<PAGE> 1
NATIONAL LIFE INSURANCE COMPANY
HOME 0FFICE
NATIONAL LIFE DRIVE
MONTPELIER, VERMONT 05604
1-800-537-7003
Sentinel Advantage
The Sentinel Advantage contracts described in this prospectus (collectively
referred to as the "Contracts") are individual flexible premium variable annuity
contracts supported by National Variable Annuity Account II (the "Variable
Account"), a separate account of National Life Insurance Company, ("National
Life"). The Contracts are sold either as Non-Qualified Contracts, or in
connection with certain retirement plans qualifying for favorable federal income
tax treatment ("Qualified Contracts"). Annuity payments under the Contracts are
deferred until a selected later date. Net Premium Payments are allocated either
to the Fixed Account or to the Variable Account, which is divided into
Subaccounts, each of which invests in shares of one of the underlying Fund
options (each a "Fund") described below:
<TABLE>
<CAPTION>
FUNDS INVESTMENT ADVISOR
- ----- ------------------
<S> <C>
ALGER AMERICAN FUND
Alger American Small Capitalization Portfolio Fred Alger Management, Inc.
Alger American Growth Portfolio Fred Alger Management, Inc.
VARIABLE INSURANCE PRODUCTS FUND
Equity-Income Portfolio Fidelity Investments
Growth Portfolio Fidelity Investments
High Income Portfolio Fidelity Investments
Overseas Portfolio Fidelity Investments
VARIABLE INSURANCE PRODUCTS FUND II
Index 500 Portfolio Fidelity Investments
Contrafund Portfolio Fidelity Investments
THE MARKET STREET FUND
Common Stock Portfolio Sentinel Advisors Company
Sentinel Growth Portfolio Sentinel Advisors Company
Aggressive Growth Portfolio Sentinel Advisors Company
Bond Portfolio Sentinel Advisors Company
Managed Portfolio Sentinel Advisors Company
Money Market Portfolio Sentinel Advisors Company
International Portfolio Boston Company Asset Management Inc.
STRONG VARIABLE INSURANCE FUNDS, INC.
Strong Growth Fund II Strong Capital Management, Inc.
STRONG SPECIAL FUND II, INC. Strong Capital Management, Inc.
VAN ECK WORLDWIDE INSURANCE TRUST
Worldwide Bond Fund Van Eck Associates Corporation
</TABLE>
This prospectus provides you with the basic information you should know
about the Sentinel Advantage Contracts, the Variable Account and the Fixed
Account before investing. You should read it and keep it for future reference. A
Statement of Additional Information dated June 20, 1997 containing further
information about the Contracts and the Variable Account has been filed with the
Securities and Exchange Commission. You can obtain a copy without charge from
National Life Insurance Company by calling 1-800-537-7003, or writing to
National Life at National Life Drive, Montpelier, Vermont 05604. You may also
obtain prospectuses for each of the underlying Fund options identified above
without charge by calling or writing to the above telephone number or address.
PLEASE READ THIS PROSPECTUS CAREFULLY AND KEEP IT FOR FUTURE REFERENCE. THIS
PROSPECTUS MUST BE ACCOMPANIED BY CURRENT PROSPECTUSES FOR THE FUNDS.
INVESTMENTS IN THESE CONTRACTS ARE NOT DEPOSITS OR OBLIGATIONS OF, AND ARE NOT
GUARANTEED OR ENDORSED BY, THE ADVISER OF ANY OF THE
<PAGE> 2
UNDERLYING FUNDS IDENTIFIED ABOVE, THE U.S. GOVERNMENT, OR ANY BANK OR BANK
AFFILIATE. INVESTMENTS ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT
INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER GOVERNMENTAL
AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THE PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE STATEMENT OF ADDITIONAL INFORMATION, DATED JUNE 20, 1997, IS INCORPORATED
HEREIN BY REFERENCE. THE TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL
INFORMATION APPEARS ON PAGE OF THE PROSPECTUS.
THE DATE OF THIS PROSPECTUS IS JUNE 20, 1997.
<PAGE> 3
TABLE OF CONTENTS
DEFINITIONS..................................................................
SUMMARY OF CONTRACT EXPENSES.................................................
UNDERLYING FUND ANNUAL EXPENSES..............................................
INTRODUCTION.................................................................
NATIONAL LIFE INSURANCE COMPANY, THE VARIABLE ACCOUNT, AND THE FUNDS.........
National Life Insurance Company.....................................
The Variable Account................................................
Underlying Fund Options.............................................
DETAILED DESCRIPTION OF CONTRACT PROVISIONS....................................
Issuance of the Contract............................................
Premium Payments....................................................
The Initial Premium Payment................................
Subsequent Premium Payments................................
Allocation of Net Premium Payments.........................
Transfers...........................................................
Value of a Variable Account Accumulation Unit.......................
Net Investment Factor
Determining the Contract Value......................................
Annuitization.......................................................
Maturity Date..............................................
Election of Payment Options................................
Frequency and Amount of Annuity Payments...................
Annuitization - Variable Account....................................
Value of an Annuity Unit...................................
Assumed Investment Rate....................................
Annuitization - Fixed Account.......................................
Annuity Payment Options.............................................
Death of Owner......................................................
Death of Annuitant Prior to the Annuitization Date..................
Required Distributions for Qualified Plans and Certain Tax Sheltered
Annuities.........................................................
Required Distributions for Individual Retirement Annuities..........
Generation-Skipping Transfers.......................................
Ownership Provisions................................................
CHARGES AND DEDUCTIONS.........................................................
Deductions from the Variable Account................................
Contingent Deferred Sales Charge....................................
Annual Contract Fee.................................................
Transfer Charge.....................................................
Premium Taxes.......................................................
Charge for Optional Enhanced Death Benefit Rider....................
Other Charges.......................................................
CONTRACT RIGHTS................................................................
Free Look...........................................................
Loan Privilege - Qualified Contracts and Certain Tax Sheltered
Annuities.........................................................
Surrender and Withdrawal ...........................................
Payments............................................................
Surrenders and Withdrawals Under a Tax Sheltered Annuity Contract...
Telephone Transaction Privilege.....................................
Available Automated Fund Management Features........................
3
<PAGE> 4
Dollar Cost Averaging....................................
Portfolio Rebalancing....................................
Systematic Withdrawals...................................
Contract Rights Under Certain Plans.................................
THE FIXED ACCOUNT..............................................................
Minimum Guaranteed and Current Interest Rates.......................
OPTIONAL ENHANCED DEATH BENEFIT RIDER..........................................
FEDERAL INCOME TAX CONSIDERATIONS..............................................
Non-Qualified Contracts.............................................
Qualified Contracts.................................................
Corporate Pension and Profit-Sharing Plans..........................
Code Section 403(b) Plans...........................................
Deferred Compensation Plans.........................................
Individual Retirement Annuities.....................................
Simple Retirement Accounts..........................................
Diversification.....................................................
Tax Legislation.....................................................
Charge for Tax Provisions...........................................
Rollover Distributions..............................................
Restrictions under Qualified Contracts..............................
Gender Neutrality...................................................
VOTING RIGHTS..................................................................
CHANGES TO VARIABLE ACCOUNT....................................................
ADVERTISING....................................................................
DISTRIBUTION OF THE CONTRACTS .................................................
STATEMENTS AND REPORTS.........................................................
OWNER INQUIRIES................................................................
LEGAL PROCEEDINGS..............................................................
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION.......................
4
<PAGE> 5
DEFINITIONS
Accumulation Unit- An accounting unit of measure used to calculate the Variable
Account Contract Value prior to the Annuitization Date.
Annuitant- A person named in the Contract who is expected to become, at
Annuitization, the person upon whose continuation of life any annuity payments
involving life contingencies depends. Unless the Owner is a different individual
who is age 85 or younger, this person must be age 85 or younger at the time of
Contract issuance unless National Life has approved a request for an Annuitant
of greater age. The Owner may change the Annuitant prior to the Annuitization
Date, as set forth in the Contract.
Annuitization- The period during which annuity payments are actually received.
Annuitization Date- The date on which annuity payments actually commence.
Annuity Payment Option- The chosen form of annuity payments. Several options are
available under the Contract.
Annuity Unit- An accounting unit of measure used to calculate the value of
Variable Annuity payments.
Beneficiary- The Beneficiary is the person designated to receive certain
benefits under the Contract upon the death of the Owner or Annuitant prior to
the Annuitization Date. The Beneficiary can be changed by the Owner as set forth
in the Contract.
Cash Surrender Value- An amount equal to Contract Value, minus any applicable
Contingent Deferred Sales Charge, minus any applicable premium tax charge.
Chosen Human Being- An individual named at the time of Annuitization upon whose
continuation of life any annuity payments involving life contingencies depends.
Code- The Internal Revenue Code of 1986, as amended.
Collateral Fixed Account- The portion of the Fixed Account which holds value
which secures a loan on the Contract.
Contract- The Sentinel Advantage individual flexible premium variable annuity
contract described in this prospectus.
Contract Anniversary- An anniversary of the Date of Issue of the Contract.
Contract Value- The sum of the value of all Variable Account Accumulation Units
attributable to the Contract, plus any amount held under the Contract in the
Fixed Account, minus any outstanding loans on the Contract and accrued interest
on such loans.
Contract Year- Each year the Contract remains in force commencing with the Date
of Issue.
Date Of Issue- The date shown as the Date of Issue on the Data Page of the
Contract.
Death Benefit- The benefit payable to the Beneficiary upon the death of the
Owner or the Annuitant.
Distribution- Any payment of part or all of the Contract Value.
Fixed Account- The Fixed Account is made up of all assets of National Life other
than those in the Variable Account or any other segregated asset account of
National Life.
5
<PAGE> 6
Fixed Annuity- An annuity providing for payments which are guaranteed by
National Life as to dollar amount during Annuitization.
Fund- A registered management investment company in which the assets of a
Subaccount of the Variable Account will be invested.
Home Office- The main office of National Life located at National Life Drive,
Montpelier, Vermont.
Individual Retirement Annuity (IRA)- An annuity which qualifies for favorable
tax treatment under Section 408 of the Code.
Investment Company Act - The Investment Company Act of 1940, as amended from
time to time.
Joint Owners- Two or more persons who own the Contract as tenants in common or
as joint tenants. If joint owners are named, references to "Owner" in this
prospectus will apply to both of the Joint Owners.
Maturity Date- The date on which annuity payments are scheduled to commence. The
Maturity Date is shown on the Data Page of the Contract, and is subject to
change by the Owner, within any applicable legal limits, subject to National
Life's approval.
Monthly Contract Date- The day in each calendar month which is the same day of
the month as the Date of Issue, or the last day of any month having no such
date, except that whenever the Monthly Contract Date would otherwise fall on a
date other than a Valuation Day, the Monthly Contract Date will be deemed to be
the next Valuation Day.
Non-Qualified Contract- A Contract which does not qualify for favorable tax
treatment under the provisions of Sections 401 or 403(a) (Qualified Plans), 408
(IRAs) or 403(b) (Tax-Sheltered Annuities) of the Code.
Owner- The Owner is the person who possesses all rights under the Contract,
including the right to designate and change any designations of the Owner,
Annuitant, Beneficiary, Annuity Payment Option, and the Maturity Date.
Payee- The person who is designated at the time of Annuitization to receive the
proceeds of the Contract upon Annuitization.
Premium Payment- A deposit of new value into the Contract. The term "Premium
Payment" does not include transfers between the Variable Account and Fixed
Account, or among the Subaccounts.
Net Premium Payments- The total of all Premium Payments made under the Contract,
less premium tax deducted from premiums.
Qualified Contract - A Contract which qualifies for favorable tax treatment
under the provisions of Sections 401 or 403(a) (Qualified Plans), 408 (IRAs),
403(b) (Tax-Sheltered Annuities) or 457 of the Code.
Qualified Plans- Retirement plans which receive favorable tax treatment under
Section 401 or 403(a) of the Code.
Subaccounts- Separate and distinct divisions of the Variable Account, to which
specific underlying Fund shares are allocated and for which Accumulation Units
and Annuity Units are separately maintained.
Tax Sheltered Annuity- An annuity which qualifies for favorable tax treatment
under Section 403(b) of the Code.
Valuation Day- Each day the New York Stock Exchange is open for business other
than the day after Thanksgiving and any day on which trading is restricted.
Unless otherwise indicated, whenever under a
6
<PAGE> 7
Contract an event occurs or a transaction is to be effected on a day that is not
a Valuation Day, it will be deemed to have occurred on the next Valuation Day.
Valuation Period- The time between two successive Valuation Days.
Variable Account- The National Variable Annuity Account II, a separate
investment account of National Life into which Net Premium Payments under the
Contracts are allocated. The Variable Account is divided into Subaccounts, each
of which invests in the shares of a separate underlying Fund.
Variable Annuity- An annuity the accumulated value of which varies with the
investment experience of a separate account.
Withdrawal- A payment made at the request of the Owner pursuant to the right
to withdraw a portion of the Contract Value of the Contract.
7
<PAGE> 8
SUMMARY OF CONTRACT EXPENSES
TRANSACTION EXPENSES
Sales Load Imposed on Purchases...........................None
Premium Taxes.............................................See below(1)
Contingent Deferred Sales Charge (as a percentage of Net
Premium Payments surrendered or withdrawn)(2)
Number of Completed Years from Date of Premium Payment None
0 7%
1 6%
2 5%
3 4%
4 3%
5 2%
6 1%
7 0%
ANNUAL EXPENSES
Mortality and Expense Risk Charge(3).....................................1.25%
Administration Charge....................................................0.15%
----
Total Basic Variable Account Annual Percentage Expenses..................1.40%
Annual Contract Fee(4)...............................................$30
Charges for Optional Enhanced Death Benefit Rider(5).....................0.20%
1 A minority of states assess premium taxes on premiums paid under the
Contract. Where National Life is required to pay this premium tax when a
Premium Payment is made, it may deduct an amount equal to the amount of
premium tax paid from the Premium Payment. National Life currently
intends to make this deduction from Premium Payments only in South
Dakota. In the remaining states which assess premium taxes, a deduction
will be made only upon Annuitization, death of the Owner, or surrender.
See "Premium Taxes", page .
2 Each Contract Year, the Owner may withdraw without a Contingent Deferred
Sales Charge (CDSC) an amount equal to 15% of the Contract Value as of the
most recent Contract Anniversary. In addition, any amount withdrawn in
order for the Contract to meet minimum Distribution requirements under the
Code shall be free of CDSC. Withdrawals may be restricted for Contracts
issued pursuant to the terms of a Tax Sheltered Annuity. This CDSC-free
Withdrawal privilege does not apply in the case of full surrenders, and is
non-cumulative, that is, free amounts not taken during any given Contract
Year cannot be taken as free amounts in a subsequent Contract Year; in
addition, certain states do not permit this CDSC-free Withdrawal
provision, in which case a different CDSC-free Withdrawal provision will
apply (see "Contingent Deferred Sales Charge", page ).
3 The Mortality and Expense Risk Charge and the Administration Charge set
forth above apply exclusively to allocations made to the Subaccount(s) of
the Variable Account. Such charges do not apply to, and will not be
assessed against, allocations made to the Fixed Account.
4 The Annual Contract Fee is assessed only upon Contracts which as of the
Date of Issue, or applicable Contract Anniversary, have a Contract Value
plus any outstanding loan and accrued interest of less than $50,000, and
is not assessed on Contract Anniversaries after the Annuitization Date.
5 This charge, which applies to the Contract Value plus the amount of any
outstanding loan and accrued interest, is assessed only if the Owner
has elected the Enhanced Death Benefit Rider. See "Optional Enhanced
Death Benefit Rider", page .
