<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
DECEMBER 31, 1998
ANNUAL REPORT
SEPARATE ACCOUNT VA-1 FUNDING
THE CHAIRMAN-TM-
COMBINATION FIXED AND VARIABLE ANNUITY CONTRACTS
PRINCIPAL OFFICE LOCATED AT:
#1 Franklin Square
Springfield, Illinois 62713
ANNUAL REPORT DATED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
DECEMBER 31, 1998
ANNUAL REPORTS
VARIABLE INSURANCE PRODUCTS FUND
VARIABLE INSURANCE PRODUCTS FUND II
PRINCIPAL OFFICE OF BOTH FIDELITY FUNDS LOCATED AT:
82 Devonshire Street
Boston, Massachusetts 02109
MFS VARIABLE INSURANCE TRUST
PRINCIPAL OFFICE LOCATED AT:
500 Boylston Street
Boston, Massachusetts 02116
ANNUAL REPORTS DECEMBER 31, 1998
The Annual Report of Separate Account VA-1 is prepared and provided by The
American Franklin Life Insurance Company. The Annual Reports of the Variable
Insurance Products Fund and the Variable Insurance Products Fund II are prepared
by Fidelity Investments. The Annual Report of MFS Variable Insurance Trust is
prepared by MFS Investment Management.
- --------------------------------------------------------------------------------
This Annual Report is not to be construed as an offering for sale of any
American Franklin Life contract. No offering is made except in conjunction with
a prospectus which must precede or accompany this report.
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF NET ASSETS
DECEMBER 31, 1998
<TABLE>
<CAPTION>
VARIABLE INSURANCE PRODUCTS FUND
-----------------------------------------------------------------------------------------
VIP VIP VIP
MONEY EQUITY- VIP VIP HIGH
MARKET INCOME GROWTH OVERSEAS INCOME
ASSETS DIVISION DIVISION DIVISION DIVISION DIVISION
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Investments in Funds at fair value
(cost: see below) $ 8,701,049 $ 20,127,458 $ 17,527,119 $ 2,378,108 $ 2,766,415
Dividends receivable 32,492 - - - -
Due from (to) general account 437 772 673 318 (19)
-----------------------------------------------------------------------------------------
NET ASSETS $ 8,733,978 $ 20,128,230 $ 17,527,792 $ 2,378,426 $ 2,766,396
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Unit value, at December 31, 1998 $ 5.34 $ 6.73 $ 7.94 $ 6.20 $ 5.54
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Units outstanding, at December 31, 1998 1,634,822 2,991,972 2,207,408 383,712 499,418
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Cost of investments $ 8,701,049 $ 18,944,344 $ 14,509,323 $ 2,322,070 $ 3,000,657
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
1
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF NET ASSETS (CONTINUED)
DECEMBER 31, 1998
<TABLE>
<CAPTION>
VARIABLE INSURANCE PRODUCTS FUND II
-----------------------------------------------------------------------
VIPII VIPII VIPII VIPII MFS
INVESTMENT ASSET INDEX CONTRA- EMERGING
GRADE BOND MANAGER 500 FUND GROWTH
ASSETS DIVISION DIVISION DIVISION DIVISION DIVISION
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Investments in Funds at fair value
(cost: see below) $ 3,408,186 $ 5,444,951 $ 26,019,563 $ 11,818,212 $ 11,991,031
Dividends receivable - - - - -
Due from (to) general account (80) 208 998 453 460
-----------------------------------------------------------------------------------------
NET ASSETS $ 3,408,106 $ 5,445,159 $ 26,020,561 $ 11,818,665 $ 11,991,491
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Unit value, at December 31, 1998 $ 5.70 $ 6.64 $ 8.07 $ 7.62 $ 7.48
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Units outstanding, at December 31, 1998 598,142 820,384 3,224,829 1,551,801 1,603,087
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Cost of investments $ 3,304,970 $ 5,123,856 $ 22,206,009 $ 9,995,665 $ 9,943,378
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
2
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF NET ASSETS (CONTINUED)
DECEMBER 31, 1998
<TABLE>
<CAPTION>
MFS VARIABLE INSURANCE TRUST
-----------------------------------------------------------------------------------------
MFS
MFS GROWTH MFS MFS MFS
RESEARCH WITH INCOME TOTAL RETURN UTILITIES VALUE
ASSETS DIVISION DIVISION DIVISION DIVISION DIVISION
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Investments in Funds at fair value
(cost: see below) $ 15,385,248 $ 10,050,682 $ 14,747,684 $ 6,360,777 $ 4,730,214
Dividends receivable - - - - -
Due from (to) general account 590 386 565 244 260
-----------------------------------------------------------------------------------------
NET ASSETS $ 15,385,838 $ 10,051,068 $ 14,748,249 $ 6,361,021 $ 4,730,474
