Great American Financial Resources, Inc. ("GAFRI" or "the Company"), through its subsidiaries, markets fixed, indexed and variable annuities, and various forms of supplemental insurance through independent agents. To a lesser extent, the Company also markets certain of its supplemental insurance products through a captive agency force.

American Financial Group, Inc. ("AFG") and its subsidiaries owned 81% of GAFRI's Common Stock at August 1, 2007. On May 17, 2007, AFG and GAFRI entered into a definitive merger agreement under which GAFRI would acquire the GAFRI shares which AFG does not currently own at a price of $24.50 per share in cash, for a total purchase price of approximately $225 million. GAFRI expects the merger to be completed in September 2007, and will use excess capital plus borrowings from AFG to fund the transaction.

Certain reclassifications have been made to prior years to conform to the current year's presentation. All significant intercompany balances and transactions have been eliminated. All acquisitions have been treated as purchases. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements.

The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.

Gains or losses on securities are determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other than temporary, a provision for impairment is charged to earnings (included in realized gains (losses) on investments) and the cost basis of that investment is reduced.

benefits accumulated) and (iv) related call options (included in other assets) designed to be consistent with the characteristics of the liabilities and used to mitigate the risk embedded in those indexed-annuity products. Changes in the fair value of derivatives are included in current earnings.

The terms of the interest rate swaps match those of the debt; therefore, the swaps are considered to be (and are accounted for as) 100% effective fair value hedges. Both the swaps and the hedged debt are adjusted for changes in fair value by offsetting amounts. Accordingly, since the swaps are included with long-term debt in the Balance Sheet, the only effect on GAFRI's financial statements is that the interest expense on the hedged debt is recorded based on the variable rate.

Under certain of these agreements, GAFRI's insurance subsidiaries cede life insurance policies to a third party on a funds withheld basis whereby GAFRI retains the assets (securities) associated with the reinsurance contracts. Interest is credited to the reinsurer based on the actual investment performance of the retained assets. These reinsurance contracts are considered to contain embedded derivatives (that must be adjusted to fair value) because the yield on the payables is based on specific blocks of the ceding companies' assets, rather than the overall creditworthiness of the ceding company. GAFRI determined that a change in the fair value of the underlying portfolios of fixed maturity securities is an appropriate measure of the value of the embedded derivative. GAFRI classifies the securities related to these transactions as "trading." The adjustment to fair value on the embedded derivatives offsets the investment income recorded on the adjustment to fair value of the related trading portfolios.

Insurance acquisition expenses in the income statement reflect primarily the amortization of DPAC and PVFP. In addition, certain commission costs are expensed as paid and included in insurance acquisition expenses. All other uncapitalized acquisition costs such as marketing and underwriting expenses are included in "Other expenses."

DPAC related to annuities and universal life insurance products is deferred to the extent deemed recoverable and amortized, with interest, in relation to the present value of actual and expected gross profits on the policies. Expected gross profits consist principally of estimated future investment margin (estimated future net investment income less interest credited on policyholder funds) and surrender, mortality, and other life and variable annuity policy charges, less death and annuitization benefits in excess of account balances and estimated future policy administration expenses.

To the extent that realized gains and losses result in adjustments to the amortization of DPAC related to annuities, such adjustments are reflected as components of realized gains. DPAC related to annuities is also adjusted, net of tax, for the change in

amortization that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in unrealized gains (losses) on marketable securities, a component of "Accumulated other comprehensive income (loss), net" in the stockholders' equity section of the Balance Sheet.

DPAC related to traditional life and health insurance is amortized over the expected premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues were estimated using the same assumptions used for computing liabilities for future policy benefits.

Life and health insurance contracts are reviewed periodically using actuarial assumptions revised based on actual and anticipated experience, to determine if there is

a potential premium deficiency. If any such deficiency exists, it is recognized by a charge to income and a reduction in unamortized acquisition costs.

The PVFP is amortized with interest in relation to expected gross profits of the acquired policies for annuities and universal life products and in relation to the premium paying period for traditional life and health insurance products.