8
<PAGE> 9
UNDERLYING FUND ANNUAL EXPENSES6(AS A PERCENTAGE OF UNDERLYING FUND NET ASSETS,
AFTER EXPENSE REIMBURSEMENT)
<TABLE>
<CAPTION>
Management Total Mutual
Fees, Other Expenses, Fund Expenses,
after expense after expense after expense
reimbursement reimbursement reimbursement
<S> <C> <C> <C>
Alger American Small Capitalization Portfolio 0.75% 0.04% 0.79%
Alger American Growth Portfolio 0.85% 0.03% 0.88%
Fidelity VIP Fund-Equity Income Portfolio 0.51% 0.07% 0.58%
Fidelity VIP Fund-Growth Portfolio 0.61% 0.08% 0.69%
Fidelity VIP Fund-High Income Portfolio 0.59% 0.12% 0.71%
Fidelity VIP Fund-Overseas Portfolio 0.76% 0.17% 0.93%
Fidelity VIP Fund II-Index 500 Portfolio 0.13% 0.15% 0.28%
Fidelity VIP Fund II-Contrafund Portfolio 0.61% 0.13% 0.74%
Market Street Common Stock Portfolio 0.40% 0.40% 0.80%
Market Street Sentinel Growth Portfolio 0.50% 0.40% 0.90%
Market Street Aggressive Growth Portfolio 0.47% 0.21% 0.68%
Market Street Managed Portfolio 0.40% 0.20% 0.60%
Market Street Bond Portfolio 0.35% 0.21% 0.56%
Market Street International Portfolio 0.75% 0.30% 1.05%
Market Street Money Market Portfolio 0.25% 0.19% 0.44%
Strong Special Fund II, Inc. 1.00% 0.20% 1.20%
Strong Growth Fund II 1.00% 1.00% 2.00%
Van Eck Worldwide Bond Fund 1.00% 0.16% 1.16%
</TABLE>
6 The Fund expenses shown above are assessed at the underlying Fund level and
are not direct charges against Variable Account assets or reductions from
Contract Values. These underlying Fund expenses are taken into consideration in
computing each underlying Fund's net asset value, which is the share price used
to calculate the unit values of the Variable Account. The management fees and
other expenses are more fully described in the prospectuses for each individual
underlying Fund. The information relating to the underlying Fund expenses was
provided by the underlying Fund and was not independently verified by National
Life. In the absence of any fee waivers or expense reimbursements, the
Management Fees, Other Expenses, and Total Expenses of the Funds listed below
would have been as follows:
<TABLE>
<CAPTION>
Management Total Mutual
Fees Other Expenses Fund Expenses
<S> <C> <C> <C>
Fidelity VIP Fund II-Index 500 Portfolio 0.28% 0.15% 0.43%
Market Street Common Stock Portfolio 0.40% 1.03% 1.43%
Market Street Sentinel Growth Portfolio 0.50% 1.01% 1.51%
</TABLE>
9
<PAGE> 10
EXAMPLE
The following chart depicts the dollar amount of expenses that would be
incurred under this Contract assuming a $1000 investment and 5% annual return,
and no election of the optional Enhanced Death Benefit Rider. THESE DOLLAR
FIGURES ARE ILLUSTRATIVE ONLY AND SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESSER THAN THOSE
SHOWN BELOW.
<TABLE>
<CAPTION>
IF YOU SURRENDER YOUR IF YOU DO NOT SURRENDER IF YOU ANNUITIZE YOUR
CONTRACT AT THE END OF YOUR CONTRACT AT THE END OF CONTRACT AT THE END OF
THE APPLICABLE TIME PERIOD THE APPLICABLE TIME PERIOD THE APPLICABLE TIME PERIOD
Subaccount* 1 Yr. 3 Yrs. 1 Yr. 3 Yrs. 1 Yr.** 3 Yrs.
- ----------- ------------------------- --------------------------- --------------------------
<S> <C> <C> <C> <C> <C> <C>
Alger American Small
Capitalization $ 94 $ 124 $ 24 $ 74 $ 24 $ 74
Alger American Growth 93 121 23 71 23 71
Fidelity VIP Fund-Equity Income 91 115 21 65 21 65
Fidelity VIP Fund-Growth 92 118 22 68 22 68
Fidelity VIP Fund-High Income 92 119 22 69 22 69
Fidelity VIP Fund-Overseas 94 125 24 75 24 75
Fidelity VIP Fund II-Index 500 88 106 18 56 18 56
Fidelity VIP Fund II-Contrafund 93 120 23 70 23 70
Market Street Common Stock 93 121 23 71 23 71
Market Street Sentinel Growth 94 124 24 74 24 74
Market Street Aggressive Growth 92 118 22 68 22 68
Market Street Managed 91 115 21 65 21 65
Market Street Bond 91 114 21 64 21 64
Market Street International 96 129 26 79 26 79
Market Street Money Market 90 110 20 60 20 60
Strong Special Fund II, Inc. 97 133 27 83 27 83
Strong Growth Fund II 105 157 35 107 35 107
Van Eck Worldwide Bond 97 132 27 82 27 82
</TABLE>
For an Owner who has elected the Enhanced Death Benefit Rider (see
"Optional Enhanced Death Benefit Rider", page ), and again assuming a
$1000 investment and 5% annual return, the chart below depicts the annual
expenses that would be incurred under this Contract:
<TABLE>
<CAPTION>
IF YOU SURRENDER YOUR IF YOU DO NOT SURRENDER IF YOU ANNUITIZE YOUR
CONTRACT AT THE END OF YOUR CONTRACT AT THE END OF CONTRACT AT THE END OF
THE APPLICABLE TIME PERIOD THE APPLICABLE TIME PERIOD THE APPLICABLE TIME PERIOD
Subaccount* 1 Yr. 3 Yrs. 1 Yr. 3 Yrs. 1 Yr.** 3 Yrs.
- ----------- ------------------------- --------------------------- --------------------------
<S> <C> <C> <C> <C> <C> <C>
Alger American Small
Capitalization $ 96 $ 130 $ 26 $ 80 $ 26 $ 80
Alger American Growth 95 127 25 77 25 77
Fidelity VIP Fund-Equity Income 93 121 23 71 23 71
Fidelity VIP Fund-Growth 94 124 24 74 24 74
Fidelity VIP Fund-High Income 94 125 24 75 24 75
Fidelity VIP Fund-Overseas 96 131 26 81 26 81
Fidelity VIP Fund II-Index 500 90 112 20 62 20 62
Fidelity VIP Fund II-Contrafund 95 125 25 75 25 75
Market Street Common Stock 95 127 25 77 25 77
Market Street Sentinel Growth 96 130 26 80 26 80
Market Street Aggressive Growth 94 124 24 74 24 74
Market Street Managed 93 121 23 71 23 71
Market Street Bond 93 120 23 70 23 70
Market Street International 98 135 28 85 28 85
Market Street Money Market 92 116 22 66 22 66
Strong Special Fund II, Inc. 99 139 29 89 29 89
Strong Growth Fund II 107 162 37 112 37 112
Van Eck Worldwide Bond 99 138 29 88 29 88
</TABLE>
10
<PAGE> 11
<TABLE>
<S> <C>
Strong Special Fund II, Inc.
Strong Growth Fund II
</TABLE>
* For purposes of computing the Annual Contract Fee, the Annual Contract Fee
has been converted into a per-dollar per-day charge. The per-dollar per-day
charge has been estimated based on the distribution of National Life's
non-variable single premium deferred annuity block of business, and works out
to 0.06% per annum. The Annual Contract Fee is waived for Contracts with
Contract Values in excess of $50,000.
** The Contract may not be annuitized in the first two years from the Date of
Issue.
The purpose of the Summary of Contract Expenses and Example is to assist
the Owner in understanding the various costs and expenses that will be borne
directly or indirectly when investing in the Contract. The expenses of the
Variable Account as well as those of the underlying Funds are reflected in the
Example. For more complete descriptions of the expenses of the Variable Account,
see "Charges and Deductions", page . For more complete information regarding
expenses paid out of the assets of the underlying Funds, see the underlying Fund
prospectuses. Deductions for premium taxes may also apply but are not reflected
in the Example shown above (see "Premium Taxes", page ). Certain states impose
a premium tax, currently ranging up to 3.5%.
11
<PAGE> 12
INTRODUCTION
These contracts may be offered as: (1) Non-Qualified Contracts, or (2)
Qualified Contracts.
The Contract is available, with certain exceptions, to Owners age 85
and younger. See "Issuance of a Contract", page . The initial Premium Payment
must be at least $5,000 for Non-Qualified Contracts, and in general must be at
least $1500 for Individual Retirement Annuities or Tax Sheltered Annuities
(National Life may at its discretion permit initial Premium Payments lower than
the $1500 minimum if a group of Contracts are being purchased by a group of
individuals and funds are remitted electronically). Subsequent Premium Payments
may be made at any time, but must be at least $100 ($50 for Individual
Retirement Annuities), except that National Life may accept lower Premium
Payments at its discretion if the Premium Payments are remitted electronically.
The cumulative total of all Premium Payments under Contracts issued on the life
of any one Designated Annuitant may not exceed $1,000,000 without the prior
consent of National Life (see "Premium Payments", page ).
If the Contract Value at the Annuitization Date is less than $3,500,
the Contract Value may be distributed in one lump sum in lieu of annuity
payments. If any annuity payment would be less than $100, National Life shall
have the right to change the frequency of payments to such intervals as will
result in payments of at least $100. In no event, however, will annuity payments
be made less frequently than annually (see "Annuitization - Frequency and Amount
of Annuity Payments", page ).
National Life does not deduct a sales charge from Premium Payments made
for these Contracts. However, if a Withdrawal is made with respect to any part
of the Contract Value of such Contracts, or the Contract is surrendered,
National Life will, with certain exceptions, deduct from the Owner's Contract
Value a Contingent Deferred Sales Charge not to exceed 7% of the lesser of the
total of all Net Premium Payments made within 84 months prior to the date of
the request to surrender, or the amount surrendered. This charge, when
applicable, is imposed to permit National Life to recover sales expenses which
have been advanced by National Life (see "Contingent Deferred Sales Charge",
page ).
National Life deducts from the Variable Account an amount, computed
daily, which is equal to an annual rate of 1.40% of the daily net asset value.
This charge consists of a 0.15% Administration Charge and a 1.25% Mortality and
Expense Risk Charge. The Mortality and Expense Risk Charge is for the mortality
and expense risks assumed by National Life under the Contracts. The
Administration Charge will reimburse National Life for the administrative
expenses related to the issue and maintenance of the Contracts (see "Charges and
Deductions," page ). National Life will also assess an Annual Contract fee in
the amount of $30, payable on the Date of Issue and at each Contract
Anniversary thereafter if on the Date of Issue or such Contract Anniversary the
Contract Value plus any outstanding loan and accrued interest is less than
$50,000 (see "Annual Contract Fee", page ).
If a governmental entity imposes premium taxes, National Life will make
a deduction for premium taxes in a corresponding amount. Certain states impose a
premium tax, currently ranging up to 3.5% (see "Premium Taxes", page ).
To be sure that the Owner is satisfied with the Contract, the Owner has
a ten day free look. Some states may require a longer period. Within ten days
of the day the Contract is received, it may be returned to the Home Office of
National Life, at the address shown on page 1 of this prospectus. When the
Contract is received by National Life, National Life will void the Contract and
refund the Contract Value plus any charges assessed at issue, including the
Annual Contract Fee, any applicable charge for the optional Enhanced Death
Benefit Rider, and any premium tax, unless otherwise required by state and/or
federal law.
In the case of Individual Retirement Annuities and Contracts issued in
states that require the return of Premium Payments , National Life will refund
the greater of: (i) Premium Payments or (ii) Contract Value plus any amount
deducted by National Life for state premium taxes. In these cases, National Life
may require that all Contract Value allocated to the Variable Account initially
be held in the Market Street Money Market Subaccount (see "Free Look", page ).
At the end of the free look
12
<PAGE> 13
period, Contract Value will be allocated among the Subaccounts of the Variable
Account and the Fixed Account based on the allocation percentages specified in
the application. For this purpose, National Life assumes the free look period
ends 20 days after the date the Contract is issued.
NATIONAL LIFE INSURANCE COMPANY, THE VARIABLE ACCOUNT, AND THE FUNDS
NATIONAL LIFE INSURANCE COMPANY
National Life, a mutual life insurance company chartered in 1848 under
Vermont law, is authorized to transact life insurance and annuity business in
Vermont and in 50 other jurisdictions. National Life assumes all mortality and
expense risks under the Contracts and its assets support the Contract's
benefits. Financial Statements for National Life are contained in the
Statement of Additional Information.
THE VARIABLE ACCOUNT
The Variable Account was established by National Life on November 1,
1996, pursuant to the provisions of Vermont law. National Life has caused the
Variable Account to be registered with the Securities and Exchange Commission as
a unit investment trust pursuant to the provisions of the Investment Company
Act. Such registration does not involve supervision of the management of the
Variable Account or National Life by the Securities and Exchange Commission.
The Variable Account is a separate investment account of National Life
and, as such, is not chargeable with liabilities arising out of any other
business National Life may conduct. National Life does not guarantee the
investment performance of the Variable Account. Obligations under the Contracts,
however, are obligations of National Life. Income, gains and losses, whether or
not realized, from the assets of the Variable Account are, in accordance with
the Contracts, credited to or charged against the Variable Account without
regard to other income, gains, or losses of National Life.
Net Premium Payments are allocated within the Variable Account among
one or more Subaccounts made up of shares in the underlying Fund options
designated by the Owner. A separate Subaccount is established within the
Variable Account for each of the underlying Fund options that may be designated
by the Owner.
UNDERLYING FUND OPTIONS
Owners may choose from among a number of different Subaccount options.
However, National Life reserves the right to limit the number of different
Subaccounts used in any Contract over its entire life to 17.
Summary information, including the investment objectives for each of
the underlying Funds held in the Subaccounts is set forth below. THERE CAN BE NO
ASSURANCE THAT THE INVESTMENT OBJECTIVES WILL BE ACHIEVED.
THE ALGER AMERICAN FUND
The Alger American Fund is a "series" type Fund registered with the SEC
as a diversified open-end management investment company issuing a
number of series or classes of shares, each of which represents an
interest in a Portfolio of the Alger American Fund. It was organized
on April 6, 1988 as a Massachusetts business trust. Fred Alger
Management, Inc., acts as the Fund's investment advisor.
ALGER AMERICAN SMALL CAPITALIZATION PORTFOLIO
Investment Objective: To seek long-term capital appreciation by
investing in a diversified, actively managed portfolio of equity
securities, at least 65% in companies with a total market
13
<PAGE> 14
capitalization within the range of companies included in the Russell
2000 Growth Index or the S&P SmallCap 600 Index, updated quarterly
(both of the above indexes are broad indexes of small capitalization
stocks).
ALGER AMERICAN GROWTH PORTFOLIO
Investment Objective: To seek long-term capital appreciation by
investing in a diversified, actively managed portfolio of equity
securities, at least 65% in companies with a total market
capitalization of $1 billion or greater.
FIDELITY VARIABLE INSURANCE PRODUCTS FUND
The Fund is an open-end, diversified, management investment company
organized as a Massachusetts business trust on November 13, 1981.
Fidelity Management & Research Company ("FMR") is the Fund's manager.
-EQUITY-INCOME PORTFOLIO
Investment Objective: To seek reasonable income by investing primarily
in income-producing equity securities. In choosing these securities FMR
also will consider the potential for capital appreciation. The
Portfolio's goal is to achieve a yield which exceeds the composite
yield on the securities comprising the Standard & Poor's 500 Composite
Stock Price Index.
-GROWTH PORTFOLIO
Investment Objective: Seeks to achieve capital appreciation. This
Portfolio will invest in the securities of both well-known and
established companies, and smaller, less well-known companies which may
have a narrow product line or whose securities are thinly traded. These
latter securities will often involve greater risk than may be found in
the ordinary investment security. FMR's analysis and expertise plays an
integral role in the selection of securities and, therefore, the
performance of the Portfolio. Many securities which FMR believes would
have the greatest potential may be regarded as speculative, and
investment in the Portfolio may involve greater risk than is inherent
in other underlying Funds. It is also important to point out that the
Portfolio makes most sense for you if you can afford to ride out
changes in the stock market, because it invests primarily in common
stocks. FMR also can make temporary investments in securities such as
investment-grade bonds, high-quality preferred stocks and short-term
notes, for defensive purposes when it believes market conditions
warrant.
-HIGH INCOME PORTFOLIO
Investment Objective: Seeks to obtain a high level of current income by
investing primarily in high-risk, lower-rated, high-yielding,
fixed-income securities, while also considering growth of capital. The
Portfolio manager will seek high current income normally by investing
the Portfolio's assets as follows:
- at least 65% in income-producing debt securities
and preferred stocks, including convertible securities; and
- up to 20% in common stocks and other equity
securities when consistent with the Portfolio's primary objective or
acquired as part of a unit combining fixed- income and equity
securities.
The Portfolio's investment strategy may provide the opportunity for
higher than average yields by investing in securities with higher than
average risk, such as lower rated and unrated debt and comparable
equity instruments. For a discussion of the risks associated with such
investments, please see the "Risks of Lower Rated Debt Securities"
section of the Portfolio's prospectus.
14
<PAGE> 15
-OVERSEAS PORTFOLIO
Investment Objective: To seek long term growth of capital primarily
through investments in foreign securities. The Overseas Portfolio
provides a means for investors to diversify their own portfolios by
participating in companies and economies outside of the United States.
FIDELITY VARIABLE INSURANCE PRODUCTS FUND II
The Variable Insurance Products Fund II is an open-end, diversified,
management investment company organized as a Massachusetts business
trust on March 21, 1988. FMR is the Fund's manager.
-INDEX 500 PORTFOLIO
Investment Objective: To seek to match the total return of the Standard
& Poors' Composite Index of 500 Stocks ("S&P 500") while keeping
expenses low. FMR normally invests at least 80% of the fund's assets in
equity securities of companies that compose the S&P 500.
-CONTRAFUND PORTFOLIO
Investment Objective: To seek capital appreciation by investing
primarily in companies that the Fund manager believes to be undervalued
due to an overly pessimistic appraisal by the public. This strategy can
lead to investments in domestic or foreign companies, small and large,
many of which may not be well known. The Fund primarily invests in
common stock and securities convertible into common stock, but it has
the flexibility to invest in any type of security that may produce
capital appreciation.