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Unit value, at December 31, 1998 $ 6.95 $ 7.51 $ 6.43 $ 7.04 $ 7.59
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Units outstanding, at December 31, 1998 2,214,458 1,338,496 2,294,198 903,586 623,561
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Cost of investments $ 13,593,484 $ 8,958,122 $ 13,776,846 $ 5,860,204 $ 4,225,853
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
3
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
VARIABLE INSURANCE PRODUCTS FUND
-------------------------------------------------------------------------------------
VIP VIP VIP
MONEY EQUITY- VIP VIP HIGH
MARKET INCOME GROWTH OVERSEAS INCOME
DIVISION DIVISION DIVISION DIVISION DIVISION
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET INVESTMENT INCOME (EXPENSE)
Income
Dividends $ 273,178 $ 96,737 $ 27,383 $ 22,675 $ 94,119
Capital gains distributions - 344,271 716,274 66,830 59,805
Expenses
Mortality and expense risk charge 71,033 175,737 141,890 39,051 27,048
-------------------------------------------------------------------------------------
Net investment income (expense) 202,145 265,271 601,767 50,454 126,876
NET REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS
Net realized gain (loss) - 55,848 88,948 (30,975) (3,120)
Net unrealized appreciation (depreciation)
Beginning of year - 181,643 (7,936) (47,635) 42,794
End of year - 1,183,114 3,017,796 56,038 (234,242)
-------------------------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) during the year - 1,001,471 3,025,732 103,673 (277,036)
-------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments - 1,057,319 3,114,680 72,698 (280,156)
-------------------------------------------------------------------------------------
Net increase (decrease) in net assets
from operations $ 202,145 $ 1,322,590 $ 3,716,447 $ 123,152 $ (153,280)
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
4
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF OPERATIONS (CONTINUED)
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
VARIABLE INSURANCE PRODUCTS FUND II
--------------------------------------------------------------------
VIPII VIPII VIPII VIPII MFS
INVESTMENT ASSET INDEX CONTRA- EMERGING
GRADE BOND MANAGER 500 FUND GROWTH
DIVISION DIVISION DIVISION DIVISION DIVISION
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET INVESTMENT INCOME (EXPENSE)
Income
Dividends $ 23,299 57,958 $ 63,920 $ 22,244 $ -
Capital gains distributions 2,764 173,875 148,050 163,653 35,970
Expenses
Mortality and expense risk charge 21,668 47,227 191,526 87,340 84,408
------------------------------------------------------------------------------------
Net investment income (expense) 4,395 184,606 20,444 98,557 (48,438)
NET REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS
Net realized gain (loss) 11,687 17,120 117,249 35,537 63,281
Net unrealized appreciation (depreciation)
Beginning of year 10,658 38,856 146,733 12,404 (379)
End of year 103,216 321,095 3,813,554 1,822,547 2,047,653
------------------------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) during the year 92,558 282,239 3,666,821 1,810,143 2,048,032
------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments 104,245 299,359 3,784,070 1,845,680 2,111,313
------------------------------------------------------------------------------------
Net increase (decrease) in net assets
from operations $ 108,640 483,965 $ 3,804,514 $ 1,944,237 $ 2,062,875
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
5
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF OPERATIONS (CONTINUED)
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
MFS VARIABLE INSURANCE TRUST
------------------------------------------------------------------------------------
MFS MFS
MFS GROWTH TOTAL MFS MFS
RESEARCH WITH INCOME RETURN UTILITIES VALUE
DIVISION DIVISION DIVISION DIVISION DIVISION
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET INVESTMENT INCOME (EXPENSE)
Income
Dividends $ 12,306 $ - $ 89,940 $ 20,082 $ 5,726
Capital gains distributions 161,384 - 105,751 91,306 3,925
Expenses
Mortality and expense risk charge 131,242 63,989 129,148 29,190 18,303
------------------------------------------------------------------------------------
Net investment income (expense) 42,448 (63,989) 66,543 82,198 (8,652)
NET REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS
Net realized gain (loss) 74,106 48,058 39,797 15,718 (6,658)
Net unrealized appreciation (depreciation)
Beginning of year 13,147 9,772 131,700 70,551 (65,257)
End of year 1,791,764 1,092,560 970,838 500,573 504,361