Reserves for two-tier annuities (annuities with different stated account values depending on whether a policyholder annuitizes, dies or surrenders) are recorded at the lower-tier value plus additional reserves for (i) accrued persistency and premium bonuses; and (ii) excess benefits expected to be paid on future deaths and annuitizations ("EDAR") that require payment of the upper-tier value. The liability for EDAR is accrued for and modified using assumptions consistent with those used in determining DPAC and DPAC amortization, except that accruals are in relation to the present value of total expected assessments. Total expected assessments consist principally of estimated future investment margin, surrender, mortality, and other life and variable annuity policy charges, and unearned revenues once they are recognized as income.

Reserves for traditional single-tier fixed annuities are generally recorded at the stated annuitization value. Reserves for indexed annuities are recorded at a value reflecting the fixed guarantees in the product plus the fair value of the equity participation in the contract.

The liability for future policy benefits for interest sensitive life and universal life policies is equal to the sum of the accumulated fund balances under such policies.

GAFRI's variable annuity contracts contain a guaranteed minimum death benefit ("GMDB") to be paid if the policyholder dies before the annuity payout period commences. In periods of declining equity markets, the GMDB may exceed the value of the policyholder's account. A GMDB liability is established for future excess death benefits using assumptions together with a range of reasonably possible scenarios for investment fund performance that are consistent with DPAC capitalization and amortization assumptions.

For interest sensitive life and universal life products, premiums are recorded in a policyholder account, which is reflected as a liability. Revenue is recognized as amounts are assessed against the policyholder account for mortality coverage and contract expenses. Surrender benefits reduce the account value. Death benefits are expensed when incurred, net of the account value.

Deferred income tax assets and liabilities are determined based on differences between financial reporting and tax basis and are measured using enacted tax rates. The Company recognizes deferred tax assets if it is more likely than not that a benefit will be realized. Current and deferred tax assets and liabilities of companies in AFG's consolidated tax group are aggregated with other amounts receivable from or payable to affiliates. Current and deferred tax assets and liabilities of companies not in the consolidated tax group are shown in "Other liabilities" in the Balance Sheet.

Implementation of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)" ("FIN 48") on January 1, 2007, had no effect on GAFRI's financial position. FIN 48 sets forth criteria for recognition and measurement of tax positions taken or expected to be taken in a tax return. FIN 48 requires that companies recognize the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest, penalties, accounting in interim periods and disclosure. GAFRI's reserve for unrecognized income tax benefits (included in "Payable to affiliates, net" in the Balance Sheet) was approximately $11 million at January 1, 2007. Recognition of these benefits would reduce GAFRI's effective tax rate. GAFRI does not anticipate significant changes to this reserve within the next twelve months.

GAFRI and certain of its subsidiaries provide certain benefits to eligible retirees. The projected future cost of providing these benefits is expensed over the period the employees earn such benefits.

On June 2, 2006, GAFRI sold Chatham Bars Inn, a resort hotel located on Cape Cod, Massachusetts, for $166 million. In accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets", the operating results and the gain on the sale of the hotel are included in discontinued operations in the Consolidated Income Statement. Discontinued operations for 2007 represent additional gains on operations sold in previous years, primarily the settlement of a contingency associated with the Chatham sale.

In January 2006, GAFRI sold Great American Life Assurance Company of Puerto Rico ("GA-PR") for $37.5 million in cash, recognizing a pre-tax loss of $0.5 million. This loss was offset by a like amount of GA-PR earnings recorded prior to the sale. In connection with the sale, GAFRI established a $7.9 million letter of credit to provide for potential liabilities.

On August 7, 2006, GAFRI (parent) acquired all of the outstanding shares of Ceres Group, Inc. During the six months ended June 30, 2007, GAFRI continued to refine the allocation of the purchase price to the individual assets acquired and liabilities assumed based on their estimated fair values. The refinement of the allocation of the purchase price included in the current period balance sheet is based on the best estimates of management and independent appraisers.