MARKET STREET FUND, INC.
The Market Street Fund, Inc is a "series" type Fund registered with
the SEC as a diversified open-end management investment company
issuing a number of series or classes of shares, each of which
represents an interest in a Portfolio of the Fund. It was incorporated
under Maryland law on March 21, 1985. Sentinel Advisors Company acts
as the Fund's investment advisor for all portfolios except the
International Fund, whose investment advisor is Providentmutual
Investment Management Company, and whose subadvisor is The Boston
Company Asset Management, Inc.
COMMON STOCK PORTFOLIO
Investment Objective: To seek a combination of long-term growth of
capital and current income with relatively low risk by investing in common
stocks of many well-established companies.
SENTINEL GROWTH PORTFOLIO
Investment Objective: To seek long-term growth of capital through
equity participation in companies having growth potential believed by its
investment adviser to be more favorable than the U.S. economy as a whole,
with a focus on relatively well-established companies.
AGGRESSIVE GROWTH PORTFOLIO
Investment Objective: To seek to achieve a high level of long-term
capital appreciation by investing in securities of a diverse group of
smaller emerging companies.
15
<PAGE> 16
BOND PORTFOLIO
Investment Objective: To seek to generate a high level of current
income consistent with prudent investment risk by investing in a
diversified portfolio of marketable debt securities.
MANAGED PORTFOLIO
Investment Objective: To seek to realize as high a level of long-term
total rate of return as is consistent with prudent investment risk by
investing in stocks, bonds, money market instruments or a combination
thereof.
INTERNATIONAL PORTFOLIO
Investment Objective: To seek long-term growth of capital principally
through investments in a diversified portfolio of marketable equity
securities of established non-United States companies.
MONEY MARKET PORTFOLIO
Investment Objective: To seek to provide maximum current income
consistent with capital preservation and liquidity by investing in
high-quality money market instruments. AN INVESTMENT IN THE MONEY MARKET
PORTFOLIO IS NEITHER INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT, AND
THERE CAN BE NO ASSURANCE THAT THE PORTFOLIO WILL BE ABLE TO MAINTAIN A
STABLE NET ASSET VALUE OF $1.
STRONG VARIABLE INSURANCE FUNDS, INC.
Strong Variable Insurance Funds, Inc. is an open-end management
investment company incorporated in the State of Wisconsin
on December 28, 1990. Strong Capital Management, Inc. is the
investment advisor to the Funds.
-GROWTH FUND II
Investment Objective: To seek capital growth. It invests primarily in
equity securities that the advisor believes have above-average growth
prospects.
STRONG SPECIAL FUND II, INC.
The Strong Special Fund II, Inc. is a diversified, open-end management
company, incorporated in Wisconsin on December 28, 1990. Strong
Capital Management, Inc. is the investment advisor for the Fund.
Investment Objective: To seek capital appreciation through investments
in a diversified portfolio of equity securities.
VAN ECK WORLDWIDE INSURANCE TRUST
Van Eck Worldwide Insurance Trust is an open-end management investment
company organized as a Massachusetts business trust on January 7, 1987. The
investment advisor and manager is Van Eck Associates Corporation.
WORLDWIDE BOND FUND
Investment Objective: To seek high total return through a flexible
policy of investing globally, primarily in debt securities.
National Life has entered into or may enter into agreements with Funds
pursuant to which the adviser or distributor pays National Life a fee based upon
an annual percentage of the average net asset amount invested by National Life
on behalf of the Variable Account and other separate accounts of National Life.
These percentages may differ, and National Life may be paid a greater percentage
by some investment advisers or distributors than other advisers or distributors.
These agreements reflect administrative services provided by National Life.
The underlying Fund options may also be available to registered
separate accounts offering variable annuity and variable life products of other
participating insurance companies, as well as to the
16
<PAGE> 17
Variable Account and other separate accounts of National Life. Although National
Life does not anticipate any disadvantages to this, there is a possibility that
a material conflict may arise between the interest of the Variable Account and
one or more of the other separate accounts participating in the underlying
Funds. A conflict may occur due to a change in law affecting the operations of
variable life and variable annuity separate accounts, differences in the voting
instructions of the Owners and those of other companies, or some other reason.
In the event of conflict, National Life will take any steps necessary to protect
Owners and variable annuity payees, including withdrawal of the Variable Account
from participation in the underlying Fund or Funds which are involved in the
conflict.
DETAILED DESCRIPTION OF CONTRACT PROVISIONS
ISSUANCE OF A CONTRACT
If the Owner is a human being, the Contract is available to Owners up to
and including age 85 on the Date of Issue. If the Contract is issued to Joint
Owners, then the oldest of the Joint Owners must be 85 years of age or younger
on the Date of Issue. If the Owner is not a human being, then the age of the
Annuitant governs, and must meet the requirements for Owners set forth above.
In order to purchase a Contract, an individual must forward an application
to National Life through a licensed National Life agent who is also a registered
representative of Equity Services, Inc. ("ESI"), the principal underwriter of
the Contracts, or another broker/dealer having a Selling Agreement with ESI or a
broker/dealer having a Selling Agreement with such a broker/dealer.
PREMIUM PAYMENTS
The Initial Premium Payment. The initial Premium Payment must be at
least $5,000 for Non-Qualified Contracts, and in general must be at least $1500
for Qualified Contracts (National Life may at its discretion permit initial
Premium Payments lower than the $1500 minimum if a group of Contracts are being
purchased by a group of individuals and funds are remitted electronically).
Subsequent Premium Payments. Subsequent Premium Payments may be made at
any time, but must be at least $100, except that National Life may accept lower
Premium Payments at its discretion if the Premium Payments are remitted
electronically. Subsequent Premium Payments to the Variable Account will be
priced on the basis of the Accumulation Unit Value next computed for the
appropriate Subaccount after the additional Premium Payment is received.
The cumulative total of all Premium Payments under Contracts issued on
the life of any one Annuitant may not exceed $1,000,000 without the prior
consent of National Life.
Premium Payments will not be processed on the following days: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving, the day after Thanksgiving and Christmas Day.
Allocation of Net Premium Payments. In the application for the
Contract, the Owner will indicate how Net Premium Payments are to be allocated
among the Subaccounts of the Variable Account and/or the Fixed Account. These
allocations may be changed at any time by the Owner by written notice to
National Life at its Home Office, or if the telephone transaction privilege has
been elected, by telephone instructions (see "Telephone Transaction Privilege",
page ). The percentages of Net Premium Payments that may be allocated to any
Subaccount must be in whole numbers of not less than 5%, and the sum of the
allocation percentages must be 100%. National Life will allocate the initial
Net Premium Payment within two business days after receipt, if the application
and all information necessary for processing the order are complete. If the
application is not properly completed, National Life will retain the initial
Premium Payment for up to five business days while attempting to complete the
application. If the application is not complete at the end of the five day
period, National Life will inform the applicant of the reason for the delay and
the initial Premium Payment will be returned immediately, unless the applicant
specifically consents to National Life retaining the initial Premium Payment
until the application is complete. Once the application is complete, the
initial Net Premium Payment will be allocated as designated by the Owner within
two business days.
17
<PAGE> 18
Notwithstanding the foregoing, in jurisdictions where National Life
must refund the greater of aggregate Premium Payments or Contract Value plus any
amount deducted for state premium taxes in the event the Owner exercises the
free look right, any portion of the initial Net Premium Payment to be allocated
to the Variable Account will be allocated to the Market Street Money Market
Subaccount for the free look period following the Date of Issue. At the end of
that period, the amount in the Market Street Money Market Subaccount will be
allocated to the Subaccounts as designated by the Owner based on the proportion
that the allocation percentage for each such Subaccount bears to the sum of the
allocation percentages to the Subaccounts set forth in the Net Premium Payment
allocation schedule then in effect.
National Life will allocate subsequent Net Premium Payments as of the
Valuation Date it receives such Net Premium Payments at its Home Office, based
on the Owner's allocation percentages then in effect. At the time of allocation,
Net Premium Payments are applied to the purchase of shares of the respective
underlying Funds at net asset value for the respective Subaccount(s) and
converted into Accumulation Units.
National Life reserves the right to limit the number of Variable
Account Subaccounts used in a single Contract over the entire life of the
Contract to 17.
The values of the Subaccounts will vary with their investment
experience and the Owner bears the entire investment risk. Owners should
periodically review their allocation percentages in light of market conditions
and the Owner's overall financial objectives.
TRANSFERS
The Owner may transfer the Contract Value among the Subaccounts of the
Variable Account, and between the Variable Account and the Fixed Account,
subject to the limitations set forth below, by making a written transfer request
to National Life, or if the telephone transaction privilege has been elected, by
telephone instructions to National Life. See "Telephone Transaction Privilege",
page . Transfers between and among the Subaccounts of the Variable Account and
the Fixed Account are made as of the Valuation Day that the request for transfer
is received at the Home Office. Transfers to or from the Subaccounts of the
Variable Account may be postponed under certain circumstances. See "Payments,"
page .
National Life currently allows transfers to the Fixed Account of all or
any part of the Variable Account Contract Value, without charge or penalty. With
respect to transfers from the Variable Account to the Fixed Account, National
Life reserves the right to restrict transfers to the Fixed Account to 25% of the
Variable Account Contract Value for any Contract Year determined as of the
most recent Contract Anniversary.
Owners may, once per year within 45 days after the end of the calendar
year, transfer a portion of the unloaned value in the Fixed Account to the
Variable Account. The maximum percentage that may be transferred will be
determined by National Life in its sole discretion prior to the end of the
calendar year, but will not be less than 10% of the Contract Value in the Fixed
Account as of the date the request is made. Following a transfer from the Fixed
Account to the Variable Account, National Life reserves the right to require
that the value so transferred remain in the Variable Account for at least one
year before it may be transferred back to the Fixed Account.
National Life does not permit transfers between the Variable Account
and the Fixed Account after the Annuitization Date.
National Life has no current intention to impose a transfer charge in
the foreseeable future. However, National Life reserves the right, upon prior
notice to Owners, to impose a transfer charge of $25 for each transfer in excess
of twelve transfers in any one Contract Year. See "Transfer Charge", page .
18
<PAGE> 19
VALUE OF A VARIABLE ACCOUNT ACCUMULATION UNIT
The value of a Variable Account Accumulation Unit for each Subaccount
was arbitrarily set initially at $10 when the Subaccounts commenced operations.
The value for any subsequent Valuation Period is determined by multiplying the
Accumulation Unit value for each Subaccount for the immediately preceding
Valuation Period by the Net Investment Factor for the Subaccount during the
subsequent Valuation Period. The value of an Accumulation Unit may increase or
decrease from Valuation Period to Valuation Period. No minimum Accumulation Unit
value is guaranteed. The number of Accumulation Units will not change as a
result of investment experience.
Net Investment Factor. Each Subaccount of the Variable Account
has its own Net Investment Factor. The Net Investment Factor measures the daily
investment performance of that Subaccount. The Net Investment Factor may be
greater or less than one; therefore, the value of an Accumulation Unit may
increase or decrease. It should be noted that changes in the Net Investment
Factor may not be directly proportional to changes in the net asset value of
underlying Fund shares, because of the deduction for the Mortality and Expense
Risk Charge and Administration Charge.
Underlying Fund shares in the Variable Account will be valued at their
net asset value. For underlying Funds that credit dividends on a daily basis and
pay such dividends once a month (the Market Street Money Market Portfolio), the
Net Investment Factor allows for the monthly reinvestment of these daily
dividends.
DETERMINING THE CONTRACT VALUE
The Contract Value is the sum of: 1) the value of all Variable Account
Accumulation Units, and 2) amounts allocated and credited to the Fixed Account,
minus any outstanding loans on the Contract and accrued interest on such loans.
When charges or deductions are made against the Contract Value, an appropriate
number of Accumulation Units from the Variable Account and an appropriate amount
from the Fixed Account will be deducted in the same proportion that the Owner's
interest in the Variable Account and Fixed Account bears to the total Contract
Value. Value held in the Fixed Account is not subject to Variable Account
charges (Mortality and Expense Risk and Administration Charges), but may be
subject to Contingent Deferred Sales Charges, the Annual Contract Fee, optional
Enhanced Death Benefit Rider Charge, and premium taxes, if applicable.
ANNUITIZATION
Maturity Date. The Owner selects a Maturity Date at the time of
application. Such date must be at least 2 years after the Date of Issue, unless
otherwise approved. If no specific Maturity Date is selected, the Maturity Date
will be the Owner's age 90 (the Annuitant's age 90 if the Owner is not a human
being); or, if later, ten years after the Date of Issue.
If the Owner requests in writing (see "Ownership Provisions",
page ), and National Life approves the request, the Maturity Date may be
accelerated or deferred.
Election of Payment Options. The Owner may, upon prior written notice
to National Life, at any time prior to the Annuitization Date, elect one of the
Annuity Payment Options. The Contract Value in each Subaccount less any premium
tax previously unpaid, will be applied to provide a Variable Annuity payment
and the Contract Value in the Fixed Account, less any premium tax previously
unpaid, will be applied to provide a Fixed Annuity payment.
If an election of an Annuity Payment Option is not on file with
National Life on the Annuitization Date, the proceeds will be paid as Option 3 -
Payments for Life with 120 months certain. An Annuity Payment Option may be
elected, revoked or changed by the Owner at any time before the Annuitization
Date upon 30 days prior written notice. The Annuity Payment Options available
are described below.
Frequency and Amount of Annuity Payments. Annuity payments will be paid
as monthly installments unless the Owner selects annual, semi-annual or
quarterly installments. However, if the amount to be applied under any Annuity
Payment Option is less than $3,500, National Life shall have the right to pay
such amount in one lump sum in lieu of the payments otherwise provided for. In
addition, if the payments provided for would be or become less than $100,
19
<PAGE> 20
National Life shall have the right to change the frequency of payments to such
intervals as will result in payments of at least $100. In no event will National
Life make payments under an annuity option less frequently than annually.
ANNUITIZATION - VARIABLE ACCOUNT
The dollar amount of the first Variable Annuity payment shall be
determined by dividing the Variable Account Contract Value on the Annuitization
Date by 1,000 and applying the result in accordance with the Applicable Annuity
Table. The amount of each Variable Annuity payment will depend on the age of
the Chosen Human Being at the time the first payment is due, and the sex of the
Chosen Human Being, if applicable, unless otherwise required by law.
Subsequent Variable Annuity payments vary in amount in accordance with
the investment performance of the Variable Account. The dollar amount of the
first annuity payment determined as above is divided by the value of an Annuity
Unit as of the Annuitization Date to establish the number of Annuity Units
representing each monthly annuity payment. This number of Annuity Units remains
fixed during the annuity payment period. The dollar amount of the second and
subsequent payments is not predetermined and may change from month to month. The
dollar amount of each subsequent payment is determined by multiplying the fixed
number of Annuity Units by the value of an Annuity Unit for the Valuation Period
in which the payment is due. National Life guarantees that the dollar amount of
each payment after the first will not be affected by variations in mortality
experience from mortality assumptions used to determine the first payment.
Value of an Annuity Unit. The value of an Annuity Unit for a Subaccount
was arbitrarily set initially at $10 when the first underlying Fund shares were
purchased. The value of an Annuity Unit for a Subaccount for any subsequent
Valuation Period is determined by multiplying the value of an Annuity Unit for
the immediately preceding Valuation Period by the applicable Net Investment
Factor for the Valuation Period for which the value of an Annuity Unit is being
calculated, and multiplying the result by an interest factor to neutralize the
assumed investment rate of 3.5% per annum (see "Net Investment Factor", page ).
Assumed Investment Rate. A 3.5% Assumed Investment Rate is built into
the Annuity Tables contained in the Contracts. A higher assumption would mean a
higher initial payment but more slowly rising or more rapidly falling subsequent
payments. A lower assumption would have the opposite effect. If the actual
investment return is at the annual rate of 3.5%, the annuity payments will be
level.
ANNUITIZATION - FIXED ACCOUNT
A Fixed Annuity is an annuity with payments which are guaranteed by
National Life as to dollar amount during the annuity payment period. The amount
of the periodic Fixed Annuity payment will be determined by applying the Fixed
Account Contract Value to the applicable Annuity Table in accordance with the
Annuity Payment Option elected. This will be done at the Annuitization Date on
an age nearest birthday basis.
National Life does not credit discretionary interest to Fixed Annuity
payments during the annuity payment period for annuity options based on life
contingencies. The Annuitant must rely on the Annuity Tables applicable to the
Contracts to determine the amount of such Fixed Annuity payments.
ANNUITY PAYMENT OPTIONS
Any of the following Annuity Payment Options may be elected:
Option 1-Payments for a Stated Time. Monthly payments will be made for
the number of years selected, which may range from 5 years to 30 years.
