= ============ 4.5% Senior convertible notes On November 22, 2002 and November 27, 2002, we issued an aggregate of $115.0 million (which included an over allotment option of $15.0 million) of 4.5% senior convertible notes, which are due December 1, 2022, to qualified institutional buyers. The notes are general unsecured obligations, ranking on a parity in right of payment with all our existing and future unsecured senior indebtedness, and senior in right of payment with all our future subordinated indebtedness. Interest on the notes is payable on June 1 and December 1 of each year, beginning on June 1, 2003. The notes are rated Baa2 by Moody's Investors Service ("Moody's") and BBB- by Standard & Poor's Ratings Group ("Standard & Poor's"). The notes are convertible into our ordinary shares at an initial conversion rate of 46.0617 ordinary shares per $1,000 principal amount of notes (equivalent to an initial conversion price of $21.71 per ordinary share), subject to our right to deliver, in lieu of our ordinary shares, cash or a combination of cash and our ordinary shares. The notes are redeemable at our option in whole or in part beginning on December 6, 2006, at a redemption price equal to 100% of the principal amount of the notes plus accrued 13 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 and unpaid interest. The notes are subject to repurchase by us upon a change of control of Scottish Annuity & Life or at a holder's option on December 6, 2006, December 1, 2010, December 1, 2012 and December 1, 2017, at a repurchase price equal to 100% of the principal amount of the notes plus accrued and unpaid interest. The notes are due on December 1, 2022 unless earlier converted, redeemed by us at our option or repurchased by us at a holder's option. A holder may surrender notes for conversion prior to the stated maturity only under the following circumstances: o during any conversion period if the sale price of our ordinary shares for at least 20 trading days in the period of 30 consecutive trading days ending on the first day of the conversion period exceeds 120% of the conversion price in effect on that 30th trading day; o during any period in which the notes are rated by either Moody's or Standard & Poor's and the credit rating assigned to the notes by either rating agency is downgraded by two levels or more, suspended or withdrawn; o if we have called those notes for redemption; or o upon the occurrence of certain specified corporate transactions. Under a registration rights agreement, we agreed to file with the Securities and Exchange Commission, a shelf registration statement, for resale of the notes and our ordinary shares issuable upon conversion of the notes. This registration statement was filed and later declared effective by the Securities and Exchange Commission on April 4, 2003. Capital securities On December 4, 2002, Scottish Holdings Statutory Trust I, a Connecticut statutory business trust ("Capital Trust") issued and sold in a private offering an aggregate of $17.5 million Floating Rate Capital Securities (the "capital securities"). All of the common shares of the Capital Trust are owned by Scottish Holdings, Inc., our wholly owned subsidiary. The capital securities mature on December 4, 2032. They are redeemable in whole or in part at any time after December 4, 2007. Interest is payable quarterly at a rate equivalent to 3 month LIBOR plus 4%. At June 30, 2003 and December 31, 2002, the interest rates were 5.12% and 5.42%, respectively. Prior to December 4, 2007, interest cannot exceed 12.5%. The Capital Trust may defer payment of the interest for up to 20 consecutive quarterly periods, but no later than December 4, 2032. Any deferred payments would accrue interest quarterly on a compounded basis if Scottish Holdings, Inc. defers interest on the Debentures due December 4, 2032 (as defined below). The sole assets of the Capital Trust consist of $18.0 million principal amount of Floating Rate Debentures (the "Debentures") issued by Scottish Holdings, Inc. The Debentures mature on December 4, 2032 and interest is payable quarterly at a rate equivalent to 3-month LIBOR plus 4%. At June 30, 2003 and December 31, 2002, the interest rates were 5.12% and 5.42%, respectively. Prior to December 4, 2007, interest cannot exceed 12.5%. Scottish Holdings, Inc. may defer payment of the interest for up to 20 consecutive quarterly periods, but no later than December 4, 2032. Any deferred payments would accrue interest quarterly on a compounded basis. Scottish Holdings, Inc. may redeem the Debentures at any time after December 4, 2007 in the event of certain changes in tax or investment company law. 14 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed Scottish Holdings, Inc.'s obligations under the Debentures and distributions and other payments due on the capital securities. 10. Stock option plans We have four stock option plans (the "1998 Plan", the "1999 Plan", the "Harbourton Plan" and the "2001 Plan", collectively the "Plans"), which allow us to grant non-statutory options, subject to certain restrictions, to certain eligible employees, non-employee directors, advisors and consultants. The minimum exercise price of the options will be equal to the fair market value, as defined in the Plans, of our ordinary shares at the date of grant. The term of the options is between seven and ten years from the date of grant. Unless otherwise provided in each option agreement, all granted options issued prior to December 31, 2001 become exercisable in three equal annual installments. Commencing January 1, 2002, all granted options will become exercisable in five equal installments commencing on the first anniversary of the grant date, except for annual grants of 2,000 to each director, which are fully exercisable on the date of grant. Total options authorized under the Plans are 3,750,000. In prior years, we adopted the provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for employee stock options. Since the exercise price of the stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense was recognized. In December 2002, the Financial Accounting Standards Board issued SFAS No.148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123". Effective January 1, 2003, we have adopted the modified prospective method of fair value-based stock option expense provisions of SFAS No. 123 as amended by SFAS No. 148. Compensation expense has been recognized for all stock options granted since January 1, 2003. This has resulted in a charge to income of $81,000 in the three and six month periods ended June 30, 2003. Pro forma information regarding net income and earnings per share for all outstanding stock options is required by SFAS No. 148 and has been determined as if we accounted for all employee stock options under the fair value method of that Statement. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period using the Black-Scholes model. The Black-Scholes and Binomial option-pricing models were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected price volatility. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our employee stock options. 15 Scottish Annuity & Life Holdings, Ltd. Notes to Unaudited Consolidated Financial Statements At June 30, 2003 Our pro forma information is as follows: Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Net income-- as reported ................... $ 7,872 $ 7,849 $ 15,115 $ 12,847 Stock-based employee compensation cost, net of related tax effects, included in the determination of net income as reported 81 -- 81 -- Stock-based employee compensation cost, net of related tax effects, that would have been included in the determination of net income if the fair value based method had been applied to all awards .. (649) (1,130) (1,319) (2,316) ------------- ------------- ------------- ------------- Net income-- pro forma ..................... $ 7,304 $ 6,719 $ 13,877 $ 10,531 ============= ============= ============= ============= Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Basic earnings per ordinary share-- as reported................................ $ 0.29 $ 0.29 $ 0.56 $ 0.55 Basic earnings per ordinary share-- pro forma................................... $ 0.27 $ 0.25 $ 0.52 $ 0.45 Diluted earnings per ordinary share-- as reported................................ $ 0.28 $ 0.28 $ 0.53 $ 0.51 Diluted earnings per ordinary share-- pro forma................................... $ 0.26 $ 0.24 $ 0.49 $ 0.42 11. Shareholders' equity On July 23, 2003, we completed a public offering of 9,200,000 ordinary shares (which included an over-allotment option of 1,200,000 ordinary shares) at an offering price of $20.75 per share in which we raised aggregate net proceeds of $179.7 million ($19.66 per share after the underwriting discount). We have used $30.0 million of these proceeds to repurchase 1,525,000 ordinary shares from Pacific Life Insurance Company at a purchase price of $19.66 per share. Other expenses of the offering are expected to be approximately $1.2 million. The remainder of the proceeds will be used for general corporate purposes. 16 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General Scottish Annuity & Life Holdings, Ltd., which we call Scottish Annuity & Life, is a holding company organized under the laws of the Cayman Islands with its principal executive office in Bermuda. We are a reinsurer of life insurance, annuities and annuity-type products. These products are written by life insurance companies and other financial institutions located principally in the United States, as well as around the world. We refer to this portion of our business as Life Reinsurance North America. On December 31, 2001, we completed the purchase of World-Wide Holdings Limited and its subsidiary World-Wide Reassurance Company Limited. World-Wide Reassurance specializes in niche markets in developed countries and broader life insurance markets in the developing world. We refer to this portion of our business as Life Reinsurance International. Life Reinsurance North America and Life Reinsurance International together are a reporting operating segment. To a lesser extent, we directly issue variable life insurance and variable annuities and similar products to high net worth individuals and families for insurance, investment and estate planning purposes. We refer to this portion of our business as Wealth Management, which is another reportable operating segment. Other revenues and expenses not related to Life Reinsurance or Wealth Management are reported in the "Other" segment. All amounts are reported in thousands of United States dollars, except per share amounts. Revenues We derive revenue from four principal sources: o premiums from reinsurance assumed on life business; o fee income from our variable life insurance and variable annuity products and from financial reinsurance transactions; o investment income from our investment portfolio; and o realized gains and losses from our investment portfolio. Premiums from reinsurance assumed on life business are included in revenues over the premium paying period of the underlying policies. When we acquire blocks of in-force business, we account for these transactions as purchases, and our results of operations include the net income from these blocks as of their respective dates of acquisition. Reinsurance assumed on annuity business does not generate premium income but generates investment income over time on the assets we receive from the ceding company. We also earn fees in our financial reinsurance transactions with U.S. insurance company clients. Because some of these transactions do not satisfy the risk transfer rules for reinsurance accounting, the premiums and benefits are not reported in the consolidated statements of income. A deposit received on a funding agreement also does not generate premium income but does create income to the extent we earn an investment return in excess of our interest payment obligations thereon. In our Wealth Management business, when we sell a variable life insurance policy or a variable annuity contract, we charge mortality, expense and distribution risk fees that are based on total assets in 17 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations each policyholder's separate account. In the case of variable life insurance policies, we also charge a cost of insurance fee based on the amount necessary to cover the death benefit under the policy. Our investment income includes