------------------------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) during the year 1,778,617 1,082,788 839,138 430,022 569,618
------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments 1,852,723 1,130,846 878,935 445,740 562,960
------------------------------------------------------------------------------------
Net increase (decrease) in net assets
from operations $ 1,895,171 $ 1,066,857 $ 945,478 $ 527,938 $ 554,308
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
6
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
VARIABLE INSURANCE PRODUCTS FUND
--------------------------------------------------------------------------------------
VIP VIP VIP
MONEY EQUITY- VIP VIP HIGH
MARKET INCOME GROWTH OVERSEAS INCOME
YEAR ENDED DECEMBER 31, 1998 DIVISION DIVISION DIVISION DIVISION DIVISION
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CHANGE IN NET ASSETS
FROM OPERATIONS:
Net investment income (expense) $ 202,145 $ 265,271 $ 601,767 $ 50,454 $ 126,876
Net realized gain (loss) on investments - 55,848 88,948 (30,975) (3,120)
Net change in unrealized appreciation
(depreciation) on investments - 1,001,471 3,025,732 103,673 (277,036)
--------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
operations 202,145 1,322,590 3,716,447 123,152 (153,280)
FROM CONTRACT RELATED TRANSACTIONS:
Net contract purchase payments 11,856,144 13,160,027 9,367,089 1,443,315 2,058,439
Withdrawals (352,036) (569,468) (562,277) (65,740) (38,135)
Transfers between Separate Account
VA-1 divisions, net (5,106,319) 554,939 737,303 (197,054) (197,465)
--------------------------------------------------------------------------------------
Net increase in net assets from contract
related transactions 6,397,789 13,145,498 9,542,115 1,180,521 1,822,839
--------------------------------------------------------------------------------------
Increase in net assets 6,599,934 14,468,088 13,258,562 1,303,673 1,669,559
Net assets, beginning of year 2,134,044 5,660,142 4,269,230 1,074,753 1,096,837
--------------------------------------------------------------------------------------
Net assets, end of year $ 8,733,978 $ 20,128,230 $ 17,527,792 $ 2,378,426 $ 2,766,396
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
FOR THE PERIOD FROM FEBRUARY 28, 1997
(DATE OF INCEPTION) TO DECEMBER 31, 1997
CHANGE IN NET ASSETS
FROM OPERATIONS:
Net investment income (expense) $ 33,936 $ (21,790) $ (14,200) $ (5,551) $ (4,705)
Net realized gain on investments - 7,054 19,623 4,079 1,744
Net change in unrealized appreciation
(depreciation) on investments - 181,643 (7,936) (47,635) 42,794
--------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
operations 33,936 166,907 (2,513) (49,107) 39,833
FROM CONTRACT RELATED TRANSACTIONS:
Net contract purchase payments 3,051,376 5,425,325 4,237,375 1,070,074 1,058,464
Withdrawals (6,825) (47,105) (25,073) (1,162) (500)
Transfers between Separate Account
VA-1 divisions, net (944,443) 115,015 59,441 54,948 (960)
--------------------------------------------------------------------------------------
Net increase in net assets from contract
related transactions 2,100,108 5,493,235 4,271,743 1,123,860 1,057,004
--------------------------------------------------------------------------------------
Increase in net assets 2,134,044 5,660,142 4,269,230 1,074,753 1,096,837
Net assets, beginning of period - - - - -
--------------------------------------------------------------------------------------
Net assets, end of period $ 2,134,044 $ 5,660,142 $ 4,269,230 $ 1,074,753 $ 1,096,837
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
</TABLE>
7
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF CHANGES IN NET ASSETS (CONTINUED)
<TABLE>
<CAPTION>
VARIABLE INSURANCE PRODUCTS FUND II
--------------------------------------------------------------------
VIPII VIPII VIPII VIPII MFS
INVESTMENT ASSET INDEX CONTRA- EMERGING
GRADE BOND MANAGER 500 FUND GROWTH
YEAR ENDED DECEMBER 31, 1998 DIVISION DIVISION DIVISION DIVISION DIVISION
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CHANGE IN NET ASSETS
FROM OPERATIONS:
Net investment income (expense) $ 4,395 $ 184,606 $ 20,444 $ 98,557 $ (48,438)
Net realized gain (loss) on investments 11,687 17,120 117,249 35,537 63,281
Net change in unrealized appreciation
(depreciation) on investments 92,558 282,239 3,666,821 1,810,143 2,048,032
--------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
operations 108,640 483,965 3,804,514 1,944,237 2,062,875
FROM CONTRACT RELATED TRANSACTIONS:
Net contract purchase payments 2,886,571 3,816,140 17,267,124 7,275,556 7,611,963