Option 2-Payments for Life-An annuity payable monthly during the
lifetime of a Chosen Human Being (who may be named at the time of
election of the Payment Option), ceasing with the last payment due
prior to the death of the Chosen Human Being. IT WOULD BE POSSIBLE
20
<PAGE> 21
UNDER THIS OPTION FOR THE PAYEE TO RECEIVE ONLY ONE ANNUITY PAYMENT IF
THE CHOSEN HUMAN BEING DIED BEFORE THE SECOND ANNUITY PAYMENT DATE, TWO
ANNUITY PAYMENTS IF THE CHOSEN HUMAN BEING DIED BEFORE THE THIRD
ANNUITY PAYMENT DATE, AND SO ON.
Option 3-Payments for Life with Period Certain - Guaranteed-An annuity
that if at the death of the Chosen Human Being payments have been made
for fewer than 120 or 240 months, as selected, guaranteed annuity
payments will be continued during the remainder of the selected period
to the Payee, or another recipient as chosen by the Payee at the time
the Annuity Payment Option was selected. In the alternative, the
recipient may, at any time, elect to have the present value of the
guaranteed number of annuity payments remaining paid in a lump sum,
computed as of the date on which notice of death of the Chosen Human
Being is received by National Life at its Home Office.
Other Annuity Payment Options may be available.
Some of the stated Annuity Payment Options may not be available in all
states. The Owner may request an alternative non-guaranteed option by giving
notice in writing prior to Annuitization. If such a request is approved by
National Life, it will be permitted under the Contract.
Individual Retirement Annuities and Tax Sheltered Annuities are subject
to the minimum Distribution requirements set forth in the Code.
Under Payment Option 1, the Owner may change to any other Payment
Option at any time. At the time of the change, the remaining value will be
applied to the new Payment Option to determine the amount of the payments. Under
Payment Option 1, the Owner may also fully surrender the Contract at any time or
make Withdrawals at any time or from time to time. A surrender or Withdrawal
will be subject to any applicable Contingent Deferred Sales Charge at the time
of the surrender or Withdrawal.
DEATH OF OWNER
If any Owner or Joint Owner dies prior to the Annuitization Date, then,
unless the Enhanced Death Benefit Rider has been elected, a Death Benefit in an
amount equal to, if such Owner or Joint Owner dies prior to attaining age 81,
the greater of (a) the Contract Value, or (b) the Net Premium Payments made to
the Contract minus all Withdrawals (including any CDSC deducted in connection
with such Withdrawals) and any outstanding loan on the Contract and accrued
interest, and, in the case of both (a) and (b), minus any applicable premium
tax charge to be assessed upon distribution, will be paid to the Beneficiary.
If such Owner or Joint Owner dies after attaining age 81, then the Death
Benefit shall be equal to the Contract Value, minus any applicable premium tax
charge.
Unless the Beneficiary is the deceased Owner's (or Joint Owner's)
spouse, the Death Benefit must be distributed within five years of such Owner's
death. The Beneficiary may, however, elect to receive Distribution in the form
of a life annuity or an annuity for a period not exceeding his or her life
expectancy. Such annuity must begin within one year following the date of the
Owner's death, and is currently available only as a Fixed Annuity. If the
Beneficiary is the spouse of the deceased Owner (or Joint Owner), then the
Contract may be continued without any required Distribution. If the deceased
Owner (or Joint Owner) and the Annuitant are the same person, the death of that
person will be treated as the death of the Owner for purposes of determining
the Death Benefit payable.
Qualified Contracts may be subject to specific rules set forth in the
Plan, Contract, or Code concerning Distributions upon the death of the Owner.
DEATH OF ANNUITANT PRIOR TO THE ANNUITIZATION DATE
If an Annuitant who is not an Owner dies prior to the Annuitization
Date, the Contract will mature, and a Death Benefit equal to the Cash Surrender
Value of the Contract will be payable to the Beneficiary, unless, in the case
where the Owner is a human being, a contingent Annuitant has been named or the
Owner names a contingent Annuitant within 90 days of such Annuitant's death, in
which case the Contract may be continued without any required Distribution. If
no Beneficiary is named (or if the Beneficiary predeceases the Annuitant), then
the Death Benefit will be paid to the Owner. If the Owner is not a human being,
then
21
<PAGE> 22
the death of the Annuitant will be treated as if it were the death of the Owner,
and the disposition of the Contract will follow the death of the Owner
provisions set forth above.
In any case where a Death Benefit is paid, the value of the Death
Benefit will be determined as of the Valuation Day coincident with or next
following the date National Life receives in writing: (1) due proof of the
Annuitant's or an Owner's (or Joint Owner's) death; (2) an election for
either a single sum payment or an Annuity Payment Option (currently only Fixed
Annuities are available in these circumstances); and (3) any form
required by state insurance laws. If a single sum payment is requested, payment
will be made in accordance with any applicable laws and regulations governing
the payment of Death Benefits. If an Annuity Payment Option is requested,
election must be made by the Beneficiary during the 90-day period commencing
with the date written notice is received by National Life, and as otherwise
required by law. If no election has been made by the end of such 90-day period
commencing with the date written notice is received by National Life, or as
otherwise required by law, the Death Benefit will be paid in a single sum
payment.
REQUIRED DISTRIBUTIONS FOR QUALIFIED PLANS AND TAX SHELTERED ANNUITIES
The entire interest of an Annuitant under a Qualified Plan or a Tax
Sheltered Annuity Contract will be distributed in a manner consistent with the
Minimum Distribution and Incidental Benefit (MDIB) provisions of Section
401(a)(9) of the Code and regulations thereunder, as applicable, and will be
paid, notwithstanding anything else contained herein, to the Owner/Annuitant
under the Annuity Payments Option selected, over a period not exceeding:
(a) the life of the Owner/Annuitant or the lives of the Owner/Annuitant
and the Owner/Annuitant's Beneficiary; or
(b) a period not extending beyond the life expectancy of the
Owner/Annuitant or the life expectancy of the Owner/Annuitant and the
Owner/Annuitant's Beneficiary.
If the Owner/Annuitant's entire interest is to be distributed in equal
or substantially equal payments over a period described in (a) or (b), such
payments will commence not later than the first day of April following the
calendar year in which the Owner/Annuitant attains age 70 1/2 (the required
beginning date). Beginning January 1, 1997, for an Owner/Annuitant other than a
"5 percent owner" (as defined in Code Section 416) in the case of a
governmental plan (as defined in Code Section 414(d)), or church plan (as
defined in Code Section 401(a)(9)(C)), the Required Beginning Date will be the
later of the dates determined under the preceding sentence or April 1 of the
calendar year following the calendar year in which the Annuitant retires.
If the Owner dies prior to the commencement of his or her Distribution,
the interest in the Qualified Plan or Tax Sheltered Annuity must be distributed
by December 31 of the calendar year in which the fifth anniversary of his or her
death occurs unless:
(a) the Owner names his or her surviving spouse as the Beneficiary and such
spouse elects to:
(i) in the case of a Tax-Sheltered Annuity, treat the annuity as
a Tax Sheltered Annuity established for his or her benefit; or
(ii) receive Distribution of the account in nearly equal payments
over his or her life (or a period not exceeding his or her
life expectancy) and commencing not later than December 31 of
the year in which the Owner would have attained age 70 1/2; or
(b) the Owner names a Beneficiary other than his or her surviving spouse
and such Beneficiary elects to receive a Distribution of the account in
nearly equal payments over his or her life (or a period not exceeding
his or her life expectancy) commencing not later than December 31 of
the year following the year in which the Owner dies.
22
<PAGE> 23
If the Owner/Annuitant dies after Distribution has commenced,
Distribution must continue at least as rapidly as under the schedule being used
prior to his or her death.
Payments commencing on the Required Beginning Date will not be less
than the lesser of the quotient obtained by dividing the entire interest of the
Owner/Annuitant by the life expectancy of the Owner/Annuitant, or the joint and
last survivor expectancy of the Owner/Annuitant and the Owner/Annuitant's
Designated Beneficiary (whichever is applicable under the applicable Minimum
Distribution or MDIB provisions). Life expectancy and joint and last survivor
expectancy are computed by the use of return multiples contained in Section
1.72-9 of the Treasury Regulations.
Other distribution rules may apply to Section 457 plans.
If the amounts distributed to the Owner are less than those mentioned
above, a penalty tax of 50% is levied on the amount that should have been
distributed for that year.
REQUIRED DISTRIBUTIONS FOR INDIVIDUAL RETIREMENT ANNUITIES
Distribution from an Individual Retirement Annuity must begin not later
than April 1 of the calendar year following the calendar year in which the Owner
attains age 70 1/2. Distribution may be accepted in a lump sum or in nearly
equal payments over: (a) the Owner's life or the lives of the Owner and the
Owner's spouse or designated Beneficiary, or (b) a period not extending beyond
the Owner and the Owner's spouse or designated Beneficiary.
If the Owner dies prior to the commencement of the Distribution, the
interest in the Individual Retirement Annuity must be distributed by December 31
of the calendar year in which the fifth anniversary of the Owner's death occurs
unless:
(a) The Owner has named his or her surviving spouse as the designated
Beneficiary and such spouse elects to:
(i) treat the annuity as an Individual Retirement Annuity established
for his or her benefit; or
(ii) receive Distribution of the account in nearly equal payments over
his or her life (or a period not exceeding his or her life
expectancy) and commencing not later than December 31 of the year
in which the Owner would have attained age 70 1/2; or
(b) The Owner has named a Beneficiary other than his or her surviving
spouse and such Beneficiary elects to receive a Distribution of the
account in nearly equal payments over his or her life (or a period not
exceeding his or her life expectancy) commencing not later than
December 31 of the year following the year in which the Owner dies.
If the Owner dies after Distribution has commenced, the Distribution
must continue at least as rapidly as under the schedule being used prior to the
Owner's death, except to the extent that a surviving spouse Beneficiary may
elect to treat the Contract as his or her own, in the same manner as is
described in section (a)(i) of this provision.
If the amounts distributed to the Owner are less than those mentioned
above, a penalty tax of 50% is levied on the amount that should have been
distributed for that year.
A pro-rata portion of all Distributions will be included in the gross
income of the person receiving the Distribution and taxed at ordinary income tax
rates. The portion of the Distribution which is taxable is based on the ratio
between the amount by which non-deductible Premium Payments exceed prior
non-taxable Distributions and total account balances at the time of the
Distribution. The Owner must annually report the amount of non-deductible
Premium Payments, the amount of any Distribution, the amount by which
non-deductible Premium Payments for all years exceed non-taxable Distributions
for all years and the total balance of all Individual Retirement Annuities.
23
<PAGE> 24
Individual Retirement Annuity Distributions will not receive the
benefit of the tax treatment of a lump sum Distribution from a Qualified Plan.
If the Owner dies prior to the time Distribution of the Owner's interest in the
annuity is completed, the balance will also be included in the Owner's gross
estate.
GENERATION-SKIPPING TRANSFERS
National Life may determine whether the Death Benefit or any other
payment constitutes a direct skip as defined in Section 2612 of the Code, and
the amount of the tax on the generation-skipping transfer resulting from such
direct skip. If applicable, the payment will be reduced by any tax National Life
is required to pay by Section 2603 of the Code.
A direct skip may occur when property is transferred to or a Death
Benefit is paid to an individual two or more generations younger than the Owner.
OWNERSHIP PROVISIONS
Unless otherwise provided, the Owner has all rights under the Contract.
IF THE PURCHASER NAMES SOMEONE OTHER THAN HIMSELF OR HERSELF AS OWNER, THE
PURCHASER WILL HAVE NO RIGHTS UNDER THE CONTRACT. If Joint Owners are named,
each Joint Owner will possess an undivided interest in the Contract. The death
of any Joint Owner will trigger the provisions of the Contract relating to the
death of the Owner. Unless otherwise provided, when Joint Owners are named, the
exercise of any ownership right in the Contract (including the right to
surrender the Contract or make a Withdrawal, to change the Owner, the Annuitant,
a Contingent Annuitant, the Beneficiary, the Annuity Payment Option or the
Maturity Date) shall require a written indication of an intent to exercise that
right, signed by all Joint Owners.
Prior to the Annuitization Date, the Owner may name a new Owner. Such
change may be subject to state and federal gift taxes, and may also result in
current federal income taxation (see "Federal Income Tax Considerations,
page __") Any change of Owner will automatically revoke any prior Owner
designation. Any request for change of Owner must be (1) made by proper written
application, (2) received and recorded by National Life at its Home Office, and
(3) may include a signature guarantee as specified in the "Surrender and
Withdrawal" provision on page __. The change will become effective as of the
date the written request is signed. A new choice of Owner will not apply to any
payment made or action taken by National Life prior to the time it was received
and recorded.
The Owner may request a change in the Annuitant or contingent Annuitant
before the Annuitization Date. Such a request must be made in writing on a form
acceptable to National Life and must be signed by the Owner and the person to be
named as Annuitant or contingent Annuitant. Any such change is subject to
underwriting and approval by National Life.
24
<PAGE> 25
CHARGES AND DEDUCTIONS
All of the charges described in this section apply to Variable Account
allocations. Allocations to the Fixed Account are subject to Contingent Deferred
Sales Charges, the Annual Contract Fee and Premium Tax deductions and the
charge for the Enhanced Death Benefit Rider, if applicable, but are not
subject to charges exclusive to the Variable Account: the Mortality and
Expense Risk Charge and the Administration Charge.
National Life deducts the charges described below to cover its costs and
expenses, services provided and risks assumed under the Contracts. National Life
incurs certain costs and expenses for the distribution and administration of the
Contracts and for providing the benefits payable thereunder. More particularly,
the administrative services include: processing applications for and issuing
the Contracts, processing purchases and redemptions of Fund shares as required
(including automatic withdrawal services), maintaining records, administering
annuity payouts, furnishing accounting and valuation services (including the
calculation and monitoring of daily Subaccount values), reconciling and
depositing cash receipts, providing Contract confirmations, providing toll-free
inquiry services and furnishing telephone transaction privileges. The risks
National Life assumes include: the risk that the actual life-span of persons
receiving annuity payments under Contract guarantees will exceed the assumptions
reflected in National Life's guaranteed rates (these rates are incorporated in
the Contract and cannot be changed); the risk that Death Benefits, or the
Enhanced Death Benefit under the optional Enhanced Death Benefit Rider, will
exceed the actual Contract Value; the risk that more Owners than expected will
qualify for waivers of the Contingent Deferred Sales Charge; and the risk that
National Life's costs in providing the services will exceed its revenues from
the Contract charges (which cannot be changed by National Life). The amount of a
charge will not necessarily correspond to the costs associated with providing
the services or benefits indicated by the designation of the charge. For
example, the Contingent Deferred Sales Charge collected may not fully cover all
of the distribution expenses incurred by National Life.
DEDUCTIONS FROM THE VARIABLE ACCOUNT
National Life deducts from the Variable Account an amount, computed
daily, which is equal to an annual rate of 1.40% of the daily net asset value.
The charge consists of a 0.15% Administration Charge and a 1.25% Mortality and
Expense Risk Charge.
CONTINGENT DEFERRED SALES CHARGE
No deduction for a sales charge is made from the Premium Payments for
these Contracts. However, if a Withdrawal is made with respect to any part of
the Contract Value of such a Contract or a Contract is surrendered, National
Life will, with certain exceptions, deduct a Contingent Deferred Sales Charge
not to exceed 7% of the lesser of the total of all Net Premium Payments made
within 84 months prior to the date of the request to surrender, or the amount
withdrawn.
The Contingent Deferred Sales Charge is calculated by multiplying the
applicable Contingent Deferred Sales Charge percentages noted below by the Net
Premium Payments that are withdrawn or surrendered. For purposes of calculating
the Contingent Deferred Sales Charge, Withdrawals or surrenders are considered
to come first from the oldest Net Premium Payment made to the Contract, then
the next oldest Net Premium Payment and so forth, with any earnings
attributable to such Net Premium Payments considered withdrawn only after all
Net Premium Payments made to the Contract have been considered withdrawn (no
Contingent Deferred Sales Charge is ever assessed with respect to a Withdrawal
or surrender of earnings). For tax purposes, a surrender is usually treated as
a withdrawal of earnings first. This charge will apply in the amounts set forth
below to Net Premium Payments within the time periods set forth.