interest earned on our fixed income investments and income from funds withheld at interest under modified coinsurance agreements. Under GAAP, because our fixed income investments are held as available for sale, these securities are carried at fair value, and unrealized appreciation and depreciation on these securities is not included in investment income on our statements of income, but is included in comprehensive income as a separate component of shareholders' equity. Realized gains and losses include gains and losses on investment securities that we sell during a period and write downs of securities deemed to be other than temporarily impaired. Expenses We have five principal types of expenses: o claims and policy benefits under our reinsurance contracts; o interest credited to interest sensitive contract liabilities; o acquisition costs and other insurance expenses; o operating expenses; and o interest expense. When we issue a life reinsurance contract, we establish reserves for benefits. These reserves are our estimates of what we expect to pay in claims and policy benefits and related expenses under the contract or policy. From time to time, we may also add to reserves if our experience leads us to believe that benefit claims and expenses will ultimately be greater than the existing reserve. We report the change in these reserves as an expense during the period when the reserve or additional reserve is established. In connection with reinsurance of annuity and annuity-type products, we record a liability for interest sensitive contract liabilities, which represents the amount ultimately due to the policyholder. We credit interest to these contracts each period at the rates determined in the underlying contract, and the amount is reported as interest credited to interest sensitive contract liabilities on our consolidated statements of income. A portion of the costs of acquiring new business, such as commissions, certain internal expenses related to our policy issuance and underwriting departments and some variable selling expenses are capitalized. The resulting deferred acquisition costs asset is amortized over future periods based on our expectations as to the emergence of future gross profits from the underlying contracts. These costs are dependent on the structure, size and type of business written. For certain products, we may retrospectively adjust our amortization when we revise our estimate of current or future gross profits to be realized. The effects of this adjustment are reflected in earnings in the period in which we revise our estimate. Operating expenses consist of salary and salary related expenses, legal and professional fees, rent and office expenses, travel and entertainment, directors' expenses, insurance and other similar expenses, except to the extent capitalized in deferred acquisition costs. Interest expense consists of interest charges on our borrowings. 18 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Factors affecting profitability We seek to generate profits from three principal sources. First, in our Life Reinsurance business, we seek to receive reinsurance premiums and financial reinsurance fees that, together with income from the assets in which those premiums are invested, exceed the amounts we ultimately pay as claims and policy benefits, acquisition costs and ceding commissions. Second, in our Wealth Management business, we seek to generate fee income that will exceed the expenses of maintaining and administering our variable life insurance and variable annuity products. Third, within our investment guidelines, we seek to maximize the return on our unallocated capital. The following factors affect our profitability: o the volume of business we write; o our ability to assess and price adequately for the risks we assume; o the mix of different types of business that we reinsure, because profits on some kinds of business emerge later than on other types; o our ability to manage our assets and liabilities to manage investment and liquidity risk; o the level of fees that we charge on our Wealth Management contracts; and o our ability to control expenses. In addition, our profits can be affected by a number of factors that are not within our control. For example, movements in interest rates can affect the volume of business that we write, the income earned from our investments, the interest we credit on interest sensitive contracts, the level of surrender activity on contracts that we reinsure and the rate at which we amortize deferred acquisition costs. Other external factors that can affect profitability include mortality experience that varies from our assumed mortality, changes in regulation or tax laws, which may affect the attractiveness of our products or the costs of doing business and changes in foreign currency exchange rates. Critical Accounting Policies Financial Accounting Standard 60 applies to traditional life policies with continuing premiums. For these policies, future benefits are estimated using a net level premium method on the basis of actuarial assumptions as to mortality, persistency and interest established at policy issue. Assumptions established at policy issue as to mortality and persistency are based on anticipated experience, which, together with interest and expense assumptions, provide a margin for adverse deviation. Acquisition costs are deferred and recognized as expense in a constant percentage of the gross premiums using these assumptions established at issue. Should the liabilities for future policy benefits plus the present value of expected future gross premiums for a product be insufficient to provide for expected future benefits and expenses for that product, deferred acquisition costs will be written off and thereafter, if required, a premium deficiency reserve will be established by a charge to income. Changes in the assumptions for mortality, persistency and interest could result in material changes to the financial statements. Financial Accounting Standard 97 applies to investment contracts, limited premium contracts, and universal life-type contracts. For investment and universal life-type contracts, future benefit liabilities are held using the retrospective deposit method, increased for amounts representing unearned 19 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations revenue or refundable policy charges. Acquisition costs are deferred and recognized as expense as a constant percentage of gross margins using assumptions as to mortality, persistency, and expense established at policy issue without provision for adverse deviation and are revised periodically to reflect emerging actual experience and any material changes in expected future experience. Liabilities and the deferral of acquisition costs are established for limited premium policies under the same practices as used for traditional life policies with the exception that any gross premium in excess of the net premium is deferred and recognized into income as a constant percentage of insurance in-force. Should the liabilities for future policy benefits plus the present value of expected future gross premiums for a product be insufficient to provide for expected future benefits and expenses for that product, deferred acquisition costs will be written off and thereafter, if required, a premium deficiency reserve will be established by a charge to income. Changes in the assumptions for mortality, persistency, maintenance expense and interest could result in material changes to the financial statements. The development of policy reserves and amortization of deferred acquisition costs for our products requires management to make estimates and assumptions regarding mortality, lapse, expense and investment experience. Such estimates are primarily based on historical experience and information provided by ceding companies. Actual results could differ materially from those estimates. Management monitors actual experience, and should circumstances warrant, will revise its assumptions and the related reserve estimates. In 2002, we completed the acquisition of an in-force block of business. The determination of the fair value of the assets acquired and the liabilities assumed required management to make estimates and assumptions regarding mortality, lapse and expenses. These estimates were based on historical experience, actuarial studies and information provided by the ceding company. Actual results could differ materially from these estimates. Present value of in-force business is established upon the acquisition of a subsidiary and is amortized over the expected life of the business at the time of acquisition. The amortization each year will be a function of the gross profits or revenues each year in relation to the total gross profits or revenues expected over the life of business, discounted at the assumed net credit rate. The determination of the initial value and the subsequent amortization require management to make estimates and assumptions regarding the future business results that could differ materially from actual results. Estimates and assumptions involved in the present value of in-force business and subsequent amortization are similar to those necessary in the establishment of reserves and amortization of deferred acquisition costs. Goodwill is established upon the acquisition of a subsidiary. Goodwill is calculated as the difference between the price paid and the value of individual assets and liabilities on the date of acquisition. In June 2001, the Financial Accounting Standards Board issued SFAS No. 142, "Goodwill and Other Intangible Assets," effective for fiscal years beginning after December 15, 2001. SFAS No. 142 requires that goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with the Statement. We applied the new rules on accounting for goodwill during 2002. Goodwill recognized in the consolidated balance sheet was assigned to reporting units and has been tested for impairment at June 30, 2003. There has been no impairment. Fixed maturity investments are evaluated for other than temporary impairments in accordance with SFAS 115 and EITF 99-20. Under these pronouncements, realized losses are recognized on securities if the securities are determined to be other than temporarily impaired. Factors involved in the determination of potential impairment include fair value as compared to cost, length of time the value has 20 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations been below cost, credit worthiness of the issuer, forecasted financial performance of the issuer, position of the security in the issuer's capital structure, the presence and estimated value of collateral or other credit enhancement, length of time to maturity, interest rates and our intent and ability to hold the security until the market value recovers. Our accounting policies addressing reserves, deferred acquisition costs, value of business acquired, goodwill and investment impairment involve significant assumptions, judgments and estimates. Changes in these assumptions, judgments and estimates could create material changes in our consolidated financial statements. Results of Operations Consolidated results of operations Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Premiums earned........................................ $ 94,737 $ 37,628 $ 159,556 $ 68,983 Investment income, net................................. 35,941 26,136 68,245 47,867 Fee income............................................. 2,380 2,201 4,371 4,275 Realized losses........................................ (3,392) (1,606) (5,713) (3,305) ------------- ------------- ------------- ------------- Total revenues......................................... 129,666 64,359 226,459 117,820 ------------- ------------- ------------- ------------- Claims and other policy benefits....................... 65,676 26,656 108,570 50,543 Interest credited to interest sensitive contract 16,874 11,228 32,767 20,406 liabilities............................................ Acquisition costs and other insurance expenses, net.... 27,884 12,040 48,539 22,869 Operating expenses..................................... 8,184 6,236 16,013 10,153 Interest expense....................................... 1,851 138 3,664 482 ------------- ------------- ------------- ------------- Total benefits and expenses............................ 120,433 56,298 209,553 104,453 ------------- ------------- ------------- ------------- Net income before income taxes......................... 