Withdrawals (119,470) (124,688) (561,189) (220,074) (227,264)
Transfers between Separate Account
VA-1 divisions, net 149,361 (51,516) 1,284,744 292,732 436,324
--------------------------------------------------------------------------------------
Net increase in net assets from contract
related transactions 2,916,462 3,639,936 17,990,679 7,348,214 7,821,023
--------------------------------------------------------------------------------------
Increase in net assets 3,025,102 4,123,901 21,795,193 9,292,451 9,883,898
Net assets, beginning of year 383,004 1,321,258 4,225,368 2,526,214 2,107,593
--------------------------------------------------------------------------------------
Net assets, end of year $ 3,408,106 $ 5,445,159 $ 26,020,561 $ 11,818,665 $ 11,991,491
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
FOR THE PERIOD FROM FEBRUARY 28, 1997
(DATE OF INCEPTION) TO DECEMBER 31, 1997
CHANGE IN NET ASSETS
FROM OPERATIONS:
Net investment income (expense) $ (1,400) $ (5,278) $ (16,370) $ (9,586) $ (11,724)
Net realized gain on investments 146 4,336 14,060 14,623 21,859
Net change in unrealized appreciation
(depreciation) on investments 10,658 38,856 146,733 12,404 (379)
--------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
operations 9,404 37,914 144,423 17,441 9,756
FROM CONTRACT RELATED TRANSACTIONS:
Net contract purchase payments 357,852 1,306,246 3,951,222 2,432,361 2,064,214
Withdrawals (312) (846) (15,675) (6,995) (6,359)
Transfers between Separate Account
VA-1 divisions, net 16,060 (22,056) 145,398 83,407 39,982
--------------------------------------------------------------------------------------
Net increase in net assets from contract
related transactions 373,600 1,283,344 4,080,945 2,508,773 2,097,837
--------------------------------------------------------------------------------------
Increase in net assets 383,004 1,321,258 4,225,368 2,526,214 2,107,593
Net assets, beginning of period - - - - -
--------------------------------------------------------------------------------------
Net assets, end of period $ 383,004 $ 1,321,258 $ 4,225,368 $ 2,526,214 $ 2,107,593
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
8
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
STATEMENT OF CHANGES IN NET ASSETS (CONTINUED)
<TABLE>
<CAPTION>
MFS VARIABLE INSURANCE TRUST
--------------------------------------------------------------------------------------
MFS MFS
MFS GROWTH TOTAL MFS MFS
RESEARCH WITH INCOME RETURN UTILITIES VALUE
YEAR ENDED DECEMBER 31, 1998 DIVISION DIVISION DIVISION DIVISION DIVISION
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CHANGE IN NET ASSETS
FROM OPERATIONS:
Net investment income (expense) $ 42,448 $ (63,989) $ 66,543 $ 82,198 $ (8,652)
Net realized gain (loss ) on investments 74,106 48,058 39,797 15,718 (6,658)
Net change in unrealized appreciation
(depreciation) on investments 1,778,617 1,082,788 839,138 430,022 569,618
--------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
operations 1,895,171 1,066,857 945,478 527,938 554,308
FROM CONTRACT RELATED TRANSACTIONS:
Net contract purchase payments 9,304,712 7,103,204 9,969,517 4,447,436 3,498,061
Withdrawals (354,707) (193,536) (288,075) (94,887) (154,469)
Transfers between Separate Account
VA-1 divisions, net 158,605 684,133 531,659 568,287 227,972
--------------------------------------------------------------------------------------
Net increase in net assets from contract
related transactions 9,108,610 7,593,801 10,213,101 4,920,836 3,571,564
--------------------------------------------------------------------------------------
Increase in net assets 11,003,781 8,660,658 11,158,579 5,448,774 4,125,872
Net assets, beginning of year 4,382,057 1,390,410 3,589,670 912,247 604,602
--------------------------------------------------------------------------------------
Net assets, end of year $ 15,385,838 $ 10,051,068 $ 14,748,249 $ 6,361,021 $ 4,730,474
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
FOR THE PERIOD FROM FEBRUARY 28, 1997
(DATE OF INCEPTION) TO DECEMBER 31, 1997
CHANGE IN NET ASSETS
FROM OPERATIONS:
Net investment income (expense) $ (20,141) $ 27,416 $ (13,566) $ (3,183) $ 77,282
Net realized gain on investments 7,944 9,844 10,482 380 12,630
Net change in unrealized appreciation
(depreciation) on investments 13,147 9,772 131,700 70,551 (65,257)
--------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
operations 950 47,032 128,616 67,748 24,655
FROM CONTRACT RELATED TRANSACTIONS:
Net contract purchase payments 4,376,126 1,342,706 3,492,360 844,009 540,032