25
<PAGE> 26
The Contingent Deferred Sales Charge applies to Premium Payments as
follows:
<TABLE>
<CAPTION>
NUMBER OF COMPLETED CONTINGENT DEFERRED NUMBER OF COMPLETED CONTINGENT DEFERRED
YEARS FROM DATE OF SALES CHARGE YEARS FROM DATE OF SALES CHARGE
PREMIUM PAYMENT PERCENTAGE PREMIUM PAYMENT PERCENTAGE
- ---------------- ---------- --------------- -----------
<S> <C> <C> <C>
0 7% 4 3%
1 6% 5 2%
2 5% 6 1%
3 4% 7 0%
</TABLE>
In any Contract Year after the first Contract Year, except in the
states referred to in the last sentence of this paragraph, the Owner may effect
Withdrawals without a Contingent Deferred Sales Charge ("CDSC") of an aggregate
amount equal to 15% of the Contract Value as of the most recent Contract
Anniversary. This CDSC-free Withdrawal privilege does not apply to full
surrenders of the Contract, and if a full surrender is made within one year of
exercising a CDSC-free Withdrawal, then the Contingent Deferred Sales Charge
which would have been assessed at the time of the Withdrawal will be assessed at
the time of surrender. The CDSC-free feature is also non-cumulative; so that
free amounts not taken during any given Contract Year cannot be taken as free
amounts in a subsequent Contract Year. In addition, any amount withdrawn in
order to meet minimum Distribution requirements under the Code shall be free of
CDSC. In the first Contract Year a CDSC-free Withdrawal is available only by
setting up a monthly systematic Withdrawal program for an amount not exceeding
the annual CDSC-free Withdrawal amount (see "Available Automated Fund
Management Features-Systematic Withdrawals," page __). The Owner may be subject
to a tax penalty if the Owner takes Withdrawals prior to age 59 1/2 (see
"Federal Income Tax Considerations"). In any states which require that any
CDSC-free Withdrawal provision be available on full surrenders as well as
Withdrawals, the CDSC-free Withdrawal provision will apply to full surrenders
but will be limited to 10% of the Contract Value as of the most recent Contract
Anniversary for both Withdrawals and full surrenders.
In addition, no Contingent Deferred Sales Charge will be deducted: (1)
upon the Annuitization of Contracts, (2) upon payment of a death benefit
pursuant to the death of the Owner, or (3) from any values which have been held
under a Contract for at least 84 months. No Contingent Deferred Sales Charge
applies upon the transfer of value among the Subaccounts or between the Fixed
Account and the Variable Account.
When a Contract is held by a charitable remainder trust, the amount
which may be withdrawn from this Contract without application of a Contingent
Deferred Sales Charge, after the first Contract Year, shall be the larger of
(a) or (b), where (a) is the amount which would otherwise be available for
Withdrawal without application of a Contingent Deferred Sales Charge; and
where (b) is the difference between the Contract Value as of the last Contract
Anniversary and the Net Premium Payments made to the Contract less all
Withdrawals and less any outstanding loan and accrued interest, as of the last
Contract Anniversary.
National Life will waive the Contingent Deferred Sales Charge if the
Owner dies, or if the Owner annuitizes (in such a case, however, the Owner may
not elect a settlement option under which he or she has the right to receive a
lump sum prior to seven years after the date of the last Premium Payment, unless
a Contingent Deferred Sales Charge is paid at the time of payment of the lump
sum).
National Life will also waive the CDSC if, following the first Contract
Anniversary, the Owner has been confined to an eligible nursing home (as
defined in the Contract) for at least the 90 consecutive days ending on the
date of the Withdrawal request.
ANNUAL CONTRACT FEE
For Contracts with a Contract Value plus any outstanding loan and accrued
interest of less than $50,000 as of the Date of Issue, or any subsequent
Contract Anniversary prior to the Annuitization Date, National Life will assess
an Annual Contract Fee of $30.00. This fee will be assessed annually in advance
on the Date of Issue and thereafter on each Contract Anniversary on which the
Contract Value plus any outstanding loan and accrued interest is less than
$50,000, until the Annuitization Date. No Annual Contract Fee will be assessed
after the Annuitization Date. This fee will be taken pro rata from all
Subaccounts of the Variable Account and the unloaned portion of the Fixed
Account.
26
<PAGE> 27
TRANSFER CHARGE
Currently, unlimited transfers are permitted among the Subaccounts, and
transfers between the Fixed Account and the Variable Account are permitted
within the limits described on page , in each case without charge. National Life
has no present intention to impose a transfer charge in the foreseeable future.
However, National Life reserves the right to impose in the future a transfer
charge of $25 on each transfer in excess of twelve transfers in any Contract
Year.
If imposed, the transfer charge will be deducted from the amount being
transferred. All transfers requested on the same Valuation Day are treated as
one transfer transaction. Any future transfer charge will not apply to transfers
resulting from loans, and any transfers made pursuant to the Dollar Cost
Averaging and Portfolio Rebalancing features. These transfers will not count
against the twelve free transfers in any Contract Year.
PREMIUM TAXES
If a governmental entity imposes premium taxes, National Life will make
a deduction for premium taxes in a corresponding amount. Certain states impose a
premium tax, currently ranging up to 3.5%. National Life will pay premium taxes
at the time imposed under applicable law. Where National Life is required to
pay this premium tax when a premium is paid, it may deduct an amount equal to
premium taxes from the Premium Payment. National Life currently intends to make
this deduction from Premium Payments only in South Dakota. In the remaining
states which assess premium taxes, National Life currently expects to make its
deduction for premium taxes at the time of Annuitization, death of the Owner,
or surrender, although it also reserves the right to make such a deduction at
the time it pays premium taxes to the applicable taxing authority.
CHARGE FOR OPTIONAL ENHANCED DEATH BENEFIT RIDER
Annual charges are made if the Owner has elected the optional Enhanced
Death Benefit Rider. See "Optional Enhanced Death Benefit Rider," page .
The annual charge for the Enhanced Death Benefit Rider is 0.20% of Contract
Value as of the date the charge is deducted plus the amount of any outstanding
loan and accrued interest. The annual charge will be deducted at issue (or at
the time of election, if elected subsequent to issue), and then on each
Contract Anniversary thereafter, up to and including age 80 on an age-nearest-
birthday basis as of the relevant Contract Anniversary. After age 80, the
charge will be discontinued. The charge will be taken pro rata from the
Subaccounts of the Variable Account and the unloaned portion of the Fixed
Account.
OTHER CHARGES
The Variable Account purchases shares of the Funds at net asset value.
The net asset value of those shares reflect management fees and expenses already
deducted from the assets of the Funds. Information on the fees and expenses for
the Funds is set forth in "Underlying Fund Annual Expenses" on page __.
More detailed information is contained in the Funds' prospectuses which
accompany this prospectus.
CONTRACT RIGHTS
FREE LOOK
The Owner may revoke the Contract at any time between the Date of Issue
and the date 10 days after receipt of the Contract, and receive a refund of the
Contract Value plus any charges assessed at issue, including the Annual
Contract Fee, charge for the Optional Enhanced Death Benefit Rider, and any
premium tax, unless otherwise required by state and/or federal law. Some states
may require a longer period. Where the Contract Value is refunded, the Owner
will have borne the investment risk and been entitled to the benefit of the
investment performance of the chosen Subaccounts during the time the Contract
was in force.
In the case of Individual Retirement Annuities and states that require
the return of Premium Payments, National Life will refund the greater of: (i)
Premium Payments or (ii) Contract Value plus
27
<PAGE> 28
any amount deducted by National Life for state premium taxes. National Life may
require that all Contract Value allocated to the Variable Account initially be
held in the Market Street Money Market Subaccount. At the end of the free look
period, Contract Value will be allocated among the Subaccounts of the Variable
Account and the Fixed Account based on the allocation percentages specified in
the application. For this purpose, National Life assumes the free look period
ends 20 days after the date the Contract is issued.
In order to revoke the Contract, it must be mailed or delivered to the
Home Office of National Life at the mailing address shown on page 1 of this
prospectus. Mailing or delivery must occur on or before 10 days after receipt of
the Contract for revocation to be effective, except where National Life required
the allocation of Contract Value to the Market Street Money Market Subaccount
for the free look period. In order to revoke the Contract, if it has not been
received, written notice must be mailed or delivered to the Home Office of
National Life at the mailing address shown on page 1 of this prospectus.
The liability of the Variable Account under this provision is limited
to the Contract Value in each Subaccount on the date of revocation. Any
additional amounts refunded to the Owner will be paid by National Life.
LOAN PRIVILEGE - QUALIFIED CONTRACTS AND CERTAIN TAX SHELTERED ANNUITIES
Prior to the Annuitization Date, the Owner of a Qualified Contract
under Section 401(a) (which includes Section 401(k) plans) or 403(a) of the
Code, or a Section 403(b) Tax Sheltered Annuity Contract which is under the
administration of an ERISA fiduciary, may receive a loan subject to the terms of
the Contract, the Plan, and the Code, which may impose restrictions on loans.
In the future, National Life may extend the loan privilege to all section
403(b) Contracts, but there can be no assurance that it will do so.
Loans from eligible Contracts are available beginning one year
after the Date of Issue. The Owner may borrow a minimum of $1500. The maximum
loan balance which may be outstanding at any time is 50% of the Contract Value,
but not more than $50,000. The $50,000 limit will be reduced by the highest loan
balances owed during the prior one-year period, which may be more than the
amount outstanding at the time of the loan if an interest payment or principal
repayment has been made. Only one loan may be outstanding with respect to any
one Contract at any time. Loans may only be secured by the Contract Value.
All loans are made from the Collateral Fixed Account. An amount equal
to the principal amount of the loan will be transferred to the Collateral Fixed
Account. Unless instructed to the contrary by the Owner, National Life will
transfer to the Collateral Fixed Account an amount equaling the loan from the
Subaccounts of the Variable Account and unloaned portion of the Fixed Account in
the same proportion that such amounts bear to the total Contract Value. No
CDSC is deducted at the time of the loan, or on any transfers to the Collateral
Fixed Account. If the Owner provides specific instructions, loan amounts must
be taken first from the Variable Account, and may only be taken from the
unloaned portion of the Fixed Account to the extent that the Contract Value in
the Variable Account is insufficient to provide the loan. If the loan cannot be
processed in accordance with instructions provided by the Owner, then the loan
will not be processed until National Life receives further instructions from
the Owner.
Until the loan has been repaid in full, that portion of the Collateral
Fixed Account equal to the outstanding loan balance shall be credited on each
Contract Anniversary with interest at an annual rate declared from time to time
by National Life, but will never be less than an annual rate of 3.0%. Specific
loan terms are disclosed at the time of loan application or loan issuance.
Loans must be repaid in substantially level payments, not less
frequently than quarterly, within five years. Loans used to purchase the
principal residence of the Owner must be repaid within 15 years. During the loan
term, the outstanding balance of the loan will continue to accrue interest at
an annual rate specified in the loan agreement. Once established, this interest
rate will be fixed for the life of the loan. Loan repayments will consist of
principal and interest in amounts set forth in the loan agreement. Loan
principal repayments will, on the day they are received, be allocated among the
Fixed Account and Subaccounts of the Variable Account in accordance with the
allocation of Net Premium Payments then in effect.
28
<PAGE> 29
If the Contract is surrendered while the loan is outstanding, the Owner
will receive the Cash Surrender Value. If the Owner/Annuitant dies while the
loan is outstanding, the Death Benefit will also be reduced to reflect the
amount of the loan outstanding plus accrued interest. If annuity payments start
while the loan is outstanding, the Contract Value will be reduced by the amount
of the outstanding loan plus accrued interest. Until the loan is repaid,
National Life reserves the right to restrict any transfer of the Contract which
would otherwise qualify as a transfer as permitted in the Code.
If a loan payment is not made when due, interest will continue to
accrue. If a loan payment is not made within 31 days of when it was due, then a
Withdrawal will be processed in an amount equal to that payment, and applied
to the amount due. This amount may be taxable to the borrower, and may be
subject to the early withdrawal tax penalty.
Loans may also be subject to additional limitations or restrictions
under the terms of the employer's plan. Loans permitted under this Contract may
still be taxable in whole or part if the participant has additional loans from
other plans or contracts. National Life will calculate the maximum nontaxable
loan based on the information provided by the participant or the employer.
Loan repayments must be identified as such or else they will be treated
as Premium Payments and will not be used to reduce the outstanding loan
principal or interest due. National Life reserves the right to modify the term
or procedures associated with the loan privilege in the event of a change in the
laws or regulations relating to the treatment of loans. National Life also
reserves the right to assess a loan processing fee. Individual Retirement
Annuities and Non-Qualified Contracts are not eligible for loans (See
"Non-Qualified Contracts" page __ and "Individual Retirement Annuities"
page __.).
All activity relating to loans and the administration of any loan
program are the responsibility of the trustee or plan administrator under the
ERISA plan.
SURRENDER AND WITHDRAWAL
At any time prior to the Annuitization Date or thereafter if Payment
Option 1 has been elected, the Owner may, upon proper written application by
the Owner deemed by National Life to be in good order, surrender the Contract
Value. "Proper written application" means that the Owner must request the
surrender in writing and include the Contract. National Life may require that
the signature(s) be guaranteed by a member firm of a major stock exchange or
other depository institution qualified to give such a guaranty.
National Life will, upon receipt of any such written request, pay to
the Owner the Cash Surrender Value. The Cash Surrender Value will reflect any
applicable Contingent Deferred Sales Charge (see "Contingent Deferred Sales
Charge"), as well as any outstanding loan and accrued interest and, in certain
states, a premium tax charge (see "Premium Taxes", page ). The Cash Surrender
Value may be more or less than the total of Premium Payments made by a Owner,
depending on the market value of the underlying Fund shares, the amount of any
applicable Contingent Deferred Sales Charge, and other factors.
National Life will normally not permit Withdrawal or surrender of Premium
Payments made by check within the 15 calendar days prior to the date the request
for Withdrawal or surrender is received.
At any time before the death of the Owner and after 30 days from the
Date of Issue, the Owner may make a Withdrawal of a portion of the Contract
Value. The minimum Withdrawal is $500, and the maximum Withdrawal is
that amount which would leave $3500 in remaining Contract Value. If the amount
requested is more than the maximum or less than the minimum, the Withdrawal
will not be processed until National Life receives further instructions from
the Owner.
Generally, Withdrawals in the first Contract Year and Withdrawals in
excess of 15% (10% in certain states) of Contract Value as of the most recent
Contract Anniversary in any Contract Year are subject to the Contingent
Deferred Sales Charge.
29
<PAGE> 30
See "Contingent Deferred Sales Charge", page . However, see "Available
Automated Fund Management Features-Systematic Withdrawals" page __ for
information on a limited means of making systematic Withdrawals in the first
year free of the Contingent Deferred Sales Charge. Withdrawals will be deemed
to be taken from Net Premium Payments in chronological order, with the oldest
Net Premium Payment being withdrawn first. This method will tend to minimize
the amount of the Contingent Deferred Sales Charge.
The Withdrawal will be taken from the Subaccounts of the Variable
Account based on the instructions of the Owner at the time of the Withdrawal
(however, during the first Contract Year, National Life may require that
Withdrawal be taken pro rata from the Subaccounts of the Variable Account and
the unloaned portion of the Fixed Account). If the Owner provides specific
instructions, amounts must be deducted first from the Variable Account, and may
only be deducted from the unloaned portion of the Fixed Account to the extent
that the Contract Value in the Variable Account is insufficient to accomplish
the Withdrawal. If specific allocation instructions are not provided by the
Owner, the Withdrawal will be deducted pro rata from the Subaccounts of the
Variable Account and from the unloaned portion of the Fixed Account. Any
Contingent Deferred Sales Charge associated with a Withdrawal will be deducted
from the Subaccounts of the Variable Account and from the Fixed Account based
on the allocation percentages of the Withdrawal itself, except that any amount
that would be so deducted from a Subaccount which is in excess of the available
value in that Subaccount will be deducted pro rata among the remaining
Subaccounts and the unloaned portion of the Fixed Account. If the Withdrawal
cannot be processed in accordance with instructions provided by the Owner, then
it will not be processed until National Life receives further instructions from
the Owner.
A surrender or a Withdrawal may have tax consequences. See "Federal Income
Tax Considerations", page .
PAYMENTS
National Life will pay any funds surrendered or withdrawn from
the Variable Account within 7 days of receipt of such request in National Life's
Home Office. However, National Life reserves the right to suspend or postpone
the date of any payment or transfer of any benefit or values for any Valuation
Period (1) when the New York Stock Exchange ("Exchange") is closed, (2) when
trading on the Exchange is restricted, (3) when an emergency exists as a result
of which disposal of securities held in the Variable Account is not reasonably
practicable or it is not reasonably practicable to determine the value of the
Variable Account's net assets, or (4) during any other period when the
Securities and Exchange Commission, by order, so permits for the protection of
security holders, provided that applicable rules and regulations of the
Securities and Exchange Commission shall govern as to whether the conditions
prescribed in (2) and (3) exist. National Life reserves the right to delay
payment of any amounts allocated to the Fixed Account which are payable as a
result of a surrender, Withdrawal or loan for up to six months after it has
received written request in a form satisfactory to it.
SURRENDERS AND WITHDRAWALS UNDER A TAX SHELTERED ANNUITY CONTRACT
Where the Contract has been issued as a Tax Sheltered Annuity, the
Owner may surrender or make a Withdrawal of part or all of the Contract Value
at any time this Contract is in force prior to the earlier of the
Annuitization Date or the death of the Designated Annuitant except as provided
below:
A. The surrender or Withdrawal of Contract Value attributable to
contributions made pursuant to a salary reduction agreement (within
the meaning of Code Section 402(g)(3)(A) or (C)), or transfers from a
Custodial Account described in Section 403(b)(7) of the Code, may be
executed only:
1. when the Owner attains age 59 1/2, separates from service, dies, or
becomes disabled (within the meaning of Code Section 72(m)(7)); or
2. in the case of hardship (as defined for purposes of Code Section 401
(k)), provided that any surrender of Contract Value in the case of
hardship may not include any income attributable to salary reduction
contributions.