9,233 8,061 16,906 13,367 Income tax expense (benefit)........................... (84) 121 166 429 ------------- ------------- ------------- ------------- Income from continuing operations...................... 9,317 7,940 16,740 12,938 ------------- ------------- ------------- ------------- Loss from discontinued operations...................... 1,445 91 1,625 91 ------------- ------------- ------------- ------------- Net income............................................. $ 7,872 $ 7,849 $ 15,115 $ 12,847 ============= ============= ============= ============= Total revenues increased by 101% to $129.7 million in the second quarter of 2003 from $64.4 million in the same period of 2002. Total revenues increased by 92% to $226.5 million during the first six months of 2003 from $117.8 million in the same period of 2002. Total revenues include premiums earned in our Life Reinsurance operations, investment income on our invested assets, fee income on our Life Reinsurance and Wealth Management operations and realized losses on our investment portfolios. The increase in premiums earned is primarily due to continued growth in our Life Reinsurance North America and Life Reinsurance International segments. The increase in investment income is due to growth in our invested assets, which arises from business growth, our equity offering in April 2002 and our debt offerings in November and December 2002. Total benefits and expenses increased by 114% to $120.4 million in the second quarter of 2003 from $56.3 million in the same period in 2002. Total benefits and expenses increased by 101% to $209.6 million during the first six months of 2003 from $104.5 million in the same period in 2002. The increase was due to continued growth in our Life Reinsurance North America and Life Reinsurance International segments, additional operating costs 21 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations required to meet the growth in our business and additional interest expense arising from the debt issuance in November and December 2002. During the period ended June 30, 2003 we decided to discontinue our Wealth Management operations in Luxembourg. We are in the process of transferring our Luxembourg Wealth Management business to third parties and expect to complete the closure of this office by December 31, 2003. We have reported the results of the Luxembourg Wealth Management activities as discontinued operations. During the quarter ended June 30, 2003 losses from these operations amounted to $1.4 million ($0.05 per diluted share) in comparison with $91,000 in the prior year period. The losses recorded in the current quarter include the write down of a deferred tax asset of $349,000, which had arisen from prior year net operating losses, and estimates of severance costs and costs to close the operation. Losses incurred in respect of these operations in the six month period ended June 30, 2003 and 2002 amounted to $1.6 million ($0.06 per diluted share) and $91,000, respectively. Earnings per ordinary share Three months Three months Six months Six months ended ended ended ended June 30, June 30, June 30, June 30, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Income from continuing operations $9,317 $7,940 $16,740 $12,938 ============ ============ ============ ============ Net income............................. $7,872 $7,849 $15,115 $12,847 ============ ============ ============ ============ Earnings per ordinary share from continuing operations -Basic........... $ 0.34 $ 0.30 $ 0.62 $ 0.55 ============ ============ ============ ============ Earnings per ordinary share from continuing operations - Diluted........ $ 0.33 $ 0.28 $ 0.59 $ 0.52 ============ ============ ============ ============ Basic earnings per ordinary share...... $ 0.29 $ 0.29 $ 0.56 $ 0.55 ============ ============ ============ ============ Diluted earnings per ordinary share.... $ 0.28 $ 0.28 $ 0.53 $ 0.51 ============ ============ ============ ============ Weighted average number of ordinary shares outstanding: Basic.................................. 27,101,357 26,683,204 27,038,103 23,432,731 ============ ============ ============ ============ Diluted................................ 28,587,540 28,504,230 28,371,379 24,946,671 ============ ============ ============ ============ Net income from continuing operations for the second quarter increased 17% to $9.3 million from $7.9 million in the same quarter in 2002. Net income from continuing operations for the first six months increased 25% to $16.7 million from $13.4 million in the same period in 2002. The increase is attributable to continued growth in our Life Reinsurance North America and Life Reinsurance International operations. Diluted earnings per ordinary share from continuing operations amounted to $0.33 for the quarter ended June 30, 2003 and $0.28 per ordinary share in the prior year period, an increase of 18%. For the six month period, diluted earnings per ordinary share increased by 13% to $0.59. Diluted earnings per ordinary share amounted to $0.28 for the second quarter of 2003 and 2002. Diluted earnings per ordinary share for the quarter increased for the reasons discussed above. This increase was offset by increased realized losses and the loss from discontinued operations. Diluted earnings per ordinary share amounted to $0.54 for the first six months of 2003 and $0.51 in the same period in 2002, an increase of 6%. Diluted earnings per ordinary share in the six month period ended June 30, 2003 increased as a result of the growth in net income discussed above. This increase was offset by an increase in the number of ordinary shares outstanding mainly due to the public offering of 6,750,000 ordinary shares in April 2002. 22 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Premiums earned Premiums earned during the three months ended June 30, 2003 increased by 152% to $94.7 million from $37.6 million in the same period in the prior year. Premiums earned during the six months ended June 30, 2003 increased by 131% to $159.6 million from $70.0 million in the same period in the prior year. Premiums earned in our Life Reinsurance North America segment during the three month period ended June 30, 2003 increased 142% to $56.6 million in comparison with $23.4 million in the three month period ended June 30, 2002. Premiums earned in this segment during the first six months increased 126% to $96.0 million in comparison with $42.5 million in the six month period ended June 30, 2002. The increase is due to increases in the amounts of life insurance in-force on existing treaties and on new business written during the quarter. As of June 30, 2003, we reinsured approximately $90.4 billion of life insurance in-force on 1,787,000 lives. During the June quarter of 2003, we added $16.2 billion of in-force in comparison with $6.7 billion in the prior year period. In the six months ended June 30, 2003, we added $22.2 billion of in-force in comparison with $14.1 billion in the prior year period. Our average benefit coverage per life was $51,000. As of June 30, 2002 we reinsured approximately $49.0 billion of life insurance in-force on 1,252,000 lives. Our average benefit coverage per life was $39,000. Premiums earned in our Life Reinsurance International segment during the second quarter increased 168% to $38.2 million in comparison with $14.2 million in the three month period ended June 30, 2002. Premiums earned in this segment during the first six months increased 140% to $63.5 million in comparison with $26.5 million in the six month period ended June 30, 2002. Our Life Reinsurance International segment completed the acquisition of an in-force reinsurance transaction effective from October 1, 2002. This transaction has contributed $8.7 million to premiums earned during the current quarter and $13.6 million during the first six months of 2003. Premiums earned on other life business increased by $11.1 million during the current quarter and $17.4 million in the first six months of 2003 in comparison with prior periods in 2002. The increase is due to an increase in the number of contracts from 1,387 at June 30, 2002 to 1,729 at June 30, 2003. Premiums earned on aircrew "loss of license" insurance increased by $3.9 million during the current quarter quarter and $5.8 million in the first six months of 2003 in comparison with the prior year periods in 2002 due to new business. At June 30, 2003, there were 216 in-force contracts of which 78 incepted during the six-month period ended June 30, 2003. Fee income Both Life Reinsurance and Wealth Management operations generate fee income. We earn fees in Life Reinsurance on certain of our financial reinsurance treaties that do not qualify under risk transfer rules for reinsurance accounting. Fee income is as follows: Three months Three months Six months Six months ended ended ended ended June 30, June 30, June 30, June 30, 2003 2002 2003 2002 ------------ ------------ ------------ ----------- Life Reinsurance North America........... $1,337 $1,316 $2,396 $2,609 Wealth Management........................ 1,043 885 1,975 1,666 ------------ ------------ ------------ ----------- $2,380 $2,201 $4,371 $4,275 ============ ============ ============ =========== 23 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Wealth Management fees increased by 18% to $1.0 million during the three month period ended June 30, 2003 and by 19% to $2.0 million during the six month period ended June 30, 2003. The growth in fees is principally due to the growth in segregated account balances, which is due to an increase in the number of clients and improved investment performance. The number of clients has grown from 140 at June 30, 2002 to 177 at June 30, 2003. Segregated assets amount to $723.9 million at June 30, 2003 in comparison to $573.1 million at June 30, 2002. Policy face amounts amounted to $1.1 billion and $914.6 million at June 30, 2003 and 2002, respectively. The change in the segregated assets is as follows: Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Balance at beginning of period..... $ 669,644 $ 603,600 $ 653,588 $ 602,800 Deposits........................... 16,712 7,607 66,739 11,807 Withdrawals........................ (3,484) - (10,168) (650) Investment performance............. 41,034 (38,052) 13,747 (40,802) ------------- ------------- ------------- ------------- Balance at end of period........... $ 723,906 $ 573,155 $ 723,906 $ 573,155 ============= ============= ============= ============= Investment income Net investment income increased by $9.7 million or 38% to $35.9 million for the three months ended June 30, 2003 from $26.1 million for the prior year period. Net investment income increased by $20.3 million or 43% to $68.2 million for the six months ended June 30, 2003 from $47.9 million for the prior year period. The increase is due to the growth in our average invested assets offset in part by decreases in realized yields during 2002 and 2003. Our total invested assets have increased significantly because of growth in our Life Reinsurance North America operations and investment of the proceeds of our equity offering in April 2002 and our convertible debt and capital securities offerings in November and December 2002. Total invested assets have increased from $1.7 billion at June 30, 2002 to $2.7 billion at June 30, 2003. Funds withheld at interest grew from $879.6 million at June 30, 2002 to $1.2 billion at June 30, 2003. During the six month period ended June 30, 2003, average book yields were lower than in the same period in 2002. On the $1.4 billion portfolio managed by our external investment managers the yields on fixed rate assets were 5.4% and 6.3% at June 30, 2003 and 2002, respectively. The reduction in yield was due primarily to the much lower market yields at which new cash flows were invested and proceeds of maturities and sales were reinvested. Yields on floating rate assets are indexed to LIBOR. The yield on our floating rate assets decreased to 3.2% from 3.7%, and the yield on our cash and cash equivalents decreased to 1.6% from 1.8%. The volume of floating rate assets increased during 2002 as a result of our investing the proceeds of a $100 million floating rate funding agreement to earn a spread over the cost of funds. 24 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations The analysis of investment income by segment is as follows: Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Life Reinsurance - North America..... $ 32,680 $ 23,157 $ 62,280 $ 42,683 - International..... 