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File Nos. 333-10285
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811-7769
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
POST-EFFECTIVE AMENDMENT NO. 1
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 2
SEPARATE ACCOUNT KG OF FIRST ALLMERICA FINANCIAL LIFE
INSURANCE COMPANY
FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY
440 Lincoln Street
Worcester, MA 01653
(Address of Principal Executive Office)
Abigail M. Armstrong, Secretary and Counsel
First Allmerica Financial Life Insurance Company
440 Lincoln Street
Worcester, MA 01653
(Name and Address of Agent for Service of Process)
It is proposed that this filing will become effective:
Immediately upon filing pursuant to paragraph (b) of Rule 485.
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X On (May 1, 1997) pursuant to paragraph (b) of Rule 485
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60 days after filing pursuant to paragraph (a)(1) of Rule 485.
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On (date) pursuant to paragraph (a)(1) of Rule 485.
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VARIABLE ANNUITY POLICIES
Pursuant to Reg. Section 270.24f-2 of the Investment Company Act of 1940,
Registrant hereby declares that an indefinite amount of its securities is
being registered under the Securities Act of 1933. The Rule 24f-2 Notice for
the issuer's fiscal year ended December 31, 1996 was filed February 28, 1997.
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Cross Reference Sheet Showing Location in Prospectus of
Items Called for by Form N-4
Form N-4 Item No Caption in Prospectus
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1. . . . . . . . Cover Page
2. . . . . . . . "Special Terms"
3. . . . . . . . "Summary"; "Annual and Transaction Expenses"
4. . . . . . . . Condensed Financial Information; "Performance Information"
5. . . . . . . . "Description of the Company, the Variable Account and the
Kemper Investor Fund."
6. . . . . . . . "Charges and Deductions"
7. . . . . . . . "Description of the Contract"
8. . . . . . . . "Electing the Form of Annuity and the Annuity Date";
Description of Variable Annuity Option"; "Annuity Benefit
Payments"
9. . . . . . . . "Death Benefit"
10 . . . . . . . " Payments"; "Computation of Values"; "Distribution" and
Annuity Payments"
11 . . . . . . . "Surrender"; "Withdrawal"; "Charge for Surrender and
Withdrawal"; "Withdrawal Without Surrender Charge"; "Texas
Optional Retirement Program"
12 . . . . . . . "Federal Tax Considerations"
13 . . . . . . . "Legal Matters"
14 . . . . . . . "Statement of Additional Information-Table of Contents"
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Form N-4 Item No. Caption in Statement of Additional Information
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15 . . . . . . . "Cover Page"
16 . . . . . . . "Table of Contents"
17 . . . . . . . "General Information and History"
18 . . . . . . . "Services"
19 . . . . . . . "Underwriters"
20 . . . . . . . "Underwriters"
21 . . . . . . . "Performance Information"
22 . . . . . . . "Annuity Payments"
23 . . . . . . . "Financial Statements"
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FIRST ALLMERICA FINANCIAL
LIFE INSURANCE COMPANY
KEMPER GATEWAY ELITE
A VARIABLE ANNUITY
PROFILE THIS PROFILE IS A SUMMARY OF SOME OF THE MORE IMPORTANT
MAY 1, 1997 POINTS THAT YOU SHOULD KNOW AND CONSIDER BEFORE PURCHASING
THE KEMPER GATEWAY ELITE CONTRACT. THE CONTRACT IS MORE
FULLY DESCRIBED LATER IN THIS PROSPECTUS. PLEASE READ THE
PROSPECTUS CAREFULLY.
1. KEMPER GATEWAY ELITE VARIABLE ANNUITY CONTRACT
The Kemper GATEWAY Elite variable annuity contract is a contract between you and
First Allmerica Financial Life Insurance Company. It is designed to help you
accumulate assets for your retirement or other important financial goals on a
tax-deferred basis. The Kemper GATEWAY Elite combines the concept of
professional money management with the attributes of an annuity contract.
Kemper GATEWAY Elite offers a customized investment portfolio with experienced
professional portfolio managers. You may allocate your payments among any of 16
investment portfolios of the Investors Fund Series, the Guarantee Period
Accounts and the Fixed Account (the Guaranteed Period Accounts and/or the Fixed
Account may not be available in certain jurisdictions.) This range of investment
choices enables you to allocate your money to meet your particular investment
needs.
Like all annuities, the contract has an ACCUMULATION PHASE and an INCOME PHASE.
During the ACCUMULATION PHASE you can make payments into the contract on any
frequency. Investment and interest gains accumulate tax deferred. You may
withdraw money from your contract during the ACCUMULATION PHASE. However, as
with other tax-deferred investments, you pay taxes on earnings and any untaxed
payments to the contract when you withdraw them. A federal tax penalty may apply
if you withdraw prior to age 59 1/2. During the INCOME PHASE you will receive
regular payments from your contract, provided you annuitize. Annuitization
involves beginning a series of payments from the capital that has built up in
your contract. The amount of your payments during the income phase will, in
part, be determined by your account's growth during the accumulation phase.
2. ANNUITY BENEFIT PAYMENTS
If you choose to annuitize your contract, you may select one of six annuity
options: 1. monthly payments for your lifetime; 2. monthly payments for your
lifetime, but for not less than 10 years; 3. monthly payments for your lifetime
with the guarantee that if payments to you are less than the accumulated value a
refund of the remaining value will be paid; 4. monthly payments for your
lifetime and your survivor's lifetime; 5. monthly payments for your lifetime and
your survivor's lifetime with the payment to the survivor being reduced to 2/3;
and 6. monthly payments for a specified period of 1 to 30 years.
You also need to decide if you want your annuity payments on a variable basis
(i.e., subject to fluctuation based on investment performance), on a fixed basis
(with benefit payments guaranteed at a fixed amount), or on a combination
variable and fixed basis. Once payments begin, the annuity option cannot be
changed.
3. PURCHASING THIS CONTRACT
You can buy a contract through your financial representative, who can also help
you complete the proper forms. There is no fixed schedule for making additional
payments into this contract. There are no limits to the frequency
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of additional payments, but there are certain limitations as to amount.
Generally, the initial payment must be at least $2,000 and additional payments
must be at least $100. However, minimums may be reduced for certain
employer-sponsored plans.
4. INVESTMENT OPTIONS
You have full investment control over the contract. You may allocate money to
the following portfolios:
<TABLE>
<S> <C>
Money Market Portfolio Value Portfolio
Total Return Portfolio Small Cap Value Portfolio
High Yield Portfolio Value + Growth Portfolio
Growth Portfolio Horizon 20+ Portfolio
Government Securities Portfolio Horizon 10+ Portfolio
International Portfolio Horizon 5 Portfolio
Small Cap Growth Portfolio Global Income Portfolio
Investment Grade Bond Portfolio Blue Chip Portfolio
</TABLE>
You may also allocate money to the Guarantee Period Accounts and the Fixed
Account. The Guarantee Period Accounts let you choose from among nine different
Guarantee Periods (ranging in maturity from 2 to 10 years) during which
principal and interest rates are guaranteed. The Fixed Account guarantees
principal and a minimum rate of interest (never less than 3% compounded
annually).
5. EXPENSES
Each year and upon surrender, a $30 contract fee is deducted from your contract.
The contract fee is waived if the value of the contract is $50,000 or more or if
the contract is issued to and maintained by the Trustees of a 401(k) plan. We
also deduct insurance charges which amount to 1.40% annually of the daily value
of your contract value allocated to the variable investment options. The
insurance charges include: Mortality and Expense Risk Charge, 1.25%; and
Administrative Expense Charge, 0.15%. There are also investment management fees
and other portfolio operating expenses that vary by portfolio.
If you decide to surrender your contract, make withdrawals or receive payments
under certain annuity options, we may impose a surrender charge between 2% and
7% of the payment withdrawn, based on when your payments were made. In states
where premium taxes are imposed, a premium tax charge will be deducted either
when withdrawals are made or annuity payments commence.
There is currently no charge for processing investment option transfers. We
reserve the right to assess a charge, not to exceed $25, for transfers in excess
of 12 per contract year.
The following chart is designed to help you understand the charges in your
contract. Column C labeled "Total Annual Charges" shows the total of the $30
contract fee (which is represented as 0.03%)and the 1.40% insurance
charges(Column A) plus the investment charges for each portfolio (Column B.)
Columns D and E show you two examples of the charges, in dollar amounts, you
would pay under a contract. The examples assume you invest $1,000 in a portfolio
which earns 5% annually and that you withdraw your money: at the end of year 1
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(Column D), and at the end of year 10 (Column E). In Column D, the Total Annual
Charges are assessed as well as the surrender charges. In Column E, the example
shows the aggregate of all the annual charges assessed for 10 years, but there
is no surrender charge. The premium tax is assumed to be 0% in both examples.
<TABLE>
<CAPTION>
TOTAL D E
ANNUAL PORTFOLIO TOTAL ANNUAL EXPENSES AT END
TOTAL ANNUAL CHARGES OF
INSURANCE ----------------- TOTAL ANNUAL ----------------------------
PORTFOLIO CHARGE CHARGES 1 YEAR 10 YEARS
- ------------------------------------- --------------- ------------------- --------------- -----------
<S> <C> <C> <C> <C> <C>
Money Market Portfolio 1.43% 0.60% 2.03% $ 82 $ 232
Total Return Portfolio 1.43% 0.59% 2.02% $ 81 $ 231
High Yield Portfolio 1.43% 0.65% 2.08% $ 82 $ 238
Growth Portfolio 1.43% 0.64% 2.07% $ 82 $ 237
Government Securities Portfolio 1.43% 0.66% 2.09% $ 82 $ 239
International Portfolio 1.43% 0.96% 2.39% $ 85 $ 269
Small Cap Growth Portfolio 1.43% 0.75% 2.18% $ 83 $ 248
Investment Grade Bond Portfolio 1.43% 0.85% 2.28% $ 84 $ 258
Value Portfolio 1.43% 0.95% 2.38% $ 85 $ 268
Small Cap Value Portfolio 1.43% 0.95% 2.38% $ 85 $ 268
Value + Growth Portfolio 1.43% 0.95% 2.38% $ 85 $ 268
Horizon 20+ Portfolio 1.43% 0.85% 2.38% $ 84 $ 258
Horizon 10+ Portfolio 1.43% 0.80% 2.23% $ 83 $ 253
Horizon 5 Portfolio 1.43% 0.90% 2.33% $ 84 $ 263
Global Income Portfolio 1.43% 1.05% 2.48% $ 86 $ 278
Blue Chip Portfolio 1.43% 0.95% 2.38% $ 85 $ 268
</TABLE>
For more detailed information, see the Fee Table in the Prospectus.
6. TAXES
You will not pay taxes until you withdraw money from your contract. During the
accumulation phase, earnings are withdrawn first and are taxed as ordinary
income. If you make a withdrawal prior to age 59 1/2, you may be subject to a
10% federal tax penalty on the earnings. Payments during the income phase are
considered partly a return of your investment and partly earnings. You will be
subject to income taxes on the earnings portion of each payment. However, if
your contract is funded with pre-tax or tax deductible dollars (such as a
pension or profit sharing plan contribution), then the entire payment will be
taxable.
7. WITHDRAWALS
You can make withdrawals from your contract any time during the accumulation
phase. The minimum withdrawal amount is $100.
For amounts invested for less than six years, you will not be assessed a
surrender charge on the greatest of:
1. 100% of the cumulative earnings;
2. 15% or less of the contract value in any calendar year; or
3. an amount calculated under the Life Expectancy Distribution option.
Except in New York, where not permitted by state law, you may receive your money
without a surrender charge if after the contract is issued, the owner is:
1. confined to a medical care facility for the later of one year from the
issue date or 90 days;
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2. diagnosed as having a fatal illness; or
3. physically disabled before attaining age 65.
Any withdrawal from a Guarantee Period Account ("GPA") prior to the end of the
Guarantee Period will be subject to a market value adjustment which may increase
or decrease the value in that account. This adjustment will never impact your
original investment, nor will earnings in the GPA amount to less than an
effective annual rate of 3%.
8. PERFORMANCE
The value of your contract will vary depending on the investment performance of
the portfolios you choose. From time to time, we may advertise "Total Return"
and "Average Annual Total Return" based upon the periods that the portfolios
have been in existence. These returns are based upon historical data and are not
intended to indicate future performance.
The contract was first offered in 1997. Therefore, performance for a complete
year is not available and is not shown here.
9. DEATH BENEFIT
If the annuitant dies during the accumulation phase, we will pay the beneficiary
a death benefit equal to the GREATEST of:
1. the accumulated value increased for any positive market value
adjustment;
2. total payments reduced proportionately to reflect any prior withdrawals;
or
3. the highest contract value on any contract anniversary, increased by any
subsequent payments and reduced proportionately to reflect any prior
withdrawals.
10. OTHER INFORMATION
FREE-LOOK PERIOD: If you cancel your contract within 10 days after receiving it
(or whatever period is required by your state), we will return the greater of
(1) your Accumulated Value in the Sub-Accounts plus the amount initially
allocated to the Fixed and Guarantee Period Accounts, or (2) your entire
payment.
DOLLAR COST AVERAGING: You may elect to automatically transfer money on a
periodic basis from the Money Market Portfolio, the Government Securities
Portfolio or Fixed Account to one or more of the variable investment options.
AUTOMATIC ACCOUNT REBALANCING: You may elect to automatically have your
contract's accumulated value periodically reallocated ("rebalanced") among your
chosen investment options to maintain your designated percentage allocation mix.
11. INQUIRIES
If you need more information you may contact us at:
First Allmerica Financial Life Insurance Company
440 Lincoln St.
Worcester, Massachusetts 01653
1-800-782-8380
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FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY
FLEXIBLE PAYMENT DEFERRED VARIABLE AND FIXED ANNUITY CONTRACTS
This Prospectus describes interests under flexible payment deferred variable and
fixed annuity contracts, known as Kemper Gateway Elite Contracts, issued either
on a group basis or as individual contracts by First Allmerica Financial Life
Insurance Company (the "Company") to individuals and businesses in connection
with retirement plans which may or may not qualify for special federal income
tax treatment. (For information about the tax status when used with a particular
type of plan, see "FEDERAL TAX CONSIDERATIONS"). Participation in a group
contract will be accounted for by the issuance of a certificate describing the
individual's interest under the group contract. Participation in an individual
contract will be evidenced by the issuance of an individual contract.
Certificates and individual contracts are referred to collectively herein as the
"Contract(s)." The following is a summary of information about these Contracts.
More detailed information can be found under the referenced captions in this
Prospectus.
Contract values may accumulate on a variable basis in the separate account known
as Separate Account KG (the "Variable Account"). The assets of the Variable
Account are divided into Sub-Accounts, each investing exclusively in shares of
one of the following Portfolios of Investors Fund Series ("IFS"):
<TABLE>
<S> <C>
MONEY MARKET PORTFOLIO VALUE PORTFOLIO
TOTAL RETURN PORTFOLIO SMALL CAP VALUE PORTFOLIO
HIGH YIELD PORTFOLIO VALUE+GROWTH PORTFOLIO
GROWTH PORTFOLIO HORIZON 20+ PORTFOLIO
GOVERNMENT SECURITIES PORTFOLIO HORIZON 10+ PORTFOLIO
INTERNATIONAL PORTFOLIO HORIZON 5 PORTFOLIO
SMALL CAP GROWTH PORTFOLIO GLOBAL INCOME PORTFOLIO
INVESTMENT GRADE BOND PORTFOLIO BLUE CHIP PORTFOLIO
</TABLE>
In most jurisdictions, values also may be allocated on a fixed basis to the
Fixed Account, which is part of the Company's General Account, and during the
accumulation period to one or more of the Guarantee Period Accounts. Amounts
allocated to the Fixed Account earn interest at a guaranteed rate for one year
from the date allocated. Amounts allocated to a Guarantee Period Account earn a
fixed rate of interest for the duration of the applicable Guarantee Period if
held for the entire Guarantee Period. If removed prior to the end of the
Guarantee Period the value may be increased or decreased by a Market Value
Adjustment. Amounts allocated to the Guarantee Period Accounts in the
accumulation phase are held in the Company's Separate Account GPA.
Additional information is contained in a Statement of Additional Information
("SAI") dated May 1, 1997, filed with the Securities and Exchange Commission
(the "SEC") and incorporated herein by reference. The Table of Contents of the
SAI is on page 3 of this Prospectus. The SAI is available upon request and
without charge through Allmerica Investments, Inc., 440 Lincoln Street,
Worcester, MA 01653, Telephone 800-782-8380.
THIS PROSPECTUS IS VALID ONLY WHEN ACCOMPANIED BY A CURRENT PROSPECTUS OF
INVESTORS FUND SERIES. INVESTORS SHOULD RETAIN A COPY OF THIS PROSPECTUS FOR
FUTURE REFERENCE.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE CONTRACTS ARE OBLIGATIONS OF FIRST ALLMERICA FINANCIAL LIFE INSURANCE
COMPANY, AND ARE DISTRIBUTED BY ALLMERICA INVESTMENTS, INC. AND/OR KEMPER
DISTRIBUTORS, INC., AND ZKI AGENCY, INC. THE CONTRACTS ARE NOT DEPOSITS OR
OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK OR CREDIT UNION. THE
CONTRACTS ARE NOT INSURED BY THE U.S. GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE
CORPORATION (FDIC), OR ANY OTHER FEDERAL AGENCY. INVESTMENTS IN THE CONTRACTS
ARE SUBJECT TO VARIOUS RISKS, INCLUDING THE FLUCTUATION OF VALUE AND POSSIBLE
LOSS OF PRINCIPAL.
DATED MAY 1, 1997
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TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
STATEMENT OF ADDITIONAL INFORMATION TABLE OF CONTENTS 4
SPECIAL TERMS 5
SUMMARY 6
ANNUAL AND TRANSACTION EXPENSES 11
PERFORMANCE INFORMATION 14
DESCRIPTION OF THE COMPANY, THE VARIABLE ACCOUNT, AND
INVESTORS FUND SERIES 17
INVESTMENT OBJECTIVES AND POLICIES 17
INVESTMENT MANAGEMENT SERVICES 19
DESCRIPTION OF THE CONTRACT 19
A. Payments 19
B. Right to Revoke Contract 20
C. Transfer Privilege 21
Automatic Transfers and Automatic Account Rebalancing Options 21
D. Surrender 21
E. Withdrawals 22
Systematic Withdrawals 23
Life Expectancy Distributions 23
F. Death Benefit 24
Death of the Annuitant Prior to the Annuity Date 24
Death of an Owner Who is Not Also the Annuitant Prior to the Annuity Date 24
Payment of the Death Benefit Prior to the Annuity Date 24
Death of the Annuitant After the Annuity Date 24
G. The Spouse of the Owner as Beneficiary 24
H. Assignment 25
I. Electing the Form of Annuity and the Annuity Date 25
J. Description of Variable Annuity Payout Options 26
K. Annuity Benefit Payments 27
The Annuity Unit 27
Determination of the First and Subsequent Annuity Benefit Payments 27
L. NORRIS Decision 28
M. Computation of Values 28
The Accumulation Unit 28
Net Investment Factor 29
CHARGES AND DEDUCTIONS 29
A. Variable Account Deductions 29
Mortality and Expense Risk Charge 29
Administrative Expense Charge 30
Other Charges 30
B. Contract Fee 30
C. Premium Taxes 31
</TABLE>
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<TABLE>
<S> <C> <C>
D. Contingent Deferred Sales Charge 31
Charges for Surrender and Withdrawal 32
Reduction or Elimination of Surrender Charge 32
Withdrawal Without Surrender Charge 33
Surrenders 34
Charge at the Time Annuity Benefit Payments Begin 34
E. Transfer Charge 35
GUARANTEE PERIOD ACCOUNTS 35
FEDERAL TAX CONSIDERATIONS 37
A. Qualified and Non-Qualified Contracts 38
B. Taxation of the Contracts in General 38
Withdrawals Prior to Annuitization 38
Annuity Payouts After Annuitization 38
Penalty on Distribution 38
Assignments or Transfers 39
Non-Natural Owners 39
Deferred Compensation Plans of State and Local Government and Tax-Exempt
Organizations 39
C. Tax Withholding 40
D. Provisions Applicable to Qualified Employer Plans 40
Corporate and Self-Employed Pension and Profit Sharing Plans 40
Individual Retirement Annuities 40
Tax-Sheltered Annuities 41
Texas Optional Retirement Program 41
REPORTS 41
LOANS (QUALIFIED CONTRACTS ONLY) 41
ADDITION, DELETION OR SUBSTITUTION OF INVESTMENTS 41
CHANGES TO COMPLY WITH LAW AND AMENDMENTS 43
VOTING RIGHTS 43
DISTRIBUTION 43
LEGAL MATTERS 43
FURTHER INFORMATION 44
APPENDIX A -- MORE INFORMATION ABOUT THE FIXED ACCOUNT A-1
APPENDIX B -- SURRENDER CHARGES AND THE MARKET VALUE ADJUSTMENT A-2
</TABLE>
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STATEMENT OF ADDITIONAL INFORMATION
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
GENERAL INFORMATION AND HISTORY 2
TAXATION OF THE VARIABLE ACCOUNT AND THE COMPANY 3
SERVICES 3
UNDERWRITERS 3
ANNUITY BENEFIT PAYMENTS 4
EXCHANGE OFFER 5
PERFORMANCE INFORMATION 7
TAX-DEFERRED ACCUMULATION 10
FINANCIAL STATEMENTS F-1
</TABLE>
THE CONTRACTS OFFERED BY THIS PROSPECTUS MAY NOT BE AVAILABLE IN ALL STATES.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING IN ANY JURISDICTION IN WHICH
SUCH OFFERING MAY NOT LAWFULLY BE MADE. NO PERSON IS AUTHORIZED TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS.
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SPECIAL TERMS
ACCUMULATED VALUE: the sum of the value of all Accumulation Units in the
Sub-Accounts and of the value of all accumulations in the Fixed Account and
Guarantee Period Accounts then credited to the Contract on any date before the
Annuity Date.
ACCUMULATION UNIT: a measure of the Owner's interest in a Sub-Account before
annuity benefit payments begin.
ANNUITANT: the person designated in the Contract upon whose life annuity benefit
payments are to be made.
ANNUITY DATE: the date on which annuity benefit payments begin as specified
pursuant to the Contract.
ANNUITY UNIT: a measure of the value of the periodic annuity benefit payments
under the Contract.
FIXED ACCOUNT: the part of the Company's General Account that guarantees
principal and a fixed minimum interest rate and to which all or a portion of a
payment or transfer under this Contract may be allocated.
FIXED ANNUITY PAYOUT: an Annuity in the payout phase providing for annuity
benefit payments which remain fixed in amount throughout the annuity benefit
payment period selected.
GENERAL ACCOUNT: all the assets of the Company other than those held in a
separate account.
GUARANTEE PERIOD: the number of years that a Guaranteed Interest Rate is
credited.
GUARANTEE PERIOD ACCOUNT: an account which corresponds to a Guaranteed Interest
Rate for a specified Guarantee Period and is supported by assets in a
non-unitized separate account.
GUARANTEED INTEREST RATE: the annual effective rate of interest, after daily
compounding, credited to a Guarantee Period Account.
MARKET VALUE ADJUSTMENT: a positive or negative adjustment assessed if any
portion of a Guarantee Period Account is withdrawn or transferred prior to the
end of its Guarantee Period.
OWNER: the person, persons or entity entitled to exercise the rights and
privileges under this Contract. Joint Owners are permitted if one of the two is
the Annuitant.
SUB-ACCOUNT: a subdivision of the Variable Account. Each Sub-Account available
under the Contract invests exclusively in the shares of a corresponding
portfolio of Investors Fund Series.
SURRENDER VALUE: the Accumulated Value of the Contract on full surrender after
application of any Contract fee, contingent deferred sales charge, and Market
Value Adjustment.
UNDERLYING PORTFOLIOS (OR PORTFOLIOS): Money Market, Total Return, High Yield,
Growth, Government Securities, International, Small Cap Growth, Investment Grade
Bond, Value, Small Cap Value, Value+Growth, Horizon 20+, Horizon 10+, Horizon 5,
Global Income and Blue Chip Portfolios of Investors Fund Series.
VALUATION DATE: a day on which the net asset value of the shares of any of the
Underlying Portfolios is determined and unit values of the Sub-Accounts are
determined. Valuation Dates currently occur on each day on which the New York
Stock Exchange is open for trading, as well as each day otherwise required.
VARIABLE ACCOUNT: Separate Account KG, one of the Company's separate accounts,
consisting of assets segregated from other assets of the Company. The investment
performance of the assets of the Variable Account is determined separately from
the other assets of the Company, and are not chargeable with liabilities arising
out of any other business which the Company may conduct.
VARIABLE ANNUITY PAYOUT: Annuity in the payout phase providing for payments
varying in amount in accordance with the investment experience of certain of the
Portfolios.
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SUMMARY
WHAT IS THE KEMPER GATEWAY ELITE VARIABLE ANNUITY?
The Kemper Gateway Elite variable annuity contract is an insurance contract
designed to help you accumulate assets for your retirement or other important
financial goals on a tax-deferred basis. The Contract combines the concept of
professional money management with the attributes of an annuity contract.
Features available through the Contract include:
- - A customized investment portfolio
- - 16 IFS Portfolios
- - 1 Fixed Account
- - 9 Guarantee Period Accounts
- - Experienced professional portfolio managers
- - Tax deferral on earnings
- - Guarantees that can protect your beneficiaries during the accumulation phase
- - Income that can be guaranteed for life.
The Contract has two phases, an accumulation phase and, if you choose to
annuitize, an annuity payout phase. During the accumulation phase, your initial
payment and any additional payments you choose to make may be allocated to the
combination of portfolio of securities ("Portfolios") under your Contract, to
the Guarantee Period Accounts, and to the Fixed Account. You select the
investment options most appropriate for your investment needs. As those needs
change, you may also change your allocation without incurring any tax
consequences. Your Contract's Accumulated Value is based on the investment
performance of the Portfolios and any accumulations in the Guarantee Period and
Fixed Accounts. No income taxes are paid on any earnings under the Contract
unless and until Accumulated Values are withdrawn. In addition, during the
accumulation phase, your beneficiaries receive certain protections and
guarantees in the event of the Annuitant's death. See discussion below "WHAT
HAPPENS UPON DEATH DURING THE ACCUMULATION PHASE?"
WHAT HAPPENS IN THE ANNUITY PAYOUT PHASE?
During the annuity payout phase, the Annuitant can receive income based on
several annuity payout options. You choose the annuity payout option and the
date for annuity benefit payments to begin. You also decide whether you want
variable annuity benefit payments based on the investment performance of certain
Portfolios, fixed annuity benefit payments with payment amounts guaranteed by
the Company, or a combination of fixed and variable annuity benefit payments.
Among the payout options available during the annuity payout phase are:
- - periodic payments for your lifetime (assuming you are the Annuitant);
- - periodic payments for your life and the life of another person selected by
you;
- - periodic payments for your lifetime with guaranteed payments continuing to
your beneficiary for ten years in the event that you die before the end of ten
years;
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- - periodic payments over a specified number of years (1 to 30) -- under this
option you may reserve the right to convert remaining payments to a lump-sum
payout by electing a "commutable" option.
WHO ARE THE KEY PERSONS UNDER THE CONTRACT?
The Contract is between you, (the Owner) and us, First Allmerica Financial Life
Insurance Company ("the Company"). Each Contract has an Owner (or an Owner and a
Joint Owner, in which case one of the two also must be the Annuitant), an
Annuitant and a beneficiary. As Owner, you make payments, choose investment
allocations and select the Annuitant and beneficiary. The Annuitant is the
individual to receive annuity benefit payments under the Contract. The
beneficiary is the person who receives any payment on the death of the Owner or
Annuitant.
HOW MUCH CAN I INVEST AND HOW OFTEN?
The number and frequency of your payments are flexible, subject to the minimum
and maximum payments stated in "A. Payments."
WHAT ARE MY INVESTMENT CHOICES?
The Contract permits net payments to be allocated among the Sub-Accounts
investing in the Portfolios, the Guarantee Period Accounts, and the Fixed
Account.
VARIABLE ACCOUNT. You have a choice of Sub-Accounts investing in the following
16 Portfolios of IFS:
<TABLE>
<S> <C>
MONEY MARKET PORTFOLIO VALUE PORTFOLIO
TOTAL RETURN PORTFOLIO SMALL CAP VALUE PORTFOLIO
HIGH YIELD PORTFOLIO VALUE+GROWTH PORTFOLIO
GROWTH PORTFOLIO HORIZON 20+ PORTFOLIO
GOVERNMENT SECURITIES PORTFOLIO HORIZON 10+ PORTFOLIO
INTERNATIONAL PORTFOLIO HORIZON 5 PORTFOLIO
SMALL CAP GROWTH PORTFOLIO GLOBAL INCOME PORTFOLIO
INVESTMENT GRADE BOND PORTFOLIO BLUE CHIP PORTFOLIO
</TABLE>
For a more detailed description of the Portfolios, see "INVESTMENT OBJECTIVES
AND POLICIES."
GUARANTEE PERIOD ACCOUNTS. Assets supporting the guarantees under the Guarantee
Period Accounts are held in the Company's Separate Account GPA, a non-unitized
insulated separate account. Values and benefits calculated on the basis of
Guarantee Period Account allocations, however, are obligations of the Company's
General Account. Amounts allocated to a Guarantee Period Account earn a
Guaranteed Interest Rate declared by the Company. The level of the Guaranteed
Interest Rate depends on the number of years of the Guarantee Period selected.
The Company currently makes available nine Guarantee Periods ranging from two to
ten years in duration. Once declared, the Guaranteed Interest Rate will not
change during the duration of the Guarantee Period. If amounts allocated to a
Guarantee Period Account are transferred, surrendered or applied to any annuity
option at any time other than the day following the last day of the applicable
Guarantee Period, a Market Value Adjustment will apply that may increase or
decrease the Account's value. For more information about the Guarantee Period
Accounts and the Market Value Adjustment, see "GUARANTEE PERIOD ACCOUNTS."
7
<PAGE>
FIXED ACCOUNT. The Fixed Account is part of the General Account, which consists
of all the Company's assets other than those allocated to the Variable Account
and any other separate account. Allocations to the Fixed Account are guaranteed
as to principal and a minimum rate of interest. Additional excess interest may
be declared periodically at the Company's discretion. Furthermore, the initial
rate in effect on the date an amount is allocated to the Fixed Account will be
guaranteed for one year from that date. For more information about the Fixed
Account see "Appendix A. MORE INFORMATION ABOUT THE FIXED ACCOUNT."
WHO ARE THE PORTFOLIO MANAGERS?
Zurich Kemper Investments, Inc. ("ZKI") is the investment manager of each
Portfolio of IFS other than the Value and Small Cap Value Portfolios which are
managed by Dreman Value Advisors, Inc. ("DVA"), a wholly owned subsidiary of
ZKI. ZKI and DVA provide each Portfolio with continuous professional investment
supervision. DVA is also the sub-adviser for the Value+Growth, Horizon 20+,
Horizon 10+, and Horizon 5 Portfolios. Under the terms of its Sub-Advisory
Agreement with ZKI, DVA will manage the value portion of each of these
Portfolios and will provide such other investment advice, research and
assistance as ZKI may, from time to time, reasonably request. Zurich Investment
Management Limited ("ZIML"), an affiliate of ZKI, is a sub-adviser for certain
Portfolios described below. Under the terms of the Sub-Advisory Agreement
between ZIML and ZKI for the Total Return, High Yield, Growth, International,
Small Cap Growth, Investment Grade Bond, Value+Growth, Horizon 20+, Horizon 10+,
Horizon 5, Global Income and Blue Chip, Portfolios, ZIML renders investment
advisory and management services with regard to that portion of a Portfolio's
assets as may be allocated by ZKI to ZIML from time to time for management of
foreign securities. Zurich Investment Management, Inc. ("ZIM"), a wholly owned
subsidiary of ZKI, is the investment manager of the Guarantee Period Accounts
pursuant to an investment advisory agreement between the Company and ZIM.
CAN I MAKE TRANSFERS AMONG THE ACCOUNTS?
Yes. Prior to the Annuity Date, you may transfer among the Sub-Accounts
investing in the Portfolios, the Guarantee Period Accounts, and the Fixed
Account. You will incur no current taxes on transfers while your money remains
in the Contract. You also may elect Automatic Account Rebalancing to ensure
assets remain allocated according to a desired mix or choose automatic dollar
cost averaging to gradually move money into one or more Portfolios. See "C.
Transfer Privilege."
WHAT IF I NEED MY MONEY BEFORE MY ANNUITY PAYOUT PHASE BEGINS?
You may surrender your Contract or make withdrawals any time before your annuity
payout phase begins. Each year you can take without a surrender charge the
greatest of 100% of cumulative earnings, 15% of the Contract's Accumulated Value
or, if you are both an Owner and the Annuitant, an amount based on your life
expectancy. A 10% tax penalty may apply on all amounts deemed to be earnings if
you are under age 59 1/2. Additional amounts may be withdrawn at anytime but may
be subject to the surrender charge for payments that have not been invested in
the Contract for more than six years. (A Market Value Adjustment may apply to
any withdrawal made from a Guarantee Period Account prior to the expiration of
the Guarantee Period.)
In addition, except in New York where not permitted under state law, you may
withdraw all or a portion of your money without a surrender charge if, after the
Contract is issued, you are admitted to a medical care facility, become disabled
or are diagnosed with a fatal illness. For details and restrictions, see
"Reduction or Elimination of Surrender Charge."
8
<PAGE>
WHAT HAPPENS UPON DEATH DURING THE ACCUMULATION PHASE?
If the Annuitant, Owner or Joint Owner should die before the Annuity Date, a
death benefit will be paid to the beneficiary. Upon the death of the Annuitant
(or an Owner who is also an Annuitant), the death benefit is equal to the
GREATEST of:
- - The Accumulated Value increased by any positive Market Value Adjustment;
- - Gross payments reduced proportionately to reflect withdrawals;
- - The highest Accumulated Value that would have been payable as a death benefit
on any Contract anniversary, increased for subsequent payments and reduced
proportionately to reflect withdrawals since that anniversary.
At the death of an Owner who is not also the Annuitant during the Accumulation
phase, the death benefit will equal the Accumulated Value of the Contract
increased by any positive Market Value Adjustment.
(If the Annuitant dies after the Annuity Date but before all guaranteed annuity
benefit payments have been made, the remaining payments will be paid to the
beneficiary at least as rapidly as under the annuity option in effect. See "F.
Death Benefit.")
WHAT CHARGES WILL I INCUR UNDER MY CONTRACT?
At each Contract anniversary and upon surrender, if the Accumulated Value is
less than $50,000, the Company will deduct a $30 Contract fee from the Contract.
There will be no Contract fee if the Accumulated Value is $50,000 or more. The
Contract fee is waived for a Contract issued to and maintained by a trustee of a
401(k) plan.
Should you decide to surrender the Contract, make withdrawals, or receive
payments under certain annuity options, you may be subject to a contingent
deferred sales charge. If applicable, this charge will be between 2% and 7% of
payments withdrawn, based on when the payments were made.
Depending upon the state in which you live, a deduction for state and local
premium taxes, if any, may be made as described under "C. Premium Taxes."
Currently, the Company makes no charge for processing transfers. The first 12
transfers in a Contract year are guaranteed to be free of a transfer charge. For
each subsequent transfer in a Contract year, the Company reserves the right to
assess a charge which is guaranteed never to exceed $25.
The Company will deduct, on a daily basis, an annual mortality and expense risk
charge and administrative expense charge equal to 1.25% and 0.15%, respectively,
of the average daily net assets invested in each Portfolio. The Portfolios will
incur certain management fees and expenses described more fully in "Other
Charges" and in the IFS prospectus which accompanies this Prospectus.
For more information, see "CHARGES AND DEDUCTIONS."
CAN I EXAMINE THE CONTRACT?
Yes. Your Contract will be delivered to you after your purchase. If you return
the Contract to the Company within ten days of receipt, the Contract will be
cancelled. If you cancel the Contract, you will receive a refund of the
9
<PAGE>
greater of (1) any amounts allocated to the Fixed and Guarantee Period Accounts
and the Accumulated Value of any amounts allocated to the Sub-Accounts (plus any
fees or charges that may have been deducted) or (2) your entire payment. See "B.
Right to Revoke Contract."
CAN I MAKE FUTURE CHANGES UNDER MY CONTRACT?
There are several changes you can make after receiving your Contract:
- - You may assign your ownership to someone else, except under certain qualified
plans.
- - You may change the beneficiary, unless you have designated a beneficiary
irrevocably.
- - You may change your allocation of payments.
- - You may make transfers of Contract value among your current investments
without any tax consequences.
- - You may cancel the Contract within ten days of delivery (or longer if required
by law).
10
<PAGE>
ANNUAL AND TRANSACTION EXPENSES
The following tables show charges under your Contract, expenses of the
Sub-Accounts, and expenses of the Portfolios. In addition to the charges and
expenses described below, premium taxes are applicable in some states and
deducted as described under "C. Premium Taxes."