B. The surrender and Withdrawal limitations described in A. above for
Tax Sheltered Annuities apply to:
30
<PAGE> 31
1. salary reduction contributions to Tax Sheltered Annuities
made for plan years beginning after December 31, 1988;
2. earnings credited to such contracts after the last plan year
beginning before January 1, 1989, on amounts attributable to
salary reduction contributions; and
3. all amounts transferred from 403(b)(7) Custodial Accounts (except
that earnings, and employer contributions as of December 31, 1988
in such Custodial Accounts may be withdrawn in the case of
hardship).
C. Any Distribution other than the above, including exercise of a
contractual ten-day free look provision (when available) may result in
the immediate application of taxes and penalties and/or retroactive
disqualification of a Qualified Contract or Tax Sheltered Annuity.
A premature Distribution may not be eligible for rollover treatment. To
assist in preventing disqualification in the event of a ten-day free look,
National Life will agree to transfer the proceeds to another contract which
meets the requirements of Section 403(b) of the Code, upon proper direction by
the Owner. The foregoing is National Life's understanding of the withdrawal
restrictions which are currently applicable under Section 403(b)(11) and Revenue
Ruling 90-24. Such restrictions are subject to legislative change and/or
reinterpretation from time to time. Distributions pursuant to Qualified Domestic
Relations Orders will not be considered to be a violation of the restrictions
stated in this provision.
The Contract surrender and Withdrawal provisions may also be modified
pursuant to the plan terms and Code tax provisions for Qualified Contracts.
TELEPHONE TRANSACTION PRIVILEGE
If the telephone transaction privilege has been elected, either on the
application for the Contract or by thereafter providing a proper written
authorization to National Life, an Owner or his or her National Life agent, if
the Owner has so provided on the application or by written authorization, may
effect changes in Net Premium Payment allocation, transfers, initiate dollar
cost averaging or portfolio rebalancing, and, in the case of Tax Deferred
Annuity Contracts, loans of up to $10,000, by providing instructions to
National Life at its Home Office over the telephone. National Life reserves the
right to suspend telephone transaction privileges at any time, for any reason,
if it deems such suspension to be in the best interests of Contract Owners.
National Life will employ reasonable procedures to confirm that
instructions communicated by telephone are genuine. If National Life follows
these procedures it will not be liable for any losses due to unauthorized or
fraudulent instructions. National Life may be liable for any such losses if
those reasonable procedures are not followed. The procedures to be followed for
telephone transfers will include one or more of the following: requiring some
form of personal identification prior to acting on instructions received by
telephone, providing written confirmation of the transaction, and making a tape
recording of the instructions given by telephone.
AVAILABLE AUTOMATED FUND MANAGEMENT FEATURES
National Life currently offers, at no charge to Owners, the following
automated fund management features. However, National Life is not legally
obligated to continue to offer these features, and although it has no current
intention to do so, it may cease offering one or more of such features at any
time, after providing 60 days prior written notice to all Owners who are
currently utilizing the features being discontinued. Only one automated fund
management feature is available under any single Contract at one time.
Dollar Cost Averaging. This feature permits an Owner to automatically
transfer funds from the Money Market Subaccount to any other Subaccounts on a
monthly basis. It may be elected at issue by marking the appropriate box on the
initial application, and completing the appropriate instructions, or, after
issue, by filling out similar information on a change request form and sending
it to the Home Office.
31
<PAGE> 32
If this feature is elected, the amount to be transferred will be taken
from the Money Market Subaccount and transferred to the Subaccount or
Subaccounts designated to receive the funds, each month on the Monthly Contract
Date (starting with the Monthly Contract Date next succeeding the Date of Issue,
or next succeeding the date of an election subsequent to purchase), until the
amount in the Money Market Fund is depleted. The minimum monthly transfer by
Dollar Cost Averaging is $100, except for the transfer which reduces the amount
in the Money Market Subaccount to zero. An Owner may discontinue Dollar Cost
Averaging at any time by sending an appropriate change request form to the Home
Office.
This feature allows an Owner to move funds into the various investment
classes on a more gradual and systematic basis than the frequency on which
Premium Payments ordinarily are made. The periodic investment of the same amount
will result in higher numbers of units being purchased when unit prices are
lower, and lower numbers of units being purchased when unit prices are higher.
This will result, over time, in a lower cost per unit than the average of the
unit costs on the days on which the automated purchases are made. This technique
will not, however, assure a profit or protect against a loss in declining
markets. Moreover, for the dollar cost averaging technique to be effective,
amounts should be available for allocation from the Money Market Subaccount
through periods of low price levels as well as higher price levels.
Portfolio Rebalancing. This feature permits an Owner to automatically
rebalance the value in the Subaccounts on a monthly, quarterly, semi-annual or
annual basis, based on the Owner's premium allocation percentages in effect at
the time of the rebalancing. It may be elected at issue by marking the
appropriate box on the initial application, or, after issue, by completing a
change request form and sending it to the Home Office.
In Contracts utilizing Portfolio Rebalancing from the Date of Issue, an
automatic transfer will take place which causes the percentages of the current
values in each Subaccount to match the current premium allocation percentages,
starting with the Monthly Contract Date three, six or twelve months after the
Date of Issue, and then on each Monthly Contract Date three, six or twelve
months thereafter. Contracts electing Portfolio Rebalancing after issue will
have the first automated transfer occur as of the Monthly Contract Date on or
next following the date that the election is received at the Home Office, and
subsequent rebalancing transfers will occur every three, six or twelve months
from such date. An Owner may discontinue Portfolio Rebalancing at any time by
submitting an appropriate change request form to the Home Office.
In the event that an Owner changes the Contract's premium allocation
percentages, Portfolio Rebalancing will automatically be discontinued unless the
Owner specifically directs otherwise.
Portfolio Rebalancing will result in periodic transfers out of Subaccounts
that have had relatively favorable investment performance in relation to the
other Subaccounts to which a Contract allocates premiums, and into Subaccounts
which have had relatively unfavorable investment performance in relation to the
other Subaccounts to which the Contract allocates premiums.
Systematic Withdrawals- At any time after one year from the Date of
Issue, and provided that the Contract Value at the time of initiation of the
program is at least $15,000, the Owner may elect in writing on a form provided
by National Life to take systematic Withdrawals of a specified dollar amount (of
at least $100) on a monthly, quarterly, semi-annual or annual basis. The Owner
may provide specific instructions as to how the systematic Withdrawals are to be
taken, but the Withdrawals must be taken first from the Subaccounts of the
Variable Account, and may only be taken from the unloaned portion of the Fixed
Account to the extent that the Contract Value in the Variable Account is
insufficient to accomplish the Withdrawal. If the Owner has not provided
specific instructions, or if such specific instructions cannot be carried out,
National Life will process the Withdrawals by taking on a pro-rata basis
Accumulation Units from all of the Subaccounts in which the Owner has an
interest and the unloaned portion of the Fixed Account. Each systematic
Withdrawal is subject to federal income taxes on the taxable portion. In
addition, a 10% federal penalty tax may be assessed on systematic Withdrawals if
the Owner is under age 59 1/2. If directed by the Owner, National Life will
withhold federal income taxes from each systematic Withdrawal. A systematic
Withdrawal program will
32
<PAGE> 33
terminate automatically when a systematic Withdrawal would cause the remaining
Contract Value to be $3,500 or less. If a systematic Withdrawal would cause the
Contract Value to be $3,500 or less, then that systematic Withdrawal transaction
will not be processed. The Owner may discontinue systematic Withdrawals at any
time by notifying National Life in writing.
A Contingent Deferred Sales Charge may apply to systematic Withdrawals
in accordance with the considerations set forth in "Contingent Deferred Sales
Charge", page . If the Owner withdraws amounts pursuant to a systematic
Withdrawal program, then, in most states, the Owner may withdraw in each
Contract Year after the first Contract Year without a CDSC an amount up to 15%
of the Contract Value as of the most recent Contract Anniversary (a different
CDSC-free Withdrawal provision may apply in certain states - see "Contingent
Deferred Sales Charge, page ). Both Withdrawals at the specific request of the
Owner and Withdrawals pursuant to a systematic Withdrawal program will count
toward the limit of the amount that may be withdrawn in any Contract Year free
of the CDSC. In addition, any amount withdrawn from any Individual Retirement
Annuity Contract in order to meet minimum Distribution requirements shall be
free of CDSC.
Limited systematic Withdrawals are also available in the first Contract
Year (but only after 30 days from issue). These systematic Withdrawals are
limited to monthly systematic Withdrawal programs. The maximum aggregate amount
for the remaining months of the first Contract Year is the annual amount that
may be withdrawn in Contract Years after the first Contract Year free of a CDSC
(i.e., either 15% or 10% of the Contract Value, depending on the state). These
systematic Withdrawals will not be subject to a CDSC. The other rules for
systematic Withdrawals made after the first Contract Year, including the
$15,000 minimum Contract Value, minimum $100 payment, and allocation rules,
will apply to these systematic Withdrawals.
CONTRACT RIGHTS UNDER CERTAIN PLANS
Contracts may be purchased in connection with a plan sponsored by an
employer. In such cases, all rights under the Contract rest with the Owner,
which may be the employer or other obligor under the plan, and benefits
available to participants under the plan will be governed solely by the
provisions of the plan. Accordingly, some of the options and elections under the
Contract may not be available to participants under the provisions of the plan.
In such cases, participants should contact their employers for information
regarding the specifics of the plan.
THE FIXED ACCOUNT
Net Premium Payments under the Fixed Account portion of the Contract
and transfers to the Fixed Account portion become part of the general account
of National Life, which support insurance and annuity obligations. Because of
exemptive and exclusionary provisions, interests in the general account have
not been registered under the Securities Act of 1933 ("Securities Act"), nor is
the general account registered as an investment company under the Investment
Company Act. Accordingly, neither the general account nor any interest therein
are generally subject to the provisions of the Securities Act or Investment
Company Act, and National Life has been advised that the staff of the Securities
and Exchange Commission has not reviewed the disclosures in this prospectus
which related to the guaranteed interest portion. Disclosures regarding the
Fixed Account portion of the Contract and the general account, however, may be
subject to certain generally applicable provisions of the federal securities
laws relating to the accuracy and completeness of statements made in
prospectuses.
The Fixed Account is made up of all the general assets of National
Life, other than those in the Variable Account and any other segregated asset
account. Fixed Account Net Premium Payments will be allocated to the Fixed
Account by election of the Owner at the time of purchase, or by a later change
in allocation of Net Premium Payments. National Life will invest the assets of
the Fixed Account in those assets chosen by National Life and allowed by
applicable law.
MINIMUM GUARANTEED AND CURRENT INTEREST RATES
The Contract Value held in the Fixed Account which is not held in a
Collateral Fixed Account is guaranteed to accumulate at a minimum effective
annual interest rate of 3.0%. National Life may credit the non-loaned Contract
Value in the Fixed Account with current rates in excess of the minimum
guarantee but is not obligated to do so. These current interest rates are
influenced by, but do not necessarily correspond to, prevailing general market
interest rates. Since National Life, in its sole discretion, anticipates
changing the current interest rate from time to time, allocations to the Fixed
Account made at different times are likely to be credited with different
current interest rates. An interest rate will be declared by National Life
each month to apply to amounts allocated or transferred to the Fixed Account
in that month. The rate declared on such amounts will remain in effect for
twelve months. At the end of the 12-month period, National Life reserves the
right to declare a new current interest rate on such amounts and accrued
interest thereon (which may be a
33
<PAGE> 34
different current interest rate than the current interest rate on new
allocations to the Fixed Account on that date). Any interest credited on the
amounts in the Fixed Account in excess of the minimum guaranteed rate of 3.0%
per year will be determined in the sole discretion of National Life. The Owner
assumes the risk that interest credited may not exceed the guaranteed minimum
rate.
Amounts deducted from the unloaned portion of the Fixed Account for
Optional Benefits charges, the Annual Contract Fee, loans or transfers to the
Variable Account are, for the purpose of crediting interest, accounted for on
a last in, first out basis. Amounts deducted from the unloaned portion of the
Fixed Account for Withdrawals are accounted for on a first in, first out basis
for such purpose.
National Life reserves the right to change the method of crediting
interest from time to time, provided that such changes do not have the effect
of reducing the guaranteed rate of interest below 3.0% per annum or shorten
the period for which the interest rate applies to less than 12 months.
OPTIONAL ENHANCED DEATH BENEFIT RIDER
The Enhanced Death Benefit Rider, which is subject to the restrictions
and limitations set forth in the Contract Rider, may be included in a Contract
at the option of the Owner. Election of this optional benefit involves an
additional cost. This Rider may not be available in all states.
If the Owner has elected the Enhanced Death Benefit Rider, then the
following enhanced death benefit will be payable to the Beneficiary if the
Owner (or the first of Joint Owners) dies prior to reaching age 81 (on an age
nearest birthday basis): the highest of (a) Contract Value; (b) the total of
all Net Premium Payments less all Withdrawals, and less any outstanding loan
and accrued interest, and (c) the largest Contract Value as of any prior
Contract Anniversary after the Enhanced Death Benefit Rider was applicable to
the Contract, plus any Net Premium Payments and less any Withdrawals,
(including any CDSC deducted in connection with such Withdrawals) loan and
accrued interest, in each case since such Contract Anniversary, and in each
case calculated as of the date National Life receives due proof of death. Any
applicable premium tax charge payable on the death of the Owner will be applied
to reduce the value of the above determined enhanced death benefit (see
"Premium Taxes, page ).
If the Owner (or the first of Joint Owners) dies at age 81 or later,
the death benefit will not be enhanced, and will be an amount equal to Contract
Value, less any applicable premium tax charge.
The Enhanced Death Benefit Rider will be available at issue to Owners
age 75 and younger. It will be available after issue to Owners age 75 or
younger only as of a Contract Anniversary, and only if at the time of the Rider
is requested, the Contract Value is greater than the total of all Net Premium
Payments less all Withdrawals. The annual charge for this Rider is 0.20% of
Contract Value. After the Owner reaches age 80, on an age nearest birthday
basis, the charge will be discontinued. See "Charges for Optional Enhanced
Death Benefit Rider", page .
The Enhanced Death Benefit will be distributed in the same manner as
the normal Death Benefit. See "Death of Owner", page .
FEDERAL INCOME TAX CONSIDERATIONS
34
<PAGE> 35
INFORMATION CONTAINED HEREIN SHOULD NOT BE SUBSTITUTED FOR THE ADVICE
OF A PERSONAL TAX ADVISOR.
This discussion is not intended to address the tax consequences
resulting from all of the situations in which a person may be entitled to or
may receive a distribution under the Contract issued by National life. Any
person concerned about these tax implications should consult a competent tax
advisor before initiating any transaction. This discussion is based upon our
understanding of the present federal income tax laws, as they are currently
interpreted by the Internal Revenue Service. No representation is made as to
the likelihood of the continuation of the present federal income tax laws or of
the current interpretation by the Internal Revenue Service. Moreover, no
attempt has been made to consider any applicable state or other tax laws.
Section 72 of the Code governs taxation of annuities in general. That
section sets forth different rules for: (1) Qualified Plans; (2) Individual
Retirement Annuities and Individual Retirement Accounts; (3) Tax Sheltered
Annuities; or (4) Non-Qualified Contracts. Each type of annuity is discussed
below.
NON-QUALIFIED CONTRACTS
The rules applicable to Non-Qualified Contracts provide that a portion
of each annuity payment received is excludable from taxable income based on the
ratio between the Owner's investment in the Contract and the expected return on
the Contract. The maximum amount excludable from income is the investment in the
Contract. If the Annuitant dies prior to excluding from income the entire
investment in the Contract, the Annuitant's final tax return may reflect a
deduction for the balance of the investment in the Contract.
Distributions made from the Contract prior to the Annuitization Date
are includible in gross income and taxable to the Owner to the extent that the
cash value of the Contract exceeds the Owner's investment at the time of the
Distribution. Distributions, for this purpose, include surrenders, Withdrawals,
dividends, loans, or any portion of the Contract which is assigned or pledged;
or for Contracts issued after April 22, 1987, any portion of the Contract
transferred by gift. For these purposes, a transfer by gift may occur upon
Annuitization if the Owner and the Annuitant are not the same individual. In
determining the taxable amount of a Distribution, all annuity contracts issued
by the same company to the same Owner during any 12 month period, will be
treated as one annuity contract. Additional limitations on the use of multiple
contracts may be imposed by Treasury regulations.
In general, certain Non-Qualified Contracts held by entities other than
individuals are taxed currently on the earnings on the Contract. There are
exceptions for immediate annuities and certain Contracts owned for the benefit
of an individual. An immediate annuity, for purposes of this discussion, is a
single premium Contract on which payments begin within one year of purchase. Any
non-individual (such as a trust) contemplating the purchase of a Non-Qualified
Contract should consult a tax advisor prior to such purchase.