Withdrawals (16,740) (6,853) (8,529) (726) (957)
Transfers between Separate Account
VA-1 divisions, net 21,721 7,525 (22,777) 1,216 40,872
--------------------------------------------------------------------------------------
Net increase in net assets from contract
related transactions 4,381,107 1,343,378 3,461,054 844,499 579,947
--------------------------------------------------------------------------------------
Increase in net assets 4,382,057 1,390,410 3,589,670 912,247 604,602
Net assets, beginning of period - - - - -
--------------------------------------------------------------------------------------
Net assets, end of period $ 4,382,057 $ 1,390,410 $ 3,589,670 $ 912,247 $ 604,602
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
9
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. NATURE OF OPERATIONS
The American Franklin Life Insurance Company (American Franklin) is a
wholly-owned subsidiary of The Franklin Life Insurance Company.
American Franklin established Separate Account VA-1 (Account) as a unit
investment trust registered under the Investment Company Act of 1940. The
Account, which consists of fifteen investment divisions, was established on
May 22, 1996 in conformity with Illinois Insurance Law. The assets in each
division are invested in units of beneficial interest (shares) of a
designated portfolio (Portfolio) of three mutual funds, sponsored by
Fidelity Investments (Variable Insurance Products Fund and Variable
Insurance Products Fund II) and MFS Investment Management (MFS Variable
Insurance Trust) (collectively, the Funds). The VIP Money Market, VIP
Equity-Income, VIP Growth, VIP Overseas, and VIP High Income Divisions of
the Account are invested in shares of a corresponding Portfolio of Variable
Insurance Products Fund; the VIPII Investment Grade Bond, VIPII Asset
Manager, VIPII Index 500, and VIPII Contrafund Divisions of the Account are
invested in shares of a corresponding Portfolio of Variable Insurance
Products Fund II; and the MFS Emerging Growth, MFS Research, MFS Growth With
Income, MFS Total Return, MFS Utilities, and MFS Value Divisions of the
Account are invested in shares of a corresponding Portfolio of MFS Variable
Insurance Trust. The Account's financial statements should be read in
conjunction with the financial statements of the Funds. The Account
commenced operations on February 28, 1997. The accumulation unit value for
each division was $5 at the inception of the account.
The Account was established by American Franklin to support the operations
of American Franklin's The Chairman(TM) Combination Fixed and Variable
Annuity Contracts (the Contracts).
Franklin Financial Services Corporation, a wholly-owned subsidiary of The
Franklin Life Insurance Company, acts as the principal underwriter, as
defined in the Investment Company Act of 1940, of the Contracts. The assets
of the Account are the property of American Franklin. The portion of the
Account's assets applicable to the Contracts is not chargeable with
liabilities arising out of any other business American Franklin may conduct.
The net assets of the Account may not be less than the reserves applicable
to the Contracts. Assets may also be set aside in American Franklin's
General Account based on the amounts allocated under the Contracts to
American Franklin's Fixed Account. Additional assets are set aside in
American Franklin's General Account to provide for other contract benefits.
2. SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies of the Account are as follows:
Investments in shares of the Funds are carried at fair value. Investments in
shares of the Funds are valued at the net asset values of the respective
Portfolios of the Funds. Investment transactions are recorded on the trade
date. Dividends are recorded as received. Realized gains and losses on sales
of the Account shares are determined based on the specific identification
method.
The operations of the Account are included in the federal income tax return
of American Franklin. Under the provisions of the Contracts, American
Franklin has the right to charge the Account for federal income tax
attributable to the Account. No charge is currently being made against the
Account for such tax since, under current tax law, American Franklin pays no
tax on investment income and capital gains of the Account. However, American
Franklin retains the right to charge for any federal income tax incurred
which is attributable to the Account if the law is changed. Charges for
state and local taxes, if any, attributable to the Account may also be made.