2,125 1,705 3,851 3,108 Wealth Management..................... 60 (46) 94 (129) Other................................. 1,076 1,320 2,020 2,205 ------------- ------------- ------------- ------------- Total................................. $ 35,941 $ 26,136 $ 68,245 $ 47,867 ============= ============= ============= ============= Realized losses During the three months ended June 30, 2003, realized losses amounted to $3.4 million in comparison with $1.6 million in 2002. During the six months ended June 30, 2003, realized losses amounted to $5.7 million in comparison with $3.3 million in 2002. During the quarter ended June 30, 2003, we recognized $0.5 million losses in respect of "other than temporary impairments" on investments. During the six month period, these losses amounted to $1.7 million. There were no "other than temporary impairment" losses recognized during the first six months of 2002. These losses include "other than temporary impairment losses" notified by ceding companies on contracts written on a modified coinsurance basis. They are stated net of the related deferred acquisition costs. Management reviews securities with material unrealized losses and tests for "other than temporary impairments" on a quarterly basis. Factors involved in the determination of impairment include fair value as compared to amortized cost, length of time the value has been below amortized cost, credit worthiness of the issuer, forecasted financial performance of the issuer, position of the security in the issuer's capital structure, the presence and estimated value of collateral or other credit enhancement, length of time to maturity, interest rates and our intent and ability to hold the security until the market value recovers. We review all investments with fair values less than amortized cost, and pay particular attention to those that have traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months and other assets with material differences between amortized cost and fair value. Investments meeting those criteria are analyzed in detail for "other than temporary impairment." When a decline is considered to be "other than temporary" a realized loss is incurred and the cost basis of the impaired asset is adjusted to its fair value. Under EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Assets", a decline in fair value below "amortized cost" basis is considered to be an "other than temporary impairment" whenever there is an adverse change in the amount or timing of cash flow to be received, regardless of the resulting yield, unless the decrease is solely a result of changes in market interest rates. During the quarter ended June 30, 2003, we recognized $1.7 million in respect of EITF 99-20 losses in comparison with $1.0 million in the prior year period. During the six month period ended June 30, 2003, these losses amounted to $2.4 million in comparison with $1.9 million for the same period in 2002. The impairment losses discussed above have been partially offset by net realized gains on the disposals of fixed maturity investments. 25 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations The following tables provide details of the sales proceeds, realized loss, the length of time the security had been in an unrealized loss position and reason for sale for securities sold at a loss during the periods ended June 30, 2003 and 2002. Three months ended June 30, 2003 -------------------------------------------------------------------------- Credit Concern Other Total ----------------------- ------------------------ ------------------------- Days Proceeds Loss Proceeds Loss Proceeds Loss ----------- ----------- ------------- ---------- ------------ ------------ (dollars in thousands) 0-90.......... $ -- $ -- $ 2,476 $ (3) $ 2,476 $ (3) 91-180........ 739 (11) -- -- 739 (11) ----------- ----------- ------------- ---------- ------------ ------------ Total......... $ 739 $ (11) $ 2,476 $ (3) $ 3,215 $ (14) =========== =========== ============= ========== ============ ============ Three months ended June 30, 2002 -------------------------------------------------------------------------- Credit Concern Other Total ----------------------- ------------------------ ------------------------- Days Proceeds Loss Proceeds Loss Proceeds Loss ----------- ----------- ------------- ---------- ------------ ------------ (dollars in thousands) 0-90.......... $ 7,131 $ (161) $ 4,337 $ (20) $ 11,468 $ (181) 91-180........ 996 (54) 996 (54) Greater than 360 658 (98) -- -- 658 (98) ----------- ----------- ------------- ---------- ------------ ------------ Total......... $ 8,785 $ (313) $ 4,337 $ (20) $ 13,122 $ (333) =========== =========== ============= ========== ============ ============ Six months ended June 30, 2003 -------------------------------------------------------------------------- Credit Concern Other Total ----------------------- ------------------------ ------------------------- Days Proceeds Loss Proceeds Loss Proceeds Loss ----------- ----------- ------------- ---------- ------------ ------------ (dollars in thousands) 0-90.......... $ $ -- $ 2,476 $ (3) $ 2,476 $ (3) 91-180........ 3,429 (212) -- -- 3,429 (212) 181-270....... 1,200 (241) -- -- 1,200 (241) Greater than 360 1,474 (13) -- -- 1,474 (13) ----------- ----------- ------------- ---------- ------------ ------------ Total......... $ 6,103 $ (466) $ 2,476 $ (3) $ 8,579 $ (469) =========== =========== ============= ========== ============ ============ Six months ended June 30, 2002 -------------------------------------------------------------------------- Credit Concern Other Total ----------------------- ------------------------ ------------------------- Days Proceeds Loss Proceeds Loss Proceeds Loss ----------- ----------- ------------- ---------- ------------ ------------ (dollars in thousands) 0-90.......... $ 10,688 $ (587) $ 8,442 $ (38) $ 19,130 $ (625) 91-180........ 2,949 (199) 2,044 (45) 4,993 (244) Greater than 360 658 (98) -- -- 658 (98) ----------- ----------- ------------- ---------- ------------ ------------ Total......... $ 14,295 $ (884) $ 10,486 $ (83) $ 24,781 $ (967) =========== =========== ============= ========== ============ ============ 26 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations At December 31, 2002, we held unit-linked securities amounting to $16.5 million. These securities comprised investments in a unit trust denominated in British pounds. These securities were acquired as part of the purchase of World-Wide Holdings and were recorded at quoted market value. Changes in market value were recorded as net realized gains or losses. During the quarter ended June 30, 2003, we novated our liabilities on our unit-linked contracts as discussed in "Claims and Other Policy Benefits". The liabilities were settled by transferring a portion of the unit-linked securities to the original ceding company. The remaining unit-linked securities were sold realizing a gain of $0.3 million during the quarter. During the quarter ended June 30, 2002 and the six month periods ended June 30, 2003 and 2002, changes in market value of those securities of $0.3 million, $0.9 million and $2.4 million, respectively, were recognized as realized losses. Claims and other policy benefits Claims and other policy benefits increased by 146% to $65.7 million in the three month period ended June 30, 2003 in comparison with $26.7 million in the prior year period. Claims and other policy benefits increased by 115% to $108.6 million in the six month period ended June 30, 2003 in comparison with $50.5 million in the prior year period. Claims and other policy benefits in our Life Reinsurance North America segment increased by 144% to $42.8 million in the three month period ended June 30, 2003 from $17.5 million in the same quarter in 2002. Claims and other policy benefits in our Reinsurance North America segment increased by 118% to $72.2 million in the six month period ended June 30, 2003 from $33.1 million in the same quarter in 2002. The increase is as a result of the increased number of clients and the increase in our traditional solutions business from these clients in our Life Reinsurance North America operations as previously described. Death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to fluctuation from quarter to quarter. Claims and other policy benefits in our Life Reinsurance International segment increased by 150% to $22.9 million in the three month period ended June 30, 2003 from $9.1 million in the same quarter in 2002. Claims and other policy benefits in our Life Reinsurance International segment increased by 109% to $36.3 million in the six month period ended June 30, 2003 from $17.4 million in the same quarter in 2002. The increase is a result of the increased volume of business, as previously described, together with the acquisition of an in-force block of business with effect from October 2002 on which claims amounted to $4.9 million for the quarter and $6.7 million during the first six months of 2003. Our targeted maximum corporate retention in our Life Reinsurance North America segment operations on any one life is $1 million, however, we currently retrocede any liability in excess of $500,000. Our maximum retention per life in our Life Reinsurance International segment is $250,000. We have also arranged catastrophe cover, which provides reinsurance for losses of approximately $11.0 million in excess of $1.0 million. This catastrophe cover provides protection for terrorism, nuclear, biological and chemical risks. During the quarter ended June 30, 2003, we entered into an agreement to novate our unit-linked liabilities. The outstanding liabilities were settled by transferring an agreed number of unit-linked securities to the counter-party to the novation agreement. The settlement was less than the liability previously recorded at March 31, 2003 of $15.5 million and therefore resulted in a release of liabilities of $3.4 million. 27 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Interest credited to interest sensitive contract liabilities For the three months ended June 30, 2003, interest credited to interest sensitive contract liabilities increased by $5.6 million or 50% to $16.9 million from $11.2 million in the same period in 2002. For the six months ended June 30, 2003, interest credited to interest sensitive contract liabilities increased by $12.4 million or 61% to $32.8 million from $20.4 million in the same period in 2002. Interest credited includes interest in respect of a funding agreement for $100 million that we wrote in June 2002. The amount due on this funding agreement is included in interest sensitive contract liabilities on our balance sheet. The remaining increase is due to interest credited on new 2002 reinsurance treaties and increases in interest credited on treaties, which commenced in prior years, due to increasing average liability balances. Interest sensitive contract liabilities amounted to $1.9 billion in comparison with $1.1 billion at June 30, 2002. Acquisition costs and other insurance expenses During the three month period ended June 30, 2003, acquisition costs and other insurance expenses increased by $15.9 million or 132% to $27.9 million from $12.0 million in the same period in 2002. During the six month period ended June 30, 2003, acquisition costs and other insurance expenses increased by $25.7 million or 112% to $48.5 million from $22.9 million in the same period in 2002. The increase was a result of the increased life and annuity business in our Life Reinsurance North America segment and, as discussed above, the acquisition of the block of business in our Life Reinsurance International segment with effect from October 2002 which added $1.9 million for the current quarter and $3.5 million during the first six months of 2003 to acquisition expenses. The increase was also a result of growth in the other business lines in our Life Reinsurance International segment, as described above. Acquisition costs also includes the amortization of the present value of in-force business. As a result of the novation of the unit linked contract liabilities (as described in "Claims and Other Policy Benefits") the present value of the in-force on this business was fully amortized during the current quarter resulting in an additional charge of $1.9 million. The components of these expenses are as follows: Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Commissions, excise taxes & other insurance expenses.......... $ 54,006 $ 30,363 $ 91,286 $ 57,881 Deferral of expenses.............. (41,147) (27,028) (67,929) (49,688) ------------- ------------- ------------- ------------- 12,858 3,335 23,357 8,193 Amortization - Present value of in-force business.............. 