FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2008

o 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 : 001-31911

American Equity Investment Life Holding Company

(Exact name of registrant as specified in its charter)

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

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1

Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x     No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes o     No x

APPLICABLE TO CORPORATE ISSUERS:

Shares of common stock outstanding at April 30, 2008: 54,604,272

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS (Continued)
(Dollars in thousands, except per share data)

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollars in thousands, except per share data)

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Dollars in thousands)

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2008

(Unaudited)

1. Organization and Significant Accounting Policies

Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements of American Equity Investment Life Holding Company (the Company) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all the information and notes required by GAAP for complete financial statements.  The unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly the Company’s financial position and results of operations on a basis consistent with the prior audited consolidated financial statements.  Operating results for the three months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the year ended December 31, 2008.  All significant intercompany accounts and transactions have been eliminated.  The preparation of financial statements requires the use of management estimates.  For further information related to a description of areas of judgment and estimates and other information necessary to understand the Company’s financial position and results of operations, refer to the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

Reclassifications

Certain amounts in the unaudited consolidated financial statements for the period ended March 31, 2007 have been reclassified to conform to the financial statement presentation for the period ended March 31, 2008.

Adopted Accounting Pronouncements

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115 (“SFAS 159”).  SFAS 159 permits entities to choose, at specified election dates, to measure eligible financial instruments and certain other items at fair value that are not currently required to be reported at fair value.  There was no impact on the unaudited consolidated financial statements upon the adoption of SFAS 159 as the Company did not elect to report any assets or liabilities at fair value that were not currently reported at such.

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements.  SFAS 157 also provides guidance regarding the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings.  For assets and liabilities that are measured at fair value on a recurring basis in periods subsequent to initial recognition, the reporting entity shall disclose information that enables financial statement users to assess the inputs used to develop those measurements.  For recurring fair value measurements using significant unobservable inputs, the reporting entity shall disclose the effect of the measurements on earnings for the period.  SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.  The adoption of SFAS 157 resulted in a change prospectively beginning on January 1, 2008 in the discount rates used in the calculation of the fair values of the embedded derivative component of the Company’s policy benefit reserves from risk-free rates to discount rates that include non performance risk related to those liabilities.  This change resulted in an increase in net income of $40.7 million for the three months ended March 31, 2008.

New Accounting Pronouncements

In March 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement 133 (“SFAS 161”).  SFAS 161 enhances required disclosures regarding derivatives and hedging activities, including enhanced disclosures regarding how an entity uses derivative instruments and how derivative instruments and related hedged items are accounted for and affect an entity’s financial position, financial performance, and cash flows.  SFAS 161 is effective for fiscal years beginning after November 15, 2008.  Adoption of SFAS 161 as of January 1, 2009 will not have a material impact on the Company’s financial position or results of operations as it impacts financial statement disclosure only.

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2. Fair Values of Financial Instruments

SFAS 157 requires companies to expand disclosures associated with fair value measurements and to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  SFAS 157 provides a hierarchy for valuation inputs in which assets and liabilities measured at fair value must be disclosed.  Accordingly, the Company groups financial assets and financial liabilities measured at fair value in the following categories:

Level 1 - Quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.

Level 2 - Quoted prices in active markets for similar assets and liabilities; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs other than quoted prices that are observable.

Level 3 - Significant inputs that are unobservable for assets or liabilities.

The following valuation techniques were used by the Company in estimating the fair values of financial instruments:

Fixed maturity and equity securities, available for sale: Quoted market prices from third parties for identical securities in active markets when available.  Quoted market prices from third parties for similar securities in active markets when identical security quotes are not available.  Quoted market prices from third parties for identical or similar securities in markets that are not active when active market prices are not available.

Derivative instruments: Quoted market prices from counterparties adjusted for credit risk of the counterparty as applicable.

Cash and cash equivalents: Amounts reported for these instruments are historical cost which approximates their fair value.