10
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
3. SALES AND ADMINISTRATIVE CHARGES
Certain jurisdictions require that deductions be made from premium payments
for premium taxes. The amount of such deductions varies and may be up to 5%
of the premium or purchase payment. Other jurisdictions assess a premium tax
at the point of annuitization. The balance of a purchase payment remaining
after any such deduction is placed by American Franklin in an account
established for each contractowner. Each year American Franklin makes a
charge of $30against each contractowner's account for administrative
expenses. This annual fee is currently waived if cumulative purchase
payments are at least $75,000. In addition, American Franklin will make
charges for a transfer between investment divisions in any contract year in
which twelve transfers have already been made ($25 for each additional
transfer in a given contract year). American Franklin assumes mortality and
expense risks related to the operations of the Account and deducts a charge
from the assets of the Account at an effective annual rate of 1.40% of the
Account's average daily net asset value to cover these risks and to offset
other administrative expenses not covered by the annual contract fee. The
total charges paid by the Account to American Franklin were $1,271,400 and
$148,200 for the year ended December 31, 1998 and the period from February
28, 1997 (date of inception) to December 31, 1997, respectively.
American Franklin imposes a surrender charge on the amount of each purchase
payment withdrawn during the first seven years after receipt, unless the
withdrawal is exempt from the surrender charge. The maximum surrender charge
is 6% of purchase payments withdrawn during the first two years after
receipt; the percentage declines ratably until elimination after the seventh
year.
11
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
4. SUMMARY OF UNIT VALUES AND CHANGES IN OUTSTANDING UNITS Unit value
information and a summary of changes in outstanding units is shown below:
<TABLE>
<CAPTION>
VARIABLE INSURANCE PRODUCTS FUND
-------------------------------------------------------------------------------
VIP VIP VIP
MONEY EQUITY- VIP VIP HIGH
MARKET INCOME GROWTH OVERSEAS INCOME
YEAR ENDED DECEMBER 31, 1998 DIVISION DIVISION DIVISION DIVISION DIVISION
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Unit value, beginning of year $ 5.14 $ 5.99 $ 5.65 $ 5.54 $ 5.89
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Unit value, end of year $ 5.34 $ 6.73 $ 7.94 $ 6.20 $ 5.54
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Number of units outstanding,
beginning of year 415,509 945,566 755,694 193,892 186,285
Net contract purchase payments 2,254,703 2,052,756 1,427,556 238,271 348,659
Withdrawals (66,473) (89,500) (81,680) (10,792) (6,632)
Transfers between Separate Account
VA-1 divisions, net (968,917) 83,150 105,838 (37,659) (28,894)
-------------------------------------------------------------------------------
Number of units outstanding,
end of year 1,634,822 2,991,972 2,207,408 383,712 499,418
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
FOR THE PERIOD FROM FEBRUARY 28, 1997
(DATE OF INCEPTION) TO DECEMBER 31, 1997
Unit value, beginning of period $ 5.00 $ 5.00 $ 5.00 $ 5.00 $ 5.00
-------------------------------------------------------------------------------
Unit value, end of period $ 5.14 $ 5.99 $ 5.65 $ 5.54 $ 5.89
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Number of units outstanding,
beginning of period - - - - -
Net contract purchase payments 602,404 934,067 749,740 184,417 186,518
Withdrawals (1,332) (8,001) (4,373) (206) (85)
Transfers between Separate Account
VA-1's Divisions, net (185,563) 19,500 10,327 9,681 (148)
-------------------------------------------------------------------------------
Number of units outstanding,
end of period 415,509 7945,566 755,694 193,892 186,285
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
12
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
4. SUMMARY OF UNIT VALUES AND CHANGES IN OUTSTANDING UNITS (continued) Unit
value information and a summary of changes in outstanding units is shown
below:
<TABLE>
<CAPTION>
VARIABLE INSURANCE PRODUCTS FUND II
------------------------------------------------------------------
VIPII VIPII VIPII VIPII MFS
INVESTMENT ASSET INDEX CONTRA- EMERGING
GRADE BOND MANAGER 500 FUND GROWTH
YEAR ENDED DECEMBER 31, 1998 DIVISION DIVISION DIVISION DIVISION DIVISION
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Unit value, beginning of year $ 5.32 $ 5.78 $ 6.21 $ 5.83 $ 5.50
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Unit value, end of year $ 5.70 $ 6.64 $ 8.07 $ 7.62 $ 7.48
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Number of units outstanding,
beginning of year 71,989 228,526 680,587 433,486 383,222