CONTRACT CHARGES:
<TABLE>
<CAPTION>
YEARS FROM
DATE OF PAYMENT CHARGE
---------------- ---------
<S> <C> <C>
CONTINGENT DEFERRED SALES CHARGE:
This charge may be assessed upon surrender, withdrawal or 0-1 7.0%
annuitization under any commutable period certain option or a 2 6.0%
non-commutable period certain option of less than ten years.The 3 5.0%
charge is a percentage of payments applied to the amount 4 4.0%
surrendered (in excess of any amount that is free of charge) 5 3.0%
within the indicated time periods. 6 2.0%
Thereafter 0.0%
TRANSFER CHARGE:
The Company currently makes no charge for processing transfers None
and guarantees that the first 12 transfers in a Contract year
will not be subject to a transfer charge. For each subsequent
transfer, the Company reserves the right to assess a charge,
guaranteed never to exceed $25, to reimburse the Company for
processing costs.
CONTRACT FEE:
The Contract fee is deducted annually and upon surrender prior to $30
the Annuity Date when the Accumulated Value is less than $50,000.
The fee is waived for a Contract issued to and maintained by the
trustee of a 401(k) plan.
SUB-ACCOUNT EXPENSES:
(on annual basis as percentage of average daily net assets)
Mortality and Expense Risk Charge: 1.25%
Administrative Expense Charge: 0.15%
Total Asset Charge: 1.40%
</TABLE>
11
<PAGE>
PORTFOLIO EXPENSES
(annual basis as percentage of average daily net assets)
<TABLE>
<CAPTION>
MANAGEMENT OTHER TOTAL
PORTFOLIO FEE EXPENSES EXPENSES
- -------------------------------------------------------------------------- ------------------- -------------- --------------
<S> <C> <C> <C>
Money Market.............................................................. 0.50% 0.10% 0.60%
Total Return.............................................................. 0.55% 0.04% 0.59%
High Yield................................................................ 0.60% 0.05% 0.65%
Growth.................................................................... 0.60% 0.04% 0.64%
Government Securities..................................................... 0.55% 0.11% 0.66%
International............................................................. 0.75% 0.21% 0.96%
Small Cap Growth.......................................................... 0.65% 0.10% 0.75%
Investment Grade Bond..................................................... 0.60% 0.25%* 0.85%
Value..................................................................... 0.75% 0.20%* 0.95%
Small Cap Value........................................................... 0.75% 0.20%* 0.95%
Value+Growth.............................................................. 0.75% 0.20%* 0.95%
Horizon 20+............................................................... 0.60% 0.25%* 0.85%
Horizon 10+............................................................... 0.60% 0.20%* 0.80%
Horizon 5................................................................. 0.60% 0.30%* 0.90%
Global Income............................................................. 0.75% 0.30%* 1.05%
Blue Chip................................................................. 0.65% 0.30%* 0.95%
</TABLE>
* Estimated First-Year Expenses
The following examples demonstrate the cumulative expenses which would be paid
by the Owner at 1-year, 3-year, 5-year and 10-year intervals under certain
contingencies. Each example assumes a $1,000 investment in a Sub-Account and a
5% annual return on assets, as required by rules of the SEC. Because the
expenses of the Portfolios differ, separate examples are used to illustrate the
expenses incurred by an Owner on an investment in the various Sub-Accounts.
THE INFORMATION GIVEN UNDER THE FOLLOWING EXAMPLES SHOULD NOT BE CONSIDERED A
REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR
LESSER THAN THOSE SHOWN.
12
<PAGE>
(1) If, at the end of the applicable period, you surrender the Contract or
annuitize* under a commutable variable period certain option or a non-commutable
period certain option of less than ten years, you would pay the following
expenses on a $1,000 investment, assuming a 5% annual return on assets:
<TABLE>
<CAPTION>
UNDERLYING PORTFOLIO 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- -------------------------------------------------------------------------- ----------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Money Market.............................................................. $ 82 $ 109 $ 137 $ 232
Total Return.............................................................. $ 81 $ 109 $ 137 $ 231
High Yield................................................................ $ 82 $ 111 $ 140 $ 238
Growth.................................................................... $ 82 $ 110 $ 139 $ 237
Government Securities..................................................... $ 82 $ 111 $ 140 $ 239
International............................................................. $ 85 $ 120 $ 155 $ 269
Small Cap Growth.......................................................... $ 83 $ 113 $ 145 $ 248
Investment Grade Bond..................................................... $ 84 $ 116 $ 150 $ 258
Value..................................................................... $ 85 $ 119 $ 154 $ 268
Small Cap Value........................................................... $ 85 $ 119 $ 154 $ 268
Value+Growth.............................................................. $ 85 $ 119 $ 154 $ 268
Horizon 20+............................................................... $ 84 $ 116 $ 150 $ 258
Horizon 10+............................................................... $ 83 $ 115 $ 147 $ 253
Horizon 5................................................................. $ 84 $ 118 $ 152 $ 263
Global Income............................................................. $ 86 $ 122 $ 159 $ 278
Blue Chip................................................................. $ 85 $ 119 $ 154 $ 268
</TABLE>
(2) If, at the end of the applicable time period, you annuitize* under a life
option or a non-commutable period certain option of ten years or longer, or if
you do not surrender or annuitize the Contract, you would pay the following
expenses on a $1,000 investment, assuming a 5% annual return on assets:
<TABLE>
<CAPTION>
UNDERLYING PORTFOLIO 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- -------------------------------------------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Money Market.............................................................. $ 20 $ 63 $ 108 $ 232
Total Return.............................................................. $ 20 $ 62 $ 107 $ 231
High Yield................................................................ $ 21 $ 64 $ 110 $ 238
Growth.................................................................... $ 21 $ 64 $ 110 $ 237
Government Securities..................................................... $ 21 $ 65 $ 111 $ 239
International............................................................. $ 24 $ 74 $ 126 $ 269
Small Cap Growth.......................................................... $ 22 $ 67 $ 115 $ 248
Investment Grade Bond..................................................... $ 23 $ 70 $ 120 $ 258
Value..................................................................... $ 24 $ 73 $ 125 $ 268
Small Cap Value........................................................... $ 24 $ 73 $ 125 $ 268
Value+Growth.............................................................. $ 24 $ 73 $ 125 $ 268
Horizon 20+............................................................... $ 23 $ 70 $ 120 $ 258
Horizon 10+............................................................... $ 22 $ 69 $ 118 $ 253
Horizon 5................................................................. $ 23 $ 72 $ 123 $ 263
Global Income............................................................. $ 25 $ 76 $ 130 $ 278
Blue Chip................................................................. $ 24 $ 73 $ 125 $ 268
</TABLE>
As required in rules promulgated under the Investment Company Act of 1940 Act
(the "1940 Act"), the Contract fee is reflected in the examples by a method to
show the "average" impact on an investment in the Variable Account. The total
Contract fees collected are divided by the total average net assets attributable
to the Contract.
13
<PAGE>
The resulting percentage is 0.03%, and the amount of the Contract fee is assumed
to be $0.30 in the examples. The Contract fee is deducted only when the
accumulated value is less than $50,000. Lower costs apply to Contracts owned and
maintained under a 401(k) plan.
* The Contract fee is not deducted after annuitization. No contingent deferred
sales charge is assessed at the time of annuitization under an option
including a life contingency or under a non-commutable period certain option
of ten years or longer.
PERFORMANCE INFORMATION
The Contract first was offered to the public in 1997. The Company and IFS,
however, may advertise "Total Return" and "Average Annual Total Return"
performance information based on the periods that the Portfolios have been in
existence. The results for any period prior to the Contract being offered will
be calculated as if the Contract had been offered during that period of time,
with all charges assumed to be those applicable to the Sub-Accounts, the
Portfolios, and (in TABLE 1) assuming that the Contract is surrendered at the
end of the applicable period.
The "Total Return" of a Sub-Account refers to the total of the income generated
by an investment in the Sub-Account and of the changes in the value of the
principal (due to realized and unrealized capital gains or losses) for a
specified period, reduced by certain charges, and expressed as a percentage of
the investment.
The "Average Annual Total Return" represents the average annual percentage
change in the value of an investment in a Sub-Account over a given period of
time. Average Annual Total Return represents averaged figures as opposed to the
actual performance of a Sub-Account, which will vary from year to year.
The "Yield" of the Sub-Account investing in the Money Market Portfolio refers to
the income generated by an investment in the Sub-Account over a seven-day period
(which period will be specified in the advertisement). This income is then
"annualized" by assuming that the income generated in the specific week is
generated over a 52-week period. This annualized Yield is shown as a percentage
of the investment. The "Effective Yield" calculation is similar but, when
annualized, the income earned by an investment in the Sub-Account is assumed to
be reinvested. Thus the "Effective Yield" will be slightly higher than the
"Yield" because of the compounding effect of this assumed reinvestment.
The Total Return, Yield, and Effective Yield figures are adjusted to reflect the
Sub-Account's asset charges. The total return figures also reflect the $30
annual Contract fee and the contingent deferred sales charge which would be
assessed if the investment were completely surrendered at the end of the
specified period.
The Company and IFS also may advertise supplemental total return performance
information. Supplemental total return refers to the total of the income
generated by an investment in the Sub-Account and of the changes in value of the
principal invested (due to realized and unrealized capital gains or losses),
adjusted by the Sub-Account's annual asset charges, and expressed as a
percentage of the investment. Because it is assumed that the investment is NOT
surrendered at the end of the specified period, the contingent deferred sales
charge is NOT included in the calculation of supplemental total return. (See
TABLE 2)
Performance information for a Sub-Account may be compared, in reports and
promotional literature, to: (1) the Standard & Poor's 500 Composite Stock Price
Index ("S&P 500"), Dow Jones Industrial Average ("DJIA"), Shearson Lehman
Aggregate Bond Index or other unmanaged indices so that investors may compare
the Sub-Account results with those of a group of unmanaged securities widely
regarded by investors as representative of the securities markets in general;
(2) other groups of variable annuity variable accounts or other investment
14
<PAGE>
products tracked by Lipper Analytical Services, a widely used independent
research firm which ranks mutual funds and other investment products by overall
performance, investment objectives, and assets, or tracked by other services,
companies, publications, or persons, who rank such investment products on
overall performance or other criteria; or (3) the Consumer Price Index (a
measure for inflation) to assess the real rate of return from an investment in
the Sub-Account. Unmanaged indices may assume the reinvestment of dividends but
generally do not reflect deductions for administrative and management costs and
expenses.
PERFORMANCE INFORMATION FOR ANY SUB-ACCOUNT REFLECTS ONLY THE PERFORMANCE OF A
HYPOTHETICAL INVESTMENT IN THE SUB-ACCOUNT DURING THE PARTICULAR TIME PERIOD ON
WHICH THE CALCULATIONS ARE BASED. PERFORMANCE INFORMATION SHOULD BE CONSIDERED
IN LIGHT OF THE INVESTMENT OBJECTIVES AND POLICIES, CHARACTERISTICS AND QUALITY
OF THE INVESTMENT PORTFOLIO OF THE PORTFOLIO IN WHICH THE SUB-ACCOUNT INVESTS
AND THE MARKET CONDITIONS DURING THE GIVEN TIME PERIOD, AND SHOULD NOT BE
CONSIDERED AS A REPRESENTATION OF WHAT MAY BE ACHIEVED IN THE FUTURE.
TABLE 1
AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDING DECEMBER 31, 1996
(ASSUMING COMPLETE SURRENDER OF INVESTMENT)
<TABLE>
<CAPTION>
10 YEARS
YEAR (OR SINCE
ENDED: INCEPTION
UNDERLYING PORTFOLIO 12/31/96 5 YEARS IF LESS)*
- ------------------------------------------------------------------------------- ------------ ----------- --------------
<S> <C> <C> <C>
Money Market................................................................... -2.58% 2.21% 4.35%
Total Return................................................................... 8.33% 6.78% 10.38%
High Yield..................................................................... 5.83% 11.17% 9.62%
Growth......................................................................... 12.98% 11.09% 12.91%
Government Securities.......................................................... -4.84% 4.06% 6.22%
International.................................................................. 8.08% N/A 8.93%
Small Cap Growth............................................................... 19.30% N/A 19.82%
Investment Grade Bond.......................................................... N/A N/A -3.45%
Value.......................................................................... N/A N/A 9.40%
Small Cap Value................................................................ N/A N/A -5.04%
Value+Growth................................................................... N/A N/A 6.83%
Horizon 20+.................................................................... N/A N/A 7.55%
Horizon 10+.................................................................... N/A N/A 3.82%
Horizon 5...................................................................... N/A N/A 2.16%
Global Income.................................................................. N/A N/A N/A
Blue Chip...................................................................... N/A N/A N/A
</TABLE>
15
<PAGE>
TABLE 2
AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDING DECEMBER 31, 1996
(ASSUMING NO SURRENDER OF INVESTMENT)
<TABLE>
<CAPTION>
10 YEARS
YEAR (OR SINCE
ENDED: INCEPTION
UNDERLYING PORTFOLIO 12/31/96 5 YEARS IF LESS)*
- ------------------------------------------------------------------------------- ------------ ----------- ---------------
<S> <C> <C> <C>
Money Market................................................................... 3.58% 2.74% 4.35%
Total Return................................................................... 15.18% 7.23% 10.38%
High Yield..................................................................... 12.52% 11.56% 9.62%
Growth......................................................................... 19.98% 11.48% 12.91%
Government Securities.......................................................... 1.18% 4.57% 6.22%
International.................................................................. 14.92% N/A 9.35%
Small Cap Growth............................................................... 26.30% N/A 21.20%
Investment Grade Bond.......................................................... N/A N/A 2.66%
Value.......................................................................... N/A N/A 16.32%
Small Cap Value................................................................ N/A N/A 0.96%
Value+Growth................................................................... N/A N/A 13.59%
Horizon 20+.................................................................... N/A N/A 14.35%
Horizon 10+.................................................................... N/A N/A 10.39%
Horizon 5...................................................................... N/A N/A 8.62%
Global Income.................................................................. N/A N/A N/A
Blue Chip...................................................................... N/A N/A N/A
</TABLE>
* The inception dates for the Portfolios are: 3/5/82 for Money Market, Total
Return and High Yield; 12/9/83 for Growth; 9/3/87 for Government Securities;
1/6/92 for International; 5/2/94 for the Small Cap Growth; 5/1/96 for
Investment Grade Bond, Value, Small Cap Value, Value+Growth, Horizon 20+,
Horizon 10+, Horizon 5; and 5/1/97 for Global Income and Blue Chip.
16
<PAGE>
DESCRIPTION OF THE COMPANY, THE VARIABLE ACCOUNT,
AND INVESTORS FUND SERIES
THE COMPANY. The Company, organized under the laws of Massachusetts in 1844, is
the fifth oldest life insurance company in America. As of December 31, 1996, the
Company and its subsidiaries had over $13.3 billion in combined assets and over
$45.2 billion of life insurance in force. Effective October 16, 1995, the
Company converted from a mutual life insurance company known as State Mutual
Life Assurance Company of America to a stock life insurance company and adopted
its present name. The Company is a wholly owned subsidiary of Allmerica
Financial Corporation ("AFC"). The Company's principal office ("Principal
Office") is located at 440 Lincoln Street, Worcester, MA 01653, Telephone
508-855-1000.
The Company is subject to the laws of the Commonwealth of Massachusetts
governing insurance companies and to regulation by the Commissioner of Insurance
of Massachusetts. In addition, the Company is subject to the insurance laws and
regulations of other states and jurisdictions in which it is licensed to
operate.
VARIABLE ACCOUNT. Separate Account KG ("Variable Account") is a separate
investment account of the Company with 16 Sub-Accounts. The assets used to fund
the variable portions of the Contract are set aside in Sub-Accounts kept
separate from the general assets of the Company. Each Sub-Account invests in a
corresponding investment series ("Portfolio") of Investors Fund Series. Each
Sub-Account is administered and accounted for as part of the general business of
the Company. The income, capital gains, or capital losses of each Sub-Account ,
however, are allocated to each Sub-Account, without regard to any other income,
capital gains or capital losses of the Company. Under Massachusetts law, the
assets of the Variable Account may not be charged with any liabilities arising
out of any other business of the Company.
The Variable Account was authorized by vote of the Board of Directors of the
Company on June 13, 1996. The Variable Account meets the definition of "separate
account" under federal securities laws, and is registered with the SEC as a unit
investment trust under the 1940 Act. This registration does not involve the
supervision of management or investment practices or policies of the Variable
Account by the SEC.
The Company reserves the right, subject to compliance with applicable law, to
change the names of the Variable Account and the Sub-Accounts.
INVESTORS FUND SERIES. The Variable Account invests in shares of Investors Fund
Series ("IFS"), a series-type mutual fund registered with the SEC as an
open-end, management investment company. Registration of IFS does not involve
supervision of its management, investment practices or policies by the SEC. IFS
is designed to provide an investment vehicle for certain variable annuity
contracts and variable life insurance policies. Shares of the Portfolios of IFS
are sold only to insurance company separate accounts.
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives of the 16 Portfolios of IFS are summarized below:
MONEY MARKET PORTFOLIO -- seeks maximum current income to the extent consistent
with stability of principal from a portfolio of high quality money market
instruments that mature in 12 months or less.
TOTAL RETURN PORTFOLIO -- seeks a high total return, a combination of income and
capital appreciation, by investing in a combination of debt securities and
common stocks.
17
<PAGE>
HIGH YIELD PORTFOLIO -- seeks to provide a high level of current income by
investing in fixed-income securities.
GROWTH PORTFOLIO -- seeks maximum appreciation of capital through
diversification of investment securities having potential for capital
appreciation.
GOVERNMENT SECURITIES PORTFOLIO -- seeks high current return consistent with
preservation of capital from a portfolio composed primarily of U.S. Government
securities.
INTERNATIONAL PORTFOLIO -- seeks total return, a combination of capital growth
and income, principally through an internationally diversified portfolio of
equity securities.
SMALL CAP GROWTH PORTFOLIO -- seeks maximum appreciation of investors' capital
from a portfolio primarily of growth stocks of smaller companies.
INVESTMENT GRADE BOND PORTFOLIO -- seeks high current income by investing
primarily in a diversified portfolio of investment grade debt securities.
VALUE PORTFOLIO -- seeks to achieve a high rate of total return from a portfolio
primarily of value stocks of larger companies.
SMALL CAP VALUE PORTFOLIO -- seeks long-term capital appreciation from a
portfolio primarily of value stocks of smaller companies.
VALUE+GROWTH PORTFOLIO -- seeks growth of capital through professional
management of a portfolio of growth and value stocks.
HORIZON 20+ PORTFOLIO, -- designed for investors with approximately a 20+ year
investment horizon, seeks growth of capital, with income as a secondary
objective.
HORIZON 10+ PORTFOLIO, -- designed for investors with approximately a 10+ year
investment horizon, seeks a balance between growth of capital and income,
consistent with moderate risk.
HORIZON 5 PORTFOLIO, -- designed for investors with approximately a five- year
investment horizon, seeks income consistent with preservation of capital, with
growth of capital as a secondary objective.
GLOBAL INCOME PORTFOLIO -- seeks high current income consistent with prudent
total return asset management by investing primarily in investment grade foreign
and domestic fixed income securities.
BLUE CHIP PORTFOLIO -- seeks growth of capital and of income by investing
primarily in common stocks of well capitalized, established companies having
potential for growth of capital, earnings and dividends.
There is no assurance that any of the Portfolios of IFS will achieve its
objective as stated in IFS's prospectus. Each Portfolio is diversified except
the Global Income Portfolio. More detailed information, including a description
of risks involved in investing in each of the portfolios, may be found in the
prospectus for IFS, which must accompany or precede this Prospectus, and IFS's
Statement of Additional Information available upon request from IFS, 222 South
Riverside Plaza, Chicago, Illinois 60606. Please read the prospectus of IFS
carefully before investing.
18
<PAGE>
INVESTMENT MANAGEMENT SERVICES
Responsibility for overall management of IFS rests with the Board of Trustees
and officers of IFS. ZKI is the investment manager of each Portfolio other than
the Value and Small Cap Value Portfolios which are managed by DVA, a wholly
owned subsidiary of ZKI. ZKI and DVA provide each Portfolio with continuous
professional investment supervision. DVA is also the sub-adviser for the
Value+Growth, Horizon 20+, Horizon 10+, and Horizon 5 Portfolios. Under the
terms of its Sub-Advisory Agreement with ZKI, DVA will manage the value portion
of each of these Portfolios and will provide such other investment advice,
research and assistance as ZKI may, from time to time, reasonably request. ZIML,
an affiliate of ZKI, is a sub-adviser of certain Portfolios of the Fund
described below. Under the terms of the Sub-Advisory Agreement between ZIML and
ZKI for the Total Return, High Yield, Growth, Small Cap Growth, Investment Grade
Bond, Value+Growth, Horizon 20+, Horizon 10+, Horizon 5 and Blue Chip
Portfolios, ZIML renders investment advisory and management services with regard
to that portion of a Portfolio's assets as may be allocated by ZKI to ZIML from
time to time for management of foreign securities, including foreign currency
transactions and related investments. Under the terms of the Sub-Advisory
Agreement between ZIML and ZKI for the International and Global Income
Portfolios, ZIML renders investment advisory and management services with regard
to that portion of the Portfolio's assets as may be allocated by ZKI to ZIML
from time to time for management, including services related to foreign
securities, foreign currency transactions and related investments.
For its services, ZKI is paid a management fee based upon the average daily net
assets of such Portfolios, as follows: Money Market (.50 of 1%), Total Return
(.55 of 1%), High Yield (.60 of 1%), Growth (.60 of 1%), Government Securities
(.55 of 1%), International (.75 of 1%), Global Income (.75 of 1%), Small Cap
Growth (.65 of 1%), Investment Grade Bond (.60 of 1%), Value+Growth (.75 of 1%),
Blue Chip (.65 of 1%), Horizon 20+ (.60 of 1%), Horizon 10+ (.60 of 1%), and
Horizon 5 (.60 of 1%). DVA serves as the investment manager for the Value and
Small Cap Value Portfolios and is paid a management fee at an annual rate of .75
of 1% of the average daily net assets of these Portfolios. ZKI pays DVA for its
services as sub-adviser for the Value+Growth Portfolio a sub-advisory fee,
payable monthly, at an annual rate of 0.25% of the average daily net assets of
that Portolio. ZKI also pays DVA a sub-advisory fee, payable monthly, at an
annual rate of 0.25% of the portion of the average daily assets of each Horizon
Portfolio allocated by ZKI to DVA for management. ZKI pays ZIML for its services
a sub-advisory fee, payable monthly at the following annual rates applied to
that portion of the average daily net assets of the applicable Portfolio
allocated by ZKI to ZIML for management: 0.35% for the Growth, International,
Small Cap Growth, Total Return, Value+Growth, Horizon 20+, Horizon 10+, Horizon
5 and Blue Chip Portfolios; and 0.30% for the High Yield, Investment Grade Bond
and Global Income Portfolio. For more information, see the IFS prospectus and
SAI.
DESCRIPTION OF THE CONTRACT
A. PAYMENTS.
The Company's underwriting requirements, which include receipt of the initial
payment and allocation instructions by the Company at its Principal Office, must
be met before a Contract can be issued. These requirements may also include the
proper completion of an application; however, where permitted, the Company may
issue a contract without completion of an application for certain classes of
annuity contracts. Payments are to be made payable to the Company. A net payment
is equal to the payment received less the amount of any applicable tax. The
initial net payment will be credited to the Contract as of the date that all
issue requirements are properly met. If all issue requirements are not complied
with within five business days of the Company's receipt of the initial
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payment, the payment will be returned unless the Owner specifically consents to
the holding of the initial payment until completion of any outstanding issue
requirements. Subsequent payments will be credited as of the Valuation Date
received at the Principal Office.
Payments are not limited as to frequency and number, but there are certain
limitations as to amount. Currently, the initial payment must be at least
$2,000. Under a salary deduction or monthly automatic payment plan, the minimum
initial payment is $167. In all cases, each subsequent payment must be at least
$100. Where the contribution on behalf of an employee under an
employer-sponsored retirement plan is less than $600 but more than $300
annually, the Company may issue a contract on the employee if the plan's average
annual contribution per eligible plan participant is at least $600. The minimum
allocation to a Guarantee Period Account is $1,000. If less than $1,000 is
allocated to a Guarantee Period Account, the Company reserves the right to apply
that amount to the Money Market Portfolio.
Generally, unless otherwise requested, all payments will be allocated among the
accounts in the same proportion that the initial net payment is allocated or, if
subsequently changed, according to the most recent allocation instructions.
However, any portion of the initial net payment and of additional net payments
received during the Contract's first 15 days measured from the date of issue,
allocated to any Sub-Account and/or any Guarantee Period Account, will be held
in the Money Market Portfolio until the end of the 15-day period. Thereafter,
these amounts will be allocated as requested.
The Owner may change allocation instructions for new payments pursuant to a
written or telephone request. If telephone requests are elected by the Owner, a
properly completed authorization must be on file before telephone requests will
be honored. The Company will not be responsible for losses resulting from acting
upon telephone requests reasonably believed to be genuine. The Company will
employ reasonable procedures to confirm that instructions communicated by
telephone are genuine; otherwise, the Company may be liable for any losses due
to unauthorized or fraudulent instructions. The procedures the Company follows
for transactions initiated by telephone include requirements that callers on
behalf of an Owner identify themselves by name and identify the Annuitant by
name, date of birth and social security number. All transfer instructions by
telephone are tape recorded.
B. RIGHT TO REVOKE CONTRACT.
An Owner may revoke the Contract at any time within ten days after receipt of
the Contract and receive a refund. In order to revoke the Contract, the Owner
must mail or deliver the Contract to the agent through whom the Contract was
purchased or to the Principal Office at 440 Lincoln Street, Worcester, MA 01653.
Mailing or delivery must occur on or before ten days after receipt of the
Contract for revocation to be effective.
Within seven days the Company will provide a refund equal to the greater of: (1)
gross payments, or (2) any amounts allocated to the Fixed and Guarantee Period
Accounts and the Accumulated Value of amounts allocated to the Sub-Accounts,
plus any amounts deducted under the Contract or by the Portfolios for taxes,
charges or fees.
The liability of the Variable Account under this provision is limited to the
Owner's Accumulated Value in the Sub-Accounts on the date of cancellation. Any
additional amounts refunded to the Owner will be paid by the Company.
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C. TRANSFER PRIVILEGE.
At any time prior to the Annuity Date an Owner may have amounts transferred
among all accounts. Transfer values will be effected at the Accumulation Value
next computed after receipt of the transfer order. The Company will make
transfers pursuant to written or telephone requests. As discussed in "A.
Payments," a properly completed authorization form must be on file before
telephone requests will be honored.
Transfers to a Guarantee Period Account must be at least $1,000. If the amount
to be transferred to a Guarantee Period Account is less than $1,000, the Company
may transfer that amount to the Sub-Account which invests in the Money Market
Portfolio.
AUTOMATIC TRANSFERS (DOLLAR COST AVERAGING) AND AUTOMATIC ACCOUNT REBALANCING
OPTIONS. The Owner may elect automatic transfers of a predetermined dollar
amount, not less than $100, on a periodic basis (monthly, bi-monthly, quarterly,
semi-annually or annually) from the Sub-Account investing in the Money Market
Portfolio or the Government Securities Portfolio, or from the Fixed Account (the
source account) to one or more of the Sub-Accounts. Automatic transfers may not
be made into the Fixed Account, the Guarantee Period Accounts or, if applicable,
the Portfolio being used as the source account. If an automatic transfer would
reduce the balance in the source account to less than $100, the entire balance
will be transferred proportionately to the chosen Portfolios. Automatic
transfers will continue until the amount in the source account on a transfer
date is zero or the Owner's request to terminate the option is received by the
Company. If additional amounts are allocated to the source account after its
balance has fallen to zero, this option will not restart automatically, and the
Owner must provide a new request to the Company.
The Owner may request automatic rebalancing of Sub-Account allocations on a
monthly, quarterly, semi-annual or annual basis in accordance with percentage
allocations specified by the Owner. As frequently as specified by the Owner, the
Company will review the percentage allocations in the Portfolios and, if
necessary, transfer amounts to ensure conformity with the designated percentage
allocation mix. If the amount necessary to re-establish the mix on any scheduled
date is less than $100, no transfer will be made. Automatic Account Rebalancing
will continue until the Owner's request to terminate the option is received by
the Company.
The Company reserves the right to limit the number of Portfolios that may be
utilized for automatic transfers and rebalancing, and to discontinue either
option upon advance written notice. The first automatic transfer and all
subsequent transfers of that request in the same Contract year count as one
transfer towards the 12 transfers which are guaranteed to be free of a transfer
charge in each Contract year. Currently, Dollar Cost Averaging and Automatic
Account Rebalancing may not be in effect simultaneously. Either option may be
elected when the Contract is purchased or at a later date.
D. SURRENDER.
At any time prior to the Annuity Date, an Owner may surrender the Contract and
receive its Surrender Value. The Owner must return the Contract and a signed,
written request for surrender, satisfactory to the Company, to the Principal
Office. The amount payable to the Owner upon surrender will be based on the
Contract's Accumulated Value as of the Valuation Date on which the request and
the Contract are received at the Principal Office.
Before the Annuity Date, a contingent deferred sales charge may be deducted when
a Contract is surrendered if payments have been credited to the Contract during
the last six full Contract years. See "CHARGES AND DEDUCTIONS." The Contract fee
will be deducted upon surrender of the Contract.
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After the Annuity Date, only a Contract under which future annuity benefit
payments are limited to a specified period (as specified in the period certain
annuity option) may be surrendered. The Surrender Amount is the commuted value
of any unpaid installments, computed on the basis of the assumed interest rate
incorporated in such annuity benefit payments. No contingent deferred sales
charge is imposed after the Annuity Date.
Any amount surrendered normally is payable within seven days following the
Company's receipt of the surrender request. The Company reserves the right to
defer surrenders and withdrawals of amounts in each Sub-Account in any period
during which (1) trading on the New York Stock Exchange is restricted as
determined by the SEC or such Exchange is closed for other than weekends and
holidays, (2) the SEC has, by order, permitted such suspension, or (3) an
emergency, as determined by the SEC, exists such that disposal of Portfolio
securities or valuation of assets of each separate account is not reasonably
practicable.
The right is reserved by the Company to defer surrenders and withdrawals of
amounts allocated to the Company's Fixed Account and Guarantee Period Accounts
for a period not to exceed six months.
The surrender rights of Owners who are participants under Section 403(b) plans
or who are participants in the Texas Optional Retirement Program ("Texas ORP")
are restricted; see "Tax Sheltered Annuities" and "Texas Optional Retirement
Program."
For important tax consequences which may result from surrender, see "FEDERAL TAX
CONSIDERATIONS."
E. WITHDRAWALS.
At any time prior to the Annuity Date, an Owner may withdraw a portion of the
Accumulated Value of his or her Contract, subject to the limits stated below.
The Owner must file a signed, written request for withdrawals, satisfactory to
the Company, at the Principal Office. The written request must indicate the
dollar amount the Owner wishes to receive and the accounts from which such
amount is to be withdrawn. The Contract value following the withdrawal will
reflect an amount withdrawn equal to the amount requested by the Owner plus any
applicable contingent deferred sales charge, as described under "CHARGES AND
DEDUCTIONS." In addition, amounts withdrawn from a Guarantee Period Account
prior to the end of the applicable Guarantee Period will be subject to a Market
Value Adjustment, as described under "GUARANTEE PERIOD ACCOUNTS."
Where allocations have been made to more than one account, a percentage of the
withdrawal may be allocated to each such account. A withdrawal from a
Sub-Account will result in cancellation of a number of units equivalent in value
to the amount withdrawn, computed as of the Valuation Date that the request is
received at the Principal Office.
Each withdrawal must be in a minimum amount of $100. No withdrawal will be
permitted if the Accumulated Value remaining under the Contract would be reduced
to less than $1,000. Withdrawals will be paid in accordance with the time
limitations described under "D. Surrender."
After the Annuity Date, only a Contract under which future variable annuity
benefit payments are limited to a specified period may be withdrawn. A
withdrawal after the Annuity Date will result in cancellation of a number of
Annuity Units equivalent in value to the amount withdrawn.
For important restrictions on withdrawals which are applicable to Owners who are
participants under Section 403(b) plans or under the Texas ORP, see "Tax
Sheltered Annuities" and "Texas Optional Retirement Program."
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For important tax consequences which may result from withdrawals, see "FEDERAL
TAX CONSIDERATIONS."
SYSTEMATIC WITHDRAWALS. The Owner may elect an automatic schedule of
withdrawals (systematic withdrawals) from amounts in the Sub-Accounts and/or the
Fixed Account on a monthly, bi-monthly, quarterly, semi-annual or annual basis.
Systematic withdrawals from Guarantee Period Accounts are not available. The
minimum amount of each automatic withdrawal is $100, and will be subject to any
applicable withdrawal charges. If elected at the time of purchase, the Owner
must designate in writing the specific dollar amount of each withdrawal and the
percentage of this amount which should be taken from each designated Sub-Account
and/or the Fixed Account. Systematic withdrawals then will begin on the 16th day
following the issue date or the date selected, if later. If elected after the
issue date, the Owner may elect, by written request, a specific dollar amount
and the percentage of this amount to be taken from each designated Sub-Account
and/or the Fixed Account, or the Owner may elect to withdraw a specific
percentage of the Accumulated Value calculated as of the withdrawal dates, and
may designate the percentage of this amount which should be taken from each
account. The first withdrawal will take place on the date the written request is
received at the Principal Office or, if later, on a date specified by the Owner.
If a withdrawal would cause the remaining Accumulated Value to be less than
$1,000, systematic withdrawals will be discontinued. Systematic withdrawals will
cease automatically on the Annuity Date. The Owner may change or terminate
systematic withdrawals by written request to the Principal Office only.
LIFE EXPECTANCY DISTRIBUTIONS. Prior to the Annuity Date an Owner who also is
the Annuitant may elect to make a series of systematic withdrawals from the
Contract according to a life expectancy distribution ("LED") option by returning
a properly signed LED request form to the Principal Office. The LED option
permits the Owner to make systematic withdrawals from the Contract over his or
her lifetime. The amount withdrawn from the Contract changes each year, because
life expectancy changes each year that a person lives. For example, actuarial
tables indicate that a person age 70 has a life expectancy of 16 years, but a
person who attains age 86 has a life expectancy of another 6.5 years.
If an Owner elects the LED option, in each calendar year a fraction of the
Accumulated Value is withdrawn based on the Owner's then life expectancy. The
numerator of the fraction is 1 (one) and the denominator of the fraction is the
remaining life expectancy of the Owner, as determined annually by the Company.
The resulting fraction, expressed as a percentage, is applied to the Accumulated
Value at the beginning of the year to determine the amount to be distributed
during the year. The Owner also may elect to receive distributions under a LED
option which is determined on the joint life expectancy of the Owner and a
beneficiary. The Owner may elect monthly, bi-monthly, quarterly, semi-annual, or
annual distributions, and may terminate the LED option at any time. LED will
terminate automatically on the Annuitant's latest alternative Annuity Date. At
the time, an annuity payout option must be elected.
If an Owner makes withdrawals under the LED option prior to age 59 1/2, the
withdrawals may be treated by the Internal Revenue Service ("IRS") as premature
distributions from the Contract. The payments then would be taxed on an "income
first" basis and be subject to a 10% federal tax penalty. For more information,
see "FEDERAL TAX CONSIDERATIONS," "B. Taxation of the Contracts in General."
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F. DEATH BENEFIT.
In the event that the Annuitant, Owner or Joint Owner, if applicable, dies while
the Contract is in force, the Company will pay the beneficiary a death benefit,
except where the Contract is continued as provided in "G. The Spouse of the
Owner as Beneficiary." The amount of the death benefit and the time requirements
for receipt of payment may vary depending upon whether the Annuitant or an Owner
dies first, and whether death occurs prior to or after the Annuity Date.
DEATH OF THE ANNUITANT PRIOR TO THE ANNUITY DATE. At the death of the Annuitant
(including an Owner who is also the Annuitant), the benefit is equal to the
greatest of (1) the Accumulated Value under the Contract increased for any
positive Market Value Adjustment; (2) gross payments reduced proportionately to
reflect withdrawals (for each withdrawal, the proportionate reduction is
calculated as the death benefit under this option immediately prior to the
withdrawal multiplied by the withdrawal amount and divided by the Accumulated
Value immediately prior to the withdrawal); or (3) the highest Accumulated Value
that would have been payable as a death benefit on any Contract anniversary,
increased for subsequent payments received since that date and reduced
proportionately to reflect withdrawals after that date.
DEATH OF AN OWNER WHO IS NOT ALSO THE ANNUITANT PRIOR TO THE ANNUITY DATE. If
an Owner who is not also the Annuitant dies before the Annuity Date, the death
benefit will be the Accumulated Value increased by any positive Market Value
Adjustment. The death benefit never will be reduced by a negative Market Value
Adjustment.