2,572 359 3,595 1,080 Amortization -- Deferred acquisition costs................. 12,454 8,346 21,587 13,596 ------------- ------------- ------------- ------------- Total............................. $ 27,884 $ 12,040 $ 48,539 $ 22,869 ============= ============= ============= ============= Commissions and excise taxes vary with premiums earned. Other insurance expenses include direct and indirect expenses of those departments involved in the marketing, underwriting and issuing of reinsurance treaties. Of these total expenses a portion is deferred and amortized over the life of the reinsurance treaty or, in the case of interest sensitive contracts, in relation to the estimated gross profit in respect of the contracts. 28 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations The analysis of acquisition costs and other insurance expenses by segment is as follows: Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Life Reinsurance - North America.... $19,815 $10,952 $34,267 $19,675 - International.... 7,690 139 13,221 1,674 Wealth Management..................... 379 949 1,051 1,513 Other................................. - - - 7 ------------- ------------- ------------- ------------- Total................................. $27,884 $12,040 $48,539 $22,869 ============= ============= ============= ============= Operating expenses Operating expenses increased to $8.1 million for the second quarter of 2003 compared to $6.2 million in the second quarter of 2002. Operating expenses increased to $16.0 million for the first six months of 2003 compared to $10.2 million for the first six months in 2002. The split of these expenses between segments is as follows: Three months Three months Six months Six months ended ended ended ended June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002 ------------- ------------- ------------- ------------- Life Reinsurance - North America...... $2,372 $1,772 $ 4,415 $ 2,697 - International...... 3,292 1,767 5,840 3,454 Wealth Management..................... 193 377 355 587 Other................................. 2,291 2,320 5,403 3,415 ------------- ------------- ------------- ------------- Total................................. $8,148 $6,236 $16,013 $10,153 ============= ============= ============= ============= The increase in operating expenses is due to increased personnel and other costs as we continued to grow our business. During 2002 and the first quarter of 2003, we continued to complete the staffing of our principal office in Bermuda. Total employees in our operations, including World-Wide, have grown from 102 at June 30, 2002 to 137 at June 30, 2003. The number of employees in our Life Reinsurance International segment has grown from 38 at June 30, 2002 to 54 at June 30, 2003. This growth has resulted in additional costs for office running expenses. In 2003, we have experienced increased compensation costs for our Board of Directors, increased legal and professional fees arising as a result of corporate governance legislation, and have also incurred additional costs for director's and officers insurance. Our operations are geographically diverse with offices in Bermuda, the Cayman Islands, Charlotte, Dallas, Dublin and Windsor. With the growth of our business operations, we have incurred additional travel, technology and communication expenses. Interest expense We incurred interest expense of $1.9 million during the second quarter of 2003 in comparison with $0.1 million during the second quarter of 2002. We incurred interest expense of $3.7 million during the first six months of 2003 in comparison with $0.5 million during the same period in 2002. Interest expense this quarter comprises of interest on the $115.0 million of convertible debt issued in November 2002 and the $17.5 million capital securities issued in December 2002. Interest expense in the first six months of 2002 was in respect of borrowings under our credit facility. These borrowings were repaid in April 2002. 29 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Condition Investments At June 30, 2003, the portfolio controlled by us consisted of $1.5 billion of traded fixed income securities, traded preferred stock and cash. Of this total, $1.4 billion represented the fixed income and preferred stock portfolios managed by external investment managers and $109.0 million represented other cash balances. At June 30, 2003, the average Standard & Poor's rating of that portfolio was "A+", the average effective duration was 3.47 years and the average book yield was 4.88% as compared with an average rating of "AA-", an average effective duration 3.03 years and an average book yield of 4.93 % at December 31, 2002. At June 30, 2003, the unrealized appreciation on investments, net of tax, was $28.4 million as compared with $8.9 million at December 31, 2002. The unrealized appreciation on investments is included in our consolidated balance sheet as part of shareholders' equity. At December 31, 2002, the portfolio controlled by us consisted of $1.1 billion of traded fixed income securities and cash. Of this total, $1.0 billion represented the fixed income portfolio managed by external investment managers, and $131.0 million represented other cash balances. In the table below are the total returns earned by our portfolio for the six months ended June 30, 2003, compared to the returns earned by three indices: the Lehman Brothers Global Bond Index, the S&P 500, and a customized index that we developed with General Re New England Asset Management ("NEAM"), an external investment manager, to take into account our investment guidelines. We believe that this customized index is a more relevant benchmark for our portfolio's performance. June 30, 2003 ------------- Portfolio performance............................. 3.66% Customized index.................................. 3.76% Lehman Brothers Global Bond Index................. 5.13% S&P 500........................................... 11.76% The following table presents the investment portfolio (market value) credit exposure by category as assigned by Standard & Poor's. June 30, 2003 December 31, 2002 -------------------- ----------------------- Ratings $ in $ in millions % millions % --------- --------- --------- --------- AAA............................................. $ 441.5 30.4% $ 405.7 35.8% AA.............................................. 156.6 10.8 113.4 10.0 A............................................... 443.6 30.6 335.3 29.5 BBB............................................. 384.1 26.5 252.4 22.2 BB or below..................................... 25.1 1.7 28.1 2.5 --------- --------- --------- --------- Total........................................... $ 1,450.9 100.0% $ 1,134.9 100.0% ========= ========= ========= ========= 30 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table illustrates the investment portfolio (market value) sector exposure. June 30, 2003 December 31, 2002 -------------------- ----------------------- Sector $ in $ in millions % millions % --------- --------- --------- --------- U.S. Treasury securities and U.S. government agency obligations.......................... $ 9.2 0.6% $ 13.8 1.3% Corporate securities............................ 727.2 50.1 549.9 48.5 Municipal bonds................................. 3.0 0.2 1.7 0.1 Mortgage and asset backed securities............ 552.8 38.1 438.5 38.6 --------- --------- --------- --------- 1,292.2 89.0 1,003.9 88.5 Preferred stock................................. 49.7 3.5 - - Cash............................................ 109.0 7.5 131.0 11.5 --------- --------- --------- --------- Total........................................... $ 1,450.9 100.0% $ 1,134.9 100.0% ========= ========= ========= ========= The data in the tables above excludes unit-linked securities and assets held by ceding insurers under modified coinsurance agreements. At June 30, 2003, our investment portfolio had 991 securities and $14.0 million of gross unrealized losses. No single position had an unrealized loss greater than $1.8 million. There were $53.3 million of unrealized gains on the remainder of the portfolio. At December 31, 2002, our investment portfolio had 617 securities and $16.1 million of gross unrealized losses. No single position had an unrealized loss greater than $1.3 million. The composition by category of securities that have an unrealized loss at June 30, 2003 and December 31, 2002 are presented in the tables below. June 30, 2003 ------------------------------------------------------ Estimated Unrealized Fair Value % Loss % ---------- ---------- ---------- --------- Dollars in thousands Corporate securities.......................... $ 43,008 18.9% $ (2,468) 17.6% Municipal bonds............................... 1,441 0.6% (158) 1.1% Collateralized mortgage obligations........... 48,087 21.2% (473) 3.4% Mortgage backed securities.................... 14,539 6.4% (59) 0.4% Other structured securities................... 111,637 49.1% (10,766) 76.7% Preferred stock............................... 8,591 3.8% (116) 0.8% ----------- ---------- ----------- --------- $ 227,303 100.0% $ (14,040) 100.0% =========== ========== =========== ========= December 31, 2002 ------------------------------------------------------ Estimated Unrealized Fair Value % Loss % ---------- ---------- ---------- --------- Dollars in thousands Corporate securities.......................... $ 68,503 34.7% $ (5,323) 33.0% Municipal bonds............................... 1,658 0.8 (1) -- Collateralized mortgage obligations........... 22,896 11.6 (608) 3.7 Other structured securities................... 104,453 52.9 (10,213) 63.3 ----------- ---------- ----------- --------- $ 197,510 100.0% $ (16,145) 100.0% =========== ========== =========== ========= 31 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations At June 30, 2003, there were 162 securities with unrealized loss positions with two securities having losses greater than $1 million. These two securities were securitized assets and were tested for impairment under EITF Issue No. 99-20. At June 30, 2003, both securities satisfied the impairment tests of EITF 99-20. At December 31, 2002, there were 114 securities with unrealized loss positions with one security having an unrealized loss greater than $1 million. This was also a securitized asset, was tested for impairment under EITF Issue No. 99-20 and satisfied the impairment tests at December 31, 2002. The following tables provide information on the length of time securities have been continuously in an unrealized loss position: June 30, 2003 ------------------------------------------------------------------------------- Estimated Unrealized Days Book Value % Fair Value % Loss % ---- ------------ --------- ---------- --------- ---------- -------- Dollars in thousands 0-90.................. $ 105,392 46.4% $ 103,905 48.7% $ (1,487) 10.6% 91-180................ 35,590 15.6% 34,735 16.3 (855) 6.1 181-270............... 9,296 4.1% 7,315 3.4 (1,981) 14.1 271-360............... 36,101 15.9% 32,963 15.5 (3,138) 22.4 Greater than 360...... 40,924 18.0% 34,345 16.1 (6,579) 46.8 ---------- --------- ---------- --------- ---------- -------- Total................. $ 227,303 100.0% $ 213,263 100.0% $ (14,040) 100.0% ========== ========= ========== ========= ========== ======== December 31, 2002 ------------------------------------------------------------------------------- Estimated Unrealized Days Book Value % Fair Value % Loss % ---- ------------ --------- ---------- --------- ---------- -------- Dollars in thousands 0-90.................. $ 81,724 38.3% $ 79,557 40.3% $ (2,167) 13.4% 91-180................ 53,663 25.1 50,082 25.4 (3,581) 22.2 181-270............... 21,621 10.1 17,759 9.0 (3,862) 23.9 271-360............... 7,227 3.4 6,212 3.1 (1,015) 6.3 Greater than 360...... 