In the first quarter of 2006, GALIC acquired, through a reinsurance transaction, the fixed annuity block written by Old Standard Life Insurance Company. As part of the assets received in the reinsurance transaction, GALIC also acquired the stock of Old West Annuity and Life Insurance Company.

GAFRI's financial statements include the results of the above since their acquisition.

GAFRI manages its business as four segments: (i) annuity operations; (ii) supplemental insurance; (iii) life operations; and (iv) corporate and other, which include holding company assets and costs as well as interest and other debt expenses.

Revenue from GAFRI's annuity operations consists primarily of investment income as well as operating revenues from its real estate investments.  GAFRI's annuity products are sold through independent agents to employees of primary and secondary educational institutions and in the non-qualified markets.  GAFRI is engaged in a variety of real estate operations including hotels and marinas.

GAFRI's supplemental insurance businesses (United Teacher Associates Insurance Company ("UTA"), Loyal American Life Insurance Company, Continental General Insurance Company, Central Reserve Life Insurance Company and Provident American Life and Health Insurance Company primarily offer a variety of Medicare Supplement, long term care and limited benefit policies to supplement primary health insurance and other insurance coverage. These products are offered primarily through independent agents and, to a lesser extent, captive agents.

Traditional term and universal life insurance products had been marketed through national marketing organizations until 2004, when GAFRI suspended new sales of these life insurance products due to inadequate volume and returns. The Company continues to service its in-force block of these policies.

"Corporate and other" consists primarily of GAFRI (parent) and AAG Holding (intermediate holding company) and includes interest expense.

(a) Subsidiary purchase accounting refinement related to the Ceres acquisition.

Unamortized insurance acquisition costs consisted of the following (in millions):

The unrealized DPAC adjustment reflects the change in DPAC assuming the unrealized gains or losses on securities had actually been realized. See Note B to the Financial Statements - "Accounting Policies".

In the second quarter of 2007, PVFP was reduced by $12.3 million due to a refinement of the purchase price allocation for the August 2006 Ceres acquisition. The PVFP amounts in the table above are net of $78.1 million and $70.5 million of accumulated amortization at June 30, 2007 and December 31, 2006, respectively. Amortization of the PVFP was $2.4 million in the second quarter of 2007 and $7.6 million in the first six months of 2007 compared to $1.6 million in the second quarter of 2006 and $3.2 million in the first six months of 2006. The increase in amortization compared to the 2006 periods reflects the acquisition of Ceres, including the effect of higher lapses in the Medicare supplement lines.

Long-term debt consisted of the following (in millions):

At June 30, 2007, GAFRI had virtually no scheduled principal payments on debt for the next five years other than AAG Holding's Senior Notes due in 2008 and the bank credit facility due in 2011.

In the first six months of 2007, GAFRI issued 432,297 shares of Common Stock upon the exercise of stock options. Also in the first six months of 2007, GAFRI granted stock options for 0.6 million shares of Common Stock (at an average price of $23.76) under GAFRI's stock option plans.

GAFRI uses the Black-Scholes option-pricing model to calculate the "fair value" of its option grants. The fair value of options granted in the first six months of 2007 was $7.33 per share based on the following assumptions: dividend yield of less than 1%; expected volatility of 20% (due to limited trading volume of GAFRI's common stock, implied volatility of a peer group's publicly traded options used); risk-free interest rate of 4.7%; and expected option life of 6.5 years.

GAFRI's total stock compensation expense was $0.7 million for the second quarter and $1.3 million in the first six months of 2007 compared to $0.6 million and $1.1 million in the second quarter and first six months of 2006, respectively.

In the first quarter of 2007, GAFRI retired 219,295 shares of common stock which had been purchased in prior years to pre-fund two of the Company's non-qualified benefit plans.

The Company is authorized to issue 25,000,000 shares of Preferred Stock, par value $1.00 per share.

Except as discussed in Management's Discussion and Analysis - "Environmental Reserve Charge", there have been no significant changes to the matters discussed and referred to in Note M - "Contingencies" of GAFRI's Annual Report on Form 10-K for 2006.