PAYMENT OF THE DEATH BENEFIT PRIOR TO THE ANNUITY DATE. The death benefit
generally will be paid to the beneficiary in one sum within seven business days
of the receipt of due proof of death at the Principal Office unless the Owner
has specified a death benefit annuity option. Instead of payment in one sum, the
beneficiary may, by written request, elect to:
(1) defer distribution of the death benefit for a period no more than five
years from the date of death; or
(2) receive a life annuity or an annuity for a period certain not extending
beyond the beneficiary's life expectancy, with annuity benefit payments
beginning one year from the date of death.
If distribution of the death benefit is deferred under (1) or (2), any value in
the Guarantee Period Accounts will be transferred to the Sub-Account investing
in the Money Market Portfolio. The excess, if any, of the death benefit over the
Accumulated Value also will be added to the Money Market Portfolio. The
beneficiary may, by written request, effect transfers and withdrawals during the
deferral period and prior to annuitization under (2), but may not make
additional payments. The death benefit will reflect any earnings or losses
experienced during the deferral period. If there are multiple beneficiaries, the
consent of all is required.
With respect to the death benefit, the Accumulated Value under the Contract will
be based on the unit values next computed after due proof of the death has been
received.
DEATH OF THE ANNUITANT AFTER THE ANNUITY DATE. If the Annuitant's death occurs
on or after the Annuity Date but before completion of all guaranteed annuity
benefit payments, any unpaid amounts or installments will be paid to the
beneficiary. The Company must pay out the remaining payments at least as rapidly
as under the payment option in effect on the date of the Annuitant's death.
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G. THE SPOUSE OF THE OWNER AS BENEFICIARY.
The Owner's spouse, if named as the sole beneficiary, may by written request
continue the Contract in lieu of receiving the amount payable upon death of the
Owner. Upon such election, the spouse will become the Owner and Annuitant
subject to the following: (1) any value in the Guarantee Period Accounts will be
transferred to the Money Market Portfolio; (2) the excess, if any, of the death
benefit over the Contract's Accumulated Value also will be added to the Money
Market Portfolio. This value never will be subject to a surrender charge when
withdrawn. Additional payments may be made; however, a surrender charge will
apply to these amounts if they have not been invested in the Contract for more
than six years. All other rights and benefits provided in the Contract will
continue, except that any subsequent spouse of such new Owner will not be
entitled to continue the Contract upon such new Owner's death.
H. ASSIGNMENT.
The Contract, other than those sold in connection with certain qualified plans,
may be assigned by the Owner at any time prior to the Annuity Date and while the
Annuitant is alive. The Company will not be deemed to have knowledge of an
assignment unless it is made in writing and filed at the Principal Office. The
Company will not assume responsibility for determining the validity of any
assignment. If an assignment of the Contract is in effect on the Annuity Date,
the Company reserves the right to pay to the assignee, in one sum, that portion
of the Surrender Value of the Contract to which the assignee appears to be
entitled. The Company will pay the balance, if any, in one sum to the Owner in
full settlement of all liability under the Contract. The interest of the Owner
and of any beneficiary will be subject to any assignment.
For important tax liability which may result from assignments, see "FEDERAL TAX
CONSIDERATIONS."
I. ELECTING THE FORM OF ANNUITY AND ANNUITY DATE.
The Annuity Date is selected by the Owner. To the extent permitted in your
state, the Annuity Date may be the first day of any month: (1) before the
Annuitant's 85th birthday, if the Annuitant's age on the issue date of the
Contract is 75 or under, or (2) within ten years from the issue date of the
Contract and before the Annuitant's 90th birthday, if the Annuitant's age on the
issue date is between 76 and 90. The Owner may elect to change the Annuity Date
by sending a request to the Principal Office at least one month before the new
Annuity Date. The new Annuity Date must be the first day of any month occurring
before the Annuitant's 90th birthday, and must be within the life expectancy of
the Annuitant. The Company shall determine such life expectancy at the time a
change in Annuity Date is requested. The Code and the terms of qualified plans
impose limitations on the age at which annuity benefit payments may commence and
the type of annuity option selected. See "FEDERAL TAX CONSIDERATIONS" for
further information.
Subject to certain restrictions described below, the Owner has the right (1) to
select the annuity payout option under which annuity benefit payments are to be
made, and (2) to determine whether payments are to be made on a fixed basis, a
variable basis, or a combination fixed and variable basis. Annuity benefit
payments are determined according to the annuity tables in the Contract, by the
annuity option selected, and by the investment performance of the Accounts
selected.
To the extent a fixed annuity payout is selected, Accumulated Value will be
transferred to the Fixed Account, and the annuity benefit payments will be fixed
in amount. See "APPENDIX A. MORE INFORMATION ABOUT THE FIXED ACCOUNT."
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Under a variable annuity, a payment equal to the value of the fixed number of
Annuity Units in the Sub-Accounts is made monthly, quarterly, semi-annually or
annually. Since the value of an Annuity Unit in a Sub-Account will reflect the
investment performance of the Sub-Account, the amount of each annuity benefit
payment will vary.
The annuity option selected must produce an initial payment of at least $50 (a
lower amount may be required in some states). The Company reserves the right to
increase this minimum amount. If the annuity option selected does not produce an
initial payment which meet this minimum, a single payment will be made. Once the
Company begins making annuity benefit payments, the Annuitant cannot make
withdrawals or surrender the annuity benefit, except where the Annuitant has
elected a commutable period certain option. Beneficiaries entitled to receive
remaining payments under either a commutable or non-commutable "period certain"
may elect instead to receive a lump sum settlement. See "J. Description of
Variable Annuity Payout Options."
If the Owner does not elect otherwise, a variable life annuity with periodic
payments for ten years guaranteed will be purchased. Changes in either the
Annuity Date or annuity option can be made up to one month prior to the Annuity
Date.
J. DESCRIPTION OF VARIABLE ANNUITY PAYOUT OPTIONS.
The Company provides the variable annuity payout options described below.
Currently, variable annuity payout options may be funded through the
Sub-Accounts investing in the Investment Grade Bond, Value+Growth, Horizon 10+
and Horizon 5 Portfolios. The Company also provides these same options funded
through the Fixed Account (fixed-amount annuity option). Regardless of how
payments were allocated during the accumulation period, any of the variable
annuity options or the fixed-amount options may be selected, or any of the
variable annuity options may be selected in combination with any of the
fixed-amount annuity options. Other annuity options may be offered by the
Company. IRS regulations may not permit certain of the available annuity options
when used in connection with certain qualified Contracts.
VARIABLE LIFE ANNUITY WITH PAYMENTS GUARANTEED FOR TEN YEARS. This variable
annuity is payable periodically during the lifetime of the payee with the
guarantee that if the payee should die before all payments have been made, the
remaining annuity benefit payments will continue to the beneficiary.
VARIABLE LIFE ANNUITY PAYABLE PERIODICALLY DURING THE LIFETIME OF THE ANNUITANT
ONLY. It would be possible under this option for the Annuitant to receive only
one annuity benefit payment if the Annuitant dies prior to the due date of the
second annuity benefit payment, two annuity benefit payments if the Annuitant
dies before the due date of the third annuity benefit payment, and so on.
Payments will continue, however, during the lifetime of the Annuitant, no matter
how long he or she lives.
UNIT FUND VARIABLE LIFE ANNUITY. This is an annuity payable periodically during
the lifetime of the payee with the guarantee that if (1) exceeds (2) then
periodic variable annuity benefit payments will continue to the beneficiary
until the number of such payments equals the number determined in (1).
Where: (1) is the dollar amount of the Accumulated Value divided by the dollar
amount of the first payment, and
(2) is the number of payments paid prior to the death of the payee.
JOINT AND SURVIVOR VARIABLE LIFE ANNUITY. This variable annuity is payable
jointly to two payees during their joint lifetime, and then continues thereafter
during the lifetime of the survivor. The amount of each payment to the
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survivor is based on the same number of Annuity Units which applied during the
joint lifetime of the two payees. One of the payees must be either the person
designated as the Annuitant in the Contract or the beneficiary. There is no
minimum number of payments under this option.
JOINT AND TWO-THIRDS SURVIVOR VARIABLE LIFE ANNUITY. This variable annuity is
payable jointly to two payees during their joint lifetime, and then continues
thereafter during the lifetime of the survivor. The amount of each periodic
payment to the survivor, however, is based upon two-thirds of the number of
Annuity Units which applied during the joint lifetime of the two payees. One of
the payees must be the person designated as the Annuitant or the beneficiary in
the Contract. There is no minimum number of payments under this option.
PERIOD CERTAIN VARIABLE ANNUITY. This variable annuity has periodic payments
for a stipulated number of years ranging from one to 30. This option may be
commutable, that is, the payee reserves the right to receive a lump sum in place
of installments, or it becomes non-commutable. The payee must reserve this right
at the time benefits begin.
It should be noted that the period certain option does not involve a life
contingency. In the computation of the payments under this option, the charge
for annuity rate guarantees, which includes a factor for mortality risks, is
made. Although not contractually required to do so, the Company currently
follows a practice of permitting persons receiving payments under the period
certain option to elect to convert to a variable annuity involving a life
contingency. The Company may discontinue or change this practice at any time,
but not with respect to election of the option made prior to the date of any
change in this practice. See "FEDERAL TAX CONSIDERATIONS" for a discussion of
the possible adverse tax consequences of selecting a Period Certain Option.
K. ANNUITY BENEFIT PAYMENTS.
THE ANNUITY UNIT. On and after the Annuity Date, the Annuity Unit is a measure
of the value of the Annuitant's monthly annuity benefit payments under a
variable annuity option. The value of an Annuity Unit in each Sub-Account
initially was set at $1.00. The value of an Annuity Unit under a Sub-Account on
any Valuation Date thereafter is equal to the value of such unit on the
immediately preceding Valuation Date, multiplied by the product of (1) the net
investment factor of the Sub-Account for the current Valuation Period, and (2) a
factor to adjust benefits to neutralize the assumed interest rate. The assumed
interest rate, discussed below, is incorporated in the variable annuity options
offered in the Contract.
DETERMINATION OF THE FIRST AND SUBSEQUENT ANNUITY BENEFIT PAYMENTS. The first
periodic annuity benefit payment is based upon the Accumulated Value as of a
date not more than four weeks preceding the date that the first annuity benefit
payment is due. Variable annuity benefit payments are due on the first of a
month, which is the date the payment is to be received by the Annuitant, and
currently are based on unit values as of the 15th day of the preceding month.
The Contract provides annuity rates which determine the dollar amount of the
first periodic payment under each form of annuity for each $1,000 of applied
value. For life contingency options and non-commutable period certain options of
ten or more years (six or more years under New York contracts), the annuity
value is the Accumulated Value less any premium taxes and adjusted for any
Market Value Adjustment. For commutable period certain options or any period
certain option for less than ten years (for less than six years under New York
contracts), the value is surrender value less any premium tax. For a death
benefit annuity, the annuity value will be the amount of the death benefit. The
annuity rates in the Contract are based on a modification of the 1983(a)
Individual Mortality Table on rates.
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The amount of the first monthly payment depends upon the form of annuity
selected, the sex (however, see "M. NORRIS Decision") and age of the Annuitant
and the value of the amount applied under the annuity option. The variable
annuity options offered by the Company are based on a 3.5% assumed interest
rate. Variable payments are affected by the assumed interest rate used in
calculating the annuity option rates. Variable annuity benefit payments will
increase over periods when the actual net investment result of the Sub-Accounts
funding the annuity exceeds the equivalent of the assumed interest rate for the
period. Variable annuity benefit payments will decrease over periods when the
actual net investment result of the respective Sub-Account is less than the
equivalent of the assumed interest rate for the period.
The dollar amount of the first periodic annuity benefit payment under life
annuity options and non-commutable period certain options of ten years or more
(six or more years under New York contracts) is determined by multiplying (1)
the Accumulated Value applied under that option (after application of any Market
Value Adjustment and less premium tax, if any) divided by $1,000, by (2) the
applicable amount of the first monthly payment per $1,000 of value. For
commutable period certain options and any period certain option of less than ten
years (six years under New York contracts), the Surrender Value less premium
taxes, if any, is used rather than the Accumulated Value. The dollar amount of
the first variable annuity benefit payment then is divided by the value of an
Annuity Unit of the selected Sub-Accounts to determine the number of Annuity
Units represented by the first payment. This number of Annuity Units remains
fixed under all annuity options except the joint and two-thirds survivor annuity
option. For each subsequent payment, the dollar amount of the variable annuity
benefit payment is determined by multiplying this fixed number of Annuity Units
by the value of an Annuity Unit on the applicable Valuation Date.
After the first benefit payment, the dollar amount of each periodic variable
annuity benefit payment will vary with subsequent variations in the value of the
Annuity Unit of the selected Sub-Accounts. The dollar amount of each fixed
amount annuity benefit payment is fixed and will not change, except under the
joint and two-thirds survivor annuity option.
From time to time, the Company may offer Owners both fixed and variable annuity
rates more favorable than those contained in the Contract. Any such rates will
be applied uniformly to all Owners of the same class.
For an illustration of variable annuity benefit payment calculation using a
hypothetical example, see "ANNUITY BENEFIT PAYMENTS" in the SAI.
L. NORRIS DECISION.
In the case of ARIZONA GOVERNING COMMITTEE V. NORRIS, the United States Supreme
Court ruled that, in connection with retirement benefit options offered under
certain employer-sponsored employee benefit plans, annuity options based on
sex-distinct actuarial tables are not permissible under Title VII of the Civil
Rights Act of 1964. The ruling requires that benefits derived from contributions
paid into a plan after August 1, 1983 be calculated without regard to the sex of
the employee. Annuity benefits attributable to payments received by the Company
under a Contract issued in connection with an employer-sponsored benefit plan
affected by the NORRIS decision will be based on the greater of (1) the
Company's unisex non-guaranteed current annuity option rates, or (2) the
guaranteed unisex rates described in such Contract, regardless of whether the
Annuitant is male or female.
M. COMPUTATION OF VALUES.
THE ACCUMULATION UNIT. Each net payment is allocated to the accounts selected
by the Owner. Allocations to the Sub-Accounts are credited to the Contract in
the form of Accumulation Units. Accumulation Units are
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credited separately for each Sub-Account. The number of Accumulation Units of
each Sub-Account credited to the Contract is equal to the portion of the net
payment allocated to the Sub-Account, divided by the dollar value of the
applicable Accumulation Unit as of the Valuation Date the payment is received in
good order at the Company's Principal Office. The number of Accumulation Units
resulting from each payment will remain fixed unless changed by a subsequent
split of Accumulation Unit value, a transfer, a withdrawal, or surrender. The
dollar value of an Accumulation Unit of each Sub-Account varies from Valuation
Date to Valuation Date based on the investment experience of that Sub-Account,
and will reflect the investment performance, expenses and charges of its
Portfolios. The value of an Accumulation Unit was set at $1.00 on the first
Valuation Date for each Sub-Account.
Allocations to Guarantee Period Accounts and the Fixed Account are not converted
into Accumulation Units, but are credited interest at a rate periodically set by
the Company. See "GUARANTEE PERIOD ACCOUNTS" and "APPENDIX A. MORE INFORMATION
ABOUT THE FIXED ACCOUNTS."
The Accumulated Value under the Contract is determined by (1) multiplying the
number of Accumulation Units in each Sub-Account by the value of an Accumulation
Unit of that Sub-Account on the Valuation Date, (2) adding the products, and (3)
adding the amount of the accumulations in the Fixed Account and Guarantee Period
Accounts, if any.
NET INVESTMENT FACTOR. The Net Investment Factor is an index that measures the
investment performance of a Sub-Account from one Valuation Period to the next.
This factor is equal to 1.000000 plus the result from dividing (1) by (2) and
subtracting (3) and (4) where:
(1) is the investment income of a Sub-Account for the Valuation Period,
including realized or unrealized capital gains and losses during the
Valuation Period, adjusted for provisions made for taxes, if any;
(2) is the value of that Sub-Account's assets at the beginning of the Valuation
Period;
(3) is a charge for mortality and expense risks equal to 1.25% on an annual
basis of the daily value of the Sub-Account's assets; and
(4) is an administrative charge of 0.15% on an annual basis of the daily value
of the Sub-Account's assets.
The dollar value of an Accumulation Unit as of a given Valuation Date is
determined by multiplying the dollar value of the corresponding Accumulation
Unit as of the immediately preceding Valuation Date by the appropriate net
investment factor. For an illustration of Accumulation Unit calculation using a
hypothetical example see the SAI.
CHARGES AND DEDUCTIONS
Deductions under the Contract and charges against the assets of the Sub-Accounts
are described below. Other deductions and expenses paid out of the assets of the
Portfolios are described in the prospectus and SAI of IFS.
A. VARIABLE ACCOUNT DEDUCTIONS.
MORTALITY AND EXPENSE RISK CHARGE. The Company makes a charge of 1.25% on an
annual basis of the daily value of each Sub-Account's assets to cover the
mortality and expense risk which the Company assumes in relation to the variable
portion of the Contract. The charge is imposed during both the accumulation
phase and the annuity payout phase. The mortality risk arises from the Company's
guarantee that it will make annuity
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benefit payments in accordance with annuity rate provisions established at the
time the Contract is issued for the life of the Annuitant (or in accordance with
the annuity option selected), no matter how long the Annuitant (or other payee)
lives and no matter how long all Annuitants as a class live. Therefore, the
mortality charge is deducted during the annuity payout phase on all Contracts,
including those that do not involve a life contingency, even though the Company
does not bear direct mortality risk with respect to variable annuity settlement
options that do not involve life contingencies. The expense risk arises from the
Company's guarantee that the charges it makes will not exceed the limits
described in the Contract and in this Prospectus.
If the charge for mortality and expense risks is not sufficient to cover actual
mortality experience and expenses, the Company will absorb the losses. If
expenses are less than the amounts provided to the Company by the charge, the
difference will be a profit to the Company. To the extent this charge results in
a profit to the Company, such profit will be available for use by the Company
for, among other things, the payment of distribution, sales and other expenses.
Since mortality and expense risks involve future contingencies which are not
subject to precise determination in advance, it is not feasible to identify
specifically the portion of the charge which is applicable to each. The Company
estimates that a reasonable allocation might be 0.85% for mortality risk and
0.40% for expense risk.
ADMINISTRATIVE EXPENSE CHARGE. The Company assesses each Sub-Account with a
daily charge at an annual rate of 0.15% of the average daily net assets of the
Sub-Account. The charge is imposed during both the accumulation phase and the
annuity payout phase. The daily administrative expense charge is assessed to
help defray administrative expenses actually incurred in the administration of
the Sub-Account, without profits. There is no direct relationship, however,
between the amount of administrative expenses imposed on a given Contract and
the amount of expenses actually attributable to that Contract.
Deductions for the Contract fee (described under "B. Contract Fee") and for the
administrative expense charge are designed to reimburse the Company for the cost
of administration and related expenses and are not expected to be a source of
profit. The administrative functions and expense assumed by the Company in
connection with the Variable Account and the Contract include, but are not
limited to, clerical, accounting, actuarial and legal services, rent, postage,
telephone, office equipment and supplies, expenses of preparing and printing
registration statements, expense of preparing and typesetting prospectuses and
the cost of printing prospectuses not allocable to sales expense, filing and
other fees.
OTHER CHARGES. Because the Sub-Accounts hold shares of the Portfolios, the
value of the net assets of the Sub-Accounts will reflect the investment advisory
fee and other expenses incurred by the Portfolios. The prospectus and SAI of the
Underlying Portfolios contain additional information concerning expenses of the
Portfolios.
B. CONTRACT FEE.
A $30 Contract fee currently is deducted on the Contract anniversary date and
upon full surrender of the Contract when the Accumulated Value is less than
$50,000. The Contract fee is waived for Contract issued to and maintained by the
trustee of a 401(k) plan. Where Contract value has been allocated to more than
one account, a percentage of the total Contract fee will be deducted from the
value in each account. The portion of the charge deducted from each account will
be equal to the percentage which the value in that account bears to the
Accumulated Value under the Contract. The deduction of the Contract fee from a
Sub-Account will result in cancellation of a number of Accumulation Units equal
in value to the percentage of the charge deducted from that account.
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Where permitted by law, the Contract fee also may be waived for Contracts where,
on the issue date, either the Owner or the Annuitant is within the following
classes of individuals; employees and registered representatives of any
broker-dealer which has entered into a sales agreement with the Company to sell
the Contract; employees of the Company or its subsidiaries and affiliates;
officers, directors, trustees and employees of any of the Portfolios; investment
managers or Sub-Advisers; and the spouses of and immediate family members
residing in the same household with such eligible persons. "Immediate family
members" means children, siblings, parents and grandparents.
C. PREMIUM TAXES.
Some states and municipalities impose a premium tax on variable annuity
contracts. State premium taxes currently range up to 3.5%. The Company makes a
charge for state and municipal premium taxes, when applicable, and deducts the
amount paid as a premium tax charge. The current practice of the Company is to
deduct the premium tax charge in one of two ways:
1. if the premium tax was paid by the Company when payments were received,
the premium tax charge is deducted on a pro-rata basis when withdrawals
are made, upon surrender of the Contract, or when annuity benefit payments
begin (the Company reserves the right instead to deduct the premium tax
charge for these Contracts at the time the payments are received); or
2. the premium tax charge is deducted when annuity benefit payments begin.
In no event will a deduction be taken before the Company has incurred a tax
liability under applicable state law. If no amount for premium tax was deducted
at the time the payment was received, but subsequently tax is determined to be
due prior to the Annuity Date, the Company reserves the right to deduct the
premium tax from the Contract value at the time such determination is made.
D. CONTINGENT DEFERRED SALES CHARGE.
No charge for sales expense is deducted from payments at the time the payments
are made. A contingent deferred sales charge is deducted from the Accumulated
Value of the Contract, however, in the case of surrender and/or withdrawals or
at the time annuity benefit payments begin, within certain time limits described
below.
For purposes of determining the contingent deferred sales charge, the
Accumulated Value is divided into three categories: (1) New Payments -- payments
received by the Company during the six years preceding the date of the
surrender; (2) Old Payments -- accumulated payments not defined as New Payments;
and (3) Earnings -- the amount of Contract Value in excess of all payments that
have not been surrendered previously. For purposes of determining the amount of
any contingent deferred sales charge, surrenders will be deemed to be taken
first from accumulated earnings, then from the withdrawal without surrender
charge amount, if greater than earnings; then from Old Payments, and then from
New Payments. Earnings and any excess withdrawal without surrender charge
amount, if applicable, followed by Old Payments may be withdrawn from the
Contract at any time without the imposition of a contingent deferred sales
charge. If a withdrawal is attributable all or in part to New Payments, a
contingent deferred sales charge may apply.
An Owner may withdraw the greater of 100% of cumulative earnings, or 15% of the
Accumulated Value in any calendar year, without assessment of a Withdrawal
Charge. If the Owner withdraws an amount in excess of the Accumulated Value in
any calendar year, the amount withdrawn in excess of 15% is subject to a
Withdrawal Charge.
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CHARGES FOR SURRENDER AND WITHDRAWAL. If the Contract is surrendered or if New
Payments are withdrawn while the Contract is in force and before the Annuity
Date, a contingent deferred sales charge may be imposed. This surrender charge
never will be applied to earnings. The amount of the charge will depend upon the
number of years that the New Payments, if any, to which the withdrawal is
attributed have remained credited under the Contract. Amounts withdrawn are
deducted first from Old Payments. Then, for the purpose of calculating surrender
charges for New Payments, all amounts withdrawn are assumed to be deducted first
from the earliest New Payment and then from the next earliest New Payment and so
on, until all New Payments have been exhausted pursuant to the FIFO method of
accounting. (See "FEDERAL TAX CONSIDERATIONS" for a discussion of how
withdrawals are treated for income tax purposes.)
The Contingent Deferred Sales Charges are as follows:
<TABLE>
<CAPTION>
YEARS FROM CHARGE AS PERCENTAGE OF
DATE OF NEW
PAYMENT PAYMENTS WITHDRAWN
- -------------- ------------------------------
<S> <C>
Less than 1 7%
2 6%
3 5%
4 4%
5 3%
6 2%
Thereafter 0%
</TABLE>
The amount withdrawn equals the amount requested by the Owner plus the charge,
if any. The charge is applied as a percentage of the New Payments withdrawn, but
in no event will the total contingent deferred sales charge exceed a maximum
limit of 7% of total gross New Payments. Such total charge equals the aggregate
of all applicable contingent deferred sales charges for surrender, withdrawals
and annuitization.
REDUCTION OR ELIMINATION OF SURRENDER CHARGE. Except in New York where not
permitted by state law, the Company will waive the contingent deferred sales
charge in the event that an Owner (or the Annuitant, if the Owner is not an
individual): (1) is admitted to a medical care facility after the issue date of
the Contract and remains confined there until the later of one year after the
issue date or 90 consecutive days; (2) is first diagnosed by a licensed
physician as having a fatal illness after the issue date of the Contract; (3) is
physically disabled after the issue date of the Contract and before attaining
age 65; or (4) commencing one year after issue of the Contract, is confined to a
hospice or receives home health services, with certification from a licensed
physician that the confinement to the hospice or receipt of home health care
services is expected to continue until death. The Company may require proof of
such disability and continuing disability, including written confirmation of
receipt and approval of any claim for Social Security Disability Benefits and
reserves the right to obtain an examination by a licensed physician of its
choice and at its expense.
For purposes of the above provision, "medical care facility" means any
state-licensed facility (or, in a state that does not require licensing, a
facility that is operating pursuant to state law) providing medically necessary
in-patient care which is prescribed in writing by a licensed "physician" and
based on physical limitations which prohibit daily living in a non-institutional
setting; "Fatal illness" means a condition diagnosed by a licensed physician
which is expected to result in death within two years of the diagnosis; and
"physician" means a person other than the Owner, Annuitant or a member of one of
their families who is state licensed to give medical care or treatment and is
acting within the scope of that license.
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Where contingent deferred sales charges have been waived under any one of the
four situations discussed above, no additional payments under the Contract will
be accepted.
In addition, from time to time the Company may allow a reduction in or
elimination of the contingent deferred sales charges, the period during which
the charges apply, or both, and/or credit additional amounts on Contracts, when
Contracts are sold to individuals or groups of individuals in a manner that
reduces sales expenses. The Company will consider factors such as the following:
(1) the size and type of group or class, and the persistency expected from that
group or class; (2) the total amount of payments to be received and the manner
in which payments are remitted; (3) the purpose for which the Contracts are
being purchased and whether that purpose makes it likely that costs and expenses
will be reduced; (4) other transactions where sales expenses are likely to be
reduced; or (5) the level of commissions paid to selling broker-dealers or
certain financial institutions with respect to Contracts within the same group
or class (for example, broker-dealers who offer this Contract in connection with
financial planning services offered on a fee for service basis). The Company
also may reduce or waive the contingent deferred sales charge, and/or credit
additional amounts on the Contract where either the Owner or the Annuitant on
the date of issue is within the following class of individuals ("eligible
persons"): employees and registered representatives of any broker-dealer which
has entered into a Sales Agreement with the Company to sell the Contract;
employees of the Company and its affiliates and subsidiaries; officers,
directors, trustees and employees of any of the Portfolios, investment managers
or sub-advisers; and the spouses of and immediate family members residing in the
same household with such eligible persons. "Immediate family members" means
children, siblings, parents and grandparents. Finally, contingent deferred sales
charges may be waived under Section 403(b) Contracts where the amount withdrawn
is being contributed to a life insurance policy issued by the Company as part of
the individual's Section 403(b) plan.
Any reduction or elimination in the amount or duration of the contingent
deferred sales charge will not discriminate unfairly among purchasers of the
Contract. The Company will not make any changes to this charge where prohibited
by law.
Pursuant to Section 11 of the 1940 Act and Rule 11a-2 thereunder, the contingent
deferred sales charge is modified to effect certain exchanges of existing
contracts issued by the Company for this Contract. See "EXCHANGE OFFER" in the
SAI.
WITHDRAWAL WITHOUT SURRENDER CHARGE. In each calendar year, including the
calendar year in which the Contract is issued, the Company will waive the
contingent deferred sales charge, if any, on an amount ("Withdrawal Without
Surrender Charge") equal to the greatest of (1), (2) or (3):
Where (1) is: 100% of Cumulative Earnings (calculated as the Accumulated Value
as of the Valuation Date the Company receives the withdrawal
request, or the following day, reduced by the total gross payments
not previously withdrawn;
Where (2) is: 15% of the Accumulated Value as of the Valuation Date the Company
receives the withdrawal request, or the following day, reduced by
the total amount of any prior withdrawals made in the same
calendar year to which no contingent deferred sales charge was
applied;
Where (3) is: the amount calculated under the Company's life expectancy
distribution (LED) option (see Life Expectancy Distributions,
above) whether or not the withdrawal was part of such distribution
(applies only if Annuitant is also an Owner).
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For example, an 81-year-old Owner/Annuitant with an Accumulated Value of
$15,000, of which $1,000 is Cumulative Earnings, would have a Withdrawal Without
Surrender Charge Amount of $2,250, which is equal to the greatest of:
(1) Cumulative Earnings ($1,000);
(2) 15% of Accumulated Value ($2,250); or
(3) LED distribution of 10.2% of Accumulated Value ($1,530).
The Withdrawal Without Surrender Charge will be deducted first from Cumulative
Earnings. If the Withdrawal Without Surrender Charge exceeds Cumulative
Earnings, the excess amount will be deemed withdrawn from payments not
previously withdrawn on a LIFO basis. If more than one withdrawal is made during
the year, on each subsequent withdrawal the Company will waive the contingent
deferred sales charge, if any, until the entire Withdrawal Without Surrender
Charge has been withdrawn. Amounts withdrawn from a Guarantee Period Account
prior to the end of the applicable Guarantee Period may be subject to a Market
Value Adjustment.
SURRENDERS. In the case of a complete surrender, the amount received by the
Owner is equal to the entire Accumulated Value under the Contract, net of the
applicable contingent deferred sales charge on New Payments, the Contract fee
and any applicable tax withholding and adjusted for any applicable Market Value
Adjustment. Subject to the same rules applicable to withdrawals, the Company
will not assess a contingent deferred sales charge on an amount equal to the
highest Withdrawal Without Surrender Charge Amount, described above.
Where an Owner who is a trustee under a pension plan surrenders, in whole or in
part, a Contract on a terminating employee, the trustee will be permitted to
reallocate all or a part of the total Accumulated Value under the Contract to
other contracts issued by the Company and owned by the trustee, with no
deduction for any otherwise applicable contingent deferred sales charge. Any
such reallocation will be at the unit values for the Sub-Accounts as of the
valuation date on which a written, signed request is received at the Principal
Office.
For further information on surrender and withdrawals, including minimum limits
on amount withdrawn and amount remaining under the Contract in the case of
withdrawals, and important tax considerations, see "D. Surrender" and "E.
Withdrawals" under "DESCRIPTION OF CONTRACT," and see "FEDERAL TAX
CONSIDERATIONS."
CHARGE AT THE TIME ANNUITY BENEFIT PAYMENTS BEGIN. If any commutable period
certain option or a non-commutable period certain option for less than ten years
(six years in New York) is chosen, a contingent deferred sales charge will be
deducted from the Accumulated Value of the Contract if the Annuity Date occurs
at any time when the surrender charge would still apply had the Contract been
surrendered on the Annuity Date. (See discussion of period certain variable
annuity under "I. Description of Variable Annuity Payout Options.")
No contingent deferred sales charge is imposed at the time of annuitization in
any Contract year under an option involving a life contingency or for any
non-commutable period certain option for ten years or more. A Market Value
Adjustment, however, may apply. See "GUARANTEE PERIOD ACCOUNTS."
If an owner of a fixed annuity contract issued by the Company wishes to elect a
variable annuity option, the Company may permit such owner to exchange, at the
time of annuitization, the fixed contract for a Contract offered in this
Prospectus. The proceeds of the fixed contract, minus any contingent deferred
sales charge
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<PAGE>
applicable under the fixed contract if a period certain option is chosen, will
be applied towards the variable annuity option desired by the owner. The number
of Annuity Units under the option will be calculated using the Annuity Unit
values as of the 15th of the month preceding the Annuity Date.
E. TRANSFER CHARGE.
The Company currently makes no charge for processing transfers. The Company
guarantees that the first 12 transfers in a Contract year will be free of
transfer charge, but reserves the right to assess a charge, guaranteed never to
exceed $25, for each subsequent transfer in a Contract year. For more
information, see "C. Transfer Privilege."
GUARANTEE PERIOD ACCOUNTS
Due to certain exemptive and exclusionary provisions in the securities laws,
interests in the Guarantee Period Accounts and the Fixed Account are not
registered as an investment company under the provisions of the Securities Act
of 1933 (the "1933 Act") or the 1940 Act. Accordingly, the staff of the SEC has
not reviewed the disclosures in this Prospectus relating to the Guarantee Period
Accounts or the Fixed Account. Nevertheless, disclosures regarding the Guarantee
Period Accounts and the Fixed Account of the Contract or any benefits offered
under these accounts may be subject to the provisions of the 1933 Act relating
to the accuracy and completeness of statements made in the Prospectus.
INVESTMENT OPTIONS. In most jurisdictions, there currently are nine Guarantee
Periods available under the Contract with durations of two, three, four, five,
six, seven, eight, nine and ten years. Each Guarantee Period Account established
for the Owner is accounted for separately in a non-unitized segregated account.
Each Guarantee Period Account provides for the accumulation of interest at a
Guaranteed Interest Rate. The Guaranteed Interest Rate on amounts allocated or
transferred to a Guarantee Period Account is determined from time to time by the
Company in accordance with market conditions; however, once an interest rate is
in effect for a Guarantee Period Account, the Company may not change it during
the duration of the Guarantee Period. In no event will the Guaranteed Interest
Rate be less than 3%.
To the extent permitted by law, the Company reserves the right at any time to
offer Guarantee Periods with durations that differ from those which were
available when a Contract initially was issued and to stop accepting new
allocations, transfers or renewals to a particular Guarantee Period. Owners may
allocate net payments or make transfers from any of the Sub-Accounts, the Fixed
Account or an existing Guarantee Period Account to establish a new Guarantee
Period Account at any time prior to the Annuity Date. Transfers from a Guarantee
Period Account on any date other than on the day following the expiration of
that Guarantee Period will be subject to a Market Value Adjustment. The Company
establishes a separate investment account each time the Owner allocates or
transfers amounts to a Guarantee Period Account except that amounts allocated to
the same Guarantee Period on the same day will be treated as one Guarantee
Period Account. The minimum that may be allocated to establish a Guarantee
Period Account is $1,000. If less than $1,000 is allocated, the Company reserves
the right to apply that amount to the Money Market Portfolio. The Owner may
allocate amounts to any of the Guarantee Periods available.
At least 45 days, but not more than 75 days, prior to the end of a Guarantee
Period, the Company will notify the Owner in writing of the expiration of that
Guarantee Period. At the end of a Guarantee Period the Owner may transfer
amounts to the Sub-Accounts, the Fixed Account or establish a new Guarantee
Period Account of any duration then offered by the Company without a Market
Value Adjustment. If reallocation instructions are not
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<PAGE>
received at the Principal Office before the end of a Guarantee Period, the
account value automatically will be applied to a new Guarantee Period Account
with the same duration unless (1) less than $1,000 would remain in the Guarantee
Period Account on the expiration date, or (2) the Guarantee Period would extend
beyond the Annuity Date or is no longer available. In such cases, the Guarantee
Period Account value will be transferred to the Money Market Portfolio. Where
amounts have been renewed automatically in a Guarantee Period Account, the
Company will allow transfers out of the Guarantee Period Account without
application of a Market Value Adjustment if the Owner's transfer request is
received within ten days of the renewal date.
MARKET VALUE ADJUSTMENT. No Market Value Adjustment will be applied to
transfers, withdrawals or a surrender from a Guarantee Period Account on the
expiration of its Guarantee Period. In addition, no negative Market Value
Adjustment will be applied to a death benefit, although a positive Market Value
Adjustment, if any, will be applied to increase the value of the death benefit
when based on the Contract's Accumulated Value. See "F. Death Benefit." A Market
Value Adjustment will apply to all other transfers, withdrawals or a surrender.
Amounts applied under an annuity option are treated as withdrawals when
calculating the Market Value Adjustment. The Market Value Adjustment will be
determined by multiplying the amount taken from each Guarantee Period Account
before deduction of any surrender charge by the market value factor. The market
value factor for each Guarantee Period Account is equal to:
[(1+i)/(1+j)](n/365)-1
where: i is the Guaranteed Interest Rate expressed as a decimal (for example:
3% = 0.03) being credited to the current Guarantee Period;
j is the new Guaranteed Interest Rate, expressed as a decimal, for a
Guarantee Period with a duration equal to the number of years remaining
in the current Guarantee Period, rounded to the next higher number of
whole years. If that rate is not available, the Company will use a
suitable rate or index allowed by the Department of Insurance; and
n is the number of days remaining from the effective Valuation Date to
the end of the current Guarantee Period.