49,420 23.1 43,900 22.2 (5,520) 34.2 ---------- --------- ---------- --------- ---------- -------- Total................. $ 213,655 100.0% $ 197,510 100.0% $ (16,145) 100.0% ========== ========= ========== ========= ========== ======== Unrealized losses on securities that have been in an unrealized loss position for periods greater than 2 years amounted to $1.8 million and $1.3 million at June 30, 2003 and December 31, 2002, respectively. Unrealized losses on non-investment grade securities amounted to $4.5 million and $3.8 million at June 30, 2003 and December 31, 2002, respectively. Of these amounts non-investment grade securities with unrealized losses of $1.8 million at June 30, 2003 and $1.6 million at December 31, 2002 had been in an unrealized loss position for a period greater than one year, of which $215,000 at June 30, 2003 and $230,000 at December 31, 2002 had been in an unrealized loss position for periods greater than 2 years. At June 30, 2003, there were ten securities with fair values that traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months. The total unrealized loss on these securities amounted to $7.2 million and the largest unrealized loss position was $1.6 million. 32 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations At December 31, 2002, there were five securities with fair values that traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months. The total unrealized loss on these securities amounted to $1.1 million and the largest unrealized loss position was $0.5 million. The following tables illustrate the industry analysis of the unrealized losses at June 30, 2003 and December 31, 2002. June 30, 2003 -------------------------------------------------------------------------------- Amortized Estimated Unrealized Cost % Fair Value % Loss % ----------- --------- ------------ --------- ------------- -------- Industry Dollars in thousands Mortgage & asset backed securities............. $ 174,262 76.7% $ 162,964 76.4% $ (11,298) 80.5% Transportation............ 11,672 5.1 10,083 4.7 (1,589) 11.3 Banking................... 9,889 4.4 9,819 4.6 (70) 0.5 Insurance................. 5,176 2.3 5,121 2.4 (55) 0.4 Reits..................... 4,355 1.9 4,338 2.0 (17) 0.1 Other..................... 21,949 9.6 20,938 9.9 (1,011) 7.2 ----------- --------- ------------ --------- ------------- -------- Total..................... $ 227,303 100.0% $ 213,263 100.0% $ (14,040) 100.0% =========== ========= ============ ========= ============= ======== December 31, 2002 -------------------------------------------------------------------------------- Amortized Estimated Unrealized Cost % Fair Value % Loss % ----------- --------- ------------ --------- ------------- -------- Industry Dollars in thousands Mortgage & asset backed securities............. $ 139,830 65.5% $ 129,007 65.4% $ (10,823) 67.1% Finance companies......... 16,967 7.9 16,637 8.4 (330) 2.0 Transportation............ 9,936 4.7 7,286 3.7 (2,650) 16.4 Consumer cyclical......... 7,763 3.6 7,235 3.7 (528) 3.3 Electric.................. 7,130 3.3 6,767 3.4 (363) 2.2 Other..................... 32,029 15.0 30,578 15.4 (1,451) 9.0 ----------- --------- ------------ --------- ------------- -------- Total..................... $ 213,655 100.0% $ 197,510 100.0% $(16,145) 100.0% =========== ========= ============ ========= ============= ======== - ------------------- Other industries each represent less than 2% of estimated fair value. 33 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations The expected maturity dates of securities that have an unrealized loss at June 30, 2003 and December 31, 2002 are presented in the table below. June 30, 2003 -------------------------------------------------------------------------------- Amortized Estimated Unrealized Cost % Fair Value % Loss % ----------- --------- ------------ --------- ------------- -------- Maturity Dollars in thousands Due in one year or less............. $ 45,400 20.0% $ 44,263 20.8% (1,137) 8.1% Due in one through five years....... 112,976 49.7 105,776 49.6 (7,200) 51.3 Due in five through ten years....... 63,480 27.9 57,904 27.1 (5,576) 39.7 Due after ten years................. 5,447 2.4 5,320 2.5 (127) 0.9 ----------- --------- ------------ --------- ------------- -------- Total............................... $ 227,303 100.0% $ 213,263 100.0% $ (14,040) 100.0% =========== ========= ============ ========= ============= ======== December 31, 2002 ------------------------------------------------------------------------------- Book Estimated Unrealized Value % Fair Value % Loss % ----------- --------- ------------ --------- ------------- -------- Maturity Dollars in thousands Due in one year or less............. $ 20,532 9.6 $ 20,067 10.2% $ (465) 2.9% Due in one through five years....... 112,591 52.7 103,679 52.5 (8,912) 55.2 Due in five through ten years....... 69,330 32.5 63,753 32.3 (5,577) 34.5 Due after ten years................. 11,202 5.2 10,011 5.0 (1,191) 7.4 ----------- --------- ------------ --------- ------------- -------- Total............................... $ 213,655 100.0 $ 197,510 100.0% $ (16,145) 100.0% =========== ========= ============ ========= ============= ======== Funds withheld at interest Funds withheld at interest arise on contracts written under modified coinsurance agreements. In each case, the business reinsured consists of fixed deferred annuities. In substance, these agreements are identical to coinsurance treaties except that the ceding company retains control of and title to the assets. The deposits paid to the ceding company by the underlying policyholders are held in a segregated portfolio and managed by the ceding company or by investment managers appointed by the ceding company. These treaties transfer a quota share of the risks. The funds withheld at interest represent our share of the ceding companies' statutory reserves. The cash flows exchanged with each monthly settlement are netted and include, among other items, our quota share of investment income on our proportionate share of the portfolio, realized losses, realized gains (amortized to reflect the statutory rules relating to interest maintenance reserve), interest credited and expense allowances. At June 30, 2003, and December 31, 2002, we had four modified coinsurance arrangements with two ceding companies. We had three contracts with Lincoln National Insurance Company that accounted for $1.2 billion, which represented 98% of the funds withheld balances. The other contract is with Illinois Mutual Insurance Company. Lincoln National Insurance Company has financial strength ratings of "A+" from A.M. Best, "AA-" from Standard & Poor's, "Aa3" from Moody's and "AA" from Fitch. In the event of insolvency of the ceding companies on our modified coinsurance arrangements we would need to exert a claim on the assets supporting the contract liabilities. However, the risk of loss is mitigated by our ability to offset amounts owed to the ceding company with the amounts owed to us by the ceding company. 34 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Interest sensitive contract liabilities relating to the Lincoln National Insurance Company contracts amounted to $1.9 billion at June 30, 2003 and December 31, 2002. At June 30, 2003, funds withheld at interest totaled $1.2 billion with an average rating of "A-", an average effective duration of 5.23 years and an average book yield of 6.21% as compared with an average rating of "A-", an average effective duration of 5.4 years and an average book yield of 6.49% at December 31, 2002. These are fixed income investments associated with modified coinsurance transactions; they include marketable securities, commercial mortgages, private placements and cash. The market value of the funds withheld amounted to $1.3 billion at June 30, 2003. According to data provided by our ceding companies, the following table reflects the market value of assets backing the funds withheld at interest portfolio using the lowest rating assigned by the three major rating agencies. June 30, 2003 December 31, 2002 ------------------------- ------------------------ Ratings $ in millions % $ in millions % ------- ------------- ------- ------------- ------ AAA................................... $ 168.4 12.5% $ 114.0 9.8% AA.................................... 59.1 4.4 52.7 4.5 A..................................... 440.3 32.6 418.7 35.8 BBB................................... 498.0 36.9 425.9 36.5 BB or below........................... 57.3 4.3 44.7 3.8 ----------- ----------- ----------- ----------- Sub-total 1,223.1 90.7 1,056.0 90.4 Commercial mortgage loans............. 126.1 9.3 112.3 9.6 ----------- ----------- ----------- ----------- Total................................. $ 1,349.2 100.0% $ 1,168.3 100.0% =========== =========== =========== =========== According to data provided by our ceding companies, the following table reflects the market value of assets backing the funds withheld at interest portfolio by sector. June 30, 2003 December 31, 2002 -------------------------- -------------------------- Sector $ in millions % $ in millions % ------- ------------- ------- ------------- ------ U.S. Treasury securities and U.S. government agency obligations.... $ 14.3 1.1% $ 10.6 0.9% Corporate securities................ 921.8 68.3 822.2 70.4 Municipal bonds..................... 5.0 0.4 0.5 0.1 Mortgage and asset backed securities 243.2 18.0 213.1 18.2 ----------- ----------- ----------- ----------- 1,184.3 87.8 1,046.4 89.6 Commercial mortgage loans........... 126.1 9.3 112.3 9.6 Cash................................ 38.8 2.9 9.6 0.8 ----------- ----------- ----------- ----------- Total............................... $ 1,349.2 100.0% $ 1,168.3 100.0% =========== =========== =========== =========== Liquidity and Capital Resources Cash flow Cash provided by operating activities amounted to $35.5 million in the first six months of 2003 in comparison with cash flow of $9.2 million used in operating activities in the same period of 2002. Operating cash flow includes cash inflows from premiums, fees and investment income, and cash 35 outflows for benefits and expenses paid. In periods of growth of new business our operating cash flow may decrease due to first year commissions paid on new business generated. For income recognition purposes these commissions are deferred and amortized over the life of the business. The increase in operating cash flow from 2002 was primarily due to increases in premiums, fees, and investment income greater than increases in benefits and expenses paid. Reinsurance premiums and fees received increased by $49.5 million due to growth in business in our Life Reinsurance segment. Investment income received increased by $20.0 million due to the growth in our invested asset base. The increase was offset by declining yields. Benefits paid increased by $29.3 million due to the growth of business in our Life Reinsurance segments. Acquisition and other costs, including commissions, increased by $42.0 million. This increase related principally to new business written in our Life Reinsurance North America segments and increased operating expenses. Acquisition costs include commissions on first year business that are deferred when paid and therefore do not impact net income until later years. Our cash flow from operations may be positive or negative in any period depending on the amount of new life reinsurance business written, the level of ceding commissions paid in connection with writing that business and the level of renewal premiums earned in the period. Capital and collateral At June 30, 2003, total capitalization was $662.7 million compared to $623.6 million at December 31, 2002. Total capitalization includes long-term debt and is analyzed as follows: June 30, 2003 December 31, 2002 ------------------- ------------------- (dollars in thousands) Shareholder's equity................ $ 530,171 $ 491,092 Long-term debt...................... 132,500 132,500 ------------------- ------------------- Total $ 662,671 $ 623,592 =================== =================== The increase in capitalization is due to the net income for the six months ended June 30, 2003 of $15.1 million less dividends paid of $2.7 million and comprehensive income of $36.5 million. Comprehensive income consists of the unrealized depreciation on investments, the cumulative translation adjustment arising from the translation of World-Wide Holdings' balance sheet at exchange rates as of June 30, 2003 and a minimum pension liability adjustment. In April 2003, we filed and had declared effective a registration statement with the Securities and Exchange Commission utilizing a "shelf" registration process relating to a number of different types of debt and equity securities. This shelf enables us to sell securities described in the registration statement up to a total of $500.0 million. On July 23, 2003, we completed a public offering of 9,200,000 ordinary shares (which included an over-allotment option of 1,200,000 ordinary shares) at an offering price of $20.75 per share in which we raised aggregate net proceeds of $179.7 million ($19.66 per share after the underwriting discount). We have used $30.0 million of these proceeds to repurchase 1,525,000 ordinary shares from Pacific Life Insurance Company at a purchase price of $19.66 per share. Other expenses of the offering are expected to be approximately $1.2 million. The remainder of the proceeds will be used for general corporate purposes. The gross proceeds of this offering were $190.9 million and as a result $309.1 million remains of the shelf capacity. 