Embedded derivatives: Amounts reported are estimated by projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and discounting the excess of the projected contract value amounts.  The projections of the policy contract values are based on best estimate assumptions for future policy growth and future policy decrements.  Best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options that will be purchased in the future to fund index credits beyond the next policy anniversary.  The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.  Increases or decreases in the fair value of embedded derivatives generally correspond to increases or decreases in the fair values of call options purchased to fund the annual index credits and changes in the discount rates used to discount the excess of the projected policy contract values over the projected minimum guaranteed contract values.  The discount rates are based on risk-free rates adjusted for the non performance risk of the Company.

The Company’s assets and liabilities which are measured at fair value on a recurring basis as of March 31, 2008 are presented below based on the fair value hierarchy levels:

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The following table provides a reconciliation of the beginning and ending balances for the Company’s Level 3 liabilities, consisting of embedded derivatives, which are measured at fair value on a recurring basis using significant unobservable inputs from December 31, 2007 to March 31, 2008:

Change in unrealized gains, net of $284.7 million, are included in change in fair value of embedded derivatives in the unaudited consolidated statement of income.

3. Contingencies

In recent years, companies in the life insurance and annuity business have faced litigation, including class action lawsuits, alleging improper product design, improper sales practices and similar claims.  The Company is currently a defendant in several purported class action lawsuits alleging improper sales practices and similar claims as described below.  It is often not possible to determine the ultimate outcome of pending legal proceedings or to provide reasonable ranges of potential losses with any degree of certainty.  The lawsuits referred to below are in very preliminary stages and the Company does not have sufficient information to make an assessment of the plaintiffs’ claims for liability or damages nor has the court decided whether a class will be certified or the size of the class and class period.  The plaintiffs are seeking undefined amounts of damages or other relief, including punitive damages, which are difficult to quantify and cannot be estimated based on the information currently available.  The Company does not believe that these lawsuits will have a material adverse effect on its financial position, results of operations or cash flows.  However, there can be no assurance that such litigation, or any future litigation, will not have a material adverse effect on the Company’s business, financial condition, or results of operations.

The Company is a defendant in two cases seeking class action status, including (i) Stephens v. American Equity Investment Life Insurance Company, et. al., in the San Luis Obispo Superior Court, San Francisco, California (complaint filed November 29, 2004) (the “SLO Case”) and (ii) In Re: American Equity Annuity Practices and Sales Litigation, in the United States District Court for the Central District of California, Western Division (complaint filed September 7, 2005) (the “Los Angeles Case”).  The plaintiff in the SLO Case seeks to represent a national class of individuals who either purchased their annuity from the Company through a co-defendant marketing organization or who purchased one of a defined set of particular annuities issued by the Company.  The Company has filed its opposition to a motion to certify the class, and the hearing on the motion began on March  18, 2008 but was not completed.  The hearing is scheduled to resume on May 16, 2008.  The Company is vigorously defending both the issue of class action status of the lawsuit as well as the underlying allegations, which include misrepresentation, breach of contract, breach of a state law regarding unfair competition and other claims.

The Los Angeles Case is a consolidated action involving several lawsuits filed by individuals and is seeking class action status for a national class of purchasers of annuities issued by the Company.  The allegations generally attach the suitability of sales of deferred annuity products to persons over the age of 65.  The Company is vigorously defending against both class action status as well as the underlying claims which include misrepresentation and violations of the Racketeer Influenced and Corrupt Organizations Act, among others.

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4. Earnings Per Share

The following table sets forth the computation of earnings per common share and earnings per common share - assuming dilution:

(1) Weighted average common shares outstanding include shares vested under the NMO Deferred Compensation Plan and exclude unallocated shares held by the ESOP.

Options to purchase shares of our common stock that were outstanding during the respective periods indicated but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares are as follows:

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis reviews our unaudited consolidated financial position at March 31, 2008, and the unaudited consolidated results of operations for the three month periods ended March 31, 2008 and 2007, and where appropriate, factors that may affect future financial performance.  This analysis should be read in conjunction with our unaudited consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q, and the audited consolidated financial statements, notes thereto and selected consolidated financial data appearing in our Annual Report on Form 10-K for the year ended December 31, 2007.