Based on the application of this formula, the value of a Guarantee Period
Account will increase after the Market Value Adjustment is applied if the then
current market rates are lower than the rate being credited to the Guarantee
Period Account. Similarly, the value of a Guarantee Period Account will decrease
after the Market Value Adjustment is applied if the then current market rates
are higher than the rate being credited to the Guarantee Period Account. The
Market Value adjustment is limited, however, so that even if the account value
is decreased after application of a Market Value Adjustment, it will equal or
exceed the Owner's principal plus 3% earnings per year less applicable Contract
fees. Conversely, if the then current market rates are lower and the account
value is increased after the Market Value Adjustment is applied, the increase in
value also is affected by the minimum guaranteed rate of 3% such that the amount
that will be added to the Guarantee Period Account is limited to the difference
between the amount earned and the 3% minimum guaranteed earnings. For examples
of how the Market Value Adjustment works, See APPENDIX B.
PROGRAM TO PROTECT PRINCIPAL AND PROVIDE GROWTH POTENTIAL. Under this feature,
the Owner elects a Guarantee Period and one or more Sub-Accounts. The Company
then will compute the proportion of the initial payment that must be allocated
to the Guarantee Period selected, assuming no transfers or withdrawals, in order
to ensure
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that on the last day of the Guarantee Period it will equal the amount of the
entire initial payment. The required amount then will be allocated to the
pre-selected Guarantee Period Account and the remaining balance to the other
investment options selected by the Owner in accordance with the procedures
described in "A. Payments."
WITHDRAWALS. Prior to the Annuity Date, the Owner may make withdrawals of
amounts held in the Guarantee Period Accounts. Withdrawals from these accounts
will be made in the same manner and be subject to the same rules as set forth
under "E. Withdrawals" and "D. Surrender." In addition, the following provisions
also apply to withdrawals from a Guarantee Period Account: (1) a Market Value
Adjustment will apply to all withdrawals, including Withdrawals without
Surrender Charge, unless made at the end of the Guarantee Period; and (2) the
Company reserves the right to defer payments of amounts withdrawn from a
Guarantee Period Account for up to six months from the date it receives the
withdrawal request. If deferred for 30 days or more, the Company will pay
interest on the amount deferred at a rate of at least 3%.
In the event that a Market Value Adjustment applies to a withdrawal of a portion
of the value of a Guarantee Period Account, it will be calculated on the amount
requested and deducted or added to the amount remaining in the Guarantee Period
Account. If the entire amount in a Guarantee Period Account is requested, the
adjustment will be made to the amount payable. If a Contingent Deferred Sales
Charge applies to the withdrawal, it will be calculated as set forth under "D.
Contingent Deferred Sales Charge" after application of the Market Value
Adjustment.
FEDERAL TAX CONSIDERATIONS
The effect of federal income taxes on the value of the Contract, on withdrawals
or surrenders, on annuity benefit payments, and on the economic benefit to the
Owner, Annuitant, or beneficiary depends upon a variety of factors. The
following discussion is based upon the Company's understanding of current
federal income tax laws as they are interpreted as of the date of this
Prospectus. No representation is made regarding the likelihood of continuation
of current federal income tax laws or of current interpretations by the IRS.
IT SHOULD BE RECOGNIZED THAT THE FOLLOWING DISCUSSION OF FEDERAL INCOME TAX
ASPECTS OF AMOUNTS RECEIVED UNDER VARIABLE ANNUITY CONTRACTS IS NOT EXHAUSTIVE,
DOES NOT PURPORT TO COVER ALL SITUATIONS AND IS NOT INTENDED AS TAX ADVICE. A
QUALIFIED TAX ADVISER ALWAYS SHOULD BE CONSULTED WITH REGARD TO THE APPLICATION
OF LAW TO INDIVIDUAL CIRCUMSTANCES.
The Company intends to make a charge for any effect which the income, assets or
existence of the Contract, the Variable Account or the Sub-Accounts may have
upon its tax. The Variable Account presently is not subject to tax, but the
Company reserves the right to assess a charge for taxes should the Variable
Account at any time become subject to tax. Any charge for taxes will be assessed
on a fair and equitable basis in order to preserve equity among classes of
Owners and with respect to each separate account as though that separate account
were a separate taxable entity.
The Variable Account is considered a part of and taxed with the operations of
the Company. The Company is taxed as a life insurance company under Subchapter L
of the Code. The Company files a consolidated tax return with its affiliates.
The IRS has issued regulations relating to the diversification requirements for
variable annuity and variable life insurance contracts under Section 817(h) of
the Code. The regulations provide that the investments of a segregated asset
account underlying a variable annuity contract are adequately diversified if no
more than 55% of the value of its assets is represented by any one investment,
no more than 70% by any two investments, no more
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than 80% by any three investments, and no more than 90% by any four investments.
If the investments are not adequately diversified, the income on the Contract,
for any taxable year of the Owner, would be treated as ordinary income received
or accrued by the Owner. It is anticipated that the Portfolios will comply with
the diversification requirements.
A. QUALIFIED AND NON-QUALIFIED CONTRACTS.
From a federal tax viewpoint there are two types of variable annuity contracts:
"qualified" contracts and "non-qualified" contracts. A qualified contract is one
that is purchased in connection with a retirement plan which meets the
requirements of Sections 401, 403 or 408 of the Code, while a non-qualified
contract is one that is not purchased in connection with one of the indicated
retirement plans. The tax treatment for certain withdrawals or surrenders will
vary according to whether they are made from a qualified contract or a
non-qualified contract. For more information on the tax provisions applicable to
qualified Contracts, see "D. Provisions Applicable to Qualified Employer Plans."
B. TAXATION OF THE CONTRACTS IN GENERAL.
The Company believes that the Contract described in this Prospectus will, with
certain exceptions (see "Non-Natural Owner" below), be considered an annuity
contract under Section 72 of the Code. This section governs the taxation of
annuities. The following discussion concerns annuities subject to Section 72.
WITHDRAWALS PRIOR TO ANNUITIZATION. With certain exceptions, any increase in
the Contract's Accumulated Value is not taxable to the Owner until it is
withdrawn from the Contract. If the Contract is surrendered or amounts are
withdrawn prior to the Annuity Date, any withdrawal of investment gain in value
over the cost basis of the Contract will be taxed as ordinary income. Under the
current provisions of the Code, amounts received under an annuity contract prior
to annuitization (including payments made upon the death of the annuitant or
owner), generally are first attributable to any investment gains credited to the
contract over the taxpayer's "investment in the contract." Such amounts will be
treated as gross income subject to federal income taxation. "Investment in the
contract" is the total of all payments to the Contract which were not excluded
from the Owner's gross income less any amounts previously withdrawn which were
not included in income. Section 72(e)(11)(A)(ii) requires that all non-qualified
deferred annuity contracts issued by the same insurance company to the same
owner during a single calendar year be treated as one contract in determining
taxable distributions.
ANNUITY PAYOUTS AFTER ANNUITIZATION. When annuity benefit payments are
commenced under the Contract, generally a portion of each payment may be
excluded from gross income. The excludable portion generally is determined by a
formula that establishes the ratio that the investment in the Contract bears to
the expected return under the Contract. The portion of the payment in excess of
this excludable amount is taxable as ordinary income. Once all the investment in
the Contract is recovered, the entire payment is taxable. If the annuitant dies
before the total investment in the Contract is recovered, a deduction for the
difference is allowed on the annuitant's final tax return.
PENALTY ON DISTRIBUTION. A 10% penalty tax may be imposed on the withdrawal of
investment gains if the withdrawal is made prior to age 59 1/2. The penalty tax
will not be imposed on withdrawals taken on or after age 59 1/2, or if the
withdrawal follows the death of the owner (or, if the Owner is not an
individual, the death of the primary annuitant, as defined in the Code) or, in
the case of the Owner's "total disability" (as defined in the Code).
Furthermore, under Section 72 of the Code, this penalty tax will not be imposed,
irrespective of age, if the amount
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received is one of a series of "substantially equal" periodic payments made at
least annually for the life or life expectancy of the payee. This requirement is
met when the owner elects to have distributions made over the Owner's life
expectancy, or over the joint life expectancy of the Owner and beneficiary. The
requirement that the amount be paid out as one of a series of "substantially
equal" periodic payments is met when the number of units withdrawn to make each
distribution is substantially the same. Any modification, other than by reason
of death or disability, of distributions which are part of a series of
substantially equal periodic payments that occurs before the Owner's age 59 1/2
or five years, will subject the Owner to the 10% penalty tax on the prior
distributions. In addition to the exceptions above, the penalty tax will not
apply to withdrawals from a qualified contract made to an employee who has
terminated employment after reaching age 55.
In a Private Letter Ruling, the IRS took the position that where distributions
from a variable annuity contract were determined by amortizing the accumulated
value of the contract over the taxpayer's remaining life expectancy (such as
under the Contract's LED option), and the option could be changed or terminated
at any time, the distributions failed to qualify as part of a "series of
substantially equal payments" within the meaning of Section 72 of the Code. The
distributions, therefore, were subject to the 10% federal penalty tax. This
Private Letter Ruling may be applicable to an Owner who receives distributions
under the LED option prior to age 59 1/2. Subsequent Private Letter Rulings,
however, have treated LED-type withdrawal programs as effectively avoiding the
10% penalty tax. The position of the IRS on this issue is unclear.
ASSIGNMENTS OR TRANSFERS. If the Owner transfers (assigns) the Contract to
another individual as a gift prior to the Annuity Date, the Code provides that
the Owner will incur taxable income at the time of the transfer. An exception is
provided for certain transfers between spouses. The amount of taxable income
upon such taxable transfer is equal to any investment gain in value over the
Owner's cost basis at the time of the transfer. The transfer also is subject to
federal gift tax provisions. Where the Owner and Annuitant are different
persons, the change of ownership of the Contract to the Annuitant on the Annuity
Date, as required under the Contract, is a gift and will be taxable to the Owner
as such; however, the Owner will not incur taxable income. Instead, the
Annuitant will incur taxable income upon receipt of annuity benefit payments as
discussed above.
NON-NATURAL OWNERS. As a general rule, deferred annuity contracts owned by
"non-natural persons" (e.g., a corporation) are not treated as annuity contracts
for federal tax purposes, and the investment income attributable to
contributions made after February 28, 1986 is taxed as ordinary income that is
received or accrued by the owner during the taxable year. This rule does not
apply to annuity contracts purchased with a single payment when the annuity date
is no later than a year from the issue date or to deferred annuities owned by
qualified employer plans, estates, employers with respect to a terminated
pension plan, and entities other than employers, such as a trust, holding an
annuity as an agent for a natural person. This exception, however, will not
apply in cases of any employer who is the owner of an annuity contract under a
non-qualified deferred compensation plan.
DEFERRED COMPENSATION PLANS OF STATE AND LOCAL GOVERNMENTS AND TAX-EXEMPT
ORGANIZATIONS. Under Section 457 of the Code, deferred compensation plans
established by governmental and certain other tax-exempt employers for their
employees may invest in annuity contracts. Contributions and investment earnings
are not taxable to employees until distributed; however, with respect to
payments made after February 28, 1986, a contract owned by a state or local
government or a tax-exempt organization will not be treated as an annuity under
Section 72 as well. In addition, plan assets are treated as property of the
employer and are subject to the claims of the employer's general creditors.
39
<PAGE>
C. TAX WITHHOLDING.
The Code requires withholding with respect to payments or distributions from
non-qualified contracts and IRAs, unless a taxpayer elects not to have
withholding. A 20% withholding requirement applies to distributions from most
other qualified contracts. In addition, the Code requires reporting to the IRS
of the amount of income received with respect to payment or distributions from
annuities.
The tax treatment of certain withdrawals or surrenders of the non-qualified
Contracts offered by this Prospectus will vary according to whether the amount
withdrawn or surrendered is allocable to an investment in the Contract made
before or after certain dates.
D. PROVISIONS APPLICABLE TO QUALIFIED EMPLOYER PLANS.
The tax rules applicable to qualified employer plans, as defined by the Code,
are complex and vary according to the type of plan. Benefits under a qualified
plan may be subject to that plan's terms and conditions irrespective of the
terms and conditions of any annuity contract used to fund such benefits. As
such, the following is simply a general description of various types of
qualified plans that may use the Contract. Before purchasing any annuity
contract for use in funding a qualified plan, more specific information should
be obtained.
A qualified Contract may include special provisions (endorsements) changing or
restricting rights and benefits otherwise available to an Owner of a
non-qualified Contract. Individuals purchasing a qualified Contract should
carefully review any such changes or limitations which may include restrictions
to ownership, transferability, assignability, contributions and distributions.
CORPORATE AND SELF-EMPLOYED ("H.R. 10" AND "KEOGH") PENSION AND PROFIT SHARING
PLANS. Sections 401(a), 401(k) and 403(a) of the Code permit business employers
and certain associations to establish various types of tax-favored retirement
plans for employees. The Self-Employed Individuals' Tax Retirement Act of 1962,
as amended, permits self-employed individuals to establish similar plans for
themselves and their employees. Employers intending to use qualified Contracts
in connection with such plans should seek competent advice as to the suitability
of the Contract to their specific needs and as to applicable Code limitations
and tax consequences.
The Company can provide prototype plans for certain pension or profit sharing
plans for review by the plan's legal counsel. For information, ask your
financial representative.
INDIVIDUAL RETIREMENT ANNUITIES. Section 408 of the Code permits eligible
individuals to contribute to an individual retirement program known as an
Individual Retirement Annuity ("IRA"). IRAs are subject to limits on the amounts
that may be contributed, the persons who may be eligible, and on the time when
distributions may commence. In addition, certain distributions from other types
of retirement plans may be "rolled over," on a tax-deferred basis, to an IRA.
Purchasers of an IRA Contract will be provided with supplementary information as
may be required by the IRS or other appropriate agency, and will have the right
to revoke the Contract as described in this Prospectus. See "B. Right to Revoke
Contract."
Eligible employers that meet specified criteria may establish simplified
employee pension plans (SEP-IRAs) or SIMPLE IRA plans for their employees using
IRAs. Employer contributions that may be made to such plans are larger than the
amounts that may be contributed to regular IRAs, and may be deductible to the
employer.
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TAX-SHELTERED ANNUITIES ("TSAS"). Under the provisions of Section 403(b) of the
Code, payments made to annuity contracts purchased for employees under annuity
plans adopted by public school systems and certain organizations which are tax
exempt under Section 501(c)(3) of the Code are excludable from the gross income
of such employees to the extent that total annual payments do not exceed the
maximum contribution permitted under the Code. Purchasers of TSA Contracts
should seek competent advice as to eligibility, limitations on permissible
payments and other tax consequences associated with the Contracts.
Withdrawals or other distributions attributable to salary reduction
contributions (including earnings thereon) made to a TSA contract after December
31, 1988, may not begin before the employee attains age 59 1/2, separates from
service, dies or becomes disabled. In the case of hardship, an Owner may
withdraw amounts contributed by salary reduction, but not the earnings on such
amounts. Even though a distribution may be permitted under these rules (e.g.,
for hardship or after separation from service), it may be subject to a 10%
penalty tax as a premature distribution, in addition to income tax.
TEXAS OPTIONAL RETIREMENT PROGRAM. Distributions under a TSA Contract issued to
participants in the Texas Optional Retirement Program may not be received except
in the case of the participant's death, retirement or termination of employment
in the Texas public institutions of higher education. These additional
restrictions are imposed under the Texas Government Code and a prior opinion of
the Texas Attorney General.
REPORTS
An Owner is sent a report semi-annually which states certain financial
information about the Portfolios. The Company also will furnish an annual report
to the Owner containing a statement of his or her account, including unit values
and other information as required by applicable law, rules and regulations.
LOANS (QUALIFIED CONTRACTS ONLY)
Loans are available to owners of TSA Contracts (i.e., contracts issued under
Section 403(b) of the Code) and to Contracts issued to plans qualified under
Sections 401(a) and 401(k) of the Code. Loans are subject to provisions of the
Code and to applicable qualified retirement plan rules. Tax advisors and plan
fiduciaries should be consulted prior to exercising loan privileges.
Loaned amounts will be withdrawn first from Sub-Account and Fixed Account values
on a pro-rata basis until exhausted. Thereafter, any additional amounts will be
withdrawn from the Guarantee Period Accounts (pro-rata by duration and LIFO
within each duration), subject to any applicable Market Value Adjustments. The
maximum loan amount will be determined under the Company's maximum loan formula.
The minimum loan amount is $1,000. Loans will be secured by a security interest
in the Contract and the amount borrowed will be transferred to a loan asset
account within the Company's General Account, where it will accrue interest at a
specified rate below the then current loan rate. Generally, loans must be repaid
within five years or less, and repayments must be made quarterly and in
substantially equal amounts. Repayments will be allocated pro rata in accordance
with the most recent payment allocation, except that any allocations to a
Guarantee Period Account will be allocated to the Money Market Portfolio
instead.
ADDITION, DELETION OR SUBSTITUTION OF INVESTMENTS
The Company reserves the right, subject to applicable law and to the provision
of the participation agreement with the Company, IFS, ZKI, and Kemper
Distributors, Inc. (the "Participation Agreement"), to make additions
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<PAGE>
to, deletions from, or substitutions for the shares that are held in the
Sub-Accounts or that the Sub-Accounts may purchase. If the shares of any
Portfolio no longer are available for investment or if in the Company's judgment
further investment in any Portfolio should become inappropriate in view of the
purposes of the Variable Account or the affected Sub-Account, the Company may
redeem the shares of that Portfolio and substitute shares of another registered
open-end management company. The Company will not substitute any shares
attributable to a Contract interest in a Sub-Account without notice to the Owner
and prior approval of the SEC and state insurance authorities, to the extent
required by the 1940 Act or other applicable law. The Variable Account may, to
the extent permitted by law, purchase other securities for other contracts or
permit a conversion between contracts upon request by an Owner.
The Company also reserves the right to establish additional sub-accounts of the
Variable Account, each of which would invest in shares corresponding to a new
portfolio or in shares of another investment company having a specified
investment objective. Subject to applicable law and any required SEC approval,
the Company may, in its sole discretion, establish new sub-accounts or eliminate
one or more Sub-Accounts if marketing needs, tax considerations or investment
conditions warrant. Any new sub-accounts may be made available to existing
Owners on a basis to be determined by the Company.
Shares of the Portfolios also are issued to separate accounts of other insurance
companies which issue variable life contracts ("mixed funding"). Shares of the
Portfolios also are issued to other unaffiliated insurance companies ("shared
funding"). It is conceivable that in the future such mixed funding or shared
funding may be disadvantageous for variable life owners or variable annuity
owners. Although the Company and IFS do not currently foresee any such
disadvantages to either variable life insurance owners or variable annuity
owners, the Company and the trustees of IFS intend to monitor events in order to
identify any material conflicts between such Owners and to determine what
action, if any, should be taken in response thereto. If the trustees were to
conclude that separate portfolios should be established for variable life and
variable annuity separate accounts, the Company will bear the attendant
expenses.
If any of these substitutions or changes is made, the Company may, by
appropriate endorsement, change the Contract to reflect the substitution or
change, and will notify Owners of all such changes. If the Company deems it to
be in the best interest of Owners, and subject to any approvals that may be
required under applicable law, the Variable Account or any Sub-Accounts may be
operated as a management company under the 1940 Act, may be deregistered under
the 1940 Act if registration no longer is required, or may be combined with
other sub-accounts or other separate accounts of the Company.
The Company reserves the right, subject to compliance with applicable law and to
the provisions of the Participation Agreement, to (1) transfers assets from the
Variable Account or Sub-Account to another of the Company's variable accounts or
sub-accounts having assets of the same class, (2) to operate the Variable
Account or any Sub-Account as a management investment company under the 1940 Act
or in any other form permitted by law, (3) to deregister the Variable Account
under the 1940 Act in accordance with the requirements of the 1940 Act, (4) to
substitute the shares of any other registered investment company for the
Portfolio shares held by a Sub-Account, in the event that Portfolio shares are
unavailable for investment, or if the Company determines that further investment
in such Portfolio shares is inappropriate in view of the purpose of the
Sub-Account, (5) to change the methodology for determining the net investment
factor, and (6) to change the names of the Variable Account or of the
Sub-Accounts. In no event will the changes described be made without notice to
Owners in accordance with the 1940 Act.
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CHANGES TO COMPLY WITH LAW AND AMENDMENTS
The Company reserves the right, without the consent of Owners, to suspend sales
of the Contract as presently offered, and to make any change to provisions of
the Contract to comply with, or give Owners the benefit of, any federal or state
statute, rule or regulations, including but not limited to requirements for
annuity contracts and retirement plans under the Code and pertinent regulations
or any state statute or regulation.
VOTING RIGHTS
The Company will vote Portfolio shares held by each Sub-Account in accordance
with instructions received from Owners and, after the Annuity Date, from the
Annuitants. Each person having a voting interest in a Sub-Account will be
provided with proxy materials of the Portfolio, together with a form with which
to give voting instructions to the Company. Shares for which no timely
instructions are received will be voted in proportion to the instructions which
are received. The Company also will vote shares in a Sub-Account that it owns
and which are not attributable to the Contract in the same proportion. If the
1940 Act or any rules thereunder should be amended, or if the present
interpretation of the 1940 Act or such rules should change, and as a result the
Company determines that it is permitted to vote shares in its own right, whether
or not such shares are attributable to the Contract, the Company reserves the
right to do so.
The number of votes which an Owner or Annuitant may cast will be determined by
the Company as of the record date established by the Portfolio. During the
accumulation phase, the number of Portfolio shares attributable to each Owner
will be determined by dividing the dollar value of the Accumulation Units of the
Sub-Account credited to the Contract by the net asset value of one Portfolio
share. During the annuity payout phase, the number of Portfolio shares
attributable to each Annuitant will be determined by dividing the reserve held
in each Sub-Account for the Annuitant's variable annuity by the net asset value
of one Portfolio share. Ordinarily, the Annuitant's voting interest in the
Portfolio will decrease as the reserve for the variable annuity is depleted.
DISTRIBUTION
The Contract offered by this Prospectus may be purchased from certain
independent broker-dealers, including representatives of Allmerica Investments,
Inc. (the Principal Underwriter) which are registered under the Securities
Exchange Act of 1934 and are members of the National Association of Securities
Dealers, Inc. ("NASD").
The Company pays commissions, not to exceed 6.0% of payments, to broker-dealers
which sell the Contract. To the extent permitted by NASD rules, promotional
incentives or payments also may be provided to such broker-dealers based on
sales volumes, the assumption of wholesaling functions, or other sales-related
criteria. Additional payments may be made for other services not directly
related to the sale of the Contract, including the recruitment and training of
personnel, production of promotional literature, and similar services.
The Company intends to recoup commissions and other sales expenses through a
combination of anticipated contingent deferred sales charges and profits from
the Company's General Account. Commissions paid on the Contract, including
additional incentives or payments, do not result in any additional charge to
Owners or to the Variable Account. Any contingent deferred sales charges
assessed on a Contract will be retained by the Company.
Owners may direct any inquiries to their financial representative or to
Allmerica Investments, Inc., 440 Lincoln Street, Worcester, MA 01653, Telephone
1-800-782-8380.
LEGAL MATTERS
There are no legal proceedings pending to which the Variable Account is a party.
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FURTHER INFORMATION
A Registration Statement under the 1933 Act relating to this offering has been
filed with the SEC. Certain portions of the Registration Statement and
amendments have been omitted in this Prospectus pursuant to the rules and
regulations of the SEC. The omitted information may be obtained from the SEC's
principal office in Washington, DC, upon payment of the SEC's prescribed fees.
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APPENDIX A
MORE INFORMATION ABOUT THE FIXED ACCOUNT
Because of exemption and exclusionary provisions in the securities laws,
interests in the Fixed Account generally are not subject to regulation under the
provisions of the 1933 Act or the 1940 Act. Disclosures regarding the fixed
portion of the Contract and the Fixed Account may be subject to the provisions
of the 1933 Act concerning the accuracy and completeness of statements made in
this Prospectus. The disclosures in this APPENDIX A have not been reviewed by
the SEC.
The Fixed Account is part of the Company's General Account which is made up of
all of the general assets of the Company other than those allocated to separate
accounts. Allocations to the Fixed Account become part of the assets of the
Company, and are used to support insurance and annuity obligations. A portion or
all of net payments may be allocated to accumulate at a fixed rate of interest
in the Fixed Account. Such net amounts are guaranteed by the Company as to
principal and a minimum rate of interest. Under the Contract, the minimum
interest which may be credited on amounts allocated to the Fixed Account is 3%
compounded annually. Additional "Excess Interest" may or may not be credited at
the sole discretion of the Company.
If the Contract is surrendered, or if an amount in excess of the Withdrawal
Without Surrender Charge Amount is withdrawn while the Contract is in force and
before the Annuity Date, a contingent deferred sales charge is imposed if such
event occurs before the payments attributable to the surrender or withdrawal
have been credited to the Contract for at least six full Contract years.
A-1
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APPENDIX B
SURRENDER CHARGES AND THE MARKET VALUE ADJUSTMENT
PART 1: SURRENDER CHARGES
FULL SURRENDER
Assume a Payment of $50,000 is made on the issue date and no additional payments
are made. Assume there are no withdrawals and that the free withdrawal amount is
equal to the greater of 15% of the current Accumulated Value or the accumulated
earnings in the Contract. The table below presents examples of the surrender
charge resulting from a full surrender, based on hypothetical Accumulated
Values.
<TABLE>
<CAPTION>
HYPOTHETICAL FREE SURRENDER
ACCOUNT ACCUMULATED WITHDRAWAL CHARGE SURRENDER
YEAR VALUE AMOUNT PERCENTAGE CHARGE
- --------- ------------- ------------- --------------- ------------
<S> <C> <C> <C> <C>
1 54,000.00 8,100.00 7% 3,213.00
2 58,320.00 8,748.00 6% 2,974.32
3 62,985.60 12,985.60 5% 2,500.00
4 68,024.45 18,024.45 4% 2,000.00
5 73,466.40 23,466.40 3% 1,500.00
6 79,343.72 29,343.72 2% 1,000.00
7 85,691.21 35,691.21 0% 0.00
</TABLE>
WITHDRAWAL
Assume a Payment of $50,000 is made on the issue date and no additional payments
are made. Assume tat the free withdrawal amount is equal to the greater of 15%
of the current Accumulated Value or the accumulated earnings in the contract and
there are withdrawals as detailed below. The table below presents examples of
the surrender charge resulting from withdrawals, based on hypothetical
Accumulated Values.
<TABLE>
<CAPTION>
HYPOTHETICAL FREE SURRENDER
ACCOUNT ACCUMULATED WITHDRAWAL CHARGE SURRENDER
YEAR VALUE WITHDRAWAL AMOUNT PERCENTAGE CHARGE
- --------- ------------- ------------- ------------- ------------- -----------
<S> <C> <C> <C> <C> <C>
1 54,000.00 0.00 8,100.00 7% 0.00
2 58,320.00 0.00 8,748.00 6% 0.00
3 62,985.60 0.00 12,985.60 5% 0.00
4 68,024.45 30,000.00 18,024.45 4% 479.02
5 41,066.40 10,000.00 6,159.96 3% 115.20
6 33,551.72 5,000.00 5,032.76 2% 0.00
7 30,835.85 10,000.00 4,625.38 0% 0.00
</TABLE>
PART 2: MARKET VALUE ADJUSTMENT
The market value factor is: [(1+i)/(1+j)](n/365)-1
The following examples assume:
1. The payment was allocated to a ten-year Guarantee Period Account with a
guaranteed interest rate of 8%.
2. The date of surrender is seven years (2,555 days) from the expiration
date.
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3. The value of the Guarantee Period Account is equal to $62,985.60 at the
end of three years.
4. No transfers or withdrawals affecting this Guarantee Period Account have
been made.
5. Surrender charges, if any, are calculated in the same manner as shown in
the examples in Part 1.
NEGATIVE MARKET VALUE ADJUSTMENT (UNCAPPED)
Assume that on the date of surrender, the current rate (j) is 10.00% or 0.10
The market value factor = [(1+i)/(1+j)](n/365)-1
= [(1+.08)/(1+.10)](2555/365)-1
= (.98182)(7)-1
= -.12054
The market value adjustment=the market value factor multiplied by the withdrawal
= -.12054 X $62,985.60
= -$7,592.11
POSITIVE MARKET VALUE ADJUSTMENT (UNCAPPED)
Assume that on the date of surrender, the current rate (j) is 7.00% or 0.07
The market value factor = [(1+i)/(1+j)](n/365)-1
= [(1+.08)/(1+.07)](2555/365)-1
= (1.0093)(7)-1
= .06694
The market value adjustment = the market value factor multiplied by the
withdrawal
= .06694 X $62,985.60
= $4,216.26
NEGATIVE MARKET VALUE ADJUSTMENT (CAPPED)
Assume that on the date of surrender, the current rate (j) is 11.00% or 0.11
The market value factor = [(1+i)/(1+j)](n/365)-1
= [(1+.08)/(1+.11)](2555/365)-1
= (.97297)(7)-1
= -.17454
The market value adjustment = Minimum of the market value factor multiplied by
the withdrawal or the negative of the excess interest earned over 3%
= Minimum (-.17454 X $62,985.60 or -$8,349.25)
= Minimum of (-$10,993.51 or -$8,349.25)
= -$8,349.25
A-3
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POSITIVE MARKET VALUE ADJUSTMENT (CAPPED)
Assume that on the date of surrender, the current rate (j) is 6.00% or 0.06
The market value factor = [(1+i)/(1+j)](n/365)-1
= [(1+.08)/(1+.06)](2555/365)-1
= (1.01887)(7)-1
=.13981
The market value adjustment = Minimum of the market value factor multiplied by
the withdrawal or the excess interest earned over
3%
= Minimum of (.13981 X $62,985.60 or $8,349.25)
= Minimum of ($8,806.02 or $8,349.25) = $8,349.25
A-4
<PAGE>
FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY
STATEMENT OF ADDITIONAL INFORMATION
FOR
FLEXIBLE PAYMENT DEFERRED VARIABLE AND FIXED ANNUITY CONTRACTS FUNDED
THROUGH
SEPARATE ACCOUNT KG
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS. IT SHOULD BE READ
IN CONJUNCTION WITH THE PROSPECTUS FOR SEPARATE ACCOUNT KG, DATED MAY 1, 1997,
("THE PROSPECTUS"). THE PROSPECTUS MAY BE OBTAINED FROM ALLMERICA INVESTMENTS,
INC., 440 LINCOLN STREET, WORCESTER, MASSACHUSETTS 01653, TELEPHONE
1-800-782-8380.
DATED MAY 1, 1997
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
TABLE OF CONTENTS
GENERAL INFORMATION AND HISTORY. . . . . . . . . . . . . . . . . . . . . . 2
TAXATION OF THE CONTRACT, THE VARIABLE ACCOUNT AND THE
COMPANY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
SERVICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
UNDERWRITERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ANNUITY BENEFIT PAYMENTS . . . . . . . . . . . . . . . . . . . . . . . . . 4
EXCHANGE OFFER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
PERFORMANCE INFORMATION. . . . . . . . . . . . . . . . . . . . . . . . . . 7
TAX-DEFERRED ACCUMULATION. . . . . . . . . . . . . . . . . . . . . . . . . 10
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
GENERAL INFORMATION AND HISTORY
Separate Account KG (the "Variable Account") is a separate investment account of
First Allmerica Financial Life Insurance Company (the "Company") authorized by
vote of the Board of Directors on June 13, 1996. The Company, organized under
the laws of Massachusetts in 1844, is the fifth oldest life insurance company in
America. Effective October 16, 1995, the Company converted from a mutual life
insurance company, known as State Mutual Life Assurance Company of America, to a
stock life insurance company and adopted its present name. At that time, the
Company became a wholly owned subsidiary of Allmerica Financial Corporation
("AFC"). The Company's principal office (the "Principal Office") is located at
440 Lincoln Street, Worcester, Massachusetts 01653, telephone 508-855-1000. The
Company is subject to the laws of the Commonwealth of Massachusetts governing
insurance companies and to regulation by the Commissioner of Insurance of
Massachusetts. In addition, the Company is subject to the insurance laws and
regulations of other states and jurisdictions in which it is licensed to
operate. As of December 31, 1996, the Company and its subsidiaries had over
$13.3 billion in combined assets and over $45.3 billion in life insurance in
force.
Each Sub-Account invests in a corresponding investment portfolio of Kemper
Investors Fund (the "Fund"), a series-type mutual fund registered with the
Securities and Exchange Commission (the "SEC") as an open-end, diversified
management investment company. Currently, 14 Sub-Accounts of the Variable
Account are available under the Contract: the Money Market Portfolio, Total
Return Portfolio, High Yield Portfolio, Growth Portfolio, Government Securities
Portfolio, International Portfolio, Small Cap Growth Portfolio, Investment Grade
Bond Portfolio, Value Portfolio, Small Cap Value Portfolio, Value+Growth
Portfolio, Horizon 20+ Portfolio, Horizon 10+ Portfolio, and Horizon 5 Portfolio
("Underlying Portfolios"). Each Portfolio available under the Contract has its
own investment objectives and certain attendant risks.
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TAXATION OF THE CONTRACT, THE VARIABLE
ACCOUNT AND THE COMPANY
The Company currently imposes no charge for taxes payable in connection with the
Contract, other than for state and local premium taxes and similar assessments
when applicable. The Company reserves the right to impose a charge for any
other taxes that may become payable in the future in connection with the
Contract or the Variable Account.
The Variable Account is considered to be a part of and taxed with the operations
of the Company. The Company is taxed as a life insurance company under
subchapter L of the Internal Revenue Code (the "Code"), and files a consolidated
tax return with its parent and affiliated companies.
The Company reserves the right to make a charge for any effect which the income,
assets or existence of the Contract or the Variable Account may have upon its
tax. Such charge for taxes, if any, will be assessed on a fair and equitable
basis in order to preserve equity among classes of Contract Owners ("Owners").
The Variable Account presently is not subject to tax.
SERVICES
CUSTODIAN OF SECURITIES. The Company serves as custodian of the assets of the
Variable Account. Fund shares owned by the Sub-Accounts are held on an open
account basis. A Sub-Account's ownership of Fund shares is reflected on the
records of the Fund and is not represented by any transferable stock
certificates.
EXPERTS. The financial statements of the Company as of December 31, 1996 and
1995, and for each of the three years in the period ended December 31, 1996,
included in this Statement of Additional Information ("SAI") constituting part
of the Registration Statement, have been so included in reliance on the report
of Price Waterhouse LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
The financial statements of the Company included herein should be considered
only as bearing on the ability of the Company to meet its obligations under the
Contract.
UNDERWRITERS
Allmerica Investments, Inc. ("Allmerica Investments"), a registered
broker-dealer under the Securities Exchange Act of 1934 and a member of the
National Association of Securities Dealers, Inc. ("NASD"), serves as principal
underwriter for the Contract pursuant to a contract with the Company and the
Variable Account. Allmerica Investments distributes the Contract on a
best-efforts basis. Allmerica Investments, Inc., 440 Lincoln Street, Worcester,
Massachusetts 01653, was organized in 1969 as a wholly owned subsidiary of First
Allmerica, and presently is indirectly wholly owned by First Allmerica.
The Contract offered by this Prospectus is offered continuously, and may be
purchased from certain independent broker-dealers which are NASD members and
whose representatives are authorized by applicable law to sell variable annuity
contracts.
All persons selling the Contract are required to be licensed by their respective
state insurance authorities for the sale of variable annuity contracts. The
Company pays commissions, not to exceed 6.0% of purchase payments, to entities
which sell the Contract. To the extent permitted by NASD rules, promotional
incentives or payments also may be provided to such entities based on sales
volumes, the assumption of wholesaling functions or other sales-related
criteria. Additional payments may be made for other services not directly
related to the sale of the Contract, including the recruitment and training of
personnel, production of promotional literature and similar services. A
Promotional Allowance of 1.0% is paid to Kemper Distributors, Inc. for
administrative and support services with respect to the distribution of the
Contract; however, Kemper Distributors, Inc. may direct the Company to pay a
portion of said allowance to broker-dealers who provide support services
directly.
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<PAGE>
Commissions are paid by the Company and do not result in any charge to Owners or
to the Variable Account in addition to the charges described under "CHARGES AND
DEDUCTIONS" in the Prospectus. The Company intends to recoup the commission and
other sales expense through a combination of anticipated surrender, withdrawal
and/or annuitization charges, profits from the Company's general account,
including the investment earnings on amounts allocated to accumulate on a fixed
basis in excess of the interest credited on fixed accumulations by the Company,
and the profit, if any, from the mortality and expense risk charge.
ANNUITY BENEFIT PAYMENTS
The method by which the Accumulated Value under the Contract is determined is
described in detail under "Computation of Values" in the Prospectus.