36 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations During the six months ended June 30, 2003, we paid a quarterly dividend totaling $2.7 million or $0.10 per share. During 2002, we paid dividends totaling $5.0 million or $0.20 per share. During 2002, we arranged two secured credit facilities with U.S. banks totaling $100.0 million. Each of the credit facilities provides for a combination of borrowing and letters of credit of $50.0 million. These facilities expire in September 2003 but are renewable with the agreement of both parties. One of the facilities requires that Scottish Annuity & Life Insurance Company (Cayman) Ltd., which we refer to as SALIC, and World-Wide Reassurance maintain Standard & Poor's ratings of at least "A-" and that SALIC maintains shareholder's equity of at least $210.0 million. At June 30, 2003, SALIC and World-Wide Reassurance each had a Standard & Poor's rating of "A-" and SALIC's shareholder's equity was $497.5 million. The other facility requires that Scottish Annuity & Life maintain consolidated net worth of $375.0 million and a maximum debt to total capitalization ratio of 25%. At June 30, 2003, Scottish Annuity & Life's net worth was $530.2 million and the ratio of debt to total capitalization was 20%. Subsequent to the public offering of ordinary shares described above, the ratio of debt to total capitalization will be approximately 16%. Our failure to comply with the requirements of the credit facilities would, subject to grace periods, result in an event of default, and we could be required to repay any outstanding borrowings. At June 30, 2003, there were no borrowings under the facilities. Outstanding letters of credit under these facilities amounted to $27.6 million. We must have sufficient assets available for use as collateral to support borrowings, letters of credit, and certain reinsurance transactions. With these reinsurance transactions, the need for collateral or letters of credit arises in four ways: o when SALIC, Scottish Re (Dublin) Limited or World-Wide Reassurance enters into a reinsurance treaty with a U.S. customer, we must contribute assets into a reserve credit trust with a U.S. bank or issue a letter of credit in order that the ceding company may obtain reserve credit for the reinsurance transaction; o when Scottish Re (U.S.), Inc. enters into a reinsurance transaction, it typically incurs a need for additional statutory capital. This need can be met by its own capital surplus, an infusion of cash or assets from Scottish Annuity & Life or an affiliate or by ceding a portion of the transaction to another company within the group or an unrelated reinsurance company, in which case that reinsurer must provide reserve credit by contributing assets in a reserve credit trust or a letter of credit; o Scottish Re (U.S.), Inc. is licensed, accredited, approved or authorized to write reinsurance in 47 states and the District of Columbia. When Scottish Re (U.S.), Inc. enters into a reinsurance transaction with a customer domiciled in a state in which it is not a licensed, accredited, authorized or approved reinsurer, it likewise must provide a reserve credit trust or letter of credit; and o even when Scottish Re (U.S.), Inc. is licensed, accredited, approved or authorized to write reinsurance in a state, it may agree with a customer to provide a reserve credit trust or letter of credit voluntarily to mitigate the counter-party risk from the customer's perspective, thereby doing transactions that would be otherwise unavailable or would be available only on significantly less attractive terms. 37 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations SALIC has agreed with Scottish Re (U.S.), Inc. that it will (1) cause Scottish Re (U.S.), Inc. to maintain capital and surplus equal to the greater of $20.0 million or such amount necessary to prevent the occurrence of a Company Action Level Event under the risk-based capital laws of the state of Delaware and (2) provide Scottish Re (U.S.), Inc. with enough liquidity to meet its obligations in a timely manner. In addition, SALIC and Scottish Annuity & Life have agreed with World-Wide Reassurance that in the event World-Wide Reassurance is unable to meet its obligations under its insurance or reinsurance agreements, SALIC (or if SALIC cannot fulfill such obligations, then Scottish Annuity & Life) will assume all of World-Wide Reassurance's obligations under such agreements. Scottish Annuity & Life and SALIC have executed similar agreements for Scottish Re (Dublin) Limited and World-Wide Life Assurance S.A. and may, from time to time, execute additional agreements guaranteeing the performance and/or obligations of their subsidiaries. Our business is capital intensive. We expect that our cash and investments, together with cash generated from our businesses, will be sufficient to meet our current liquidity and letter of credit needs. However, if our business continues to grow significantly, we will need to raise additional capital. Off balance sheet arrangements We have no obligations, assets or liabilities other than those disclosed in the financial statements; no trading activities involving non-exchange traded contracts accounted for at fair value; and no relationships and transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties. Changes in Accounting Standards In December 2002, the Financial Accounting Standards Board issued SFAS No.148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123". In prior years, we applied the intrinsic value-based expense provisions set forth in ABP Opinion No. 25, "Accounting for Stock Issued to Employees". Effective January 1, 2003, we have prospectively adopted the fair value-based stock option expense provisions of SFAS No. 123 as amended by SFAS No. 148. This has resulted in a charge to income of $81,000 in the three and six month periods ended June 30, 2003. In May 2003, FASB approved for issuance a Statement of Position ("SOP"), "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Insurance Contracts and for Separate Accounts". This Statement of Position provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts and is effective for financial statements for fiscal years beginning after December 15, 2003. At the date of initial application of this SOP, we are required to make various determinations, such as qualification for separate account treatment, classification of securities in separate account arrangements, significance of mortality and morbidity risk, adjustments to contract holder liabilities, and adjustments to estimated gross profits as defined in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments". We do not believe the implementation of this SOP will have a material effect on our financial statements. The Derivative Implementation Group has released Statement 133 Implementation Issue No. 36, "Embedded Derivatives: Bifurcation of a Debt Instrument that Incorporates Both Interest Rate Risk and Credit Rate Risk Exposures that are Unrelated or Only Partially Related to the Creditworthiness of the 38 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Issuer of that Instrument" ("DIG B36"). DIG B36 addresses whether SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" requires bifurcation of a debt instrument into a debt host contract and an embedded derivative if the debt instrument incorporates both interest rate risk and credit risk exposures that are unrelated or only partially related to the creditworthiness of the issuer of that instrument. Under DIG B36 modified coinsurance reinsurance agreements where interest is determined by reference to a pool of fixed maturity assets are arrangements containing embedded derivatives requiring bifurcation. Our funds withheld at interest, which arise under modified coinsurance agreements are therefore considered to contain embedded derivatives requiring bifurcation. We are required to adopt DIG B36 in the quarter ending December 31, 2003. We have not yet determined the value of the related embedded derivatives in our funds withheld at interest. The market value of funds withheld at interest was $1.3 billion at June 30, 2003. Forward-Looking Statements Some of the statements contained in this report are not historical facts and are forward-looking within the meaning of the Private Securities Litigation Reform Act. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results to differ materially from the forward-looking statements. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates", "may", "will", "continue", "project", and similar expressions, as well as statements in the future tense, identify forward-looking statements. These forward-looking statements are not guarantees of our future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements. These risks and uncertainties include: o uncertainties relating to the ratings accorded to our insurance subsidiaries; o the risk that our risk analysis and underwriting may be inadequate; o exposure to mortality experience which differs from our assumptions; o risks arising from our investment strategy, including risks related to the market value of our investments, fluctuations in interest rates and our need for liquidity; o uncertainties arising from control of our invested assets by third parties; o developments in global financial markets that could affect our investment portfolio and fee income; o changes in the rate of policyholder withdrawals or recapture of reinsurance treaties; o the risk that our retrocessionaires may not honor their obligations to us; o terrorist attacks on the United States and the impact of such attacks on the economy in general and on our business in particular; o political and economic risks in developing countries; o the impact of acquisitions, including the ability to successfully integrate acquired businesses, the competing demands for our capital and the risk of undisclosed liabilities; 39 Scottish Annuity & Life Holdings, Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations o loss of the services of any of our key employees; o losses due to foreign currency exchange rate fluctuations; o uncertainties relating to government and regulatory policies (such as subjecting us to insurance regulation or taxation in additional jurisdictions); o the competitive environment in which we operate and associated pricing pressures; and o changes in accounting principles. The effects of these factors are difficult to predict. New factors emerge from time to time and we cannot assess the financial impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward looking statement. Any forward looking statement speaks only as of the date of this report and we do not undertake any obligation, other than as may be required under the Federal securities laws, to update any forward looking statements to reflect events or circumstances after the date of such statement or to reflect the occurrence of unanticipated events. Risk Factors of Investing in Our Ordinary Shares Investing in our ordinary shares involves a high degree of risk. Prior to investing in the ordinary shares, potential investors should consider carefully the risk factors set forth in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, in addition to the other information set forth in this Form 10-Q. 40 Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes since December 31, 2002. Please refer to "Item 7A: Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report on Form 10-K. Item 4. Disclosure Controls and Procedures Evaluation of disclosure controls and procedures. Based on their evaluation as of June 30, 2003, our principal executive officers and principal financial officer have concluded that Scottish Annuity & Life's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities and Exchange Act of 1934 (the "Exchange Act")) are effective to ensure that information required to be disclosed by Scottish Annuity & Life in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Changes in internal controls. There have been no significant changes in internal control over financial reporting that occurred during the quarter ended June 30, 2003 that have materially affected, or are reasonably likely to materially affect, Scottish Annuity & Life's internal control over financial reporting. 