Net contract purchase payments 520,769 619,396 2,444,038 1,108,876 1,191,562
Withdrawals (21,276) (20,250) (77,752) (33,774) (35,893)
Transfers between Separate Account
VA-1 divisions, net 26,660 (7,288) 177,956 43,213 64,196
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Number of units outstanding,
end of year 598,142 820,384 3,224,829 1,551,801 1,603,087
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
FOR THE PERIOD FROM FEBRUARY 28, 1997
(DATE OF INCEPTION) TO DECEMBER 31, 1997
Unit value, beginning of period $ 5.00 $ 5.00 $ 5.00 $ 5.00 $ 5.00
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Unit value, end of period $ 5.32 $ 5.78 $ 6.21 $ 5.83 $ 5.50
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Number of units outstanding,
beginning of period - - - - -
Net contract purchase payments 69,000 233,481 660,464 420,462 377,275
Withdrawals (59) (146) (2,563) (1,189) (1,139)
Transfers between Separate Account
VA-1's Divisions, net 3,048 (4,809) 22,686 14,213 7,086
---------------------------------------------------------------------------------
Number of units outstanding,
end of period 71,989 228,526 680,587 433,486 383,222
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
</TABLE>
13
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
4. SUMMARY OF UNIT VALUES AND CHANGES IN OUTSTANDING UNITS (continued) Unit
value information and a summary of changes in outstanding units is shown
below:
<TABLE>
<CAPTION>
MFS VARIABLE INSURANCE TRUST
---------------------------------------------------------------------------------
MFS MFS
MFS GROWTH TOTAL MFS MFS
RESEARCH WITH INCOME RETURN UTILITIES VALUE
YEAR ENDED DECEMBER 31, 1998 DIVISION DIVISION DIVISION DIVISION DIVISION
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Unit value, beginning of year $5.61 $6.09 $5.73 $6.01 $5.99
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Unit value, end of year $6.95 $7.51 $6.43 $7.04 $7.59
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Number of units outstanding,
beginning of year 780,716 228,416 626,024 151,829 100,943
Net contract purchase payments 1,470,024 1,039,794 1,629,993 678,587 513,502
Withdrawals (56,418) (27,958) (46,902) (14,429) (21,848)
Transfers between Separate Account
VA-1 divisions, net 20,136 98,244 85,083 87,599 30,964
---------------------------------------------------------------------------------
Number of units outstanding,
end of year 2,214,458 1,338,496 2,294,198 903,586 623,561
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
FOR THE PERIOD FROM FEBRUARY 28, 1997
(DATE OF INCEPTION) TO DECEMBER 31, 1997
Unit value, beginning of period $5.00 $5.00 $5.00 $5.00 $5.00
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Unit value, end of period $5.61 $6.09 $5.73 $6.01 $5.99
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Number of units outstanding,
beginning of period - - - - -
Net contract purchase payments 780,936 229,569 632,529 151,754 94,256
Withdrawals (2,963) (1,141) (1,523) (126) (165)
Transfers between Separate Account
VA-1 Divisions, net 2,743 (12) (4,982) 201 6,852
---------------------------------------------------------------------------------
Number of units outstanding,
end of period 780,716 228,416 626,024 151,829 100,943
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
</TABLE>
14
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
5. REMUNERATION OF MANAGEMENT
The Account incurs no liability or expense for remuneration to directors,
members of advisory boards, officers or any other person who might provide a
service for the Account, except as described in Note 3.
6. YEAR 2000 (UNAUDITED)
INTERNAL SYSTEMS. American Franklin's ultimate parent, American General
Corporation (AGC), has numerous technology systems that are managed on a
decentralized basis. AGC's Year 2000 readiness efforts are therefore being
undertaken by its key business units with centralized oversight. Each
business unit, including American Franklin, has developed and is
implementing a plan to minimize the risk of a significant negative impact on
its operations.
While the specifics of the plans vary, the plans include the following
activities: (1) perform an inventory of American Franklin's information
technology and non-information technology systems; (2) assess which items in
the inventory may expose American Franklin to business interruptions due to
Year 2000 issues; (3) reprogram or replace systems that are not Year 2000
ready; (4) test systems to prove that they will function into the next
century as they do currently; and (5) return the systems to operations. As
of December 31, 1998, substantially all of American Franklin's critical
systems are Year 2000 ready and have been returned to operations. However,
activities (3) through (5) for certain systems are ongoing, with vendor
upgrades expected to be received during the first half of 1999.