ILLUSTRATION OF ACCUMULATION UNIT CALCULATION USING HYPOTHETICAL EXAMPLE. The
Accumulation Unit calculation for a daily Valuation Period may be illustrated by
the following hypothetical example: Assume that the assets of a Sub-Account at
the beginning of a one-day Valuation Period were $5,000,000; that the value
of an Accumulation Unit on the previous date was $1.135000; and that during the
Valuation Period, the investment income and net realized and unrealized capital
gains exceed net realized and unrealized capital losses by $1,675. The
Accumulation Unit value at the end of the current Valuation Period would be
calculated as follows:
(1) Accumulation Unit Value -- Previous Valuation Period . . . . . $ 1.135000
(2) Value of Assets -- Beginning of Valuation Period . . . . . . . . $5,000,000
(3) Excess of Investment Income and Net Gains Over Capital Losses. . $1,675
(4) Adjusted Gross Investment Rate for the Valuation Period (3)
DIVIDED BY (2) . . . . . . . . . . . . . . . . . . . . . . . . . 0.000335
(5) Annual Charge (one-day equivalent of 1.40% per annum). . . . . . 0.000039
(6) Net Investment Rate (4) - (5). . . . . . . . . . . . . . . . . . 0.000296
(7) Net Investment Factor 1.000000 + (6) . . . . . . . . . . . . . . 1.000296
(8) Accumulation Unit Value -- Current Period (1) x (7). . . . . . . $ 1.135336
Conversely, if unrealized capital losses and charges for expenses and taxes
exceeded investment income and net realized capital gains by $1,675, the
accumulated unit value at the end of the Valuation Period would have been
$1.134576.
The method for determining the amount of annuity benefit payments is described
in detail under "Determination of First and Subsequent Annuity Benefit Payments"
in the Prospectus.
ILLUSTRATION OF VARIABLE ANNUITY BENEFIT PAYMENT CALCULATION USING HYPOTHETICAL
EXAMPLE. The determination of the Annuity Unit value and the variable annuity
payment may be illustrated by the following hypothetical example: Assume an
Annuitant has 40,000 Accumulation Units in a Variable Account, and that the
value of an Accumulation Unit on the Valuation Date used to determine the amount
of the first variable annuity payment is $1.120000. Therefore, the Accumulation
Value of the Contract is $44,800 (40,000 x $1.120000). Assume also that the
Owner elects an option for which the first monthly payment is $6.57 per $1,000
of Accumulated Value applied. Assuming no premium tax or contingent deferred
sales charge, the first monthly payment would be 44.800 multiplied by $6.57, or
$294.34.
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<PAGE>
Next, assume that the Annuity Unit value for the assumed rate of 3.5% per annum
for the Valuation Date as of which the first payment was calculated was
$1.100000. Annuity Unit values will not be the same as Accumulation Unit values
because the former reflect the 3.5% assumed interest rate used in the annuity
rate calculations. When the Annuity Unit value of $1.100000 is divided into the
first monthly payment the number of Annuity Units represented by that payment is
determined to be 267.5818. The value of this same number of Annuity Units will
be paid in each subsequent month under most options. Assume further that the
net investment factor for the Valuation Period applicable to the next annuity
payment is 1.000190. Multiplying this factor by .999906 (the one-day adjustment
factor for the assumed interest rate of 3-1/2% per annum) produces a factor of
1.000096. This then is multiplied by the Annuity Unit value on the immediately
preceding Valuation Date (assumed here to be $1.105000). The result is an
Annuity Unit value of $1.105106 for the current monthly payment. The current
monthly payment then is determined by multiplying the number of Annuity Units by
the current Annuity Unit value, or 267.5818 times $1.105106, which produces a
current monthly payment of $295.71.
METHOD FOR DETERMINING COMMUTED VALUE ON VARIABLE ANNUITY PERIOD CERTAIN OPTIONS
AND ILLUSTRATION USING HYPOTHETICAL EXAMPLE. The Contract offers both
commutable and non-commutable period certain options. A commutable option gives
the Annuitant the right to exchange any remaining payments for a lump sum
payment based on the commuted value. The Commuted Value is the present value of
remaining payments calculated at 3.5% interest. The determination of the
Commuted Value may be illustrated by the following hypothetical example.
Assume a commutable period certain option is elected. The number of Annuity
Units on which each payment is based would be calculated using the Surrender
Value less any premium tax. Assume this results in 250.0000 Annuity Units.
Assume the Commuted Value is requested with 60 monthly payments remaining and a
current Annuity Unit Value of $1.200000. Based on these assumptions, the dollar
amount of remaining payments would be $300 a month for 60 months. The present
value at 3.5% of all remaining payments would be $16,560.72.
EXCHANGE OFFER
A. VARIABLE ANNUITY CONTRACT EXCHANGE OFFER
The Company will permit Owners of certain variable annuity contracts issued by
Allmerica Financial Life Insurance and Annuity Company ("AFLIAC"), described
below, to exchange their contracts at net asset value for the variable annuity
contracts described in the Prospectus, which are issued on Form No. A3025-96 or
a state variation thereof ("new Contract"). The Company reserves the right to
suspend this exchange offer at any time.
This offer applies to the exchange of Elective Payment Variable Annuity
contracts issued by AFLIAC on Forms A3012-79 and A3013-79 ("Elective Payment
Exchanged Contract," all such contracts having numbers with a "JQ" or "JN"
prefix), and Single Payment Variable Annuity contracts issued on Forms A3014-79
and A3015-79 ("Single Payment Exchanged Contract," all such contracts having
numbers with a "KQ" or "KN" prefix). These contracts are referred to
collectively as the "Exchanged Contract." To effect an exchange, the Company
should receive (1) a completed application for the new Contract, (2) the
contract being exchanged, and (3) a signed Letter of Awareness.
CONTINGENT DEFERRED SALES CHARGE COMPUTATION. No surrender charge otherwise
applicable to the Exchanged Contract will be assessed as a result of the
exchange. Instead, the contingent deferred sales charge under the new Contract
will be computed as if the payments that had been made to the Exchanged Contract
were made to the new Contract as of the date of issue of the Exchanged Contract.
Any additional payments to the new Contract after the exchange will be subject
to the contingent deferred sales charge computation outlined in the new Contract
and Prospectus; i.e., the charge will be computed based on the number of years
that the additional payment (or portion of that payment) that is being withdrawn
has been credited to the new Contract.
-5-
<PAGE>
SUMMARY OF DIFFERENCES BETWEEN EXCHANGED CONTRACT AND THE NEW CONTRACT. The new
Contract and the Exchanged Contract differ substantially as summarized below.
There may be additional differences important to a person considering an
exchange, and the Prospectuses for the new Contract and the Exchanged Contract
should be reviewed carefully before the exchange request is submitted to the
Company.
CONTINGENT DEFERRED SALES CHARGE. The contingent deferred sales charge under
the new Contract, as described in the Prospectus, imposes higher charge
percentages against the excess amount redeemed than the Single Payment Exchanged
Contract. In addition, if an Elective Payment Exchanged Contract was issued
more than nine years before the date of an exchange under this offer, additional
payments to the Exchanged Contract would not be subject to a surrender charge.
New payments to the new Contract may be subject to a charge if withdrawn prior
to the surrender charge period described in the Prospectus.
CONTRACT FEE. Under the new Contract, the Company deducts a $30 fee on each
contract anniversary and at surrender if the Accumulated Value is less than
$50,000. This fee is waived if the new Contract is part of a 401(k) plan. No
Contract fees are charged on the Single Payment Exchanged Contract. A $9
semi-annual fee is charged on the Elective Payment Exchanged Contract if the
Accumulated Value is $10,000 or less.
VARIABLE ACCOUNT ADMINISTRATIVE EXPENSE CHARGE. Under the new Contract, the
Company assesses each Sub-Account a daily administrative expense charge at an
annual rate of 0.15% of the average daily net assets of the Sub-Account. No
administrative expense charge based on a percentage of Sub-Account assets is
imposed under the Exchanged Contract.
TRANSFER CHARGE. No charge for transfers is imposed under the Exchanged
Contract. Currently, no transfer charge is imposed under the new Contract;
however, the Company reserves the right to assess a charge not to exceed $25 for
each transfer after the twelfth in any contract year.
DEATH BENEFIT. The Exchanged Contract offers a death benefit that is guaranteed
to be the greater of a Contract's Accumulated Value or gross payments made (less
withdrawals). At the time an exchange is processed, the Accumulated Value of
the Exchanged Contract becomes the "payment" for the new Contract. Therefore,
prior purchase payments made under the Exchanged Contract (if higher than the
Exchanged Contract's Accumulated Value) no longer are a basis for determining
the death benefit under the new Contract. Consequently, whether the initial
minimum death benefit under the new Contract is greater than, equal to, or less
than, the death benefit of the Exchanged Contract depends on whether the
Accumulated Value transferred to the new Contract is greater than, equal to, or
less than, the gross payments under the Exchanged Contract. In addition, under
the Exchanged Contract, the amount of any prior withdrawals are subtracted from
the value of the death benefit. Under the new Contract, where there is a
reduction in the death benefit amount due to a prior withdrawal, the value of
the death benefit is reduced in the same proportion that the new Contract's
Accumulated Value was reduced on the date of the withdrawal.
ANNUITY TABLES. The Exchanged Contract contains higher guaranteed annuity
rates.
INVESTMENTS. Accumulated Values and payments under the new Contract may be
allocated to significantly more investment options than are available under the
Exchanged Contract.
B. FIXED ANNUITY EXCHANGE OFFER.
This exchange offer also applies to all fixed annuity contracts issued by the
Company. A fixed annuity contract to which this exchange offer applies may be
exchanged at net asset value for the Contract described in this Prospectus,
subject to the same provisions for effecting the exchange and for applying the
new Contract's contingent deferred sales charge as described above for variable
annuity contracts. This Prospectus should be read carefully before making such
exchange. Unlike a fixed annuity, the new Contract's value is not guaranteed
and will vary depending on the investment performance of the Underlying Funds to
which it is allocated. The new Contract has a different charge structure than a
fixed annuity contract, which includes not only a contingent deferred sales
charge that may vary from that of the class of contracts to which the
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<PAGE>
exchanged fixed contract belongs, but also Contract fees, mortality and expense
risk charges (for the Company's assumption of certain mortality and expense
risks), administrative expense charges, transfer charges (for transfers
permitted among Sub-Accounts and the Fixed Account), and expenses incurred by
the Underlying Funds. Additionally, the interest rates offered under the Fixed
Account of the new Contract and the Annuity Tables for determining minimum
annuity benefit payments may be different from those offered under the exchanged
fixed contract.
C. EXERCISE OF "FREE-LOOK PROVISION" AFTER ANY EXCHANGE.
Persons who, under the terms of this exchange offer, exchange their contract for
the new Contract and subsequently revoke the new Contract within the time
permitted, as described in the sections of this Prospectus captioned "Right to
Revoke Individual Retirement Annuity" and "Right to Revoke All Other Contracts,"
will have their exchanged contract automatically reinstated as of the date of
revocation. The refunded amount will be applied as the new current Accumulated
Value under the reinstated contract, which may be more or less than it would
have been had no exchange and reinstatement occurred. The refunded amount will
be allocated initially among the Fixed Account and Sub-Accounts of the
reinstated contract in the same proportion that the value in the Fixed Account
and the value in each Sub-Account bore to the transferred Accumulated Value on
the date of the exchange of the contract for the new Contract. For purposes of
calculating any contingent deferred sales charge under the reinstated contract,
the reinstated contract will be deemed to have been issued and to have received
past purchase payments as if there had been no exchange.
PERFORMANCE INFORMATION
Performance information for a Sub-Account may be compared, in reports and
promotional literature, to certain indices described in the Prospectus under
"PERFORMANCE INFORMATION." In addition, the Company may provide advertising,
sales literature, periodic publications or other materials information on
various topics of interest to Owners and prospective Owners. These topics may
include the relationship between sectors of the economy and the economy as a
whole and its effect on various securities markets, investment strategies and
techniques (such as value investing, market timing, dollar cost averaging, asset
allocation, constant ratio transfer and account rebalancing), the advantages and
disadvantages of investing in tax-deferred and taxable investments, customer
profiles and hypothetical purchase and investment scenarios, financial
management and tax and retirement planning, and investment alternatives to
certificates of deposit and other financial instruments, including comparisons
between the Contract and the characteristics of and market for such financial
instruments. Total Return data may be advertised based on the period of time
that an Underlying Portfolio has been in existence, even if longer than the
period of time that the Contract has been offered. The results for any period
prior to a Contract being offered will be calculated as if the Contract had been
offered during that period of time, with all charges assumed to be those
applicable to the Contract.
TOTAL RETURN
"Total Return" refers to the total of the income generated by an investment in a
Sub-Account and of the changes of value of the principal invested (due to
realized and unrealized capital gains or losses) for a specified period, reduced
by the Sub-Account's asset charge and any applicable contingent deferred sales
charge which would be assessed upon complete withdrawal of the investment.
Total Return figures are calculated by standardized methods prescribed by rules
of the Securities and Exchange Commission ("SEC"). The quotations are computed
by finding the average annual compounded rates of return over the specified
periods that would equate the initial amount invested to the ending redeemable
values, according to the following formula:
P(1 + T)n = ERV
Where: P = a hypothetical initial payment to the Variable Account of $1,000
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T = average annual total return
n = number of years
ERV = the ending redeemable value of the $1,000 payment at the end of the
specified period
The calculation of Total Return includes the annual charges against the asset of
the Sub-Account. This charge is 1.40% on an annual basis. The calculation of
ending redeemable value assumes (1) the Contract was issued at the beginning of
the period, and (2) a complete surrender of the Contract at the end of the
period. The deduction of the contingent deferred sales charge, if any,
applicable at the end of the period is included in the calculation, according to
the following schedule:
Years from date of Charge as Percentage of
Payment New Payments Withdrawn*
0-1 7%
2 6%
3 5%
4 4%
5 3%
6 2%
Thereafter 0%
*Subject to the maximum limit described in the Prospectus.
No contingent deferred sales charge is deducted upon expiration of the periods
specified above. In all calendar years, an amount equal to the greater of (a)
15% of the Accumulated Value, (b) cumulative earnings (Accumulated Value less
total gross payments not previously withdrawn), or (c) the life expectancy
distribution is not subject to the contingent deferred sales charge.
The calculations of Total Return reflect the deduction of an $0.88 annual
Contract fee, representing a pro-rata portion of the $30 annual Contract fee,
based on a mean contract size of $40,000.
SUPPLEMENTAL TOTAL RETURN INFORMATION
The Supplemental Total Return information in this section refers to the total of
the income generated by an investment in a Sub-Account and of the changes of
value of the principal invested (due to realized and unrealized capital gains or
losses) for a specified period reduced by the Sub-Account's asset charges.
However, it is assumed that the investment is NOT withdrawn at the end of each
period.
-8-
<PAGE>
The quotations of Supplemental Total Return are computed by finding the average
annual compounded rates of return over the specified periods that would equate
the initial amount invested to the ending values, according to the following
formula:
P(1 + T)n = EV
Where: P = a hypothetical initial payment to the Variable Account of $1,000
T = average annual total return
n = number of years
EV = the ending value of the $1,000 payment at the end of the
specified period
The calculation of Supplemental Total Return reflects the 1.40% annual charge
against the assets of the Sub-Accounts. The ending value assumes that the
Contract is NOT surrendered at the end of the specified period, and therefore
there is no adjustment for the contingent deferred sales charge that would be
applicable if the Contract was surrenderd at the end of the period.
The calculations of Supplemental Total Return include the deduction of an $0.88
Annual Contract fee, representing a pro-rata portion of the $30 annual Contract
fee based on a mean contract size of $40,000.
YIELD AND EFFECTIVE YIELD -- MONEY MARKET SUB-ACCOUNT
Set forth below is yield and effective yield information for the Money Market
Sub-Account for the seven-day period ended December 31, 1996:
Yield 3.49%
Effective Yield 3.55%
The yield and effective yield figures are calculated by standardized methods
prescribed by rules of the SEC. Under those methods, the yield quotation is
computed by determining the net change (exclusive of capital changes) in the
value of a hypothetical pre-existing account having a balance of one
accumulation unit of the Sub-Account at the beginning of the period, subtracting
a charge reflecting the annual 1.40% deduction for mortality and expense risk
and the administrative charge, dividing the difference by the value of the
account at the beginning of the same period to obtain the base period return,
and then multiplying the return for a seven-day base period by (365/7), with the
resulting yield carried to the nearest hundredth of one percent.
The Money Market Sub-Account computes effective yield by compounding the
unannualized base period return by using the formula:
Effective Yield = [(base period return + 1)(365/7)] - 1
The calculations of yield and effective yield do NOT reflect the $30 annual
Contract fee.
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TAX-DEFERRED ACCUMULATION
NON-QUALIFIED CONVENTIONAL
ANNUITY CONTRACT SAVINGS PLAN
After-tax contributions
and tax-deferred earnings
Taxable Lump After-tax contributions
No Withdrawals Sum Withdrawal and taxable earnings
-------------- -------------- -----------------------
10 Years . . . . . $107,946 $ 86,448 $ 81,693
20 Years . . . . . 233,048 165,137 133,476
30 Years . . . . . 503,133 335,021 218,082
This chart compares the accumulation of a $50,000 initial investment into a
non-qualified annuity contract with a conventional savings plan. Contributions
to the non-qualified annuity contract and the conventional savings plan are made
after tax. Only the gain in the non-qualified annuity contract will be subject
to income tax in a taxable lump sum withdrawal. The chart assumes a 37.1%
federal marginal tax rate and an 8% annual return. The 37.1% federal marginal
tax is based on a marginal tax rate of 36%, representative of the target market,
adjusted to reflect a decrease of $3 of itemized deductions for each $100 of
income over $117,950. Tax rates are subject to change as is the tax-deferred
treatment of the Contract. Income on non-qualified annuity contracts is taxed
as ordinary income upon withdrawal. A 10% tax penalty may apply to early
withdrawals. See "Federal Income Taxes" in the Prospectus.
The chart does not reflect the following charges and expenses under the
Contract: 1.25% for mortality and expense risk; 0.15% administration charges; 7%
maximum deferred sales charge; and $30 annual Contract fee. The tax-deferred
accumulation would be reduced if these charges were reflected. No implication
is intended by the use of these assumptions that the return shown is guaranteed
in any way or that the return shown represents an average or expected rate of
return over the period of the Contract. (IMPORTANT -- THIS IS NOT AN
ILLUSTRATION OF YIELD OR RETURN.)
Unlike savings plans, contributions to non-qualified annuity contracts provide
tax-deferred treatment on earnings. In addition, contributions to tax-deferred
retirement annuities are not subject to current tax in the year of contribution.
When monies are received from a non-qualified annuity contract (and you have
many different options on how you receive your funds), they are subject to
income tax. At the time of receipt, if the person receiving the monies is
retired, not working or has additional tax exemptions, these monies may be taxed
at a lesser rate.
FINANCIAL STATEMENTS
Financial Statements are included for First Allmerica Financial Life Insurance
Company and for Separate Account KG for First Allmerica Financial Life
Insurance Company.
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FIRST ALLMERICA
FINANCIAL LIFE
INSURANCE COMPANY
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholder of
First Allmerica Financial Life Insurance Company
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of shareholder's equity, and of cash flows
present fairly, in all material respects, the financial position of First
Allmerica Financial Life Insurance Company and its subsidiaries at December 31,
1996 and 1995, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in the accompanying notes to the consolidated financial
statements, the Company changed its method of accounting for investments
(Note 1) and postemployment benefits (Note 11) in 1994.
/s/ Price Waterhouse LLP
Price Waterhouse LLP
Boston, Massachusetts
February 3, 1997, except as to Notes 1 and 2,
which are as of February 19, 1997
F-2
<PAGE>
FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF ALLMERICA FINANCIAL CORPORATION)
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
----------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
REVENUES
Premiums................................... $2,236.3 $2,222.8 $2,181.8
Universal life and investment product
policy fees............................... 197.2 172.4 156.8
Net investment income...................... 669.9 710.1 743.1
Net realized investment gains.............. 66.8 19.1 1.1
Realized gain on sale of mutual fund
processing business....................... -- 20.7 --
Other income............................... 102.7 95.4 112.3
--------- --------- ---------
Total revenues......................... 3,272.9 3,240.5 3,195.1
--------- --------- ---------
BENEFITS, LOSSES AND EXPENSES
Policy benefits, claims, losses and loss
adjustment expenses....................... 1,957.0 2,010.3 2,047.0
Policy acquisition expenses................ 483.5 470.3 475.7
Other operating expenses................... 483.2 455.0 518.9
--------- --------- ---------
Total benefits, losses and expenses.... 2,923.7 2,935.6 3,041.6
--------- --------- ---------
Income before federal income taxes............. 349.2 304.9 153.5
--------- --------- ---------
FEDERAL INCOME TAX EXPENSE (BENEFIT)
Current.................................... 96.8 119.7 45.4
Deferred................................... (15.7) (37.0) 8.0
--------- --------- ---------
Total federal income tax expense....... 81.1 82.7 53.4
--------- --------- ---------
Income before minority interest, extraordinary
item, and cumulative effect of accounting
change........................................ 268.1 222.2 100.1
Minority interest.............................. (74.6) (73.1) (51.0)
--------- --------- ---------
Income before extraordinary item and cumulative
effect of accounting changes.................. 193.5 149.1 49.1
Extraordinary item -- demutualization
expenses...................................... -- (12.1) (9.2)
Cumulative effect of changes in accounting
principles.................................... -- -- (1.9)
--------- --------- ---------
Net income..................................... $ 193.5 $ 137.0 $ 38.0
--------- --------- ---------
--------- --------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-3
<PAGE>
FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF ALLMERICA FINANCIAL CORPORATION)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
-------------------------------------------------------- ---------- ----------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities--at fair value (amortized cost of
$7,279.1 and $7,467.9)............................. $ 7,461.5 $ 7,739.3
Equity securities--at fair value (cost of $327.9 and
$410.6)............................................ 473.1 517.2
Mortgage loans...................................... 650.1 799.5
Real estate......................................... 120.7 179.6
Policy loans........................................ 132.4 123.2
Other long-term investments......................... 128.8 71.9
---------- ----------
Total investments............................... 8,966.6 9,430.7
---------- ----------
Cash and cash equivalents............................. 175.9 236.6
Accrued investment income............................. 148.6 163.0
Deferred policy acquisition costs..................... 822.7 735.7
---------- ----------
Reinsurance receivables:
Future policy benefits.............................. 102.8 97.1
Outstanding claims, losses and loss adjustment
expenses........................................... 663.8 799.6
Unearned premiums................................... 46.2 43.8
Other............................................... 62.8 58.9
---------- ----------
Total reinsurance receivables................... 875.6 999.4
---------- ----------
Deferred federal income taxes......................... 93.2 81.2
Premiums, accounts and notes receivable............... 533.0 526.7
Other assets.......................................... 302.2 361.4
Closed Block assets................................... 811.8 818.9
Separate account assets............................... 6,233.0 4,348.8
---------- ----------
Total assets.................................... $18,962.6 $17,702.4
---------- ----------
---------- ----------
LIABILITIES
Policy liabilities and accruals:
Future policy benefits.............................. $ 2,613.7 $ 2,639.3
Outstanding claims, losses and loss adjustment
expenses........................................... 2,944.1 3,081.3
Unearned premiums................................... 822.5 800.9
Contractholder deposit funds and other policy
liabilities........................................ 2,060.4 2,737.4
---------- ----------
Total policy liabilities and accruals........... 8,440.7 9,258.9
---------- ----------
Expenses and taxes payable............................ 615.3 600.3
Reinsurance premiums payable.......................... 31.4 42.0
Short-term debt....................................... 38.4 28.0
Deferred federal income taxes......................... 34.6 47.8
Long-term debt........................................ 2.7 2.8
Closed Block liabilities.............................. 892.1 902.0
Separate account liabilities.......................... 6,227.2 4,337.8
---------- ----------
Total liabilities............................... 16,282.4 15,219.6
---------- ----------
Minority interest..................................... 784.0 758.5
Commitments and contingencies (Notes 14 and 19)
SHAREHOLDER'S EQUITY
Common stock, $10 par value, 1 million shares
authorized, 500,000 shares issued and outstanding.... 5.0 5.0
Additional paid-in-capital............................ 392.4 392.4
Unrealized appreciation on investments, net........... 131.4 153.0
Retained earnings..................................... 1,367.4 1,173.9
---------- ----------
Total shareholder's equity...................... 1,896.2 1,724.3
---------- ----------
Total liabilities and shareholder's equity...... $18,962.6 $17,702.4
---------- ----------
---------- ----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-4
<PAGE>
FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF ALLMERICA FINANCIAL CORPORATION)
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
----------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
COMMON STOCK
Balance at beginning of year............... $ 5.0 $ -- $ --
Demutualization transaction................ -- 5.0 --
--------- --------- ---------
Balance at end of year..................... 5.0 5.0 --
--------- --------- ---------
ADDITIONAL PAID-IN-CAPITAL
Balance at beginning of year............... 392.4 -- --
Contributed from parent.................... -- 392.4 --
--------- --------- ---------
Balance at end of year..................... 392.4 392.4 --
--------- --------- ---------
RETAINED EARNINGS
Balance at beginning of year............... 1,173.9 1,071.4 1,033.4
Net income prior to demutualization........ -- 93.2 38.0
--------- --------- ---------
1,173.9 1,164.6 1,071.4
Demutualization transaction................ -- (34.5) --
Net income subsequent to demutualization... 193.5 43.8 --
--------- --------- ---------
Balance at end of year..................... 1,367.4 1,173.9 1,071.4
--------- --------- ---------
NET UNREALIZED APPRECIATION (DEPRECIATION) ON
INVESTMENTS
Balance at beginning of year............... 153.0 (79.0) 17.5
--------- --------- ---------
Cumulative effect of accounting change:
Net appreciation on available-for-sale
debt securities....................... -- -- 296.1
Provision for deferred federal income
taxes and minority interest........... -- -- (149.1)
--------- --------- ---------
-- -- 147.0
--------- --------- ---------
Effect of transfer of securities from
held-to-maturity to available-for-sale:
Net appreciation on available-for-sale
debt securities....................... -- 22.4 --
Provision for deferred federal income
taxes and minority interest........... -- (9.6) --
--------- --------- ---------
-- 12.8 --
--------- --------- ---------
Appreciation (depreciation) during the
period:
Net appreciation (depreciation) on
available-for-sale securities......... (35.1) 466.0 (492.1)
(Provision) benefit for deferred
federal income taxes.................. 11.8 (163.1) 171.9
Minority interest...................... 1.7 (83.7) 76.7
--------- --------- ---------
(21.6) 219.2 (243.5)
--------- --------- ---------
Balance at end of year................. 131.4 153.0 (79.0)
--------- --------- ---------
Total shareholder's equity......... $1,896.2 $1,724.3 $ 992.4
--------- --------- ---------
--------- --------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-5
<PAGE>
FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY
(A WHOLLY OWNED SUBSIDIARY OF ALLMERICA FINANCIAL CORPORATION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
-------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.............................. $ 193.5 $ 137.0 $ 38.0
Adjustments to reconcile net income to
net cash provided by operating
activities:
Minority interest................... 74.6 73.1 50.1
Net realized gains.................. (66.8) (39.8) (1.1)
Net amortization and depreciation... 44.7 57.7 45.9
Deferred federal income taxes....... (15.7) (37.0) 8.0
Change in deferred acquisition
costs................................ (73.9) (38.4) (34.6)
Change in premiums and notes
receivable, net of reinsurance
payable.............................. (16.8) (42.0) (25.6)
Change in accrued investment
income............................... 16.7 7.0 4.6
Change in policy liabilities and
accruals, net........................ (184.3) 116.2 175.9
Change in reinsurance receivable.... 123.8 (75.6) (31.9)
Change in expenses and taxes
payable.............................. 26.0 7.5 88.0
Separate account activity, net...... 5.2 (0.1) 0.4
Other, net.......................... 38.5 (33.8) 14.0
---------- ---------- ----------
Net cash provided by operating
activities.................... 165.5 131.8 331.7
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from disposals and maturities
of available-for-sale fixed
maturities............................. 3,985.8 2,738.4 2,097.8
Proceeds from disposals of
held-to-maturity fixed maturities...... -- 271.3 304.4
Proceeds from disposals of equity
securities............................. 228.7 120.0 143.9
Proceeds from disposals of other
investments............................ 99.3 40.5 25.9
Proceeds from mortgages matured or
collected.............................. 176.9 230.3 256.4
Purchase of available-for-sale fixed
maturities............................. (3,771.1) (3,273.3) (2,150.1)
Purchase of held-to-maturity fixed
maturities............................. -- -- (111.6)
Purchase of equity securities........... (90.9) (254.0) (172.2)
Purchase of other investments........... (168.0) (24.8) (26.6)
Proceeds from sale of mutual fund
processing business.................... -- 32.9 --
Capital expenditures.................... (12.8) (14.1) (43.1)
Other investing activities, net......... 4.3 4.7 2.4
---------- ---------- ----------
Net cash provided by (used in)
provided by investing
activities.................... 452.2 (128.1) 327.2
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits and interest credited to
contractholder deposit funds........... 268.7 445.8 786.3
Withdrawals from contractholder deposit
funds.................................. (905.0) (1,069.9) (1,187.0)
Change in short-term debt............... 10.4 (4.8) (6.0)
Change in long-term debt................ (0.1) 0.2 0.3
Dividends paid to minority
shareholders........................... (3.9) (4.1) (4.2)
Capital contributed from parent......... -- 392.4 --
Payments for policyholders' membership
interests.............................. -- (27.9) --
Subsidiary treasury stock purchased, at
cost................................... (42.0) (20.9) --
---------- ---------- ----------
Net cash used in financing
activities.................... (671.9) (289.2) (410.6)
---------- ---------- ----------
Net change in cash and cash equivalents..... (54.2) (285.5) 248.3
Net change in cash held in the Closed
Block...................................... (6.5) (17.6) --
Cash and cash equivalents, beginning of
year....................................... 236.6 539.7 291.4
---------- ---------- ----------
Cash and cash equivalents, end of year...... $ 175.9 $ 236.6 $ 539.7
---------- ---------- ----------
---------- ---------- ----------
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid........................... $ 18.6 $ 4.1 $ 4.3
Income taxes paid....................... $ 72.0 $ 90.6 $ 46.1
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
First Allmerica Financial Life Insurance Company ("FAFLIC", or the
"Company", formerly State Mutual Life Assurance Company of America ["State
Mutual"]) was organized as a mutual life insurance company until October 16,
1995. FAFLIC converted to a stock life insurance company pursuant to a plan of
reorganization effective October 16, 1995 and became a wholly owned subsidiary
of Allmerica Financial Corporation ("AFC"). The consolidated financial
statements have been prepared as if FAFLIC were organized as a stock life
insurance company for all periods presented. Thus, generally accepted accounting
principles for stock life insurance companies have been applied retroactively
for all periods presented.
The consolidated financial statements of FAFLIC include the accounts of
Allmerica Financial Life Insurance and Annuity Company ("AFLIAC", formerly SMA
Life Assurance Company), its wholly owned life insurance subsidiary,
non-insurance subsidiaries (principally brokerage and investment advisory
subsidiaries), and Allmerica Property and Casualty Companies, Inc. ("Allmerica
P&C", a 59.5%-owned non-insurance holding company). The Closed Block assets and
liabilities at December 31, 1996 and 1995, and its results of operations
subsequent to demutualization are presented in the consolidated financial
statements as single line items. Prior to demutualization such amounts are
presented line by line in the consolidated financial statements (see Note 6).
Unless specifically stated, all disclosures contained herein supporting the
consolidated financial statements at December 31, 1996 and 1995, and the years
then ended exclude the Closed Block related amounts. All significant
intercompany accounts and transactions have been eliminated.
Minority interest relates to the Company's investment in Allmerica P&C and
its only significant subsidiary, The Hanover Insurance Company ("Hanover").
Hanover's 82.5%-owned subsidiary is Citizens Corporation, the holding company
for Citizens Insurance Company of America ("Citizens"). Minority interest also
includes an amount related to the minority interest in Citizens Corporation.
On February 19, 1997, AFC announced a definitive merger agreement under
which it would acquire, at consideration of $33.00 per share, all of the shares
of Allmerica P&C currently held by the minority stockholders. Additional
information pertaining to the merger agreement is included in Note 2,
significant transactions.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
B. CLOSED BLOCK
As of October 16, 1995, the Company established and began operating a closed
block (the "Closed Block") for the benefit of the participating policies
included therein, consisting of certain individual life insurance participating
policies, individual deferred annuity contracts and supplementary contracts not
involving life contingencies which were in force on October 16, 1995; such
policies constitute the "Closed Block Business". The purpose of the Closed Block
is to protect the policy dividend expectations of such FAFLIC dividend paying
policies and contracts after the demutualization. Unless the Commissioner
consents to an earlier termination, the Closed Block will continue to be in
effect until the date none of the Closed Block policies are in force. On October
16, 1995, FAFLIC allocated to the Closed Block assets in an amount that is
expected to produce cash flows which, together with future revenues from the
Closed Block Business, are reasonably sufficient to support the Closed Block
Business, including provision for payment of policy benefits, certain future
expenses and taxes and for continuation of policyholder dividend scales
F-7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
payable in 1994 so long as the experience underlying such dividend scales
continues. The Company expects that the factors underlying such experience will
fluctuate in the future and policyholder dividend scales for Closed Block
Business will be set accordingly.
Although the assets and income allocated to the Closed Block inure solely to
the benefit of the holders of policies included in the Closed Block, the excess
of Closed Block liabilities over Closed Block assets at October 16, 1995
measured on a GAAP basis represent the expected future post-tax income from the
Closed Block which may be recognized in income over the period the policies and
contracts in the Closed Block remain in force.
If the actual income from the Closed Block in any given period equals or
exceeds the expected income for such period as determined at October 16, 1995,
the expected income would be recognized in income for that period. Further, any
excess of the actual income over the expected income would also be recognized in
income to the extent that the aggregate expected income for all prior periods
exceeded the aggregate actual income. Any remaining excess of actual income over
expected income would be accrued as a liability for policyholder dividends in
the Closed Block to be paid to the Closed Block policyholders. This accrual for
future dividends effectively limits the actual Closed Block income recognized in
income to the Closed Block income expected to emerge from operation of the
Closed Block as determined as of October 16, 1995.
If, over the period the policies and contracts in the Closed Block remain in
force, the actual income from the Closed Block is less than the expected income
from the Closed Block, only such actual income (which could reflect a loss)
would be recognized in income. If the actual income from the Closed Block in any
given period is less than the expected income for that period and changes in
dividends scales are inadequate to offset the negative performance in relation
to the expected performance, the income inuring to shareholders of the Company
will be reduced. If a policyholder dividend liability had been previously
established in the Closed Block because the actual income to the relevant date
had exceeded the expected income to such date, such liability would be reduced
by this reduction in income (but not below zero) in any periods in which the
actual income for that period is less than the expected income for such period.
C. VALUATION OF INVESTMENTS
Effective January 1, 1994, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities" (SFAS No. 115). SFAS No. 115 requires that
investments be classified into one of three categories; held-to-maturity,
available-for-sale, or trading.
The effect of implementing SFAS No. 115, as of January 1, 1994, was an
increase in the carrying value of fixed maturity investments of $335.3 million,
a decrease in deferred policy acquisition costs of $20.8 million, an increase in
policyholder liabilities of $18.4 million, a net increase in deferred income tax
liabilities of $103.7 million, an increase in minority interest of $45.4 million
and an increase in shareholder's equity of $147.0 million, which resulted from
changing the carrying value of certain fixed maturities from amortized cost to
fair value and related adjustments. The implementation had no effect on net
income.
In November 1995, the Financial Accounting Standards Board issued a Special
Report, A GUIDE TO IMPLEMENTATION OF STATEMENT 115 ON ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES, which permitted companies to
reclassify securities, where appropriate, based on the new guidance. As a
result, the Company transferred securities with amortized cost and fair value of
$696.4 million and $725.6 million, respectively, from the held-to-maturity
category to the available-for-sale category, which resulted in a net increase in
shareholder's equity of $12.8 million.
Realized gains and losses on sales of fixed maturities and equity securities
are determined on the specific-identification basis using amortized cost for
fixed maturities and cost for equity securities. Fixed maturities and equity
securities with other than temporary declines in fair value are written down to
estimated fair value resulting in the recognition of realized losses.
F-8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Mortgage loans on real estate are stated at unpaid principal balances, net
of unamortized discounts and reserves. Reserves on mortgage loans are based on
losses expected by management to be realized on transfers of mortgage loans to
real estate (upon foreclosure), on the disposition or settlement of mortgage
loans and on mortgage loans which management believes may not be collectible in
full. In establishing reserves, management considers, among other things, the
estimated fair value of the underlying collateral.
Fixed maturities and mortgage loans that are delinquent are placed on
non-accrual status, and thereafter interest income is recognized only when cash
payments are received.