All statements, trend analyses and other information contained in this report and elsewhere (such as in filings by us with the Securities and Exchange Commission (“SEC”), press releases, presentations by us or our management or oral statements) relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” and other similar expressions, constitute forward-looking statements.  These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things:

·                                    general economic conditions and other factors, including prevailing interest rate levels and stock and credit market performance which may affect (among other things) our ability to sell our products, our ability to access capital resources and the costs associated therewith, the fair value of our investments, which could result in other than temporary impairments, and certain liabilities, and the lapse rate and profitability of policies;

·                                    customer response to new products and marketing initiatives;

·                                    changes in Federal income tax laws and regulations which may affect the relative income tax advantages of our products;

·                                    increasing competition in the sale of annuities;

·                                    regulatory changes or actions, including those relating to regulation of financial services affecting (among other things) bank sales and underwriting of insurance products and regulation of the sale, underwriting and pricing of products; and

·                                    the risk factors or uncertainties listed from time to time in our private placement memorandums or filings with the SEC.

Overview

We specialize in the sale of individual annuities (primarily deferred annuities) and, to a lesser extent, we also sell life insurance policies.  Under U.S. generally accepted accounting principles (“GAAP”), premium collections for deferred annuities are reported as deposit liabilities instead of as revenues.  Similarly, cash payments to policyholders are reported as decreases in the liabilities for policyholder account balances and not as expenses.  Sources of revenues for products accounted for as deposit liabilities are net investment income, surrender charges deducted from the account balances of policyholders in connection with withdrawals, realized gains and losses on investments and changes in fair value of derivatives.  Components of expenses for products accounted for as deposit liabilities are interest credited to account balances, changes in fair value of embedded derivatives, amortization of deferred policy acquisition costs and deferred sales inducements, other operating costs and expenses and income taxes.

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Annuity deposits by product type collected during the three months ended March 31, 2008 and 2007, were as follows:

Net annuity deposits after coinsurance ceded increased 16% during the first quarter of 2008 compared to the same period in 2007.  We attribute this increase to several factors including: our continued strong position with our national marketing organizations and field force of licensed, independent insurance agents; the increased attractiveness of safe money products in volatile markets; declining interest rates on competing products such as bank certificates of deposit; and product enhancements including a new generation of guaranteed income withdrawal benefit riders.

Earnings from products accounted for as deposit liabilities are primarily generated from the excess of net investment income earned over the interest credited or the cost of providing index credits to the policyholder, or the “investment spread”.  Our investment spread is summarized as follows:

The cost of money for index annuities and average crediting rates for fixed rate annuities are computed based upon policyholder account balances and do not include the impact of amortization of deferred sales inducements.  See Critical Accounting Policies - Deferred Policy Acquisition Costs and Deferred Sales Inducements included in Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2007.  With respect to our index annuities, the cost of money includes the average crediting rate on amounts allocated to the fixed rate strategy, expenses we incur to fund the annual index credits and where applicable, minimum guaranteed interest credited.  Proceeds received upon expiration or early termination of call options purchased to fund annual index credits are recorded as part of the change in fair value of derivatives, and are largely offset by an expense for interest credited to annuity policyholder account balances.  See Critical Accounting Policies - Derivative Instruments - Index Products included in Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2007.

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Our profitability depends in large part upon the amount of assets under our management, investment spreads we earn on our policyholder account balances, our ability to manage our investment portfolio to maximize returns and minimize risks such as interest rate changes, defaults or impairment of assets, our ability to manage interest rates credited to policyholders and costs of the options purchased to fund the annual index credits on our index annuities, our ability to manage the costs of acquiring new business (principally commissions to agents and first year bonuses credited to policyholders) and our ability to manage our operating expenses.

Results of Operations

Three Months Ended March 31, 2008 and 2007

Net income increased 395% to $49.2 million in the first quarter of 2008 compared to $9.9 million for the same period in 2007 primarily attributable to the adoption of SFAS No. 157, Fair Value Measurements (“SFAS 157”) as discussed below.  In general, net income has been increasing due to the growth in the volume of business in force and increases in the investment spread earned on our annuity liabilities.  Our investment spread measured on a percentage basis was lower in the first quarter of 2008 than in the first quarter of 2007 (2.59% compared to 2.63%) due to a higher average cost of money for index annuities.  This higher average cost of money generally resulted from increases in the cost of options purchased during 2007 to fund the index credits on index annuities which was attributable to increased equity market volatility.