41 PART II. OTHER INFORMATION Item 1. Legal Proceedings The Company is not currently involved in any material litigation or arbitration. Item 2. Changes in Securities and Use of Proceeds On July 17, 2003, the Company completed a public offering of 9,200,000 ordinary shares (Commission File Number 333-104545), which included an over-allotment option of 1,200,000 ordinary shares, for an aggregate offering price of $190.9 million. After deducting estimated expenses of $11.2 million, the Company raised aggregate net proceeds of $179.7 million. The managing underwriters were Bear, Stearns & Co. Inc., UBS Investment Bank, A.G. Edwards & Sons, Inc, Keefe Bruyette & Woods, Inc and Putnam Lovell NBF Securities Inc. The Company used the proceeds of the offering to repurchase 1,525,000 shares, from Pacific Life Insurance Company, and will use the remainder for general corporate purposes. Item 3. Defaults Upon Senior Securities Not applicable. 42 Item 4. Submission of Matters to a Vote of Securities Holders The 2003 Annual Meeting of Shareholders of the Company was held on May 5, 2003. The following items of business were presented to the shareholders of the Company (the "Shareholders"): Election of Directors The results of the vote of the Shareholders with respect to the three Class II Directors were elected as proposed in the Proxy Statement dated April 2, 2003 under the caption titled "Proposal for Election of Directors" were as follows: Total Vote Total Vote For Withheld From Name Each Director Each Director Class II Directors Michael Austin 22,642,133 16,500 Lord Norman Lamont 22,642,133 16,500 Scott E. Willkomm 22,620,083 38,550 43 Ratification of Independent Auditors The Board of Directors has selected, based upon the recommendation of the Audit Committee, Ernst & Young, as the independent auditors for the Company for the fiscal year ending December 31, 2003. The results of the vote of the Shareholders with respect to this selection were as follows: For: 22,432,236 Against: 223,287 Abstain: 3,110 Item 5. Other Information Not applicable. Item 6. Exhibits and Reports on Form 8-K A. Exhibits Except as otherwise indicated, the following Exhibits are filed herewith and made a part hereof: 3.1 Memorandum of Association of Scottish Annuity & Life, as amended as of December 14, 2001 (incorporated herein by reference to Scottish Annuity & Life's Current Report on Form 8-K/A).(6) 3.2 Articles of Association of Scottish Annuity & Life, as amended as of May 2, 2002 (incorporated herein by reference to Scottish Annuity & Life's Current Report on Form 8-K filed with the SEC on April 14, 2003). 4.1 Specimen Ordinary Share Certificate (incorporated herein by reference to Exhibit 4.1 to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 4.2 Form of Amended and Restated Class A Warrant (incorporated herein by reference to Exhibit 4.2 to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 4.3 Form of Amended and Restated Class B Warrant (incorporated herein by reference to Exhibit 4.3 to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 44 4.4 Form of Securities Purchase Agreement for the Class A Warrants (incorporated herein by reference to Exhibit 4.4 to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 4.5 Form of Warrant Purchase Agreement for the Class B Warrants (incorporated herein by reference to Exhibit 4.5 to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 4.6 Form of Securities Purchase Agreement between Scottish Annuity & Life and the Shareholder Investors (incorporated herein by reference to Exhibit 4.10 to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 4.7 Form of Securities Purchase Agreement between Scottish Annuity & Life and the Non-Shareholder Investors (incorporated herein by reference to Exhibit to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 10.1 Employment Agreement dated June 18, 1998 between Scottish Annuity & Life and Michael C. French (incorporated herein by reference to Exhibit 10.1 to Scottish Annuity & Life's Registration Statement on Form S-1).(1)(10) 10.2 Second Amended and Restated 1998 Stock Option Plan effective October 22, 1998 (incorporated herein by reference to Exhibit 10.3 to Scottish Annuity & Life's Registration Statement on Form S-1).(1)(10) 10.3 Form of Stock Option Agreement in connection with 1998 Stock Option Plan (incorporated herein by reference to Exhibit 10.4 to Scottish Annuity & Life's Registration Statement on Form S-1).(1)(10) 10.4 Investment Management Agreement dated October 22, 1998 between Scottish Annuity & Life and General Re-New England Asset Management, Inc. (incorporated herein by reference to Exhibit 10.14 to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 10.5 Form of Omnibus Registration Rights Agreement (incorporated herein by reference to Exhibit 10.17 to Scottish Annuity & Life's Registration Statement on Form S-1).(1) 10.6 1999 Stock Option Plan (incorporated herein by reference to Exhibit 10.14 to Scottish Annuity & Life's 1999 Annual Report on Form 10-K).(2)(10) 10.7 Form of Stock Options Agreement in connection with 1999 Stock Option Plan (incorporated herein by reference to Exhibit 10.15 to Scottish Annuity & Life's 1999 Annual Report on Form 10-K).(2)(10) 10.8 Employment Agreement dated September 18, 2000 between Scottish Annuity & Life and Oscar R. Scofield (incorporated herein by reference to Exhibit 10.16 to Scottish Annuity & Life's 2000 Annual Report on Form 10-K).(3)(10) 45 10.9 Share Purchase Agreement by and between Scottish Annuity & Life and Pacific Life dated August 6, 2001 (incorporated by reference to Scottish Annuity & Life's Current Report on Form 8-K).(7) 10.10 Amendment No. 1, dated November 8, 2001, to Share Purchase Agreement dated August 6, 2001 by and between Scottish Annuity & Life and Pacific Life (incorporated by reference to the Company's Current Report on Form 8-K).(5) 10.11 2001 Stock Option Plan (incorporated herein by reference to Exhibit 10.17 to Scottish Annuity & Life's 2001 Annual Report on Form 10-K). (4)(10) 10.12 Form of Nonqualified Stock Option Agreement in connection with 2001 Stock Option Plan. (incorporated herein by reference to Exhibit 10.17 to Scottish Annuity & Life's 2001 Annual Report on Form 10-K). (4)(10) 10.13 Service Agreement dated December 31, 2001 between World-Wide Holdings, Paul Andrew Bispham and Scottish Annuity & Life.(4)(10) 10.14 Registration Rights Agreement dated December 31, 2001 between Scottish Annuity & Life and Pacific Life (incorporated by reference to Scottish Annuity & Life's Current Report on Form 8-K).(5) 10.15 Stockholder Agreement dated December 31, 2001 between Scottish Annuity & Life and Pacific Life (incorporated by reference to Scottish Annuity & Life's Current Report on Form 8-K).(5) 10.16 Tax Deed of Covenant dated December 31, 2001 between Scottish Annuity & Life and Pacific Life (incorporated by reference to Scottish Annuity & Life's Current Report on Form 8-K).(5) 10.17 Letter Agreement dated December 28, 2001 between Scottish Annuity & Life and Pacific Life (incorporated by reference to Scottish Annuity & Life's Current Report on Form 8-K).(5) 10.18 Form of Indemnification Agreement between Scottish Annuity & Life and each of its directors and officers (incorporated by reference to Scottish Annuity & Life's Amended Quarterly Report on Form 10-Q/A for the period ended June 30, 2002).(8)(10) 10.19 Employment Agreement dated July 1, 2002 between Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Thomas A. McAvity, Jr. (incorporated by reference to Scottish Annuity & Life's Amended Quarterly Report on Form 10-Q/A for the period ended June 30, 2002).(8)(10) 10.20 Employment Agreement dated June 3, 2002 between Scottish Re (U.S.), Inc. and J. Clay Moye, III (incorporated by reference to Scottish Annuity & Life's Amended Quarterly Report on Form 10-Q/A for the period ended June 30, 2002).(8)(10) 10.21 Employment Agreement dated June 1, 2002 between Scottish Annuity & Life and Elizabeth Murphy (incorporated by reference to Scottish Annuity & Life's Amended Quarterly Report on Form 10-Q/A for the period ended June 30, 2002).(8)(10) 46 10.22 Employment Agreement dated June 1, 2002 between Scottish Annuity & Life and Clifford J. Wagner (incorporated by reference to Scottish Annuity & Life's Amended Quarterly Report on Form 10-Q/A for the period ended June 30, 2002).(8)(10) 10.23 Employment Agreement dated July 8, 2002 between Scottish Annuity & Life and Scott E. Willkomm (incorporated by reference to Scottish Annuity & Life's Amended Quarterly Report on Form 10-Q/A for the period ended June 30, 2002).(8)(10) 10.24 Employment Agreement dated February 10, 2003 between Scottish Annuity & Life and Michael C. French. (10) 10.25 Employment Agreement dated February 10, 2003 between Scottish Re (U.S), Inc. and Oscar R. Scofield. (10) 10.26 Amended employment Agreement dated February 10, 2003 between Scottish Annuity & Life and Thomas A. McAvity. (10) 10.27 Indenture, dated November 22, 2002, between Scottish Annuity & Life and The Bank of New York (incorporated herein by reference to Scottish Annuity & Life's Registration Statement on Form S-3). (9) 10.28 Registration Rights Agreement, dated November 22, 2002, between Scottish Annuity & Life and Bear Stearns & Co. and Putnam Lovell Securities Inc. (incorporated herein by reference to Scottish Annuity & Life's Registration Statement on Form S-3). (9) 10.29 Employment Agreement dated May 1, 2003 between World-Wide Holdings Ltd. and David Huntley. (10) 10.30 Share Purchase Agreement dated July 3, 2003 by and between Scottish Annuity & Life and Pacific Life Insurance Company (incorporated herein by reference to Scottish Annuity & Life's Current Report on Form 8-K filed with the SEC on July 8, 2003). 23.1 Consent of Ernst & Young LLP. 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.3 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.3 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ----------------------- (1) Scottish Annuity & Life's Registration Statement on Form S-1 was filed with the SEC on June 19, 1998, as amended. (2) Scottish Annuity & Life's 1999 Annual Report on Form 10-K was filed with the SEC on April 3, 2000. 47 (3) Scottish Annuity & Life's 2000 Annual Report on Form 10-K was filed with the SEC on March 30, 2001. (4) Scottish Annuity & Life's 2001 Annual Report on Form 10-K was filed with the SEC on March 5, 2002. (5) Scottish Annuity & Life's Current Report on Form 8-K was filed with the SEC on December 31, 2001. (6) Scottish Annuity & Life's Current Report on Form 8-K/A was filed with the SEC on January 11, 2002. (7) Scottish Annuity & Life's Current Report on Form 8-K was filed with the SEC on August 9, 2001. (8) Scottish Annuity & Life's Amended Quarterly Report on Form 10-Q/A was filed with the SEC on August 8, 2002. (9) Scottish Annuity & Life's Registration Statement on Form S-3 was filed with the SEC on January 31, 2003, as amended. (10) This exhibit is a management contract or compensatory plan or arrangement. B. Reports on Form 8-K The following reports on Form 8-K were filed during the three month period ended June 30, 2003. The Company filed a report on Form 8-K on April 14, 2003 to file under Item 5 (Other Events) the current text of Scottish Annuity & Life's Articles of Association. The Company filed a report on Form 8-K on May 7, 2003 to report under Item 12 (Results of Operations and Financial Condition) that the Company had issued on May 7, 2003 a press release announcing its second quarter earnings. 48 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SCOTTISH ANNUITY & LIFE HOLDINGS, LTD. Date: August 12, 2003 By: /s/ Scott E. Willkomm Scott E. Willkomm President Date: August 12, 2003 By: /s/ Michael C. French Michael C. French Chief Executive Officer Date: August 12, 2003 By: /s/ Elizabeth A. Murphy Elizabeth A. Murphy Chief Financial Officer 49