Policy loans are carried principally at unpaid principal balances.
Real estate that has been acquired through the foreclosure of mortgage loans
is valued at the estimated fair value at the time of foreclosure. The Company
considers several methods in determining fair value at foreclosure, using
primarily third-party appraisals and discounted cash flow analyses. After
foreclosure, the Company makes a determination as to whether the asset should be
held for production of income or held for sale.
Real estate investments held for the production of income and held for sale
are carried at depreciated cost less valuation allowances, if necessary, to
reduce the carrying value to fair value. Depreciation is generally calculated
using the straight-line method.
Realized investment gains and losses, other than those related to separate
accounts for which the Company does not bear the investment risk, are reported
as a component of revenues based upon specific identification of the investment
assets sold. When an other-than-temporary impairment of the value of a specific
investment or a group of investments is determined, a realized investment loss
is recorded. Changes in the valuation allowance for mortgage loans and real
estate are included in realized investment gains or losses.
D. FINANCIAL INSTRUMENTS
In the normal course of business, the Company enters into transactions
involving various types of financial instruments, including debt, investments
such as fixed maturities, mortgage loans and equity securities, investment and
loan commitments, and interest rate futures contracts. These instruments involve
credit risk and also may be subject to risk of loss due to interest rate
fluctuation. The Company evaluates and monitors each financial instrument
individually and, when appropriate, obtains collateral or other security to
minimize losses.
E. CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes cash on hand, amounts due from banks and
highly liquid debt instruments purchased with an original maturity of three
months or less.
F. DEFERRED POLICY ACQUISITION COSTS
Acquisition costs consist of commissions, underwriting costs and other
costs, which vary with, and are primarily related to, the production of
revenues. Property and casualty, group life and group health insurance business
acquisition costs are deferred and amortized over the terms of the insurance
policies. Acquisition costs related to universal life products and
contractholder deposit funds are deferred and amortized in proportion to total
estimated gross profits over the expected life of the contracts using a revised
interest rate applied to the remaining benefit period. Acquisition costs related
to annuity and other life insurance businesses are deferred and amortized,
generally in proportion to the ratio of annual revenue to the estimated total
revenues over the contract periods based upon the same assumptions used in
estimating the liability for future policy benefits. Deferred acquisition costs
for each product are reviewed to determine if they are recoverable from future
income, including investment income. If such costs are determined to be
unrecoverable, they are expensed at the time of determination.
F-9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Although realization of deferred policy acquisition costs is not assured,
management believes it is more likely than not that all of these costs will be
realized. The amount of deferred policy acquisition costs considered realizable,
however, could be reduced in the near term if the estimates of gross profits or
total revenues discussed above are reduced. The amount of amortization of
deferred policy acquisition costs could be revised in the near term if any of
the estimates discussed above are revised.
G. PROPERTY AND EQUIPMENT
Property, equipment and leasehold improvements are stated at cost, less
accumulated depreciation and amortization. Depreciation is provided using the
straight-line or accelerated method over the estimated useful lives of the
related assets which generally range from 3 to 30 years. Amortization of
leasehold improvements is provided using the straight-line method over the
lesser of the term of the leases or the estimated useful life of the
improvements.
H. SEPARATE ACCOUNTS
Separate account assets and liabilities represent segregated funds
administered and invested by the Company for the benefit of certain pension,
variable annuity and variable life insurance contractholders. Assets consist
principally of bonds, common stocks, mutual funds, and short-term obligations at
market value. The investment income, gains, and losses of these accounts
generally accrue to the contractholders and, therefore, are not included in the
Company's net income. Appreciation and depreciation of the Company's interest in
the separate accounts, including undistributed net investment income, is
reflected in shareholder's equity or net investment income.
I. POLICY LIABILITIES AND ACCRUALS
Future policy benefits are liabilities for life, health and annuity
products. Such liabilities are established in amounts adequate to meet the
estimated future obligations of policies in force. The liabilities associated
with traditional life insurance products are computed using the net level
premium method for individual life and annuity policies, and are based upon
estimates as to future investment yield, mortality and withdrawals that include
provisions for adverse deviation. Future policy benefits for individual life
insurance and annuity policies are computed using interest rates ranging from
2 1/2% to 6% for life insurance and 2% to 9 1/2% for annuities. Estimated
liabilities are established for group life and health policies that contain
experience rating provisions. Mortality, morbidity and withdrawal assumptions
for all policies are based on the Company's own experience and industry
standards. Liabilities for universal life include deposits received from
customers and investment earnings on their fund balances, less administrative
charges. Universal life fund balances are also assessed mortality and surrender
charges.
Liabilities for outstanding claims, losses and loss adjustment expenses are
estimates of payments to be made on property and casualty and health insurance
for reported losses and estimates of losses incurred but not reported. These
liabilities are determined using case basis evaluations and statistical analyses
and represent estimates of the ultimate cost of all losses incurred but not
paid. These estimates are continually reviewed and adjusted as necessary; such
adjustments are reflected in current operations. Estimated amounts of salvage
and subrogation on unpaid property and casualty losses are deducted from the
liability for unpaid claims.
Premiums for property and casualty, group life, and accident and health
insurance are reported as earned on a pro-rata basis over the contract period.
The unexpired portion of these premiums is recorded as unearned premiums.
Contractholder deposit funds and other policy liabilities include
investment-related products such as guaranteed investment contracts, deposit
administration funds and immediate participation guarantee funds and consist of
deposits received from customers and investment earnings on their fund balances.
F-10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
All policy liabilities and accruals are based on the various estimates
discussed above. Although the adequacy of these amounts cannot be assured,
management believes that it is more likely than not that policy liabilities and
accruals will be sufficient to meet future obligations of policies in force. The
amount of liabilities and accruals, however, could be revised in the near term
if the estimates discussed above are revised.
J. PREMIUM AND FEE REVENUE AND RELATED EXPENSES
Premiums for individual life and health insurance and individual and group
annuity products, excluding universal life and investment-related products, are
considered revenue when due. Property and casualty and group life, accident and
health insurance premiums are recognized as revenue over the related contract
periods. Benefits, losses and related expenses are matched with premiums,
resulting in their recognition over the lives of the contracts. This matching is
accomplished through the provision for future benefits, estimated and unpaid
losses and amortization of deferred policy acquisition costs. Revenues for
investment-related products consist of net investment income and contract
charges assessed against the fund values. Related benefit expenses primarily
consist of net investment income credited to the fund values after deduction for
investment and risk charges. Revenues for universal life products consist of net
investment income, and mortality, administration and surrender charges assessed
against the fund values. Related benefit expenses include universal life benefit
claims in excess of fund values and net investment income credited to universal
life fund values.
K. POLICYHOLDER DIVIDENDS
Prior to demutualization, certain life, health and annuity insurance
policies contained dividend payment provisions that enabled the policyholder to
participate in the earnings of the Company. The amount of policyholders'
dividends was determined annually by the Board of Directors. The aggregate
amount of policyholders' dividends was related to the actual interest,
mortality, morbidity and expense experience for the year and the Company's
judgment as to the appropriate level of statutory surplus to be retained. Upon
demutualization, certain participating individual life insurance policies and
individual annuity and supplemental contracts were transferred to the Closed
Block. The Closed Block was funded to protect the dividend expectations of such
policies and contracts. Accordingly, these policies no longer participate in the
earnings and surplus of the Open Block. Subsequent to demutualization, the
Company ceased issuance of participating policies.
Prior to demutualization, the participating life insurance in force was
16.2% of the face value of total life insurance in force at December 31, 1994.
The premiums on participating life, health and annuity policies were 11.3% and
6.4% of total life, health and annuity statutory premiums prior to
demutualization in 1995 and 1994, respectively. Total policyholders' dividends
were $23.3 million and $32.8 million prior to demutualization in 1995 and 1994,
respectively.
L. FEDERAL INCOME TAXES
AFC, FAFLIC, AFLIAC and FAFLIC's non-insurance domestic subsidiaries file a
consolidated United States federal income tax return. Entities included within
the consolidated group are segregated into either a life insurance or non-life
insurance company subgroup. The consolidation of these subgroups is subject to
certain statutory restrictions on the percentage of eligible non-life tax losses
that can be applied to offset life company taxable income. Allmerica P&C and its
subsidiaries file a separate United States federal income tax return.
Deferred income taxes are generally recognized when assets and liabilities
have different values for financial statement and tax reporting purposes, and
for other temporary taxable and deductible differences
F-11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
as defined by Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes" (SFAS No. 109). These differences result primarily from loss
reserves, policy acquisition expenses, and unrealized appreciation/depreciation
on investments.
M. NEW ACCOUNTING PRONOUNCEMENTS
In March 1995, SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" was issued. This statement
requires companies to write down to fair value long-lived assets whose carrying
value is greater than the undiscounted cash flows of those assets. The statement
also requires that long-lived assets of which management is committed to
dispose, either by sale or abandonment, be valued at the lower of their carrying
amount or fair value less costs to sell. This statement is effective for fiscal
years beginning after December 15, 1995. The adoption of this statement has not
had a material effect on the financial statements.
N. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
2. SIGNIFICANT TRANSACTIONS
On February 19, 1997, AFC and Allmerica P&C entered into an Agreement and Plan
of Merger (the "Merger Agreement") pursuant to which AFC will acquire all of the
outstanding Common Stock, $1.00 par value per share, of Allmerica P&C that it
does not already own for consideration consisting of $33.00 per share of Common
Stock, subject to adjustment, payable in cash and shares of common stock, par
value $0.01 per share, AFC (the "AFC Common Stock"). In addition, a shareholder
of Allmerica P&C may elect to receive the consideration in cash, without
interest, or in shares of AFC Common Stock, subject to proration as set forth in
the Merger Agreement. The maximum number of shares of AFC Common Stock to be
issued in the Merger is approximately 9.67 million shares. The acquisition will
be accomplished by merging a newly-created, wholly-owned subsidiary of AFC with
and into Allmerica P&C (the "Merger"), resulting in Allmerica P&C becoming a
wholly-owned subsidiary of AFC. Also, immediately prior to the Merger, Allmerica
P&C's Certificate of Incorporation will be amended to authorize a new class of
Common Stock, one share of which will be exchanged for each share of Common
Stock currently held by SMA Financial Corp., a wholly-owned subsidiary of AFC.
The consummation of the Merger is subject to the satisfaction of various
conditions, including the approval of regulatory authorities.
On February 3, 1997, AFC Capital Trust (the "Trust"), a subsidiary business
trust of AFC, issued $300 million Series A Capital Securities, which pay
cumulative dividends at a rate of 8.207% semiannually commencing August 15,
1997. The Trust exists for the sole purpose of issuing the Capital Securities
and investing the proceeds thereof in an equivalent amount of 8.207% Junior
Subordinated Deferrable Interest Debentures due 2027 of AFC (the "Subordinated
Debentures"). Through certain guarantees, the Subordinated Debentures and the
terms of related agreements, AFC has irrevocably and unconditionally guaranteed
the obligations of the Trust under the Capital Securities. Net proceeds from the
offering of approximately $296.3 million are intended to fund a portion of the
acquisition of the 24.2 million publicly-held shares of Allmerica P&C pursuant
to an Agreement and Plan of Merger dated February 19, 1997.
Pursuant to the plan of reorganization effective October 16, 1995, AFC
issued 37.5 million shares of its common stock to eligible policyholders. AFC
also issued 12.6 million shares of its common stock at a price of $21.00 per
share in a public offering, resulting in net proceeds of $248.0 million, and
issued Senior Debentures in the principal amount of $200.0 million which
resulted in net proceeds of $197.2 million. AFC contributed $392.4 million of
these proceeds to FAFLIC.
Effective March 31, 1995, the Company entered into an agreement with TSSG, a
division of First Data Corporation, pursuant to which the Company sold its
mutual fund processing business and agreed not to engage in this business for
four years after that date. In accordance with this agreement, the Company
F-12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
received proceeds of $32.1 million. A gain of $13.5 million, net of taxes of
$7.2 million, was recorded in March 1995. Additionally, the Company received a
non-recurring $3.1 million contingent payment, net of taxes of $1.7 million, in
1996, related to the aforementioned sale.
3. INVESTMENTS
A. SUMMARY OF INVESTMENTS
The Company accounts for its investments, all of which are classified as
available-for-sale, in accordance with SFAS No. 115. The amortized cost and fair
value of available-for-sale fixed maturities and equity securities were as
follows:
<TABLE>
<CAPTION>
1996
-----------------------------------------------
GROSS GROSS
DECEMBER 31 AMORTIZED UNREALIZED UNREALIZED FAIR
(IN MILLIONS) COST (1) GAINS LOSSES VALUE
- ---------------------------------------- --------- ---------- ----------- --------
<S> <C> <C> <C> <C>
U.S. Treasury securities and U.S.
government and agency securities....... $ 273.6 $ 9.3 $ 1.6 $ 281.3
States and political subdivisions....... 2,236.9 48.5 7.7 2,277.7
Foreign governments..................... 108.0 7.3 -- 115.3
Corporate fixed maturities.............. 4,277.5 140.3 15.7 4,402.1
Mortgage-backed securities.............. 383.1 4.7 2.7 385.1
--------- ---------- ----------- --------
Total fixed maturities.................. $7,279.1 $210.1 $ 27.7 $7,461.5
--------- ---------- ----------- --------
--------- ---------- ----------- --------
Equity securities....................... $ 327.9 $148.9 $ 3.7 $ 473.1
--------- ---------- ----------- --------
--------- ---------- ----------- --------
<CAPTION>
1995
-----------------------------------------------
GROSS GROSS
DECEMBER 31 AMORTIZED UNREALIZED UNREALIZED FAIR
(IN MILLIONS) COST (1) GAINS LOSSES VALUE
- ---------------------------------------- --------- ---------- ----------- --------
<S> <C> <C> <C> <C>
U.S. Treasury securities and U.S.
government and agency securities....... $ 377.0 $ 21.0 -- $ 398.0
States and political subdivisions....... 2,110.6 60.7 4.0 2,167.3
Foreign governments..................... 60.6 3.4 0.6 63.4
Corporate fixed maturities.............. 4,582.1 200.8 16.4 4,766.5
Mortgage-backed securities.............. 337.6 8.6 2.1 344.1
--------- ---------- ----------- --------
Total fixed maturities.................. $7,467.9 $294.5 $ 23.1 $7,739.3
--------- ---------- ----------- --------
--------- ---------- ----------- --------
Equity securities....................... $ 410.6 $111.7 $ 5.1 $ 517.2
--------- ---------- ----------- --------
--------- ---------- ----------- --------
</TABLE>
(1) Amortized cost for fixed maturities and cost for equity securities.
In March 1994, AFLIAC voluntarily withdrew its license in New York in order
to provide for certain commission arrangements prohibited by New York comparable
to AFLIAC's competitors. In connection with the withdrawal, FAFLIC, which is
licensed in New York, became qualified to sell the products previously sold by
AFLIAC in New York. AFLIAC agreed with the New York Department of Insurance to
maintain, through a custodial account in New York, a security deposit, the
market value of which will at all times equal 102% of all outstanding general
account liabilities of AFLIAC for New York policyholders, claimants and
creditors. At December 31, 1996, the amortized cost and market value of assets
on deposit were $284.9 million and $292.2 million, respectively. At December 31,
1995, the amortized cost and market value of assets on deposit were $295.0
million and $303.6 million, respectively. In addition, fixed maturities,
excluding those securities on deposit in New York, with an amortized cost of
$98.0 million and $82.2 million were on deposit with various state and
governmental authorities at December 31, 1996 and 1995, respectively.
F-13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
There were no contractual fixed maturity investment commitments at December
31, 1996 and 1995, respectively.
The amortized cost and fair value by maturity periods for fixed maturities
are shown below. Actual maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties, or the Company may have the right to put
or sell the obligations back to the issuers. Mortgage backed securities are
included in the category representing their ultimate maturity.
<TABLE>
<CAPTION>
1996
--------------------
DECEMBER 31 AMORTIZED FAIR
(IN MILLIONS) COST VALUE
- ---------------------------------------- --------- --------
<S> <C> <C>
Due in one year or less................. $ 567.1 $ 570.7
Due after one year through five years... 2,216.4 2,297.2
Due after five years through ten
years.................................. 2,373.1 2,432.0
Due after ten years..................... 2,122.5 2,161.6
--------- --------
Total............................... $7,279.1 $7,461.5
--------- --------
--------- --------
</TABLE>
The proceeds from voluntary sales of available-for-sale securities and the
gross realized gains and gross realized losses on those sales were as follows:
<TABLE>
<CAPTION>
PROCEEDS FROM
FOR THE YEARS ENDED DECEMBER 31 VOLUNTARY GROSS GROSS
(IN MILLIONS) SALES GAINS LOSSES
- --------------------------------------------- ------------------ ----- ------
<S> <C> <C> <C>
1996
Fixed maturities............................. $2,432.8 $19.3 $30.5
-------- ----- ------
Equity securities............................ $ 228.1 $56.1 $ 1.3
-------- ----- ------
1995
Fixed maturities............................. $1,612.3 $23.7 $33.0
-------- ----- ------
Equity securities............................ $ 122.2 $23.1 $ 6.9
-------- ----- ------
1994
Fixed maturities............................. $1,026.2 $12.6 $21.6
-------- ----- ------
Equity securities............................ $ 124.3 $17.4 $ 4.5
-------- ----- ------
</TABLE>
F-14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Unrealized gains and losses on available-for-sale and other securities, are
summarized as follows:
<TABLE>
<CAPTION>
EQUITY
SECURITIES
FOR THE YEARS ENDED DECEMBER 31 FIXED AND OTHER
(IN MILLIONS) MATURITIES (1) TOTAL
- ------------------------------------------------------------ ---------- ----------- -------
<S> <C> <C> <C>
1996
Net appreciation, beginning of year......................... $108.7 $ 44.3 $ 153.0
---------- ----------- -------
Net (depreciation) appreciation on available-for-sale
fixed maturities......................................... (94.1) 35.9 (58.2)
Net appreciation from the effect on deferred policy
acquisition costs and on policy liabilities.............. 23.1 -- 23.1
Provision for deferred federal income taxes and minority
interest................................................. 33.6 (20.1) 13.5
---------- ----------- -------
(37.4) 15.8 (21.6)
---------- ----------- -------
Net appreciation, end of year............................... $ 71.3 $ 60.1 $ 131.4
---------- ----------- -------
---------- ----------- -------
1995
Net appreciation (depreciation), beginning of year.......... $(89.4) $ 10.4 $ (79.0)
---------- ----------- -------
Effect of transfer of securities between classifications:
Net appreciation on available-for-sale fixed maturities... 29.2 -- 29.2
Effect of transfer on deferred policy acquisition costs
and on policy liabilities................................ (6.8) -- (6.8)
Provision for deferred federal income taxes and minority
interest................................................. (9.6) -- (9.6)
---------- ----------- -------
12.8 -- 12.8
---------- ----------- -------
Net appreciation on available-for-sale securities........... 465.4 87.5 552.9
Net depreciation from the effect on deferred policy
acquisition costs and on policy liabilities................ (86.9) (86.9)
Provision for deferred federal income taxes and minority
interest................................................... (193.2) (53.6) (246.8)
---------- ----------- -------
185.3 33.9 219.2
---------- ----------- -------
Net appreciation, end of year............................... $108.7 $ 44.3 $ 153.0
---------- ----------- -------
---------- ----------- -------
1994
Net appreciation, beginning of year......................... $-- $ 17.5 $ 17.5
---------- ----------- -------
Cumulative effect of accounting change:
Net appreciation on available-for-sale fixed maturities... 335.3 -- 335.3
Net depreciation from the effect of accounting change on
deferred policy acquisition costs and on policy
liabilities.............................................. (39.2) -- (39.2)
Provision for deferred federal income taxes and minority
interest................................................. (149.1) -- (149.1)
---------- ----------- -------
147.0 -- 147.0
---------- ----------- -------
Net depreciation on available-for-sale securities........... (547.9) (17.4) (565.3)
Net appreciation from the effect on deferred policy
acquisition costs and on policy liabilities................ 73.2 -- 73.2
Provision for deferred federal income taxes and minority
interest................................................... 238.3 10.3 248.6
---------- ----------- -------
(236.4) (7.1) (243.5)
---------- ----------- -------
Net (depreciation) appreciation, end of year................ $(89.4) $ 10.4 $ (79.0)
---------- ----------- -------
---------- ----------- -------
</TABLE>
(1) Includes net appreciation on other investments of $0.6 million, 2.2
million, and $0.6 million in 1996, 1995, and 1994, respectively.
F-15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
B. MORTGAGE LOANS AND REAL ESTATE
FAFLIC's mortgage loans and real estate are diversified by property type and
location. Real estate investments have been obtained primarily through
foreclosure. Mortgage loans are collateralized by the related properties and
generally are no more than 75% of the property's value at the time the original
loan is made.
The carrying values of mortgage loans and real estate investments net of
applicable reserves were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
- ---------------------------------------- ------ --------
<S> <C> <C>
Mortgage loans.......................... $650.1 $ 799.5
------ --------
Real estate:
Held for sale......................... 110.4 168.9
Held for production of income......... 10.3 10.7
------ --------
Total real estate................... 120.7 179.6
------ --------
Total mortgage loans and real estate.... $770.8 $ 979.1
------ --------
------ --------
</TABLE>
Reserves for mortgage loans were $19.6 million and $33.8 million at December
31, 1996 and 1995, respectively.
During 1996, 1995 and 1994, non-cash investing activities included real
estate acquired through foreclosure of mortgage loans, which had a fair value of
$0.9 million, $26.1 million and $39.2 million, respectively.
At December 31, 1996, contractual commitments to extend credit under
commercial mortgage loan agreements amounted to approximately $22.1 million, of
which $3.1 million related to the Closed Block. These commitments generally
expire within one year.
F-16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Mortgage loans and real estate investments comprised the following property
types and geographic regions:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
- ---------------------------------------- ------ --------
<S> <C> <C>
Property type:
Office building....................... $317.1 $ 435.9
Residential........................... 95.4 145.3
Retail................................ 177.0 205.6
Industrial / warehouse................ 124.8 93.8
Other................................. 91.0 151.9
Valuation allowances.................. (34.5) (53.4)
------ --------
Total................................... $770.8 $ 979.1
------ --------
------ --------
Geographic region:
South Atlantic........................ 227.0 $ 281.4
Pacific............................... 154.4 191.9
East North Central.................... 119.2 118.2
Middle Atlantic....................... 112.6 148.9
West South Central.................... 41.6 79.7
New England........................... 50.9 94.9
Other................................. 99.6 117.5
Valuation allowances.................. (34.5) (53.4)
------ --------
Total................................... $770.8 $ 979.1
------ --------
------ --------
</TABLE>
F-17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
At December 31, 1996, scheduled mortgage loan maturities were as follows:
1997 -- $131.9 million; 1998 -- $161.7 million; 1999 -- $99.9 million; 2000 --
$138.0 million; 2001 -- $34.4 million; and $84.2 million thereafter. Actual
maturities could differ from contractual maturities because borrowers may have
the right to prepay obligations with or without prepayment penalties and loans
may be refinanced. During 1996, the Company refinanced $7.8 million of mortgage
loans based on terms which differed from those granted to new borrowers.
C. INVESTMENT VALUATION ALLOWANCES
Investment valuation allowances which have been deducted in arriving at
investment carrying values as presented in the consolidated balance sheets and
changes thereto are shown below.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED BALANCE AT
DECEMBER 31 BALANCE AT DECEMBER
(IN MILLIONS) JANUARY 1 ADDITIONS DEDUCTIONS 31
- ------------------------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
1996
Mortgage loans........... $33.8 $ 5.5 $19.7 $19.6
Real estate.............. 19.6 -- 4.7 14.9
----- --------- ----- -----
Total................ $53.4 $ 5.5 $24.4 $34.5
----- --------- ----- -----
----- --------- ----- -----
1995
Mortgage loans........... $47.2 $ 1.5 $14.9 $33.8
Real estate.............. 22.9 (0.6) 2.7 19.6
----- --------- ----- -----
Total................ $70.1 $ 0.9 $17.6 $53.4
----- --------- ----- -----
----- --------- ----- -----
1994
Mortgage loans........... $73.8 $14.6 $41.2 $47.2
Real estate.............. 21.0 3.2 1.3 22.9
----- --------- ----- -----
Total................ $94.8 $17.8 $42.5 $70.1
----- --------- ----- -----
----- --------- ----- -----
</TABLE>
The carrying value of impaired loans was $33.6 million and $55.7 million,
with related reserves of $11.9 million and $22.3 million as of December 31, 1996
and 1995, respectively. All impaired loans were reserved as of December 31, 1996
and 1995.
The average carrying value of impaired loans was $50.4 million, $117.9
million and $155.5 million, with related interest income while such loans were
impaired of $5.8 million, $9.3 million and $12.4 million as of December 31,
1996, 1995 and 1994 respectively.
D. FUTURES CONTRACTS
FAFLIC purchases long futures contracts and sells short futures contracts on
margin to hedge against interest rate fluctuations and their effect on the net
cash flows from the sales of guaranteed investment contracts. The notional
amount of such futures contracts outstanding were $(33.0) million net short and
$74.7 million long contracts at December 31, 1996 and 1995, respectively.
Because the Company purchases and sells futures contracts through brokers who
assume the risk of loss, the Company's exposure to credit risk under futures
contracts is limited to the margin deposited with the broker. The maturity of
all futures contracts outstanding are less than one year. The fair value of
futures contracts outstanding were $(32.4) million and $75.7 million at December
31, 1996 and 1995, respectively.
Gains and losses on hedge contracts related to interest rate fluctuations
are deferred and recognized in income over the period being hedged corresponding
to related guaranteed investment contracts. Deferred hedging gains (losses) were
$0.5 million, $5.6 million, and $(7.7) million in 1996, 1995 and 1994,
respectively. Gains and losses on hedge contracts that are deemed ineffective by
management are realized immediately.
F-17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
A reconciliation of the notional amount of futures contracts is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------- ------ ------ ------
<S> <C> <C> <C>
Contracts outstanding, beginning of year..... $ 74.7 $126.6 $141.7
New contracts................................ (1.1) 349.2 816.0
Contracts terminated......................... (106.6) (401.1) (831.1)
------ ------ ------
Contracts outstanding, end of year........... $(33.0) $ 74.7 $126.6
------ ------ ------
------ ------ ------
</TABLE>
E. FOREIGN CURRENCY SWAP CONTRACTS
The Company enters into foreign currency swap contracts to hedge exposure to
currency risk on foreign fixed maturity investments. Interest and principal
related to foreign fixed maturity investments payable in foreign currencies, at
current exchange rates, are exchanged for the equivalent payment translated at a
specific currency exchange rate. The Company's maximum exposure to counterparty
credit risk is the difference between the foreign currency exchange rate, as
agreed upon in the swap contract, and the foreign currency spot rate on the date
of the exchange. The fair values of the foreign currency swap contracts
outstanding were $(9.2) million and $(1.8) million at December 31, 1996 and
1995, respectively.
The difference between amounts paid and received on foreign currency swap
contracts is reflected in the net investment income related to the underlying
assets and is not material in 1996, 1995 and 1994. The Company had no deferred
gains or losses on foreign currency swap contracts.
A reconciliation of the notional amount of swap contracts is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------- ------ ------ ------
<S> <C> <C> <C>
Contracts outstanding, beginning of year..... $104.6 $118.7 $128.8
New contracts................................ -- -- 10.1
Contracts expired............................ (36.0) -- (15.1)
Contracts terminated......................... -- (14.1) (5.1)
------ ------ ------
Contracts outstanding, end of year........... $ 68.6 $104.6 $118.7
------ ------ ------
------ ------ ------
</TABLE>
Expected maturities of foreign currency swap contracts are $18.2 million in
1997 and $50.4 million in 1999 and thereafter. There are no expected maturities
of foreign currency swap contracts in 1998.
F. INTEREST RATE AND OTHER SWAP CONTRACTS
The Company enters into interest rate swap contracts to hedge exposure to
interest rate fluctuations. Under these swap contracts, the Company agrees to
exchange, at specified intervals, the difference between fixed and floating
interest amounts calculated on an agreed-upon notional principal amount. In
addition, the Company has entered into two new types of swap contracts in 1996:
security return-linked swap contracts and insurance portfolio-linked swap
contracts for investment purposes. Under the security return-linked contracts,
the Company agrees to exchange cash flows according to the performance of a
specified security or portfolio of securities. Under the insurance
portfolio-linked swap contracts, the Company agrees to exchange cash flows
according to the performance of a specified underwriter's portfolio of insurance
business. Because the underlying principal of swap contracts is not exchanged,
the Company's maximum exposure to counterparty credit risk is the difference in
payments exchanged.
The net amount receivable or payable is recognized over the life of the swap
contract as an adjustment to net investment income. The increase or (decrease)
in net investment income related to interest rate and other swap contracts was
$0.6 million, $0.7 million and $(1.3) million for the years ended December 31,
1996,
F-18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
1995 and 1994, respectively. The Company had no deferred gains or losses
relating to interest rate and other swap contracts. The fair values of interest
rate and other swap contracts outstanding were $0.1 million, $0.4 million and
$0.6 million for the years ended December 31, 1996, 1995 and 1994, respectively.
A reconciliation of the notional amount of interest rate and other swap
contracts is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------- ------ ------ ------
<S> <C> <C> <C>
Contracts outstanding, beginning of year..... $ 17.5 $ 22.8 $ 22.8
New contracts................................ 63.6 -- --
Contracts expired............................ (17.5) (5.3) --
------ ------ ------
Contracts outstanding, end of year........... $ 63.6 $ 17.5 $ 22.8
------ ------ ------
------ ------ ------
</TABLE>
Expected maturities of interest rate and other swap contracts outstanding at
December 31 are as follows: $43.6 million in 1997, $5.0 million in 1998, and
$15.0 million in 1999 and thereafter.
G. OTHER
At December 31, 1996, FAFLIC had no concentration of investments in a single
investee exceeding 10% of shareholder's equity, except for investments with the
U.S. Treasury with a carrying value of $262.8 million.
4. INVESTMENT INCOME AND GAINS AND LOSSES
A. NET INVESTMENT INCOME
The components of net investment income were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------- ------ ------ ------
<S> <C> <C> <C>
Fixed maturities............................. $553.8 $555.1 $578.3
Mortgage loans............................... 69.5 97.0 119.9
Equity securities............................ 11.1 13.2 9.9
Policy loans................................. 10.3 20.3 23.3
Real estate.................................. 40.8 48.7 44.6
Other long-term investments.................. 19.0 7.1 5.7
Short-term investments....................... 10.6 21.2 10.3
------ ------ ------
Gross investment income...................... 715.1 762.6 792.0
Less investment expenses..................... (45.2) (52.5) (48.9)
------ ------ ------
Net investment income........................ $669.9 $710.1 $743.1
------ ------ ------
------ ------ ------
</TABLE>
At December 31, 1996, fixed maturities and mortgage loans on non-accrual
status were $2.0 million and $6.8 million, including restructured loans of $4.4
million. The effect of non-accruals, compared with amounts that would have been
recognized in accordance with the original terms of the investments, was to
reduce net income by $0.5 million, $0.6 million and $5.1 million in 1996, 1995
and 1994, respectively.
The payment terms of mortgage loans may from time to time be restructured or
modified. The investment in restructured mortgage loans, based on amortized
cost, amounted to $51.3 million, $98.9 million and $126.8 million at December
31, 1996, 1995 and 1994, respectively. Interest income on restructured mortgage
loans that would have been recorded in accordance with the original terms of
such loans amounted to $7.7 million, $11.1 million and $14.4 million in 1996,
1995 and 1994, respectively. Actual interest income on these loans included in
net investment income aggregated $4.5 million, $7.1 million and $8.2 million in
1996, 1995 and 1994, respectively.
F-19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
At December 31, 1996, fixed maturities with a carrying value of $2.0 million
were non-income producing for the twelve months ended December 31, 1996. There
were no mortgage loans which were non-income producing for the twelve months
ended December 31, 1996.
Included in long-term investments is income from limited partnerships of
$13.7 million, $0.1 million and $0.6 million in 1996, 1995 and 1994,
respectively.
B. REALIZED INVESTMENT GAINS AND LOSSES
Realized gains (losses) on investments were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------- ------ ------ ------
<S> <C> <C> <C>
Fixed maturities............................. $ (9.7) $ (7.0) $ 2.4
Mortgage loans............................... (2.4) 1.4 (12.1)
Equity securities............................ 54.8 16.2 12.4
Real estate.................................. 21.1 5.3 1.4
Other........................................ 3.0 3.2 (3.0)
------ ------ ------
Net realized investment gains................ $ 66.8 $ 19.1 $ 1.1
------ ------ ------
------ ------ ------
</TABLE>
Proceeds from voluntary sales of investments in fixed maturities were
$2,432.8 million, $1,612.3 million and $1,036.5 million in 1996, 1995 and 1994,
respectively. Realized gains on such sales were $19.3 million, $23.7 million and
$12.9 million; and realized losses were $30.5 million, $33.0 million and $21.6
million for 1996, 1995 and 1994, respectively.
5. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", requires
disclosure of fair value information about certain financial instruments
(insurance contracts, real estate, goodwill and taxes are excluded) for which it
is practicable to estimate such values, whether or not these instruments are
included in the balance sheet. The fair values presented for certain financial
instruments are estimates which, in many cases, may differ significantly from
the amounts which could be realized upon immediate liquidation. In cases where
market prices are not available, estimates of fair value are based on discounted
cash flow analyses which utilize current interest rates for similar financial
instruments which have comparable terms and credit quality. Fair values of
interest rate futures were not material at December 31, 1996 and 1995.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
CASH AND CASH EQUIVALENTS
For these short-term investments, the carrying amount approximates fair value.
FIXED MATURITIES
Fair values are based on quoted market prices, if available. If a quoted market
price is not available, fair values are estimated using independent pricing
sources or internally developed pricing models using discounted cash flow
analyses.
EQUITY SECURITIES
Fair values are based on quoted market prices, if available. If a quoted market
price is not available, fair values are estimated using independent pricing
sources or internally developed pricing models.
F-20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
MORTGAGE LOANS
Fair values are estimated by discounting the future contractual cash flows using
the current rates at which similar loans would be made to borrowers with similar
credit ratings. The fair value of below investment grade mortgage loans are
limited to the lesser of the present value of the cash flows or book value.
POLICY LOANS
The carrying amount reported in the consolidated balance sheets approximates
fair value since policy loans have no defined maturity dates and are inseparable
from the insurance contracts.
REINSURANCE RECEIVABLES
The carrying amount reported in the consolidated balance sheets approximates
fair value.
INVESTMENT CONTRACTS (WITHOUT MORTALITY FEATURES)
Fair values for the Company's liabilities under guaranteed investment type
contracts are estimated using discounted cash flow calculations using current
interest rates for similar contracts with maturities consistent with those
remaining for the contracts being valued. Other liabilities are based on
surrender values.
DEBT
The carrying value of short-term debt reported in the balance sheet approximates
fair value. The fair value of long-term debt was estimated using market quotes,
when available, and, when not available, discounted cash flow analyses.