Code Section 72 also provides for a penalty, equal to 10% of any
Distribution which is includible in gross income, if such Distribution is made
prior to attaining age 59 1/2 or the death or disability of the Owner. The
penalty also does not apply if the Distribution is one of a series of
substantially equal periodic
35
<PAGE> 36
payments made over the life or life expectancy (or joint lives or life
expectancies) of the taxpayer (and the taxpayer's Beneficiary), or for the
purchase of an immediate annuity, or is allocable to an investment in the
Contract before August 14, 1982. An Owner wishing to begin taking Distributions
to which the 10% tax penalty does not apply should forward a written request to
National Life. Upon receipt of a written request from the Owner, National Life
will inform the Owner of the procedures pursuant to National Life policy and
subject to limitations of the Contract including but not limited to first year
withdrawals.
In order to qualify as an annuity Contract under Section 72 of the
Code, the Contract must provide that the entire interest in the Contract be
distributed upon the death of any Owner before the Annuitization Date. In such
case, the Beneficiary generally must receive this Distribution within 5 years
of such Owner's death. However, the Beneficiary may elect for payments to be
made over their life or life expectancy if such payments begin within one year
from the death of the Owner. If the Beneficiary is the surviving spouse of the
deceased Owner, such spouse may be treated as the Owner and the Contract may be
continued throughout the life of the surviving spouse. In the event any Owner
dies on or after the Annuitization Date and before the entire interest has been
distributed, the remaining portion must be distributed at least as rapidly as
under the method of Distribution being used as of the date of such Owner's
death (see "Required Distribution For Qualified Plans and Tax Sheltered
Annuities"). If the Owner is not an individual, the death of the Annuitant (or
a change in the Annuitant) will result in a Distribution pursuant to these
rules, regardless of whether a Contingent Annuitant has been named.
National Life is required to withhold tax from certain Distributions to
the extent that such Distribution would constitute income to the Owner. The
Owner is generally entitled to elect not to have federal income tax withheld
from any such Distribution, but may be subject to penalties in the event
insufficient federal income tax is withheld during a calendar year.
Generally, the taxable portion of any Distribution from a Contract to a
nonresident alien of the United States is subject to tax withholding at a rate
equal to thirty percent (30%) of such amount or, if applicable, a lower treaty
rate. A payment may not be subject to withholding where the recipient
sufficiently establishes that such payment is effectively connected to the
recipient's conduct of a trade or business in the United States and such payment
is includible in the recipient's gross income.
National Life may be required to determine whether the Death Benefit or
any other payment constitutes a direct skip as defined in Section 2612 of the
Code, and the amount of the tax on the generation-skipping transfer resulting
from such direct skip. If applicable, such payment will be reduced by any tax
National Life is required to pay by Section 2603 of the Code. A direct skip may
occur when property is transferred to or a Death Benefit is paid to an
individual two or more generations younger than the Owner.
Amounts may be distributed from a Contract because of an Owner's death
or the death of the Annuitant. Generally, such amounts are includible in the
income of the recipient as follows: (i) if distributed in a lump sum, they are
taxed in the same manner as a surrender of the Contract, or (ii) if distributed
under a Payment Option, they are taxed in the same way as annuity payments.
A transfer or assignment of ownership of a Contract, the designation of
an Annuitant of other than the Owner, the selection or change of certain
Maturity Dates, or the exchange of a Contract may result in certain tax
consequences to the Owner that are not discussed herein. An Owner contemplating
any such transfer, assignment or exchange, should consult a tax advisor as to
the tax consequences.
QUALIFIED CONTRACTS
The Qualified Contract is designed for use with several types of
retirement plans. The tax rules applicable to participants and beneficiaries in
retirement plans vary according to the type of plan and the
36
<PAGE> 37
terms and conditions of the plan. Special favorable tax treatment may be
available for certain types of contributions and distributions. Adverse tax
consequences may result from contributions in excess of specified limits;
distributions prior to age 59 1/2 (subject to certain exceptions);
distributions that do not conform to specified commencement and minimum
distribution rules; aggregate distributions in excess of a specified annual
amount; and in other specified circumstances.
National Life makes no attempt to provide more than general information
about use of the Contracts with the various types of retirement plans. Owners
and participants under retirement plans as well as Annuitants and Beneficiaries
are cautioned that the rights of any person to any benefits under Qualified
Contracts may be subject to the terms and conditions of the Contract issued in
connection with such a plan. Some retirement plans are subject to distribution
and other requirements that are not incorporated in the administration of the
Contracts. Owners are responsible for determining that contributions,
distributions and other transactions with respect to the Contracts satisfy
applicable law. Federal income tax withholding will generally be made from
Distributions under Qualified Contracts, unless the participant elects not to
have tax withheld. Withholding is required from certain tax distributions (see
"Rollover Distributions", page ). Purchasers of Contracts for use with any
retirement plan should consult their legal counsel and tax adviser regarding the
suitability of the Contract.
Distributions to participants from Qualified Plans or Tax Sheltered
Annuities are generally taxed when received. A portion of each Distribution for
such Annuities is excludable from income based on the ratio between the after
tax investment of the Owner/Annuitant in the Contract and the value of the
Contract at the time of the withdrawal or Annuitization. For Qualified Plans,
thereafter the tax investment of the Owner/Annuitant may be zero.
Distributions from Individual Retirement Annuities and Contracts owned
by Individual Retirement Accounts are also generally taxed when received. The
portion of each such payment which is excludable is based on the ratio between
the amount by which nondeductible Premium Payments to all such Contracts exceeds
prior non-taxable Distributions from such Contracts, and the total account
balances in such Contracts at the time of the Distribution. The Owner of such
Individual Retirement Annuities or the Designated Annuitant under Contracts held
by Individual Retirement Accounts must annually report to the Internal Revenue
Service the amount of nondeductible Premium Payments, the amount of any
Distribution, the amount by which nondeductible Premium Payments for all years
exceed non-taxable Distributions for all years, and the total balance in all
Individual Retirement Annuities and Accounts. Owners should consult a financial
consultant, legal counsel or tax advisor to discuss in detail the taxation and
the use of the Contracts.
CORPORATE PENSION AND PROFIT-SHARING PLANS
Code section 401(a) permits employers to establish various types of
retirement plans for employees, and permits self-employed individuals to
establish retirement plans for themselves and their employees. These retirement
plans may permit the purchase of the Contracts to accumulate retirement savings
under the plans. Adverse tax consequences to the plan, to the participant or to
both may result if this Contract is assigned or transferred to any individual as
a means to provide benefit payments.
CODE SECTION 403(b) PLANS
Under Code section 403(b), payments made by public school systems and
certain tax-exempt organizations to purchase annuity contracts for their
employees are excludable from the gross income of the employee, subject to
certain limitations. However, these payments may be subject to FICA (Social
Security) taxes.
Code section 403(b)(11) restricts the distribution under Code section
403(b) annuity contracts of: (1) elective contributions made in years beginning
after December 31, 1988; (2) earnings on those contributions; and (3) earnings
in such years on amounts held as of the last year beginning before January 1,
1989. Distribution of those amounts may only occur upon death of the employee,
attainment of age 59 1/2, separation from service, disability, or financial
hardship. In addition, income attributable to elective contributions may not be
distributed in the case of hardship. Employee loans may be available, subject to
certain restrictions (see "Loan Privilege - Qualified Contracts and Certain
Tax-Sheltered Annuities", page ).
DEFERRED COMPENSATION PLANS
Code section 457 provides for certain deferred compensation plans. These
plans may be offered with respect to service for state governments, local
governments, political subdivisions, agencies, instrumentalities and certain
affiliates of such entities, and tax-exempt organizations. These plans are
subject to various restrictions on contributions and distributions. The plans
may permit participants to specify the form of investment for their deferred
compensation account. In general, with respect to non-governmental plans all
investments are owned by the sponsoring employer and are subject to the claims
of the general creditors of the employer. Depending on the terms of the
particular plan, a non-government employer may be entitled to draw on deferred
amounts for purposes unrelated to its section 457 plan obligations. In general,
all amounts received under a section 457 plan are taxable.
37
<PAGE> 38
INDIVIDUAL RETIREMENT ANNUITIES
The Contract may be purchased as an Individual Retirement Annuity under
Section 408(b) of the Code. The Owner should seek competent advice as to the
tax consequences associated with the use of a Contract as an Individual
Retirement Annuity.
Recent changes to the Code permit the rollover of most Distributions
from Qualified Plans to other Qualified Plans or Individual Retirement Accounts.
Most Distributions from Tax-Sheltered Annuities may be rolled into another
Tax-Sheltered Annuity or Individual Retirement Account. Distributions which may
not be rolled over are those which are:
1. one of a series of substantially equal annual (or more frequent)
payments made: (a) over the life (or life expectancy) of the employee,
(b) the joint lives (or joint life expectancies) of the employee and
the employee's designated Beneficiary, or (c) for a specified period of
ten years or more, or
2. a required minimum Distribution.
Any Distribution eligible for rollover will be subject to federal tax
withholding at a rate of twenty percent (20%) unless the Distribution is
transferred directly to an appropriate plan as described above.
Individual Retirement Accounts and Individual Retirement Annuities may
not provide life insurance benefits. If the Death Benefit exceeds the greater of
the cash value of the Contract or the sum of all Premium Payments (less any
surrender, the sum of all Withdrawals, or any outstanding loan and accrued
interest on such loan), it is possible the Internal Revenue Service could
determine that the Individual Retirement Account or Individual Retirement
Annuity did not qualify for the desired tax treatment.
The Internal Revenue Service has not reviewed the Contract for qualification as
an IRA and has not generally ruled whether a Death Benefit provision such as the
provision in the Contract comports with IRA qualification requirements.
SIMPLE RETIREMENT ACCOUNTS
Beginning January 1, 1997, certain small employers may establish Simple
Retirement Accounts as provided by Section 408(p) of the Code, under which
employees may elect to defer up to $6000 (as increased for cost of living
adjustments) as a percentage of compensation. The sponsoring employer is
required to make a matching contribution on behalf of contributing employees.
Distributions from a Simple Retirement Account are subject to the same
restrictions that apply to IRA distributions and are taxed as ordinary income.
Subject to certain exceptions, premature distributions prior to age 59 1/2 are
subject to a 10% penalty tax, which is increased to 25% if the distribution
occurs within the first two years after the commencement of the employee's
participation in the plan. The failure of the Simple Retirement Account to meet
Code requirements may result in adverse tax consequences.
DIVERSIFICATION
The Internal Revenue Service has promulgated regulations under Section
817(h) of the Code relating to diversification standards for the investments
underlying a variable annuity contract. The regulations provide that a variable
annuity contract which does not satisfy the diversification standards will not
be treated as an annuity contract, unless the failure to satisfy the regulations
was inadvertent, the failure is corrected, and the Owner or National Life pays
an amount to the Internal Revenue Service. The amount will be based on the tax
that would have been paid by the Owner if the income, for the period the
contract was not diversified, had been received by the Owner. If the failure to
38
<PAGE> 39
diversify is not corrected in this manner, the Owner of an annuity contract will
be deemed the owner of the underlying securities and will be taxed on the
earnings of his or her account. National Life believes, under its interpretation
of the Code and regulations thereunder, that the investments underlying this
Contract meet these diversification standards.
In certain circumstances, owners of variable annuity contracts have
been considered for Federal income tax purposes to be the owners of the assets
of the Variable Account supporting their contracts due to their ability to
exercise investment control over those assets. When this is the case, the
contract owners have been currently taxed on income and gains attributable to
the variable account assets. There is little guidance in this area, and some
features of the Contracts, such as the flexibility of an Owner to allocate Net
Premium Payments and transfer Contract Value, have not been explicitly addressed
in published rulings. While National Life believes that the Contracts do not
give Owners investment control over Variable account assets, National Life
reserves the right to modify the Contracts as necessary to prevent an Owner from
being treated as the owner of the variable Account assets supporting the
Contract.
TAX LEGISLATION. In past years, legislation has been proposed in the
U.S. Congress which would have adversely modified the federal taxation of
certain annuity contracts. For example, one such proposal would have adversely
affected annuity contracts that do not have "substantial life contingencies" by
taxing income as it is credited to the annuity contract. Although Congress is
not now actively considering any legislation regarding the taxation of annuity
contracts, there is no way of knowing if legislation affecting the taxation of
annuity contracts will, at some time, be enacted, or the extent to which any
change in the taxation of annuity contracts would be retroactive in effect
(i.e., effective prior to the date of enactment).
CHARGE FOR TAX PROVISIONS
National Life is no longer required to maintain a capital gain reserve
liability on Non-Qualified Contracts since capital gains attributable to assets
held in the Variable Account for such Contracts are not taxable to National
Life. However, National Life reserves the right to implement and adjust the tax
charge in the future, if the tax laws change.
ROLLOVER DISTRIBUTIONS
The Code permits the rollover of most Distributions from Qualified
Plans to other Qualified Plans, Individual Retirement Accounts, or Individual
Retirement Annuities. Most Distributions from Tax Sheltered Annuities may be
rolled into another Tax Sheltered Annuity, an Individual Retirement Account, or
an Individual Retirement Annuity. Distributions which may not be rolled over
are those which are:
1. one of a series of substantially equal annual (or more frequent)
payments made: (a) over the life (or life expectancy) of the employee,
(b) the joint lives (or joint life expectancies) of the employee and
the employee's designated Beneficiary, or (c) for a specified period of
ten years or more, or
2. a required minimum Distribution.
Any Distribution eligible for rollover will be subject to federal tax
withholding at a 20 percent rate unless the Distribution is transferred directly
to an appropriate plan as described above. Owner's should consult a financial
consultant to discuss in detail a particular tax situation and the use of the
Contracts.
RESTRICTIONS UNDER QUALIFIED CONTRACTS
Other restrictions with respect to the election, commencement, or
distribution of benefits may apply under Qualified Contracts or under the terms
of the plans in respect of which Qualified Contracts are issued.
GENDER NEUTRALITY
In 1983, the United States Supreme Court held that optional annuity
benefits provided under an employee's deferred compensation plan could not,
under Title VII of the Civil Rights Act of 1964 vary between men and women on
the basis of sex. The Court applied its decision to benefits derived from
contributions made on or after August 1, 1983. Lower federal courts have since
held that the Title VII prohibition of sex-distinct benefits may apply at an
earlier date. In addition, some states prohibit using sex-distinct mortality
tables.
39
<PAGE> 40
The Contract uses sex-distinct actuarial tables, unless state law
requires the use of sex-neutral actuarial tables. As a result, the Contract
generally provides different benefits to men and women of the same age.
Employers and employee organizations which may consider buying Contracts in
connection with any employment-related insurance or benefits program should
consult their legal advisors to determine whether the Contract is appropriate
for this purpose.
VOTING RIGHTS
Voting rights under the Contracts apply only with respect to Net
Premium Payments or accumulated amounts allocated to the Variable Account.
In accordance with its view of present applicable law, National Life
will vote the shares of the underlying Funds held in the Variable Account at
regular and special meetings of the shareholders of the underlying Funds. These
shares will be voted in accordance with instructions received from Owners who
have an interest in the Variable Account. If the Investment Company Act or any
regulation thereunder should be amended or if the present interpretation
thereof should change, and as a result National Life determines that it is
permitted to vote the shares of the underlying Funds in its own right, it may
elect to do so.
The person having the voting interest under a Contract shall be the
Owner. The number of underlying Fund shares attributable to each Owner is
determined by dividing the Owner's interest in each respective Subaccount of the
Variable Account by the net asset value of the underlying Fund corresponding to
the Subaccount.
The number of shares which a person has the right to vote will be
determined as of the date to be chosen by National Life not more than 90 days
prior to the meeting of the underlying Fund. Voting instructions will be
solicited by written communication at least 21 days prior to such meeting.
Underlying Fund shares held in the Variable Account as to which no
timely instructions are received will be voted by National Life in the same
proportion as the voting instructions which are received with respect to all
Contracts participating in the Variable Account.
Each person having a voting interest will receive periodic reports
relating to the underlying Fund, proxy material and a form with which to give
such voting instructions.
CHANGES TO VARIABLE ACCOUNT
National Life reserves the right to create one or more new separate
accounts, combine or substitute separate accounts, or to add new investments
Funds for use in the Contracts at any time. In addition, if the shares of the
underlying Funds described in this prospectus should no longer be available for
investment by the Variable Account or if, in the judgment of National Life's
management, further investment in such underlying Fund shares should become
inappropriate, National Life may eliminate Subaccounts, combine two or more
Subaccounts or substitute one or more underlying Funds for other underlying
Fund shares already purchased or to be purchased in the future by Premium
Payments under the Contract. No substitution of securities in the Variable
Account may take place without prior approval of the Securities and Exchange
Commission, and under such requirements as it may impose. National Life may
also operate the Variable Account as a management investment company under the
Investment Company Act, deregister the Variable Account under the Investment
Company Act if such registration is no longer required, transfer all or part of
the assets of the Variable Account to another separate account or to the Fixed
Account (subject to obtaining all necessary regulatory approvals), and make any
other changes reasonably necessary under the Investment Company Act or
applicable state law.