The comparability of the amounts is impacted by (i) realized gains (losses) on investments and (ii) the impact of the application of Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”) to our index annuity business and contingent convertible senior notes.  We estimate that these items increased (decreased) net income as follows:

Realized gains and losses on investments fluctuate from year to year based upon changes in the interest rate and economic environment and the timing of the sale of investments or the recognition of other than temporary impairments.  Amounts attributable to the application of SFAS 133 to our index annuity business fluctuate based upon changes in the fair values of call options purchased to fund the annual index credits for index annuities and changes in the interest rates used to discount the embedded derivative liability.  The significant increase in the impact from this item for the first quarter of 2008 is primarily attributable to the adoption of SFAS No. 157 which requires that the discount rates used in the calculation of the fair value of embedded derivatives for index annuities include non performance risk related to those liabilities.  The discount rates are based on risk-free rates adjusted for the non performance risk of the Company.  Prior to the adoption of SFAS 157 the discount rates used were risk-free interest rates.  SFAS 157 was adopted prospectively on January 1, 2008 and the changes in discount rates resulted in an increase to net income of $40.7 million for the first quarter of 2008.  Changes in the amounts attributable to the application of SFAS 133 to our contingent convertible senior notes are discussed below under change in fair value of embedded derivatives and interest expense on notes payable.

Annuity product charges (surrender charges assessed against policy withdrawals) increased 35% to $12.1 million for the first quarter of 2008 compared to $9.0 million for the same period in 2007.  The increase was principally due to increases in policy withdrawals subject to surrender charges due to growth in the volume and aging of the business in force.  Withdrawals from annuity and single premium universal life policies subject to surrender charges were $76.0 million and $62.0 million for the three months ended March 31, 2008 and 2007, respectively.  The average surrender charge collected on withdrawals subject to a surrender charge was 15.7% and 14.4% for the three months ended March 31, 2008 and 2007, respectively.

Net investment income increased 15% to $195.5 million in the first quarter of 2008 compared to $169.4 million for the same period in 2007.  The increase was principally attributable to the growth in our annuity business and a corresponding increase in our invested assets and the average yield earned on investments.  Average invested assets excluding derivative instruments (on an amortized cost basis) increased 13% to $12.7 billion at March 31, 2008 compared to $11.2 billion at March 31, 2007, while the average yield earned on average invested assets was 6.14% and 6.06% for the three months ended March 31, 2008 and 2007, respectively.  The increase in the yield earned on average invested assets was attributable to higher yields on investments purchased subsequent to March 31, 2007.

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Realized gains (losses) on investments include gains and losses on the sale of securities as well as losses recognized when the fair value of a security is written down through earnings in recognition of an other than temporary impairment.  Realized gains and losses on investments fluctuate from year to year due to changes in the interest rate and economic environment and the timing of the sale of investments or the recognition of other than temporary impairments.  The components of realized gains (losses) on investments for the three months ended March 31, 2008 and 2007 are set forth in the table that follows.  See Financial Condition – Investments for additional discussion of write downs of the fair value of securities for other than temporary impairments.

Change in fair value of derivatives (principally call options purchased to fund annual index credits on index annuities) is affected by the performance of the indices upon which our options are based and the aggregate cost of options purchased.  The components of change in fair value of derivatives for the three months ended March 31, 2008 and 2007 are set forth as follows:

The differences between the change in fair value of derivatives between years are primarily due to the performance of the indices upon which our call options are based.  A substantial portion of our call options are based upon the S&P 500 Index with the remainder based upon other equity and bond market indices.  The range of index appreciation for options expiring during the three months ended March 31, 2008 and 2007 is as follows:

Actual amounts credited to policyholder account balances may be less than the index appreciation due to contractual features in the index annuity policies (participation rates, caps and asset fees) which allow us to manage the cost of the options purchased to fund the annual index credits.  The change in fair value of derivatives is also influenced by the aggregate costs of options purchased.  The aggregate cost of options has increased primarily due to an increased amount of index annuities in force.  The

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aggregate cost of options is also influenced by the amount of policyholder funds allocated to the various indices and market volatility which affects option pricing.  The increases in market volatility experienced during 2007 resulted in increased option costs.  Option costs in the first quarter of 2008 have decreased due to adjustments to participation rates, caps and asset fees.  See Critical Accounting Policies - Derivative Instruments - Index Products included in Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2007.

