MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS in 2004. Earnings during 2001 were adversely affected by the  terrorist attacks of September 11, 2001, investment losses on sales and impairments of investment securities, and the accrual of additional reserves to support our reinsurance of Argentine pension business. impairments, and the establishment of arbitration or litigation reserves. The balances of these accounts are significant to the Company’s financial position and require extensive use of assumptions and estimates, particularly related to the future performance of the underlying business. Consolidated investment income increased 24.3% and 10.0%  during 2003 and 2002, respectively. These increases related to  a growing invested asset base due to positive cash flows from  operations and deposits from several annuity reinsurance treaties, offset, in part, by declining invested asset yields primarily due to  a decline in prevailing interest rates. The cost basis of invested assets increased by $2.1 billion, or 32.3%, in 2003 and increased $1.4 billion, or 27.5%, in 2002. In excess of $400 million of the increase in the cost basis of invested assets during 2003 was due to the Company’s common equity offering in which 12,075,000 new shares were issued. The additional increase during 2003 is due to the factors previously discussed. The average yield earned  on investments, excluding funds withheld, was 6.39% in 2003, compared with 6.51% in 2002, and 6.79% in 2001. The average yield will vary from year to year depending on a number of variables, including the prevailing interest rate environment and changes in the mix of our underlying investments. Funds withheld assets are associated with annuity contracts on which we earn a spread. Additionally, for each of its reinsurance contracts, the Company must determine if the contract provides indemnification against loss or liability relating to insurance risk, in accordance with applicable accounting standards. The Company must review all contractual features, particularly those that may limit the amount of insurance risk to which the Company is subject or features that delay the timely reimbursement of claims. If the Company determines that the possibility of a significant loss from insurance risk will occur only under remote circumstances, it records the contract under  a deposit method of accounting with the net amount payable/ receivable reflected in other reinsurance assets or liabilities on  the consolidated balance sheet. Fees earned on the contracts  are reflected as other revenues, as opposed to premiums, on the consolidated statements of income. Fluctuations in the yield on funds withheld assets are generally  offset by a corresponding adjustment to the interest credited on  the liabilities. Investment income is allocated to the operating  segments based upon average assets and related capital levels deemed appropriate to support the segment business volumes. Costs of acquiring new business, which vary with and are primarily related to the production of new business, have been deferred to the extent that such costs are deemed recoverable from future  premiums or gross profits. Deferred policy acquisition costs (“DAC”) reflect our expectations about the future experience of the business in force and include commissions and allowances as well as certain costs of policy issuance and underwriting. Some of the factors that can affect the carrying value of DAC include mortality assumptions, interest spreads and policy lapse rates. The Company performs  periodic tests to determine that DAC remains recoverable, and the cumulative amortization is re-estimated and, if necessary, adjusted by a cumulative charge or credit to current operations. No adjustments were made during 2003, however, for the years ended December 31, 2002 and 2001, the Company reflected charges of $1.0 million and $3.1 million, respectively, for unrecoverable deferred policy acquisition costs. As of December 31, 2003, the Company estimates that approximately 51.9% of its DAC balance is collateralized by surren- der fees due to the Company and the reduction of policy liabilities, in excess of termination values, upon surrender or lapse of a policy. The consolidated provision for income taxes for continuing  operations represented approximately 34.3%, 33.8%, and 39.7% of pre-tax income for 2003, 2002, and 2001, respectively. Absent unusual items, we expect the consolidated effective tax rate to be between 34% and 35%. The effective tax rate for 2002 includes the effect of a $2.0 million reduction in tax liabilities resulting  from a settlement of an Internal Revenue Service (“IRS”) audit. The effective tax rate for 2001 was affected by realized capital losses domestically and operating losses from foreign subsidiaries for which deferred tax assets cannot be fully established. The Company calculated tax benefits related to its discontinued operations of $3.1 million for 2003 and 2002, and $3.7 million for 2001. The effective tax rate on the discontinued operations was approximately 35.0% for each of the three years.  The Company periodically reviews actual and anticipated  experience compared to the assumptions used to establish policy benefits. Further, it establishes premium deficiency reserves if  actual and anticipated experience indicates that existing policy  liabilities together with the present value of future gross premiums are not sufficient to cover the present value of future benefits,  settlement and maintenance costs and to recover unamortized acquisition costs. The premium deficiency reserve is established by a charge to income, as well as a reduction in unamortized acquisition costs and, to the extent there are no unamortized acquisition costs, an increase in future policy benefits. The Company’s accounting policies are described in Note 2 to the Consolidated Financial Statements. The Company believes its most critical accounting policies include the capitalization and amortiza- tion of deferred acquisition costs, the establishment of liabilities for future policy benefits, other policy claims and benefits, including incurred but not reported claims, the valuation of investment THIS IS RGA. 2003 ANNUAL REPORT 23 CRITICAL ACCOUNTING POLICIES 