THIRD PARTY RELATIONSHIPS. American Franklin has relationships with various
third parties who must also be Year 2000 ready. These third parties provide
(or receive) resources and services to (or from) American Franklin and
include organizations with which American Franklin exchanges information.
Third parties include vendors of hardware, software, and information
services; providers of infrastructure services such as voice and data
communications and utilities for office facilities; investors; customers;
distribution channels; and joint venture partners. Third parties differ from
internal systems in that American Franklin exercises less, or no, control
over Year 2000 readiness. American Franklin has developed a plan to assess
and attempt to mitigate the risks associated with the potential failure of
third parties to achieve Year 2000 readiness. The plan includes the
following activities: (1) identify and classify third party dependencies;
(2) research, analyze, and document Year 2000 readiness for critical third
parties; and (3) test critical hardware and software products and electronic
interfaces. As of December 31, 1998, AGC has identified and assessed
approximately 700 critical third party dependencies, including those
relating to American Franklin. A more detailed evaluation will be completed
during first quarter 1999 as part of American Franklin's contingency
planning efforts. Due to the various stages of third parties' Year 2000
readiness, American Franklin's testing activities will extend through 1999.
CONTINGENCY PLANS. American Franklin has commenced contingency planning to
reduce the risk of Year 2000-related business failures. The contingency
plans, which address both internal systems and third party relationships,
include the following activities: (1) evaluate the consequences of failure
of business processes with significant exposure to Year 2000 risk; (2)
determine the probability of a Year 2000-related failure for those processes
that have a high consequence of failure; (3) develop an action plan to
complete contingency plans for those processes that rank high in consequence
and probability of failure; and (4) complete the applicable action plans.
American Franklin is currently developing contingency plans and expects to
substantially complete all contingency planning activities by April 30,
1999.
RISKS AND UNCERTAINTIES. Based on its plans to make internal systems ready
for Year 2000, to deal with third party relationships, and to develop
contingency actions, American Franklin believes that it will experience at
most isolated and minor disruptions of business processes following the turn
of the century. Such disruptions are not expected to have a material effect
on American Franklin's future results of operations, liquidity, or financial
condition. However, due to the magnitude and complexity of this project,
risks and uncertainties exist and American Franklin is not able to predict a
most reasonably likely worst case scenario. If conversion of American
Franklin's internal systems is not completed on a timely basis (due to
non-performance by significant
15
<PAGE>
THE AMERICAN FRANKLIN LIFE INSURANCE COMPANY
SEPARATE ACCOUNT VA-1
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
third party-vendors, lack of qualified personnel to perform the Year 2000
work, or other unforeseen circumstances in completing American Franklin's
plans), or if critical third parties fail to achieve Year 2000 readiness on
a timely basis, the Year 2000 issues could have a material adverse impact on
American Franklin's operations following the turn of the century.
COSTS. Through December 31, 1998, American Franklin has incurred, and
anticipates that it will continue to incur, costs for internal staff, third
party vendors, and other expenses to achieve Year 2000 readiness. These
costs are not passed to the divisions of the Account. The cost of activities
related to Year 2000 readiness has not had a material adverse effect on
American Franklin's results of operations or financial condition. In
addition, The American Franklin has elected to accelerate the planned
replacement of certain systems as part of the Year 2000 plans. Costs of the
replacement systems are being capitalized and amortized over their useful
lives, in accordance with The American Franklin's normal accounting
policies.
16
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
The American Franklin Life Insurance Company
Contractowners of Separate Account VA-1
We have audited the accompanying statement of net assets of Separate Account
VA-1 (comprising, respectively, the Money Market, Equity-Income, Growth,
Overseas, High Income, Investment Grade Bond, Asset Manager, Index 500,
Contrafund, MFS Emerging Growth, MFS Research, MFS Growth With Income, MFS
Total Return, MFS Utilities and MFS Value Divisions) as of December 31, 1998,
and the related statement of operations for the year then ended and the
statement of changes in net assets for the year ended December 31, 1998, and
for the period from February 28, 1997 (date of inception) to December 31, 1997.
These financial statements are the responsibility of Separate Account VA-1
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Our procedures included
confirmation of securities owned as of December 31, 1998 by correspondence with
the custodian. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of each of the respective
Divisions constituting Separate Account VA-1 at December 31, 1998, and the
results of their operations for the year then ended and changes in net assets
for the year ended December 31, 1998 and the period from February 28, 1997
(date of inception) to December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
February 12, 1999
17