Interest credited to account balances decreased 53% to $54.2 million in the first quarter of 2008 compared to $116.0 million for the same period in 2007.  The components of interest credited to account balances are summarized as follows:

The changes in index credits were attributable to changes in the appreciation of the underlying indices (see discussion above under change in fair value of derivatives) and the amount of funds allocated by policyholders to the respective index options.  Total proceeds received upon expiration or gains recognized upon early termination of the call options purchased to fund the annual index credits were $13.8 million and $73.8 million for the three months ended March 31, 2008 and 2007, respectively.  The decrease in interest credited was due to reductions in the account balances receiving a fixed rate of interest and decreases in interest crediting rates on several of our products.  A significant factor in the reductions in interest credited on fixed rate annuities is the reduced interest on multi-year rate guarantee annuities.  The average amount of annuity liabilities outstanding (net of annuity liabilities ceded under coinsurance agreements) increased 15% during the three months ended March 31, 2008 to $12.9 billion from $11.2 billion during the same period in 2007.

Amortization of deferred sales inducements increased 625% to $31.9 million in the first quarter of 2008 compared to $4.4 million for the same period in 2007.  In general, amortization of deferred sales inducements has been increasing each period due to growth in our annuity business and the deferral of sales inducements incurred with respect to sales of premium and interest bonus annuity products.  Bonus products represented 91% and 83% of our total annuity deposits during the three months ended March 31, 2008 and 2007, respectively.  The anticipated increase in amortization from these factors has been affected by amortization associated with the application of SFAS 133 to our index annuity business.  The application of SFAS 133 to our index annuity business creates differences in the recognition of revenues and expenses from derivative instruments including the embedded derivative liabilities in our index annuity contracts.  The change in fair value of the embedded derivatives will not correspond to the change in fair value of derivatives (purchased call options) because the purchased call options are one-year options while the options valued in the fair value of embedded derivatives cover the expected life of the contracts which typically exceed 10 years.  The gross profit adjustments resulting from the application of SFAS 133 to our index annuity business increased amortization by $21.5 million in the first quarter of 2008 and decreased amortization by $3.4 million for the same period in 2007.  Excluding these amounts, amortization for the three months ended March 31, 2008 would have been $10.6 million compared to $7.8 million for the same period in 2007.  See Critical Accounting Policies - Deferred Policy Acquisition Costs and Deferred Sales Inducements included in Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2007.  The comparison between periods is also affected by amortization associated with realized gains (losses) on investments.  The gross profit adjustments from net realized gains (losses) on investments decreased amortization by $0.2 million for the three months ended March 31, 2008 and had no effect on amortization for the same period in 2007.

Change in fair value of embedded derivatives was a decrease of $218.6 million in the first quarter of 2008 compared to a decrease of $6.6 million for the same period in 2007.  The changes related to the embedded derivatives within our index annuities resulted from (i) changes in the expected index credits on the next policy anniversary dates, which are related to the change in fair value of the call options acquired to fund these index credits discussed above in change in fair value of derivatives; (ii) changes in discount

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rates used in estimating our liability for policy growth subsequent to the next policy anniversary; (iii) changes in estimates of expected costs of annual call options that will be purchased in the future to fund index credits beyond the next policy anniversary and (iv) the growth in the host component of the embedded derivative.  See Critical Accounting Policies - Derivative Instruments - Index Products included in Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2007.  The primary reasons for the decrease in fair value of the embedded derivatives in the first quarter of 2008 was increases in the discount rates used in estimating our liability for policy growth subsequent to the next policy anniversary and a decrease in the expected future cost of annual call options.  The increase in the discount rates upon the adoption of SFAS 157 as discussed above to reflect non performance risk of the Company and the decrease in expected future cost of annual options decreased the fair value of the embedded derivatives in the first quarter of 2008 by $150.6 million and $51.6 million, respectively.