The estimated fair values of the financial instruments were as follows:
<TABLE>
<CAPTION>
1996 1995
-------------------- --------------------
DECEMBER 31 CARRYING FAIR CARRYING FAIR
(IN MILLIONS) VALUE VALUE VALUE VALUE
- --------------------------------------------- --------- -------- --------- --------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and cash equivalents.................. $ 175.9 $ 175.9 $ 236.6 $ 236.6
Fixed maturities........................... 7,461.5 7,461.5 7,739.3 7,739.3
Equity securities.......................... 473.1 473.1 517.2 517.2
Mortgage loans............................. 650.1 675.7 799.5 845.4
Policy loans............................... 132.4 132.4 123.2 123.2
--------- -------- --------- --------
$ 8,893.0 $8,918.6 $ 9,415.8 $9,461.7
--------- -------- --------- --------
--------- -------- --------- --------
FINANCIAL LIABILITIES
Guaranteed investment contracts............ $ 1,101.3 $1,119.2 $ 1,632.8 $1,677.0
Supplemental contracts without life
contingencies............................. 23.1 23.1 24.4 24.4
Dividend accumulations..................... 87.3 87.3 86.2 86.2
Other individual contract deposit funds.... 76.9 74.3 95.7 92.8
Other group contract deposit funds......... 789.1 788.3 894.0 902.8
Individual annuity contracts............... 935.6 719.0 966.3 810.0
Short-term debt............................ 38.4 38.4 28.0 28.0
Long-term debt............................. 2.7 2.7 2.8 2.9
--------- -------- --------- --------
$ 3,054.4 $2,852.3 $ 3,730.2 $3,624.1
--------- -------- --------- --------
--------- -------- --------- --------
</TABLE>
F-21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
6. CLOSED BLOCK
Included in other income in the Consolidated Statement of Income in 1996 and
1995 is a net pre-tax contribution from the Closed Block of $8.6 million and
$2.9 million, respectively. Summarized financial information of the Closed Block
as of December 31, 1996 and 1995 and for the period ended December 31, 1996, and
the period from October 1, 1995 through December 31, 1995, is as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
- ----------------------------------------------------------------------------------------------- --------- ---------
<S> <C> <C>
Assets
Fixed maturities, at fair value (amortized cost of $397.2 and $447.4, respectively).......... $ 403.9 $ 458.0
Mortgage loans............................................................................... 114.5 57.1
Policy loans................................................................................. 230.2 242.4
Cash and cash equivalents.................................................................... 24.1 17.6
Accrued investment income.................................................................... 14.3 16.6
Deferred policy acquisition costs............................................................ 21.1 24.5
Other assets................................................................................. 3.7 2.7
--------- ---------
Total assets................................................................................... $ 811.8 $ 818.9
--------- ---------
--------- ---------
Liabilities
Policy liabilities and accruals.............................................................. $ 883.4 $ 899.2
Other liabilities............................................................................ 8.7 2.8
--------- ---------
Total liabilities.............................................................................. $ 892.1 $ 902.0
--------- ---------
--------- ---------
</TABLE>
F-22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
<TABLE>
<CAPTION>
PERIOD FROM
DECEMBER 31, DECEMBER 31, OCTOBER 1 THROUGH
(IN MILLIONS) 1996 DECEMBER 31, 1995
- -------------------------------------------------------------------------------- ------------ -----------------
<S> <C> <C>
Revenues
Premiums...................................................................... $ 61.7 $ 11.5
Net investment income......................................................... 52.6 12.8
Realized investment loss...................................................... (0.7) --
------------ -------
Total revenues.................................................................. 113.6 24.3
------------ -------
Benefits and expenses
Policy benefits............................................................... 101.2 20.6
Policy acquisition expenses................................................... 3.2 0.8
Other operating expenses...................................................... 0.6 --
------------ -------
Total benefits and expenses..................................................... 105.0 21.4
------------ -------
Contribution from the Closed Block.............................................. $ 8.6 $ 2.9
------------ -------
------------ -------
Cash flows
Cash flows from operating activities:
Contribution from the Closed Block.......................................... $ 8.6 $ 2.9
Initial cash transferred to the Closed Block................................ -- 139.7
Change in deferred policy acquisition costs, net............................ 3.4 0.4
Change in premiums and other receivables.................................... 0.2 (0.1)
Change in policy liabilities and accruals................................... (13.9) 2.0
Change in accrued investment income......................................... 2.3 (1.3)
Other, net.................................................................. 2.5 0.8
------------ -------
Net cash provided by operating activities....................................... 3.1 144.4
------------ -------
Cash flows from investing activities:
Sales, maturities and repayments of investments............................. 188.1 29.0
Purchases of investments.................................................... (196.9) (158.8)
Other, net.................................................................. 12.2 3.0
------------ -------
Net cash provided by (used in) investing activities............................. 3.4 (126.8)
------------ -------
Net increase in cash and cash equivalents....................................... 6.5 17.6
Cash and cash equivalents, beginning of year.................................... 17.6 --
------------ -------
Cash and cash equivalents, end of year.......................................... $ 24.1 $ 17.6
------------ -------
------------ -------
</TABLE>
On October 16, 1995, there were no valuation allowances transferred to the
Closed Block on mortgage loans. There are no valuation allowances on mortgage
loans in the Closed Block at December 31, 1996 or 1995, respectively.
Many expenses related to Closed Block operations are charged to operations
outside the Closed Block; accordingly, the contribution from the Closed Block
does not represent the actual profitability of the Closed Block operations.
Operating costs and expenses outside of the Closed Block are, therefore,
disproportionate to the business outside the Closed Block.
F-23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
7. DEBT
Short- and long-term debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
- ------------------------------------------------------------------------------------------------- --------- ---------
<S> <C> <C>
Short-Term
Commercial paper............................................................................... $ 37.8 $ 27.7
Other.......................................................................................... 0.6 0.3
--------- ---------
Total short-term debt............................................................................ $ 38.4 $ 28.0
--------- ---------
--------- ---------
Long-term debt................................................................................... $ 2.7 $ 2.8
--------- ---------
--------- ---------
</TABLE>
FAFLIC issues commercial paper primarily to manage imbalances between
operating cash flows and existing commitments. Commercial paper borrowing
arrangements are supported by various lines of credit. At December 31, 1996, the
weighted average interest rate for outstanding commercial paper was
approximately 5.5%.
At December 31, 1996, FAFLIC had approximately $140.0 million in committed
lines of credit provided by U.S. banks, of which $102.2 million was available
for borrowing. These lines of credit generally have terms of less than one year,
and require the Company to pay annual commitment fees of 0.07% of the available
credit. Interest that would be charged for usage of these lines of credit is
based upon negotiated arrangements.
During 1996, the Company utilized repurchase agreements to finance certain
investments. Although the repurchase agreements were entirely settled by year
end, management may utilize this policy again in future periods.
In October, 1995, AFC issued $200.0 million face amount of Senior Debentures
for proceeds of $197.2 million net of discounts and issuance costs. These
securities have an effective interest rate of 7.65%, and mature on October 16,
2025. Interest is payable semiannually on October 15 and April 15 of each year.
The Senior Debentures are subject to certain restrictive covenants, including
limitations on issuance of or disposition of stock of restricted subsidiaries
and limitations on liens. AFC is in compliance with all covenants. The primary
source of cash for repayment of the debt by AFC is dividends from FAFLIC.
Interest expense was $16.8 million, $4.1 million and $4.3 million in 1996,
1995 and 1994, respectively. Interest expense included $11.0 million related to
interest payments on repurchase agreements. All interest expense is recorded in
other operating expenses.
8. FEDERAL INCOME TAXES
Provisions for federal income taxes have been calculated in accordance with the
provisions of SFAS No. 109. A summary of the federal income tax expense
(benefit) in the consolidated statements of income is shown below:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- -------------------------------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
Federal income tax expense (benefit)
Current............................................................................. $ 96.8 $ 119.7 $ 45.4
Deferred............................................................................ (15.7) (37.0) 8.0
--------- --------- ---------
Total................................................................................. $ 81.1 $ 82.7 $ 53.4
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The federal income taxes attributable to the consolidated results of
operations are different from the amounts determined by multiplying income
before federal income taxes by the expected federal income tax rate. The sources
of the difference and the tax effects of each were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- ------------------------------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
Expected federal income tax expense.................................................. $ 122.3 $ 105.6 $ 53.7
Tax-exempt interest................................................................ (35.3) (32.2) (35.9)
Differential earnings amount....................................................... (10.2) (7.6) 35.0
Dividend received deduction........................................................ (1.6) (4.0) (2.5)
Changes in tax reserve estimates................................................... 4.7 19.3 4.0
Other, net......................................................................... 1.2 1.6 (0.9)
--------- --------- ---------
Federal income tax expense........................................................... $ 81.1 $ 82.7 $ 53.4
--------- --------- ---------
--------- --------- ---------
</TABLE>
Until conversion to a stock life insurance company, FAFLIC, as a mutual
company, reduced its deduction for policyholder dividends by the differential
earnings amount. This amount was computed, for each tax year, by multiplying the
average equity base of the FAFLIC/AFLIAC consolidated group, as determined for
tax purposes, by the estimate of an excess of an imputed earnings rate over the
average mutual life insurance companies' earnings rate. The differential
earnings amount for each tax year was subsequently recomputed when actual
earnings rates were published by the Internal Revenue Service (IRS). The
differential earnings amount included in 1996 related to an adjustment for the
1994 tax year based on the actual mutual life insurance companies' earnings rate
issued by the IRS in 1996. As a stock life company, FAFLIC is no longer required
to reduce its policyholder dividend deduction by the differential earnings
amount.
The deferred income tax asset represents the tax effects of temporary
differences attributable to Allmerica P&C, a separate consolidated group for
federal tax return purposes. Its components were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
- --------------------------------------------------------------------------------------------- --------- ---------
<S> <C> <C>
Deferred tax (assets) liabilities
AMT carryforwards.......................................................................... $ (16.3) $ (9.8)
Loss reserve discounting................................................................... (182.1) (178.3)
Deferred acquisition costs................................................................. 57.5 55.1
Employee benefit plans..................................................................... (25.1) (25.5)
Investments, net........................................................................... 73.4 77.4
Bad debt reserve........................................................................... (1.7) (1.8)
Other, net................................................................................. 1.1 1.7
--------- ---------
Deferred tax asset, net...................................................................... $ (93.2) $ (81.2)
--------- ---------
--------- ---------
</TABLE>
F-25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The deferred income tax liability represents the tax effects of temporary
differences attributable to the FAFLIC/AFLIAC consolidated federal tax return
group. Its components were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
- --------------------------------------------------------------------------------------------- --------- ---------
<S> <C> <C>
Deferred tax (assets) liabilities
Loss reserve discounting................................................................... $ (153.7) $ (129.1)
Deferred acquisition costs................................................................. 189.6 169.7
Employee benefit plans..................................................................... (16.3) (14.6)
Investments, net........................................................................... 55.1 67.0
Bad debt reserve........................................................................... (24.5) (26.3)
Other, net................................................................................. (15.6) (18.9)
--------- ---------
Deferred tax liability, net.................................................................. $ 34.6 $ 47.8
--------- ---------
--------- ---------
</TABLE>
Gross deferred income tax assets totaled $435.3 million and $405.1 million
at December 31, 1996 and 1995, respectively. Gross deferred income tax
liabilities totaled $376.7 million and $371.7 million at December 31, 1996 and
1995, respectively.
Management believes, based on the Company's recent earnings history and its
future expectations, that the Company's taxable income in future years will be
sufficient to realize all deferred tax assets. In determining the adequacy of
future income, management considered the future reversal of its existing
temporary differences and available tax planning strategies that could be
implemented, if necessary.
At December 31, 1996, there are available non-life net operating loss
carryforwards of $0.8 million, and alternative minimum tax credit carryforwards
of $16.3 million.
The Company's federal income tax returns are routinely audited by the IRS,
and provisions are routinely made in the financial statements in anticipation of
the results of these audits. The IRS has examined the FAFLIC/AFLIAC consolidated
group's federal income tax returns through 1991. The IRS has also examined the
Allmerica P&C consolidated group's federal income tax returns through 1991. The
Company is currently considering its response to certain adjustments proposed by
the IRS with respect to the federal income tax returns for 1989, 1990 and 1991
for both the FAFLIC/AFLIAC consolidated group, as well as the Allmerica P&C
consolidated group. Also, certain adjustments proposed by the IRS with respect
to FAFLIC/AFLIAC's federal income tax returns for 1982 and 1983 remain
unresolved. If upheld, these adjustments would result in additional payments;
however, the Company will vigorously defend its position with respect to these
adjustments. In management's opinion, adequate tax liabilities have been
established for all years. However, the amount of these tax liabilities could be
revised in the near term if estimates of the Company's ultimate liability are
revised.
9. PENSION PLANS
FAFLIC provides retirement benefits to substantially all of its employees under
three separate defined benefit pension plans. Through December 31, 1994,
retirement benefits were based primarily on employees' years of service and
compensation during the highest five consecutive plan years of employment.
Benefits under this defined benefit formula were frozen for most employees (but
not for eligible agents) effective December 31, 1994. In their place, the
Company adopted a defined benefit cash balance formula, under which the Company
annually provides an allocation to each eligible employee as a percentage of
that employee's salary, similar to a defined contribution plan arrangement. The
1996 and 1995 allocations were based on 7.0% of each eligible employee's salary.
The Company's policy for the plans is to fund at least the minimum amount
required by the Employee Retirement Income Security Act of 1974.
F-26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Components of net pension expense were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- -------------------------------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
Service cost -- benefits earned during the year....................................... $ 19.0 $ 19.7 $ 13.0
Interest accrued on projected benefit obligations..................................... 21.9 21.1 20.0
Actual return on assets............................................................... (42.2) (89.3) (2.6)
Net amortization and deferral......................................................... 9.3 66.1 (16.3)
--------- --------- ---------
Net pension expense................................................................... $ 8.0 $ 17.6 $ 14.1
--------- --------- ---------
--------- --------- ---------
</TABLE>
The following table summarizes the combined status of the three pension
plans. At December 31, 1996 the plans' assets exceeded their projected benefit
obligations and in 1995 the plans' projected benefit obligations exceeded their
assets.
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
- ----------------------------------------------------------------------------------------------- --------- ---------
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation.................................................................... $ 308.9 $ 325.6
Unvested benefit obligation.................................................................. 6.6 5.0
--------- ---------
Accumulated benefit obligation................................................................. $ 315.5 $ 330.6
--------- ---------
--------- ---------
Pension liability included in Consolidated Balance Sheets:
Projected benefit obligation................................................................. $ 344.2 $ 367.1
Plan assets at fair value.................................................................... 347.8 321.2
--------- ---------
Plan assets greater (less) than projected benefit obligation............................... 3.6 (45.9)
Unrecognized net (gain) loss from past experience............................................ (9.1) 48.8
Unrecognized prior service benefit........................................................... (11.5) (13.8)
Unamortized transition asset................................................................. (24.7) (26.5)
--------- ---------
Net pension liability.......................................................................... $ (41.7) $ (37.4)
--------- ---------
--------- ---------
</TABLE>
Determination of the projected benefit obligations was based on a weighted
average discount rate of 7.0% in 1996 and 1995, and the assumed long-term rate
of return on plan assets was 9%. The actuarial present value of the projected
benefit obligations was determined using assumed rates of increase in future
compensation levels ranging from 5.5% to 6.5%. Plan assets are invested
primarily in various separate accounts and the general account of FAFLIC. The
plans also hold stock of AFC.
The Company has a profit sharing and 401(k) plan for its employees.
Effective for plan years beginning after 1994, the profit sharing formula for
employees has been discontinued and a 401(k) match feature has been added to the
continuing 401(k) plan for the employees. Total plan expense in 1996, 1995 and
1994 was $5.5 million, $5.2 million and $12.6 million, respectively. In addition
to this Plan, the Company has a defined contribution plan for substantially all
of its agents. The Plan expense in 1996, 1995 and 1994 was $2.0 million, $3.5
million and $2.7 million, respectively.
10. OTHER POSTRETIREMENT BENEFIT PLANS
In addition to the Company's pension plans, the Company currently provides
postretirement medical and death benefits to certain full-time employees and
dependents, under several plans sponsored by FAFLIC, Hanover and Citizens.
Generally, employees become eligible at age 55 with at least 15 years of
service. Spousal coverage is generally provided for up to two years after death
of the retiree. Benefits include hospital, major medical and a payment at death
equal to retirees' final compensation up to certain limits.
F-27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Effective January 1, 1996, the Company revised these benefits so as to establish
limits on future benefit payments and to restrict eligibility to current
employees. The medical plans have varying copayments and deductibles, depending
on the plan. These plans are unfunded.
The plan changes effective January 1, 1996 resulted in a negative plan
amendment (change in eligibility and medical benefits) of $26.8 million and
curtailment (no future increases in life insurance) of $5.3 million. The
negative plan amendment will be amortized as prior service cost over the average
number of years to full eligibility (approximately 9 years or $3.0 million per
year). Of the $5.3 million curtailment gain, $3.3 million has been deducted from
unrecognized loss and $2.0 million has been recorded as a reduction of the net
periodic postretirement benefit expense.
The plans' funded status reconciled with amounts recognized in the Company's
consolidated balance sheet were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
(IN MILLIONS) 1996 1995
- ---------------------------------------------------------------------------------------------- --------- ---------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees.................................................................................... $ 40.4 $ 44.9
Fully eligible active plan participants..................................................... 7.5 14.0
Other active plan participants.............................................................. 24.4 45.9
--------- ---------
72.3 104.8
Plan assets at fair value..................................................................... -- --
--------- ---------
Accumulated postretirement benefit obligation in excess of plan assets........................ 72.3 104.8
Unrecognized prior service benefit............................................................ 23.8 --
Unrecognized loss............................................................................. (5.0) (13.4)
--------- ---------
Accrued postretirement benefit costs.......................................................... $ 91.1 $ 91.4
--------- ---------
--------- ---------
</TABLE>
The components of net periodic postretirement benefit expense were as
follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
- ---------------------------------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
Service cost............................................................................ $ 3.2 $ 4.2 $ 6.6
Interest cost........................................................................... 4.6 6.9 6.9
Amortization of (gain) loss............................................................. (2.8) (0.5) 1.4
--------- --------- ---------
Net periodic postretirement benefit expense............................................. $ 5.0 $ 10.6 $ 14.9
--------- --------- ---------
--------- --------- ---------
</TABLE>
For purposes of measuring the accumulated postretirement benefit obligation
at December 31, 1996, health care costs were assumed to increase 9.0% in 1997,
declining thereafter until the ultimate rate of 5.5% is reached in 2001 and
remains at that level thereafter. The health care cost trend rate assumption has
a significant effect on the amounts reported. For example, increasing the
assumed health care cost trend rates by one percentage point in each year would
increase the accumulated postretirement benefit obligation at December 31, 1996
by $5.3 million, and the aggregate of the service and interest cost components
of net periodic postretirement benefit expense for 1996 by $0.7 million.
The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation was 7.0% at December 31, 1996 and 1995.
F-28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
11. POSTEMPLOYMENT BENEFITS
Effective January 1, 1994, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 112, (SFAS No. 112), "Employers' Accounting
for Postemployment Benefits", which requires employers to recognize the costs
and obligations of severance, disability and related life insurance and health
care benefits to be paid to inactive or former employees after employment but
before retirement. Prior to adoption, the Company had recognized the cost of
these benefits on an accrual or paid basis, depending on the plan.
Implementation of SFAS No. 112 resulted in a transition obligation of $1.9
million, net of federal income taxes and minority interest, and is reported as a
cumulative effect of a change in accounting principle in the consolidated
statement of income. The impact of this accounting change, after recognition of
the cumulative effect, was not significant.
12. STOCK-BASED COMPENSATION PLANS
In October 1995 the FASB issued Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (SFAS 123). The Standard is
effective for fiscal years beginning after December 15, 1995, and requires the
company either to apply a fair value measure to any stock-based compensation
granted by the company, or continue to apply the valuation provisions of
existing accounting standards, but with pro-forma net income and earnings per
share disclosures using a fair value methodology to value the stock-based
compensation. Beginning for the year ended December 31, 1996, AFC has elected to
continue to apply the valuation provisions of existing accounting standards (APB
25). The pro-forma effect of applying SFAS 123 is not material.
Effective June 17, 1996, AFC adopted a Long Term Stock Incentive Plan for
employees of AFC (the "Employees' Plan"). Key employees of AFC and its
subsidiaries are eligible for awards pursuant to the Plan administered by the
Compensation Committee of the Board of Directors (the "Committee") of AFC. Under
the terms of the Employees' Plan, options may be granted to eligible employees
at a price not less than the market price of AFC's common stock on the date of
grant. Option shares may be exercised subject to the terms prescribed by the
Committee at the time of grant, otherwise options vest at the rate of 20%
annually for five consecutive years and must be exercised not later than ten
years from the date of grant. At June 17, 1996, 231,500 option shares were
granted at an option price of $27.50. During 1996, 22,000 option shares were
forfeited leaving 209,500 option shares outstanding at December 31, 1996. There
were no options exercised during 1996. At December 31, 1996, there were no
options exercisable and 2,140,500 option shares were available for future grant.
13. DIVIDEND RESTRICTIONS
Massachusetts, Delaware, New Hampshire and Michigan have enacted laws governing
the payment of dividends to stockholders by insurers. These laws affect the
dividend paying ability of FAFLIC, AFLIAC, Hanover and Citizens, respectively.
Massachusetts' statute limits the dividends an insurer may pay in any twelve
month period, without the prior permission of the Commonwealth of Massachusetts
Insurance Commissioner, to the greater of (i) 10% of its statutory policyholder
surplus as of the preceding December 31 or (ii) the individual company's
statutory net gain from operations for the preceding calendar year (if such
insurer is a life company), or its net income for the preceding calendar year
(if such insurer is not a life company). In addition, under Massachusetts law,
no domestic insurer shall pay a dividend or make any distribution to its
shareholders from other than unassigned funds unless the Commissioner shall have
approved such dividend or distribution. At January 1, 1997, FAFLIC could pay
dividends of $151.8 million to AFC without prior approval of the Commissioner.
Dividends from FAFLIC to AFC will be the primary source of cash for
repayment of the debt by AFC and payment of dividends to AFC stockholders.
F-29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Pursuant to Delaware's statute, the maximum amount of dividends and other
distributions that an insurer may pay in any twelve month period, without the
prior approval of the Delaware Commissioner of Insurance, is limited to the
greater of (i) 10% of its policyholders' surplus as of the preceding December 31
or (ii) the individual company's statutory net gain from operations for the
preceding calendar year (if such insurer is a life company) or its net income
(not including realized capital gains) for the preceding calendar year (if such
insurer is not a life company). Any dividends to be paid by an insurer, whether
or not in excess of the aforementioned threshold, from a source other than
statutory earned surplus would also require the prior approval of the Delaware
Commissioner of Insurance. At January 1, 1997, AFLIAC could pay dividends of
$11.9 million to FAFLIC without prior approval.
Pursuant to New Hampshire's statute, the maximum dividends and other
distributions that an insurer may pay in any twelve month period, without the
prior approval of the New Hampshire Insurance Commissioner, is limited to 10% of
such insurer's statutory policyholder surplus as of the preceding December 31.
At January 1, 1997, the maximum dividend and other distributions that could be
paid to Allmerica P&C by Hanover, without prior approval of the Insurance
Commissioner, was approximately $15.4 million, which considers dividends
declared to Allmerica P&C of $105.0 million during 1996, including $80.0 million
which was declared in December. On January 2, 1997, Hanover declared an
extraordinary dividend in the amount of $120.0 million, payable on or after
January 21, 1997 to Allmerica P&C. The dividend, which was approved by the New
Hampshire Department on January 9, 1997, is to be paid in a lump sum or in such
installments as Allmerica P&C in its discretion may determine.
Pursuant to Michigan's statute, the maximum dividends and other
distributions that an insurer may pay in any twelve month period, without prior
approval of the Michigan Insurance Commissioner, is limited to the greater of
10% of policyholders' surplus as of December 31 of the immediately preceding
year or the statutory net income less realized gains, for the immediately
preceding calendar year. At January 1, 1997, Citizens Insurance could pay
dividends of $39.9 million to Citizens Corporation without prior approval.
14. SEGMENT INFORMATION
The Company offers financial products and services in two major areas: Risk
Management and Retirement and Asset Management. Within these broad areas, the
Company conducts business principally in five operating segments.
The Risk Management group includes two segments: Regional Property and
Casualty and Corporate Risk Management Services.
The Regional Property and Casualty segment includes property and casualty
insurance products, such as automobile insurance, homeowners insurance,
commercial multiple-peril insurance, and workers' compensation insurance. These
products are offered by Allmerica P&C through its operating subsidiaries,
Hanover and Citizens. Substantially all of the Regional Property and Casualty
segment's earnings are generated in Michigan and the Northeast (Connecticut,
Massachusetts, New York, New Jersey, New Hampshire, Rhode Island, Vermont and
Maine). The Corporate Risk Management Services segment includes group life and
health insurance products and services which assist employers in administering
employee benefit programs and in managing the related risks.
The Retirement and Asset Management group includes three segments: Retail
Financial Services, Institutional Services and Allmerica Asset Management. The
Retail Financial Services segment includes variable annuities, variable
universal life-type, traditional and health insurance products distributed via
retail channels to individuals across the country. The Institutional Services
segment includes primarily group retirement products such as 401(k) plans,
tax-sheltered annuities and GIC contracts which are distributed to institutions
across the country via work-site marketing and other arrangements. Allmerica
Asset Management is a Registered Investment Advisor which provides investment
advisory services primarily to affiliates and to other institutions, such as
insurance companies and pension plans.
F-30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Summarized below is financial information with respect to business segments
for the year ended and as of December 31.
<TABLE>
<CAPTION>
(IN MILLIONS) 1996 1995 1994
-------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Risk Management
Regional Property and Casualty.......... $ 2,193.7 $ 2,095.1 $ 2,004.8
Corporate Risk Management............... 361.5 328.5 302.4
---------- ---------- ----------
Subtotal.............................. 2,555.2 2,423.6 2,307.2
---------- ---------- ----------
Retirement and Asset Management
Retail Financial Services............... 450.9 486.7 507.9
Institutional Services.................. 266.7 330.2 397.9
Allmerica Asset Management.............. 8.8 4.4 4.0
---------- ---------- ----------
Subtotal.............................. 726.4 821.3 909.8
---------- ---------- ----------
Eliminations.............................. (8.7) (4.4) (21.9)
---------- ---------- ----------
Total....................................... $ 3,272.9 $ 3,240.5 $ 3,195.1
---------- ---------- ----------
---------- ---------- ----------
Income (loss) from continuing operations
before income taxes:
Risk Management
Regional Property and Casualty.......... $ 197.7 $ 206.3 $ 113.1
Corporate Risk Management............... 20.7 18.3 19.9
---------- ---------- ----------
Subtotal.............................. 218.4 224.6 133.0
---------- ---------- ----------
Retirement and Asset Management...........
Retail Financial Services............... 76.9 35.2 14.2
Institutional Services.................. 52.8 42.8 4.4
Allmerica Asset Management.............. 1.1 2.3 1.9
---------- ---------- ----------
Subtotal.............................. 130.8 80.3 20.5
---------- ---------- ----------
Total....................................... $ 349.2 $ 304.9 $ 153.5
---------- ---------- ----------
---------- ---------- ----------
Identifiable assets:
Risk Management
Regional Property and Casualty.......... $ 5,703.9 $ 5,741.8 $ 5,408.7
Corporate Risk Management............... 506.0 458.9 386.3
---------- ---------- ----------
Subtotal.............................. 6,209.9 6,200.7 5,795.0
---------- ---------- ----------
Retirement and Asset Management
Retail Financial Services............... 8,871.3 7,218.7 5,639.8
Institutional Services.................. 3,879.0 4,280.9 4,484.5
Allmerica Asset Management.............. 2.4 2.1 2.2
---------- ---------- ----------
Subtotal.............................. 12,752.7 11,501.7 10,126.5
---------- ---------- ----------
Total....................................... $18,962.6 $17,702.4 $15,921.5
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
15. LEASE COMMITMENTS
Rental expenses for operating leases, principally with respect to buildings,
amounted to $33.6 million, $36.4 million and $35.2 million in 1996, 1995 and
1994, respectively. At December 31, 1996, future minimum rental payments under
non-cancelable operating leases were approximately $71.7 million, payable as
follows: 1997 -- $26.4 million; 1998 -- $19.6 million; 1999 -- $12.8 million;
2000 -- $8.0 million; and $5.0 million thereafter.
F-31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
It is expected that in the normal course of business, leases that expire
will be renewed or replaced by leases on other property and equipment; thus, it
is anticipated that future minimum lease commitments will not be less than the
amounts shown for 1997.
16. REINSURANCE
In the normal course of business, the Company seeks to reduce the loss that may
arise from catastrophes or other events that cause unfavorable underwriting
results by reinsuring certain levels of risk in various areas of exposure with
other insurance enterprises or reinsurers. Reinsurance transactions are
accounted for in accordance with the provisions of SFAS No. 113.
Amounts recoverable from reinsurers are estimated in a manner consistent
with the claim liability associated with the reinsured policy. Reinsurance
contracts do not relieve the Company from its obligations to policyholders.
Failure of reinsurers to honor their obligations could result in losses to the
Company; consequently, allowances are established for amounts deemed
uncollectible. The Company determines the appropriate amount of reinsurance
based on evaluation of the risks accepted and analyses prepared by consultants
and reinsurers and on market conditions (including the availability and pricing
of reinsurance). The Company also believes that the terms of its reinsurance
contracts are consistent with industry practice in that they contain standard
terms with respect to lines of business covered, limit and retention,
arbitration and occurrence. Based on its review of its reinsurers' financial
statements and reputations in the reinsurance marketplace, the Company believes
that its reinsurers are financially sound.
The Company is subject to concentration of risk with respect to reinsurance
ceded to various residual market mechanisms. As a condition to the ability to
conduct certain business in various states, the Company is required to
participate in various residual market mechanisms and pooling arrangements which
provide various insurance coverages to individuals or other entities that are
otherwise unable to purchase such coverage voluntarily provided by private
insurers.
These market mechanisms and pooling arrangements include the Massachusetts
Commonwealth Automobile Reinsurers ("CAR"), the Maine Workers' Compensation
Residual Market Pool ("MWCRP") and the Michigan Catastrophic Claims Association
("MCCA"). At December 31, 1996, the MCCA and CAR were the only two reinsurers
which represented 10% or more of the Company's reinsurance business. As a
servicing carrier in Massachusetts, the Company cedes a significant portion of
its private passenger and commercial automobile premiums to CAR. Net premiums
earned and losses and loss adjustment expenses ceded to CAR in 1996, 1995 and
1994 were $38.0 million and $21.8 million, $49.1 million and $33.7 million, and
$50.0 million and $29.8 million, respectively.
From 1988 through 1992, the Company was a servicing carrier in Maine, and
ceded a significant portion of its workers' compensation premiums to the Maine
Workers' Compensation Residual Market Pool, which is administered by The
National Council on Compensation Insurance ("NCCI"). The Company was involved in
legal proceedings regarding the MWCRP's deficit which through a legislated
settlement issued on June 23, 1995 provided for an initial funding of $220.0
million, of which the insurance carriers were responsible for $65.0 million.
Hanover paid its allocation of $4.2 million in December 1995. Some of the small
carriers are currently appealing this decision. The Company's right to recover
reinsurance balances for claims properly paid is not at issue in any such
proceedings. The Company expects to collect its reinsurance balance; however,
funding of the cash flow needs of the MWCRP may in the future be affected by
issues related to certain litigation, the outcome of which the Company cannot
predict. The Company ceded to MCCA net premiums earned and losses and loss
adjustment expenses in 1996, 1995 and 1994 of $50.5 million and $(52.9) million,
$66.8 million and $62.9 million, and $80.0 million and $24.2 million,
respectively. Because the MCCA is supported by assessments permitted by statute,
and all amounts billed by the Company to CAR, MWCRP and MCCA have been paid when
due, the Company believes that it has no significant exposure to uncollectible
reinsurance balances.
F-32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The effects of reinsurance were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
----------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
Life insurance premiums:
Direct....................................... $ 389.1 $ 438.9 $ 447.2
Assumed...................................... 87.8 71.0 54.3
Ceded........................................ (138.9) (150.3) (111.0)
--------- --------- ---------
Net premiums................................... $ 338.0 $ 359.6 $ 390.5
--------- --------- ---------
--------- --------- ---------
Property and casualty premiums written:
Direct....................................... $2,039.7 $2,039.4 $1,992.4
Assumed...................................... 108.7 125.0 128.6
Ceded........................................ (234.0) (279.1) (298.1)
--------- --------- ---------
Net premiums................................... $1,914.4 $1,885.3 $1,822.9
--------- --------- ---------
--------- --------- ---------
Property and casualty premiums earned:
Direct....................................... $2,018.5 $2,021.7 $1,967.1
Assumed...................................... 112.4 137.7 116.1
Ceded........................................ (232.6) (296.2) (291.9)
--------- --------- ---------
Net premiums................................... $1,898.3 $1,863.2 $1,791.3
--------- --------- ---------
--------- --------- ---------
Life insurance and other individual policy
benefits, claims, losses and loss adjustment
expenses:
Direct....................................... $ 618.0 $ 749.6 $ 773.0
Assumed...................................... 44.9 38.5 28.9
Ceded........................................ (77.8) (69.5) (61.6)
--------- --------- ---------
Net policy benefits, claims, losses and loss
adjustment expenses........................... $ 585.1 $ 718.6 $ 740.3
--------- --------- ---------
--------- --------- ---------
Property and casualty benefits, claims, losses
and loss adjustment expenses:
Direct....................................... $1,288.3 $1,372.7 $1,364.4
Assumed...................................... 85.8 146.1 102.7
Ceded........................................ (2.2) (229.1) (160.4)
--------- --------- ---------
Net policy benefits, claims, losses and loss
adjustment expenses........................... $1,371.9 $1,289.7 $1,306.7
--------- --------- ---------
--------- --------- ---------
</TABLE>
17. DEFERRED POLICY ACQUISITION COSTS
The following reflects changes to the deferred policy acquisition asset:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
-------------------------------------------------- -------- -------- --------
<S> <C> <C> <C>
Balance at beginning of year...................... $ 735.7 $ 802.8 $ 746.9
Acquisition expenses deferred................... 560.8 504.8 510.3
Amortized to expense during the year............ (483.5) (470.3) (475.7)
Adjustment to equity during the year............ 9.7 (50.4) 21.3
Transferred to the Closed Block................. -- (24.8) --
Adjustment for cession of term life insurance... -- (26.4) --
-------- -------- --------
Balance at end of year............................ $ 822.7 $ 735.7 $ 802.8
-------- -------- --------
-------- -------- --------
</TABLE>
F-33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
18. LIABILITIES FOR OUTSTANDING CLAIMS, LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company regularly updates its estimates of liabilities for outstanding
claims, losses and loss adjustment expenses as new information becomes available
and further events occur which may impact the resolution of unsettled claims for
its property and casualty and its accident and health lines of business. Changes
in prior estimates are reflected in results of operations in the year such
changes are determined to be needed and recorded.
The liability for future policy benefits and outstanding claims, losses and
loss adjustment expenses related to the Company's accident and health business
was $471.7 million, $446.9 million and $371.4 million at December 31, 1996, 1995
and 1994, respectively. Accident and health claim liabilities have been re-
estimated for all prior years and were increased by $0.6 million and $2.2
million in 1996 and 1994, respectively, and increased by $17.6 million in 1995.
Unfavorable development in the accident and health business during 1995 is
primarily due to reserve strengthening and adverse experience in the Company's
individual disability line of business
The following table provides a reconciliation of the beginning and ending
property and casualty reserve for unpaid losses and loss adjustment expenses
(LAE):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
(IN MILLIONS) 1996 1995 1994
----------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
Reserve for losses and LAE, beginning of
year.......................................... $2,896.0 $2,821.7 $2,717.3
Incurred losses and LAE, net of reinsurance
recoverable:
Provision for insured events of the current
year........................................ 1,513.3 1,427.3 1,434.8
Decrease in provision for insured events of
prior years................................. (141.4) (137.6) (128.1)
--------- --------- ---------
Total incurred losses and LAE.................. 1,371.9 1,289.7 1,306.7
--------- --------- ---------
Payments, net of reinsurance recoverable:
Losses and LAE attributable to insured events
of current year............................. 759.6 652.2 650.2
Losses and LAE attributable to insured events
of prior years.............................. 627.6 614.3 566.9
--------- --------- ---------
Total payments................................. 1,387.2 1,266.5 1,217.1
--------- --------- ---------
Change in reinsurance recoverable on unpaid
losses........................................ (136.6) 51.1 14.8
--------- --------- ---------
Reserve for losses and LAE, end of year........ $2,744.1 $2,896.0 $2,821.7
--------- --------- ---------
--------- --------- ---------
</TABLE>
As part of an ongoing process, the property and casualty reserves have been
re-estimated for all prior accident years and were decreased by $141.4 million,
$137.6 million and $128.1 million in 1996, 1995 and 1994, respectively. The
increase in favorable development on prior years' reserves of $3.8 million in
1996 results primarily from an $11.4 million increase in favorable development
at Citizens.
The increase in Citizens' favorable development of $11.4 million in 1996
reflects improved severity in the personal automobile line, where favorable
development increased $28.6 million to $33.0 million in 1996, partially offset
by less favorable development in the workers' compensation line. In 1995, the
workers' compensation line had favorable development of $32.7 million, primarily
as a result of Citizens re-estimating reserves to reflect the new claims cost
management programs and the Michigan Supreme Court ruling, which decreases the
maximum to be paid for indemnity cases on all existing and future claims. In
1996, the favorable development in the workers' compensation line of $21.8
million also reflected these developments. Hanover's favorable development,
including voluntary and involuntary pools, decreased $7.7 million in 1996 to
$82.9 million, primarily attributable to a decrease in favorable development in
the workers' compensation line of $19.8 million to favorable development of
$17.3 million in 1996. This decrease is primarily attributable to a re-estimate
of reserves with respect to certain types of workers' compensation policies
including large deductibles and excess of loss policies. In addition, during
1995 the Regional Property and Casualty subsidiaries refined their estimation of
unallocated loss adjustment expenses which increased favorable
F-34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
development in that year. Favorable development in the personal automobile line
also decreased $4.7 million, to $42.4 million in 1996. These decreases were
offset by increases in favorable development of $1.9 million and $5.6 million,
to $12.6 million and $5.7 million, in the commercial automobile and commercial
multiple peril lines, respectively. Favorable development in other lines
increased by $8.8 million, primarily as a result of environmental reserve
strengthening in 1995. Favorable development in Hanover's voluntary and
involuntary pools increased $3.7 million to $4.1 million during 1996.