Interest expense on subordinated debentures decreased 6% to $5.2 million in the first quarter of 2008 compared to $5.6 million for the same period in 2007.  This decrease was primarily due to decreases in the weighted average interest rate on the outstanding subordinated debentures which were 7.72% and 8.32% for the first quarter of 2008 and 2007, respectively.  The weighted average interest rates have decreased because substantially all of the subordinated debentures issued during 2004 - 2006 have a floating rate of interest based upon the three month London Interbank Offered Rate plus an applicable margin.  See Financial Condition - Liabilities included in Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2007.

Interest expense on amounts due under repurchase agreements decreased 26% to $3.0 million in the first quarter of 2008 compared to $4.0 million for the same period in 2007.  This decrease was primarily due to decreases in the weighted average interest rates on amounts borrowed, offset by increases in the borrowings outstanding.  Weighted average interest rates were 3.20% and 5.50% for the three months ended March 31, 2008 and 2007, respectively, and average borrowings outstanding were $374.1 million and $296.2 million for the first quarter of 2008 and 2007, respectively.

Amortization of deferred policy acquisition costs increased 359% to $80.7 million in the first quarter of 2008 compared to $17.6 million for the same period in 2007.  In general, amortization of deferred policy acquisition costs has been increasing each period due to the growth in our annuity business and the deferral of policy acquisition costs incurred with respect to sales of annuity products.  The anticipated increase in amortization from these factors has been affected by amortization associated with the application of SFAS 133 to our index annuity business.  As discussed above, the application of SFAS 133 to our index annuity business creates differences in the recognition of revenues and expenses from derivative instruments including the embedded derivative liabilities in our index annuity contracts.  The gross profit adjustments resulting from the application of SFAS 133 to our index annuity business increased amortization by $51.7 million in the first quarter of 2008 and decreased amortization by $8.1 million for the same period in 2007.  Excluding these amounts, amortization for the three months ended March 31, 2008 would have been $29.6 million compared to $25.7 million for the same period in 2007.  The comparisons between years are also affected by amortization associated with realized gains (losses) on investments.  The gross profit adjustments from net realized gains (losses) on investments decreased amortization by $0.6 million for the three months ended March 31, 2008 and had no effect on amortization for the same period in 2007.

Other operating costs and expenses increased 11% to $12.7 million in the first quarter of 2008 compared to $11.4 million for the same period in 2007.  This increase was principally attributable to an increase in legal fees related to the defense of ongoing litigation of $1.1 million and an increase in salaries and benefits of $0.6 million, offset by a $0.2 million decrease in costs associated with the creation of a document database during 2007.

Income tax expense increased 398% to $26.1 million in the first quarter of 2008, compared to $5.3 million for the same period in 2007.  This increase was primarily due to the increase in income before income taxes.  The effective tax rates were 34.7% and 34.6% for the three months ended March 31, 2008 and 2007, respectively.  The effective tax rates for 2008 and 2007 were less than the applicable statutory federal income tax rate of 35% primarily due to state income tax benefits attributable to losses in the non-life subgroup.

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Financial Condition

Investments

Our investment strategy is to maintain a predominantly investment grade fixed income portfolio, provide adequate liquidity to meet our cash obligations to policyholders and others and maximize current income and total investment return through active investment management.  Consistent with this strategy, our investments principally consist of fixed maturity securities, mortgage loans on real estate and short-term investments.

Insurance statutes regulate the type of investments that our life subsidiaries are permitted to make and limit the amount of funds that may be used for any one type of investment.  In light of these statutes and regulations and our business and investment strategy, we generally seek to invest in United States government and government-sponsored agency securities and corporate securities rated investment grade by established nationally recognized rating organizations or in securities of comparable investment quality, if not rated and mortgage loans on real estate.

We have classified a portion of our fixed maturity investments as available for sale.  Available for sale securities are reported at fair value and unrealized gains and losses, if any, on these securities (net of income taxes and certain adjustments for changes in amortization of deferred policy acquisition costs and deferred sales inducements) are included directly in a separate component of stockholders’ equity, thereby exposing stockholders’ equity to volatility for changes in the reported fair value of securities classified as available for sale.

The composition of our investment portfolio is summarized in the table below (dollars in thousands):

The table below presents our fixed maturity securities by the National Association of Insurance Commissioners (“NAIC”) designation and the equivalent ratings of the nationally recognized securities rating organizations (dollars in thousands).

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