The increase in favorable development on prior years' reserves of $9.5
million in 1995 results primarily from a $34.6 million increase in favorable
development at Citizens. Favorable development in Citizens' personal automobile
and workers' compensation lines increased $16.6 million and $15.5 million, to
favorable development of $4.4 million and $32.7 million, respectively, due to
the aforementioned change in claims cost management and the Michigan Supreme
Court ruling. Hanover's favorable development, not including the effect of
voluntary and involuntary pools, was relatively unchanged at $90.2 million in
1995 compared to $91.7 million in 1994. Favorable development in Hanover's
workers' compensation line increased $27.7 million to $31.0 million during 1995.
This was offset by decreases of $14.6 million and $12.6 million, to $45.5
million and $0.1 million, in the personal automobile and commercial multiple
peril lines, respectively. Favorable development in Hanover's voluntary and
involuntary pools decreased $23.6 million to $0.4 million during 1995.
This favorable development reflects the Regional Property and Casualty
subsidiaries' reserving philosophy consistently applied over these periods.
Conditions and trends that have affected development of the loss and LAE
reserves in the past may not necessarily occur in the future.
Due to the nature of business written by the Regional Property and Casualty
subsidiaries, the exposure to environmental liabilities is relatively small, and
therefore, their reserves are relatively small compared to other types of
liabilities. Losses and LAE reserves related to environmental damage and toxic
tort liability, included in the total reserve for losses and LAE, were $50.8
million and $43.2 million, net of reinsurance of $20.2 million and $8.4 million,
at the end of 1996 and 1995, respectively. During 1995, the Regional Property
and Casualty subsidiaries redefined their environmental liabilities in
conformity with new guidelines issued by the NAIC. This had no impact on results
of operations. The Regional Property and Casualty subsidiaries do not
specifically underwrite policies that include this coverage, but as case law
expands policy provisions and insurers' liability beyond the intended coverage,
the Regional Property and Casualty subsidiaries may be required to defend such
claims. During 1995, Hanover performed an actuarial review of its environmental
reserves. This resulted in Hanover's providing additional reserves for "IBNR"
(incurred but not reported) claims, in addition to existing reserves for
reported claims. Although these claims are not material, their existence gives
rise to uncertainty and is discussed because of the possibility, however remote,
that they may become material. Management believes that, notwithstanding the
evolution of case law expanding liability in environmental claims, recorded
reserves related to these claims for environmental liability are adequate. In
addition, management is not aware of any litigation or pending claims that may
result in additional material liabilities in excess of recorded reserves. The
environmental liability could be revised in the near term if the estimates used
in determining the liability are revised.
19. MINORITY INTEREST
The Company's interest in Allmerica P&C is represented by ownership of 59.5%,
58.3% and 57.4% of the outstanding shares of common stock at December 31, 1996,
1995 and 1994, respectively. Earnings and shareholder's equity attributable to
minority shareholders are included in minority interest in the consolidated
financial statements.
F-35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
20. CONTINGENCIES
REGULATORY AND INDUSTRY DEVELOPMENTS
Unfavorable economic conditions may contribute to an increase in the number
of insurance companies that are under regulatory supervision. This may result in
an increase in mandatory assessments by state guaranty funds, or voluntary
payments by, solvent insurance companies to cover losses to policyholders of
insolvent or rehabilitated companies. Mandatory assessments, which are subject
to statutory limits, can be partially recovered through a reduction in future
premium taxes in some states. The Company is not able to reasonably estimate the
potential effect on it of any such future assessments or voluntary payments.
LITIGATION
On June 23, 1995, the governor of Maine approved a legislative settlement
for the Maine Workers' Compensation Residual Market Pool deficit for the years
1988 through 1992. The settlement provides for an initial funding of $220.0
million toward the deficit. The insurance carriers are liable for $65.0 million,
and employers will contribute $110.0 million payable through surcharges on
premiums over the course of the next ten years. The major insurers are
responsible for 90% of the $65.0 million. Hanover's allocated share of the
settlement is approximately $4.2 million, which was paid in December 1995. The
remainder of the deficit of $45.0 million will be paid by the Maine Guaranty
Fund, payable in quarterly contributions over ten years. A group of smaller
carriers filed litigation to appeal the settlement. The Company believes that
adequate reserves have been established for any additional liability.
The Company has been named a defendant in various other legal proceedings
arising in the normal course of business. In the opinion of management, based on
the advice of legal counsel, the ultimate resolution of these proceedings will
not have a material effect on the Company's consolidated financial statements.
However, liabilities related to these proceedings could be established in the
near term if estimates of the ultimate resolution of these proceedings are
revised.
RESIDUAL MARKETS
The Company is required to participate in residual markets in various
states. The results of the residual markets are not subject to the
predictability associated with the Company's own managed business, and are
significant to the workers' compensation line of business and both the private
passenger and commercial automobile lines of business.
21. STATUTORY FINANCIAL INFORMATION
The insurance subsidiaries are required to file annual statements with state
regulatory authorities prepared on an accounting basis prescribed or permitted
by such authorities (statutory basis). Statutory surplus differs from
shareholder's equity reported in accordance with generally accepted accounting
principles for stock life insurance companies primarily because policy
acquisition costs are expensed when incurred, investment reserves are based on
different assumptions, postretirement benefit costs are based on different
assumptions and reflect a different method of adoption, life insurance reserves
are based on different assumptions and income tax expense reflects only taxes
paid or currently payable. Statutory net income and surplus are as follows:
<TABLE>
<CAPTION>
(IN MILLIONS) 1996 1995 1994
--------------------------------------------------- --------- --------- -------
<S> <C> <C> <C>
Statutory net income (Combined)
Property and Casualty Companies.................. $ 155.3 $ 155.3 $ 79.9
Life and Health Companies........................ 133.3 134.3 40.7
--------- --------- -------
Statutory Shareholder's Surplus (Combined)
Property and Casualty Companies.................. $1,201.6 $1,128.4 $974.3
Life and Health Companies........................ 1,120.1 965.6 465.3
--------- --------- -------
</TABLE>
F-36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
22. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The quarterly results of operations for 1996 and 1995 are summarized below:
<TABLE>
<CAPTION>
For the Three Months Ended
(In millions)
<S> <C> <C> <C> <C>
1996 March 31 June 30 Sept. 30 Dec. 31
Total revenues............................ $827.9 $799.4 $806.3 $839.3
-------- ------- -------- -------
Net income................................ $ 50.6 $ 45.3 $ 49.4 $ 48.2
-------- ------- -------- -------
-------- ------- -------- -------
1995
Total revenues............................ $841.4 $791.9 $822.8 $784.4
-------- ------- -------- -------
Income before extraordinary item.......... $ 39.2 $ 29.9 $ 34.8 $ 45.2
Extraordinary item -- demutualization
expense.................................. (2.5) (3.5) (4.7) (1.4)
-------- ------- -------- -------
Net income................................ $ 36.7 $ 26.4 $ 30.1 $ 43.8
-------- ------- -------- -------
-------- ------- -------- -------
</TABLE>
23. SUBSEQUENT EVENT (UNAUDITED)
On April 14, 1997, the Company entered into an agreement in principle to
transfer the Company's individual disability income business under a 100%
coinsurance arrangement to Metropolitan Life Insurance Company. The consummation
of the transaction is subject to the negotiation of definitive agreements and
regulatory approvals and is expected to occur on or before October 1, 1997. In
connection with this transaction, the Company has recorded an after-tax charge
of $35 million net income in the first quarter of 1997 related to the
reinsurance of this business.
F-37
<PAGE>
SEPARATE ACCOUNT KG
KEMPER GATEWAY ELITE
STATEMENTS OF ASSETS AND LIABILITIES
DECEMBER 31, 1996
<TABLE>
<CAPTION>
SMALL CAP SMALL CAP
VALUE GROWTH VALUE INTERNATIONAL GROWTH VALUE+GROWTH HORIZON 20+ TOTAL RETURN
----------- ----------- --------- ------------- --------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Investments in shares
of Kemper Investors
Fund................ -- -- -- -- -- -- -- --
LIABILITIES: -- -- -- -- -- -- -- --
----------- ----------- --------- ------------- --------- ------------- ------------ ------------
Net assets............ -- -- -- -- -- -- -- --
----------- ----------- --------- ------------- --------- ------------- ------------ ------------
----------- ----------- --------- ------------- --------- ------------- ------------ ------------
</TABLE>
SEPARATE ACCOUNT KG
KEMPER GATEWAY ELITE
STATEMENTS OF ASSETS AND LIABILITIES--CONTINUED
DECEMBER 31, 1996
<TABLE>
<CAPTION>
INVESTMENT GRADE GOVERNMENT
HORIZON 10+ HORIZON 5 HIGH YIELD BOND SECURITIES MONEY MARKET
------------ ----------- ----------- ----------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Investments in shares of
Kemper Investors Fund..... -- -- -- -- -- --
LIABILITIES: -- -- -- -- -- --
------------ ----------- ----------- -------- ----------- -------------
Net assets................ -- -- -- -- -- --
------------ ----------- ----------- -------- ----------- -------------
------------ ----------- ----------- -------- ----------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-1
<PAGE>
SEPARATE ACCOUNT KG--KEMPER GATEWAY ELITE
NOTES TO FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION
Separate Account KG--Kemper Gateway Elite (VA-KG) is a separate investment
account of First Allmerica Financial Life Insurance Company (the Company),
established on November 14, 1996 for the purpose of separating from the general
assets of the Company those assets used to fund certain variable annuity
policies issued by the Company. Under applicable insurance law, the assets and
liabilities of VA-KG are clearly identified and distinguished from the other
assets and liabilities of the Company. VA-KG cannot be charged with liabilities
arising out of any other business of the Company.
VA-KG is registered as a unit investment trust under the Investment Company
Act of 1940, as amended (the 1940 Act). VA-KG currently offers fourteen
Sub-Accounts under the Kemper Gateway Elite contracts. Each Sub-Account invests
exclusively in a corresponding investment portfolio of Kemper Investors Fund
(KINF) managed by Zurich Kemper Investments, Inc. (ZKI). The Value and Small Cap
Value Portfolios are managed by Dreman Value Advisors, Inc. (DVA), a wholly
owned subsidary of ZKI. KINF is an open-end, diversified management investment
company registered under the 1940 Act.
VA-KG has two types of variable annuity policies, "qualified" policies and
"non-qualified" policies. A qualified policy is one that is purchased in
connection with a retirement plan which meets the requirements of Section 401,
403, or 408 of the Internal Revenue Code, while a non-qualified policy is one
that is not purchased in connection with one of the indicated retirement plans.
The tax treatment for certain partial redemptions or surrenders will vary
according to whether they are made from a qualified policy or a non-qualified
policy.
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES
Investments--Security transactions are recorded on the trade date.
Investments held by the Sub-Accounts are stated at the net asset value per share
of the respective investment portfolio of KINF. Net realized gains and losses on
securities sold are determined on the average cost method. Dividends and capital
gain distributions are recorded on the ex-dividend date and are reinvested in
additional shares of the respective investment portfolio of KINF at net asset
value.
Federal Income Taxes--The Company is taxed as a "life insurance company"
under Subchapter L of the Internal Revenue Code and files a consolidated federal
income tax return. The Company anticipates no tax liability resulting from the
operations of VA-KG. Therefore, no provision for income taxes has been charged
against VA-KG.
NOTE 3--INVESTMENTS
There were no investment purchases and sales for the year ended December 31,
1996.
NOTE 4--RELATED PARTY TRANSACTIONS
The Company makes a charge of .95% per annum based on the average daily net
assets of each Sub-Account at each valuation date for mortality and expense
risks. The Company also charges each Sub-Account .15% per annum based on the
average daily net assets of each Sub-Account for administrative expenses. These
charges are deducted from the daily value of each Sub-Account but are paid to
the Company on a monthly basis.
F-3
<PAGE>
SEPARATE ACCOUNT KG--KEMPER GATEWAY ELITE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--RELATED PARTY TRANSACTIONS (CONTINUED)
A contract fee of $35 is currently deducted on the Contract anniversary date
and upon full surrender of the contract when the accumulated value is less than
$50,000. The contract fee is waived for contracts issued to and maintained by
the Trustee of a 401(k) plan.
Allmerica Investments, Inc. (Allmerica Investments), a wholly-owned
subsidiary of the Company, is principal underwriter and general distributor of
VA-KG, and does not receive any compensation for sales of the VA-KG--Kemper
Gateway Elite contracts. Commissions are paid to registered representatives of
Allmerica Investments by the Company. As the current series of policies have a
contingent deferred sales charge, no deduction is made for sales charges at the
time of the sale.
NOTE 5--DIVERSIFICATION REQUIREMENTS
Under the provisions of Section 817(h) of the Internal Revenue Code, a
variable annuity contract, other than a contract issued in connection with
certain types of employee benefit plans, will not be treated as an annuity
contract for federal income tax purposes for any period for which the
investments of the segregated asset account on which the contract is based are
not adequately diversified. The Code provides that the "adequately diversified"
requirement may be met if the underlying investments satisfy either a statutory
safe harbor test or diversification requirements set forth in regulations issued
by the Secretary of Treasury.
The Internal Revenue Service has issued regulations under Section 817(h) of
the Code. The Company believes that VA-KG satisfies the current requirements of
the regulations, and it intends that VA-KG will continue to meet such
requirements.
F-4
<PAGE>
PART C. OTHER INFORMATION
Item 24. FINANCIAL STATEMENTS AND EXHIBITS.
(a) FINANCIAL STATEMENTS
FINANCIAL STATEMENTS INCLUDED IN PART A
None
FINANCIAL STATEMENTS INCLUDED IN PART B
Financial Statements for First Allmerica Financial Life Insurance
Company and for Separate Account KG
FINANCIAL STATEMENTS INCLUDED IN PART C
None
(b) EXHIBITS
Exhibit 1 - Vote of Board of Directors Authorizing Establishment of
Registrant dated June 13, 1996 was previously filed on August 16,
1996 in Initial Registration Statement and is incorporated by
reference herein.
Exhibit 2 - Not Applicable. Pursuant to Rule 26a-2, the Insurance Company
may hold the assets of the Registrant NOT pursuant to a
trust, indenture or other such instrument.
<PAGE>
Exhibit 3 - (a) Wholesaling Agreement is filed herewith was previously filed
in Pre-Effective Amendment No. 1 and is incorporated by
reference herein.
(b) Form of Sales Agreement was previously filed on August 16, 1996
in Initial Registration Statement and is incorporated by
reference herein.
(c) Broker's Agreement and Specimen Schedule of Sales Commissions
for Variable Annuity Policies were previously filed on
November 3, 1994 in Registration Statement No. 33-85916, and are
incorporated by reference herein.
Exhibit 4 - Policy Form was previously filed on August 16, 1996 in Initial
Registration Statement and is incorporated by reference herein.
Exhibit 5 - Application Form was previously filed on August 16, 1996 in Initial
Registration Statement and is incorporated by reference herein.
Exhibit 6 - The Depositor's Articles of Incorporation, as amended effective
October 1, 1995 to reflect its new name, and Bylaws were previously
filed on August 16, 1996 in Initial Registration Statement and are
incorporated by reference herein.
Exhibit 7 - Not Applicable.
Exhibit 8 - None
Exhibit 9 - Consent and Opinion of Counsel is filed herewith
Exhibit 10 - Consent of Independent Accountants is filed herewith
Exhibit 11 - None.
Exhibit 12 - None.
Exhibit 13 - None.
Exhibit 15 - Participation Agreement was previously filed in Pre-Effective
Amendment No. 1 and is incorporated by reference herein.
<PAGE>
Item 25. DIRECTORS AND OFFICERS OF THE DEPOSITOR.
The principal business address of all the following Directors and
Officers is:
440 Lincoln Street
Worcester, Massachusetts 01653
DIRECTORS AND PRINCIPAL OFFICERS OF THE COMPANY
<TABLE>
<CAPTION>
NAME AND POSITION PRINCIPAL OCCUPATION(S) DURING
WITH COMPANY PAST FIVE YEARS
------------ ---------------
<S> <C>
Bruce C. Anderson, Director and Vice President Director of First Allmerica since 1996; Vice President,
First Allmerica
Abigail M. Armstrong, Secretary and Counsel Secretary of First Allmerica since 1996; Counsel, First
Allmerica
John P. Kavanaugh, Director, Vice President and Director and Chief Investment Officer of First Allmerica
Chief Investment Officer since 1996; Vice President, First Allmerica since 1991
John F. Kelly, Director, Senior Vice President and Director of First Allmerica since 1996; Senior Vice
General Counsel President, General Counsel and Assistant Secretary, First
Allmerica
J. Barry May, Director Director of First Allmerica since 1996; Director and
President, The Hanover Insurance Company since 1996; Vice
President, The Hanover Insurance Company, 1993 to 1996
James R. McAuliffe, Director Director of First Allmerica since 1996; President and CEO,
Citizens Insurance Company of America since 1994; Vice
President 1982 to 1994 and Chief Investment Officer, First
Allmerica 1986 to 1994
John F. O Brien, Director, Chairman of the Board, Director, Chairman of the Board, President and Chief
President and Chief Executive Officer Executive Officer, First Allmerica since 1989
Edward J. Parry, III, Director, Vice President, Director and Chief Financial Officer of First Allmerica
Chief Financial Officer and Treasurer since 1996; Vice President and Treasurer, First Allmerica
since 1993
Richard M. Reilly, Director and Vice President Director of First Allmerica since 1996; Vice President,
First Allmerica since 1990; Director, Allmerica
Investments, Inc. since 1990; Director and President,
Allmerica Investment Management Company, Inc. since 1990
Larry C. Renfro, Director and Vice President Director of First Allmerica since 1996; Vice President,
First Allmerica since 1990
<PAGE>
Eric A. Simonsen, Director and Vice President Director of First Allmerica since 1996; Vice President,
First Allmerica since 1990; Chief Financial Officer, First
Allmerica 1990 to 1996
Phillip E. Soule, Director and Vice President Director of First Allmerica since 1996; Vice President,
First Allmerica
</TABLE>
Item 26. PERSONS UNDER COMMON CONTROL WITH REGISTRANT. See attached
organization chart.
FIRST ALLMERICA FINANCIAL LIFE INSURANCE COMPANY
<TABLE>
<CAPTION>
NAME ADDRESS TYPE OF BUSINESS
---- ------- ----------------
<S> <C> <C>
AAM Equity Fund 440 Lincoln Street Massachusetts Grantor Trust
Worcester MA 01653
Allmerica Asset Management Limited 440 Lincoln Street Investment advisory service
Worcester MA 01653
Allmerica Asset Management, Inc. 440 Lincoln Street Investment advisory services
Worcester MA 01653
Allmerica Employees Insurance Agency, 440 Lincoln Street Insurance Agency
Inc. Worcester MA 01653
Allmerica Financial Alliance 100 North Parkway Multi-line property and casualty insurance
Insurance Company Worcester MA 01605
Allmerica Financial Benefit 100 North Parkway Multi-line property and casualty insurance
Insurance Company Worcester MA 01605
Allmerica Financial Corporation 440 Lincoln Street Holding Company
Worcester MA 01653
Allmerica Financial Insurance Brokers, 440 Lincoln Street Insurance Broker
Inc. Worcester MA 01653
Allmerica Financial Life Insurance 440 Lincoln Street Life insurance, accident and health insurance,
and Annuity Company (formerly known Worcester MA 01653 annuities, variable annuities and variable
as SMA Life Assurance Company) life insurance
Allmerica Financial Services 440 Lincoln Street Insurance Agency
Insurance Agency, Inc. Worcester MA 01653
<PAGE>
Allmerica Funding Corp. 440 Lincoln Street Special purpose funding vehicle for
Worcester MA 01653 commercial paper
Allmerica Funds 440 Lincoln Street Investment Company
Worcester MA 01653
Allmerica, Inc. 440 Lincoln Street Common employer for Allmerica Financial
Worcester MA 01653 Corporation entities
Allmerica Institutional Services, 440 Lincoln Street Accounting, marketing and shareholder
Inc. Worcester MA 01653 services for investment companies
(formerly known as 440 Financial
Group of Worcester, Inc.)
Allmerica Investment Management 440 Lincoln Street Investment advisory services
Company, Inc. Worcester MA 01653
Allmerica Investments, Inc. 440 Lincoln Street Securities, retail broker-dealer
Worcester MA 01653
Allmerica Investment Trust 440 Lincoln Street Investment Company
Worcester MA 01653
Allmerica Property & Casualty, 440 Lincoln Street Holding Company
Companies Inc. Worcester MA 01653
Allmerica Securities Trust 440 Lincoln Street Investment Company
Worcester MA 01653
Allmerica Services Corporation 440 Lincoln Street Internal administrative services
Worcester MA 01653 provider to Allmerica Financial
Corporation entities
Allmerica Trust Company, N.A. 440 Lincoln Street Limited purpose national trust company
Worcester MA 01653
AMGRO, Inc. 100 North Parkway Premium financing
Worcester MA 01605
APC Funding Corp. 440 Lincoln Street Special purpose funding vehicle
Worcester MA 01653 for commercial paper
Beltsville Drive Limited 440 Lincoln Street Real estate partnership
Partnership Worcester MA 01653
Citizens Corporation 440 Lincoln Street Holding Company
Worcester MA 01653
<PAGE>
Citizens Insurance Company of 645 West Grand River Multi-line property and casualty insurance
America Howell MI 48843
Citizens Insurance Company of 333 Pierce Road Multi-line property and casualty insurance
Illinois Itasca IL 60143
Citizens Insurance Company of 3950 Priority Way Multi-line property and casualty insurance
the Midwest South Drive, Suite 200
Indianapolis IN 46280
Citizens Insurance Company of Ohio 8101 N. High Street Multi-line property and casualty insurance
P.O. Box 342250
Columbus OH 43234
Citizens Management, Inc. 645 West Grand River Services management company
Howell MI 48843
First Allmerica Financial Life 440 Lincoln Street Life, pension, annuity, accident
Insurance Company (formerly State Worcester MA 01653 and health insurance company
Mutual Life Assurance Company
of America)
Greendale Special Placements Fund 440 Lincoln Street Massachusetts Grantor Trust
Worcester MA 01653
The Hanover American Insurance 100 North Parkway Multi-line property and casualty insurance
Company Worcester MA 01605
The Hanover Insurance Company 100 North Parkway Multi-line property and casualty insurance
Worcester MA 01605
Hanover Texas Insurance Management 801 East Campbell Road Attorney-in-fact for Hanover Lloyd's
Company, Inc. Richardson TX 75081 Insurance Company
Hanover Lloyd's Insurance Company 801 East Campbell Road Multi-line property and casualty insurance
Richardson TX 75081
Linder Skokie Real Estate Corporation 440 Lincoln Street Real estate holding company
Worcester MA 01653
Lloyds Credit Corporation 440 Lincoln Street Premium financing service franchises
Worcester MA 01653
Logan Wells Water Company, Inc. 603 Heron Drive Water Company serving land development
Bridgeport NJ 08014 investment
<PAGE>
Massachusetts Bay Insurance Company 100 North Parkway Multi-line property and casualty insurance
Worcester MA 01605
SMA Financial Corp. 440 Lincoln Street Holding Company
Worcester MA 01653
Somerset Square, Inc. 440 Lincoln Street Real estate holding company
Worcester MA 01653
Sterling Risk Management Services, 440 Lincoln Street Risk management services
Inc. Worcester MA 01653
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Allmerica Financial Corporation
Delaware
| | | | |
___________________________________________________________________________________
100% 100% 100% 100% 100%
Allmerica, Inc. Allmerica First Allmerica AFC Capital Allmerica
Funding Corp. Financial Life Trust I Services
Insurance Corporation
Company
Massachusetts Massachusetts Massachusetts Delaware Massachusetts
|
_______________________________________________
|
100%
Logan Wells
Water Company,
Inc.
New Jersey
______________________________________________________________________________________________________________________
| | | | | |
59.47% 100% 99.2% 100% 100% 100%
Allmerica Sterling Risk Allmerica Somerset Allmerica Allmerica
Property Management Trust Square, Inc. Financial Life Institutional
& Casualty Services, Inc. Company, N.A. Insurance and Services, Inc.
Companies, Inc. Annuity Company
Federally
Delaware Delaware Chartered Massachusetts Delaware Massachusetts
|
___________________________________________________________________________
| | | |
100% 100% 100% 100%
APC The Hanover Allmerica Citizens
Funding Corp. Insurance Financial Insurance
Company Insurance Company of
Brokers, Inc. Illinois
Massachusetts New Hampshire Massachusetts Illinois
|
______________________________________________________________________________________________________________________
| | | | | |
100% 100% 100% 100% 82.5% 100%
Allmerica Allmerica The Hanover Hanover Texas Citizens Massachusetts
Financial Employee American Insurance Corporation Bay Insurance
Benefit Insurance Insurance Management Company
Insurance Agency, Inc. Company Company, Inc.
Company
Pennsylvania Massachusetts New Hampshire Texas Delaware New Hampshire
|
________________________________________________________
| | |
100% 100% 100%
Citizens Citizens Insurance Citizens
Insurance Company of Insurance
Company of Ohio America Company of the
Midwest
Ohio Michigan Indiana
|
_______________
100%
Citizens
Management Inc.
Michigan
<CAPTION>
Allmerica Financial Corporation
Delaware
| | | | |
___________________________________________________________________________________
100% 100% 100% 100% 100%
Allmerica, Inc. Allmerica First Allmerica AFC Capital Allmerica
Funding Corp. Financial Life Trust I Services
Insurance Corporation
Company
Massachusetts Massachusetts Massachusetts Delaware Massachusetts
|
_______________________________________________
|
100%
SMA
Financial Corp.
Massachusetts
|
______________________________________________________________________________________________________________________
| | | | | |
100% 100% 100% 100% 100% Allmerica
Allmerica Allmerica Allmerica Allmerica Linder Asset
Investments, Investment Asset Financial Services Skokie Management,
Inc. Management Management, Insurance Real Estate Limited
Company, Inc. Inc. Agency, Inc. Corporation
Massachusetts Massachusetts Massachusetts Massachusetts Massachusetts Bermuda
________________ _________________________________
Allmerica Equity Greendale AAM
Index Pool Special Equity Fund
Placements
Fund
Massachusetts Massachusetts Massachusetts
_____________________________________
| | Grantor Trusts established for the benefit of First
100% 100% Allmerica, Allmerica Financial Life, Hanover and
Allmerica AMGRO, Inc. Citizens
Financial Allmerica Allmerica Allmerica
Alliance Investment Trust Funds Securities
Insurance Trust
Company
Massachusetts Massachusetts Massachusetts
New Hampshire Massachusetts
|
|
100% Affiliated Management Investment Companies
Lloyd's
Credit Hanover Lloyd's
Corporation Insurance
Company
Massachusetts Texas
Affiliated Lloyd's plan company, controlled by
Underwriters for the benefit of the Hanover
Insurance Company
Beltsville
AAM High Drive
Yield Fund, Properties
L.L.C. Limited
Partnership
Massachusetts
Delaware
LLC established for the benefit of
First Allmerica, Allmerica Limited partnership involving First Allmerica, as
Financial Life, Hanover and general partner and Allmerica Financial Life as
Citizens limited partner
</TABLE>
<PAGE>
Item 27. NUMBER OF CONTRACT OWNERS.
As of December 31, 1996 the Variable Account had no Contract Owners
ITEM 28. INDEMNIFICATION.
Article VIII of the Bylaws of the Depositor state: Each Director and each
Officer of the Corporation, whether or not in office, (and his executors or
administrators), shall be indemnified or reimbursed by the Corporation against
all expenses actually and necessarily incurred by him in the defense or
reasonable settlement of any action, suit, or proceeding in which he is made a
party by reason of his being or having been a Director or Officer of the
Corporation, including any sums paid in settlement or to discharge judgement,
except in relation to matters as to which he shall be finally adjudged in such
action, suit or proceeding to be liable for negligence or misconduct in the
performance of his duties as such Director or Officer; and the foregoing right
of indemnification or reimbursement shall not affect any other rights to which
he may be entitled under the Articles of Incorporation, any statute, bylaw,
agreement, vote of stockholders, or otherwise.
Insofar as indemnification for liability arising under the 1933 Act may
be permitted to Directors, Officers and Controlling Persons of Registrant
under any registration statement, underwriting agreement or otherwise,
Registrant has been advised that, in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as
expressed in the 1933 Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by Registrant of expenses incurred or paid by a Director, Officer or
Controlling Person of Registrant in the successful defense of any action,
suit or proceeding) is asserted by such Director, Officer or Controlling
Person in connection with the securities being registered, Registrant will,
unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the 1933 Act and will be governed by the final adjudication of
such issue.
Item 29. PRINCIPAL UNDERWRITERS.
(a) Allmerica Investments, Inc. also acts as principal underwriter for the
following:
- VEL Account, VEL II Account, Group Vel, Separate Accounts VA-A, VA-B,
VA-C, VA-G, VA-H, VA-K, VA-P, Allmerica Select Separate Account,
Inheiritage Account, Separate Account KG and KGC, Separate Account
Fulcrum and Fulcrum Variable Life Separate Accountof Allmerica
Financial Life Insurance and Annuity Company
<PAGE>
- Separate Accounts I, VA-K, VA-P, VEL II Account, Inheiritage Account,
Group VEL Account, Allmerica Select Separate Account and Separate
Account KGC of First Allmerica Financial Life Insurance Company.
- Allmerica Investment Trust
(b) The Principal Business Address of each of the following Directors and
Officers of Allmerica Investments, Inc. is:
440 Lincoln Street
Worcester, Massachusetts 01653
Name Position or Office with Underwriter
---- -----------------------------------
Emil J. Aberizk Vice President and Chief Compliance Officer
Abigail M. Armstrong Secretary and Counsel
Richard F. Betzler, Jr. Vice President
Phillip J. Coffey Vice President
Thomas J. Cunningham Vice President, Chief Financial Officer
and Controller
John F. Kelly Director
William F. Monroe, Jr. Vice President
David J. Mueller Vice President
John F. O'Brien Director
Stephen Parker President, Director and Chief
Executive Officer
Edward J. Parry, III Treasurer
Richard M. Reilly Director
Eric A. Simonsen Director
Mark Steinberg Senior Vice President
<PAGE>
Item 30. LOCATION OF ACCOUNTS AND RECORDS.
Each account, book or other document required to be maintained by Section 31(a)
of the Investment Company Act of 1940 and Rules 31a-1 to 31a-3 thereunder are
maintained by the Company at 440 Lincoln Street, Worcester, Massachusetts.
Item 31. MANAGEMENT SERVICES.
The Company provides daily unit value calculations and related services for
the Company's separate accounts.
Item 32. UNDERTAKINGS.
(a) Subject to the terms and conditions of Section 15(d) of the Securities
Exchange Act of 1934, the undersigned registrant hereby undertakes to file with
the Securities and Exchange Commission such supplementary and periodic
information, documents, and reports as may be prescribed by any rule or
regulation of the Commission heretofore or hereafter duly adopted pursuant to
authority conferred in that section.
(b) The registrant hereby undertakes to include in the prospectus a postcard
that the applicant can remove to send for a Statement of Additional Information.
(c) The registrant hereby undertakes to deliver a Statement of Additional
Information promptly upon written or oral request, according to the requirements
of Form N-4.
(e) The Company and the Registrant hereby represent that the aggregate fees and
charges under the Contracts offered by this Registration Statement are
reasonable in relation to the services
<PAGE>
rendered, the expenses expected to be incurred, and the risks assumed by the
Company.
Item 33. REPRESENTATIONS CONCERNING WITHDRAWAL RESTRICTIONS ON SECTION 403(b)
PLANS AND UNDER THE TEXAS OPTIONAL RETIREMENT PROGRAM.
Registrant, a separate account of First Allmerica Financial Life Insurance
Company ("Company"), states that it is (a) relying on Rule 6c-7 under the
1940 Act with respect to withdrawal restrictions under the Texas Optional
Retirement Program ("Program") and (b) relying on the "no-action" letter
(Ref. No. IP-6-88) issued on November 28, 1988 to the American Council of
Life Insurance, in applying the withdrawal restrictions of Internal Revenue
Code Section 403(b)(11). Registrant has taken the following steps in
reliance on the letter:
1. Appropriate disclosures regarding the redemption restrictions imposed by
the Program and by Section 403(b)(11) have been included in the prospectus
of each registration statement used in connection with the offer of the
Company's variable contracts.
2. Appropriate disclosures regarding the redemption restrictions imposed by
the Program and by Section 403(b)(11) have been included in sales
literature used in connection with the offer of the Company's variable
contracts.
3. Sales Representatives who solicit participants to purchase the variable
contracts have been instructed to specifically bring the redemption
restrictions imposed by the Program and by Section 403(b)(11) to the
attention of potential participants.
4. A signed statement acknowledging the participant's understanding of (I) the
restrictions on redemption imposed by the Program and by Section 403(b)(11)
and (ii) the investment alternatives available under the employer's
arrangement will be obtained from each participant who purchases a variable
annuity contract prior to or at the time of purchase.
Registrant hereby represents that it will not act to deny or limit a transfer
request except to the extent that a Service-Ruling or written opinion of
counsel, specifically addressing the fact pattern involved and taking into
account the terms of the applicable employer plan, determines that denial or
limitation is necessary for the variable annuity contracts to meet the
requirements of the Program or of Section 403(b). Any transfer request not so
denied or limited will be effected as expeditiously as possible.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940 the Registrant certifies that it meets all the requirements
for effectiveness of this Registration Statement pursuant to Rule 485(b) under
the Securities Act of 1933 and has duly caused this Registration Statement to be
signed on its behalf by the undersigned, thereto duly authorized, in the City of
Worcester, and Commonwealth of Massachusetts on the 2nd day of April, 1997.
SEPARATE ACCOUNT KG OF
FIRST ALLMERICA FINANCIAL LIFE INSURANCE
COMPANY
By: /s/ Abigail M. Armstrong
------------------------
Abigail M. Armstrong
Secretary
SIGNATURES TITLE DATE
- ---------- ----- ----
/s/ John F. O'Brien Director, President and Chief
John F. O'Brien Executive Officer
/s/ Bruce C. Anderson Director and Vice President
Bruce C. Anderson
/s/ John P. Kavanaugh Director and Vice President April 2, 1997
John P. Kavanaugh
/s/ John F. Kelly Director, Senior Vice President
John F. Kelly and General Counsel
/s/J. Barry May Director
J. Barry May
/s/ James R. McAuliffe Director
James R. McAuliffe
<PAGE>
/s/ Edward J. Parry, III Director, Vice President, Treasurer
Edward J. Parry, III and Chief Accounting Officer
/s/ Richard M. Reilly Director and Vice President
Richard M. Reilly
/s/ Larry C. Renfro Director and Vice President
Larry C. Renfro
/s/ Eric A. Simonsen Director, Vice President and Chief
Eric A. Simonsen Financial Officer
/s/ Phillip E. Soule Director and Vice President
Phillip E. Soule
<PAGE>
EXHIBIT TABLE
Exhibit 9 - Consent and Opinion of Counsel.
Exhibit 10 - Consent of Independent Accountants
<PAGE>
April 2, 1997
First Allmerica Financial Life Insurance Company
440 Lincoln Street
Worcester, MA 01653
Gentlemen:
In my capacity as Counsel of First Allmerica Financial Life Insurance Company
(the "Company"), I have participated in the preparation of the Post-Effective
Amendment to the Registration Statement for the Separate Account KG on
Form N-4 under the Securities Act of 1933 and the Investment Company Act of
1940, with respect to the Company's individual and group variable annuity
policies offered by the Separate Account.
I am of the following opinion:
1. Separate Account KG is a separate account of the company validly existing
pursuant to the Massachusetts Insurance Code and the regulations issued
thereunder.
2. The assets held in Separate Account KG are not chargeable with
liabilities arising out of any other business the Company may conduct.
3. The individual and group variable annuity policies, when issued in
accordance with the Prospectus contained in the Registration Statement and
upon compliance with applicable local law, will be legal and binding
obligations of the Company in accordance with their terms and when sold
will be legally issued, fully paid and non-assessable.
In arriving at the foregoing opinion, I have made such examination of law and
examined such records and other documents as in my judgment are necessary or
appropriate.
I hereby consent to the filing of this opinion as an exhibit to the
Post Effective Amendment to the Registration Statement of Separate Account
KG filed under the Securities Act of 1933.
Very truly yours,
/s/ Sylvia Kemp-Orino
Sylvia Kemp-Orino
Assistant Vice President and Counsel
<PAGE>
Exhibit 10
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Statement of Additional Information
constituting part of this Post-Effective Amendment No. 1 to the Registration
Statement on Form N-4 of our report dated February 3, 1997, except as to
Notes 1 and 2, which are as of February 19, 1997, relating to the financial
statements of First Allmerica Financial Life Insurance Company which appears
in such Statement of Additional Information. We also consent to the
reference to us under the heading "Experts" in such Statement of Additional
Information.
/s/ Price Waterhouse LLP
Price Waterhouse LLP
Boston, Massachusetts
April 21, 1997