ADVERTISING
A "yield" and "effective yield" may be advertised for the Market Street
Money Market Portfolio Subaccount. "Yield" is a measure of the net dividend and
interest income earned over a specific seven-day period (which period will be
stated in the advertisement) expressed as a percentage of the offering price of
the Subaccount's units. Yield is an annualized figure, which means that it is
assumed that the Subaccount generates the same level of net income over a
52-week period. The "effective yield" is calculated similarly but includes the
effect of assumed compounding, calculated under rules prescribed by the
Securities and Exchange Commission. The effective yield will be slightly higher
than yield due to this compounding effect.
40
<PAGE> 41
National Life may also from time to time advertise the performance of
the Subaccounts of the Variable Account relative to the performance of other
variable annuity Subaccounts or underlying Funds with similar or different
objectives, or the investment industry as a whole. Other investments to which
the Subaccounts may be compared include, but are not limited to: precious
metals; real estate; stocks and bonds; closed-end funds; CDs; bank money market
deposit accounts and passbook savings; and the Consumer Price Index.
The Subaccounts of the Variable Account may also be compared to certain
market indexes, which may include, but are not limited to: S&P 500;
Shearson/Lehman Intermediate Government/Corporate Bond Index; Shearson/Lehman
Long-Term Government/Corporate Bond Index; Donoghue Money Fund Average; U.S.
Treasury Note Index; Bank Rate Monitor National Index of 2 Year CD Rates; and
Dow Jones Industrial Average.
Normally these rankings and ratings are published by independent
tracking services and publications of general interest including, but not
limited to: Lipper Analytical Services, Inc., CDA/ Wiesenberger, Morningstar,
Donoghue's; magazines such as Money, Forbes, Kiplinger's Personal Finance
Magazine, Financial World, Consumer Reports, Business Week, Time, Newsweek,
National Underwriter, U.S. News and World Report; rating services such as LIMRA,
Value, Best's Agent Guide, Western Annuity Guide, Comparative Annuity Reports;
and other publications such as the Wall Street Journal, Barron's, Investor's
Daily, and Standard & Poor's Outlook. In addition, Variable Annuity Research &
Data Service (The VARDS Report) is an independent rating service that ranks over
500 variable annuity funds based upon total return performance. These rating
services and publications rank the performance of the underlying Funds against
all underlying Funds over specified periods and against funds in specified
categories. The rankings may or may not include the effects of sales or other
charges.
National Life is also ranked and rated by independent financial rating
services, among which are Moody's, Standard & Poor's and A.M. Best. The purpose
of these ratings is to reflect the financial strength or claims-paying ability
of National Life. The ratings are not intended to reflect the investment
experience or financial strength of the Variable Account. National Life may
advertise these ratings from time to time. In addition, National Life may
include in certain advertisements, endorsements in the form of a list of
organizations, individuals or other parties which recommend National Life or the
Contracts. Furthermore, National Life may occasionally include in advertisements
comparisons of currently taxable and tax deferred investment programs, based on
selected tax brackets, or discussions of alternative investment vehicles and
general economic conditions.
National Life may from time to time advertise several types of
historical performance for the Subaccounts of the Variable Account. National
Life may advertise for the Subaccounts standardized "average annual total
return", calculated in a manner prescribed by the Securities and Exchange
Commission, and nonstandardized "total return". "Average annual total return"
will show the percentage rate of return of a hypothetical initial investment of
$1,000 for at least the most recent one, five and ten year period, or for a
period covering the time the underlying Fund option held in the Subaccount has
been in existence, if the underlying Fund option has not been in existence for
one of the prescribed periods. This calculation reflects the deduction of all
applicable charges made to the Contracts except for premium taxes, which may be
imposed by certain states.
Nonstandardized "total return" will be calculated in a similar manner
and for the same time periods as the average annual total return except total
return will assume an initial investment of $10,000 and will not reflect the
deduction of any applicable Contingent Deferred Sales Charge, which, if
reflected, would decrease the level of performance shown. The Contingent
Deferred Sales Charge is not reflected because the Contracts are designed for
long term investment. An assumed initial investment of $10,000 will be used
because that figure more closely approximates the size of a typical Contract
than does the $1,000 figure used in calculating the standardized average annual
total return quotations.
41
<PAGE> 42
The tables below provide performance information for each Subaccount
for specified periods ending December 31, 1996. Because all the Subaccounts had
not commenced operations as of that date, performance information for the
Contracts will be calculated based on the performance of the Fund portfolios and
the assumption that the Subaccounts were in existence for the same periods with
the level of Contract charges that were in effect at the inception of the
Subaccounts.
All performance information and comparative material advertised by
National Life is historical in nature and is not intended to represent or
guarantee future results. An Owner's Contract Value at redemption may be more or
less than original cost.
Below are quotations of standardized average annual total return and
non-standardized total return calculated as described above, for each of the
Subaccounts available within the Variable Account for which there is significant
investment history. These figures are based upon historical earnings and are not
necessarily representative of future results. The first set of charts assumes
that the Enhanced Death Benefit Rider has not been elected by the Owner.
NON-STANDARDIZED TOTAL RETURN
<TABLE>
<CAPTION>
1 YEAR TO 5 YEARS TO 10 YEARS TO LIFE OF FUND DATE FUND
12/31/96 12/31/96 12/31/96 12/31/96 EFFECTIVE
<S> <C> <C> <C> <C> <C>
Alger American Small Capitalization 2.67% 9.42% N/A % 18.48% 9/21/88
Alger American Growth 11.73 14.97 N/A 16.96 1/9/89
Fidelity VIP Fund-Equity Income 12.65 16.29 12.11 N/A 10/9/86
Fidelity VIP Fund-Growth 13.07 13.51 13.50 N/A 10/9/86
Fidelity VIP Fund-High Income 12.39 13.32 9.53 N/A 9/19/85
Fidelity VIP Fund-Overseas 11.53 7.56 N/A 6.32 1/28/87
Fidelity VIP Fund II-Index 500 20.97 N/A N/A 15.37 8/27/92
Fidelity VIP Fund II-Contrafund 19.48 N/A N/A 28.38 1/3/95
Market Street Common Stock N/A N/A N/A 16.50 3/18/96
Market Street Sentinel Growth N/A N/A N/A 12.88 3/18/96
Market Street Aggressive Growth 19.27 6.62 N/A 11.95 5/1/89
Market Street Managed 9.38 9.51 7.31 N/A 12/12/85
Market Street Bond (0.02) 4.61 5.09 N/A 2/24/84
Market Street International 9.29 8.28 N/A 7.55 11/1/91
Market Street Money Market 3.69 2.57 4.11 N/A 2/24/84
Strong Special Fund II, Inc. 16.46 N/A N/A 17.22 5/8/92
Strong Growth Fund II N/A N/A N/A N/A 1/1/97
Van Eck Worldwide Bond 1.04 2.42 N/A 5.15 9/1/89
</TABLE>
STANDARDIZED AVERAGE ANNUAL TOTAL RETURN
<TABLE>
<CAPTION>
1 YEAR TO 5 YEARS TO 10 YEARS TO LIFE OF FUND DATE FUND
12/31/96 12/31/96 12/31/96 12/31/96 EFFECTIVE
<S> <C> <C> <C> <C> <C>
Alger American Small Capitalization (4.33)% 9.00% N/A % 18.48% 9/21/88
Alger American Growth 4.73 14.62 N/A 16.96 1/9/89
Fidelity VIP Fund-Equity Income 5.65 15.96 12.11 N/A 10/9/86
Fidelity VIP Fund-Growth 6.07 13.15 13.50 N/A 10/9/86
Fidelity VIP Fund-High Income 5.93 12.95 9.53 N/A 9/19/85
Fidelity VIP Fund-Overseas 4.53 7.11 N/A 6.32 1/28/87
Fidelity VIP Fund II-Index 500 13.97 N/A N/A 14.94 8/27/92
Fidelity VIP Fund II-Contrafund 12.48 N/A N/A 26.02 1/3/95
Market Street Common Stock N/A N/A N/A 7.45 3/18/96
Market Street Sentinel Growth N/A N/A N/A 3.89 3/18/96
Market Street Aggressive Growth 12.27 6.15 N/A 11.95 5/1/89
Market Street Managed 2.38 9.09 7.31 N/A 12/12/85
Market Street Bond (7.02) 4.10 5.09 N/A 2/24/84
Market Street International 2.29 7.84 N/A 7.26 11/1/91
Market Street Money Market (3.31) 2.02 4.11 N/A 2/24/84
Strong Special Fund II, Inc. 9.46 N/A N/A 16.85 5/8/92
Strong Growth Fund II N/A N/A N/A N/A 1/1/97
Van Eck Worldwide Bond (5.96) 1.87 N/A 5.15 9/1/89
</TABLE>
42
<PAGE> 43
The following quotations of standardized and non-standardized total
return assume that the Owner has elected the Enhanced Death Benefit Rider:
NON-STANDARDIZED TOTAL RETURN
<TABLE>
<CAPTION>
1 YEAR TO 5 YEARS TO 10 YEARS TO LIFE OF FUND DATE FUND
12/31/96 12/31/96 12/31/96 12/31/96 EFFECTIVE
<S> <C> <C> <C> <C> <C>
Alger American Small Capitalization 2.47% 9.20% N/A % 18.24% 9/21/88
Alger American Growth 11.50 14.74 N/A 16.73 1/9/89
Fidelity VIP Fund-Equity Income 12.43 16.06 11.88 N/A 10/9/86
Fidelity VIP Fund-Growth 12.84 13.29 13.28 N/A 10/9/86
Fidelity VIP Fund-High Income 12.17 13.10 9.31 N/A 9/19/85
Fidelity VIP Fund-Overseas 11.31 7.35 N/A 6.11 1/28/87
Fidelity VIP Fund II-Index 500 20.73 N/A N/A 15.13 8/27/92
Fidelity VIP Fund II-Contrafund 19.25 N/A N/A 28.13 1/3/95
Market Street Common Stock N/A N/A N/A 16.26 3/18/96
Market Street Sentinel Growth N/A N/A N/A 12.64 3/18/96
Market Street Aggressive Growth 19.03 6.41 N/A 11.73 5/1/89
Market Street Managed 9.16 9.29 7.09 N/A 12/12/85
Market Street Bond (0.22) 4.40 4.88 N/A 2/24/84
Market Street International 9.08 8.06 N/A 7.33 11/1/91
Market Street Money Market 3.48 2.36 3.90 N/A 2/24/84
Strong Special Fund II, Inc. 16.23 N/A N/A 16.99 5/8/92
Strong Growth Fund II N/A N/A N/A N/A 1/1/97
Van Eck Worldwide Bond 0.84 2.22 N/A 4.94 9/1/89
</TABLE>
STANDARDIZED AVERAGE ANNUAL TOTAL RETURN
<TABLE>
<CAPTION>
1 YEAR TO 5 YEARS TO 10 YEARS TO LIFE OF FUND DATE FUND
12/31/96 12/31/96 12/31/96 12/31/96 EFFECTIVE
<S> <C> <C> <C> <C> <C>
Alger American Small Capitalization (4.53)% 8.78% N/A % 18.24% 9/21/88
Alger American Growth 4.50 14.39 N/A 16.73 1/9/89
Fidelity VIP Fund-Equity Income 5.43 15.73 11.88 N/A 10/9/86
Fidelity VIP Fund-Growth 5.84 12.92 13.28 N/A 10/9/86
Fidelity VIP Fund-High Income 5.17 12.73 9.31 N/A 9/19/85
Fidelity VIP Fund-Overseas 4.31 6.89 N/A 6.11 1/28/87
Fidelity VIP Fund II-Index 500 13.73 N/A N/A 14.70 8/27/92
Fidelity VIP Fund II-Contrafund 12.25 N/A N/A 25.76 1/3/95
Market Street Common Stock N/A N/A N/A 7.21 3/18/96
Market Street Sentinel Growth N/A N/A N/A 3.66 3/18/96
Market Street Aggressive Growth 12.03 5.94 N/A 11.73 5/1/89
Market Street Managed 2.16 8.87 7.09 N/A 12/12/85
Market Street Bond (7.22) 3.89 4.88 N/A 2/24/84
Market Street International 2.08 7.62 N/A 7.04 11/1/91
Market Street Money Market (3.52) 1.81 3.90 N/A 2/24/84
Strong Special Fund II, Inc. 9.23 N/A N/A 16.62 5/8/92
Strong Growth Fund II N/A N/A N/A N/A 1/1/97
Van Eck Worldwide Bond 6.16 1.66 N/A 4.94 9/1/89
</TABLE>
DISTRIBUTION OF THE CONTRACTS
The principal underwriter for the contracts is ESI, which is an
SEC-registered broker-dealer firm which is a member of the National Association
of Securities Dealers, Inc. ESI is a wholly-owned subsidiary of National Life.
It distributes a full line of securities products, including mutual funds, unit
investment trusts, and variable insurance contracts, and provides individual
securities brokerage
43
<PAGE> 44
services. The maximum commission payable for selling the Contracts will
generally be 6.5%; however, during an introductory period of approximately six
months to be announced by National Life, the maximum commission payable on
Contracts purchased will be 7.0%.
STATEMENTS AND REPORTS
National Life will mail to Owners, at their last known address of
record, any statements and reports required by applicable laws or regulations.
Owners should therefore give National Life prompt notice of any address change.
National Life will send a confirmation statement to Owners each time a
transaction is made affecting the Owner's Variable Account Contract Value, such
as making additional Premium Payments, transfers, exchanges or Withdrawals.
Quarterly statements are also mailed detailing the Contract activity during the
calendar quarter. Instead of receiving an immediate confirmation of transactions
made pursuant to some types of periodic payment plans (such as a dollar cost
averaging program) or salary reduction arrangement, the Owner may receive
confirmation of such transactions in their quarterly statements. The Owner
should review the information in these statements carefully. All errors or
corrections must be reported to National Life immediately to assure proper
crediting to the Owner's Contract. National Life will assume all transactions
are accurately reported on quarterly statements or confirmation statements
unless the Owner notifies National Life otherwise within 30 days after receipt
of the statement. National Life will also send to Owners each year an annual
report and a semi-annual report containing financial statements for the Variable
Account, as of December 31 and June 30, respectively.
OWNER INQUIRIES
Owner inquiries may be directed to National Life Insurance Company by
writing to it at National Life Drive, Montpelier, Vermont 05604, or calling
1-800-527-7003.
LEGAL PROCEEDINGS
There are no legal proceedings involving National Life or the
Variable Account which are likely to have a material adverse effect upon the
Variable Account or upon the ability of National Life to meet its obligations
under the Contracts. ESI is not engaged in any litigation of any material
nature.
In recent years, life insurance companies have been named as
defendants in lawsuits, including class action lawsuits, relating to life
insurance pricing and sales practices. A number of these lawsuits have resulted
in substantial jury awards or settlements. In May 1997 a lawsuit of this nature
was filed against National Life on behalf of a purported class of persons who
purchased certain insurance products from National Life. This lawsuit is in an
early stage and has not been certified as a class action. National Life has
highly meritorious defenses and believes that plaintiffs' claims are entirely
without merit and further, does not believe that this lawsuit will have any
material adverse effect upon its ability to meet its obligations under the
Contracts.
National Life is also party to ordinary routine litigation incidental
to its business, none of which is expected to have a material adverse effect
upon its ability to meet its obligations under the Contracts.
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
National Life Insurance Company.......................................
Additional Contract Provisions........................................
The Contract.................................................
Misstatement of Age or Sex...................................
Dividends....................................................
Assignment...................................................
Calculation of Yields and Total Returns...............................
Money Market Subaccount Yields...............................
Other Subaccount Yields......................................
Average Annual Total Returns.................................
Other Total Returns..........................................
Effect of the Annual Contract Fee on Performance Data........
Distribution of the Contracts ........................................
Safekeeping of Account Assets.........................................
State Regulation......................................................
Records and Reports...................................................
Legal Matters.........................................................
Experts
Other Information.....................................................
Financial Statements
1996-1995 Financial Statements...............................
1995-1994 Statutory Basis Financial Statements...............
44
<PAGE> 45
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE> 46
NATIONAL LIFE INSURANCE COMPANY
STATEMENT OF ADDITIONAL INFORMATION
NATIONAL VARIABLE ANNUITY ACCOUNT II
THE SENTINEL ADVANTAGE VARIABLE ANNUITY CONTRACT
OFFERED BY
NATIONAL LIFE INSURANCE COMPANY
National Life Drive
Montpelier, Vermont 05604
This Statement of Additional Information expands upon subjects
discussed in the current Prospectus for the above-named Sentinel Advantage
Variable Annuity Contract ("Contract") offered by National Life Insurance
Company. You may obtain a copy of the Prospectus dated June 20, 1997 by
calling 1-800-537-7003, or writing to National Life Insurance Company, One
National Life Drive, Montpelier, Vermont 05604. Definitions of terms used in
the current Prospectus for the Contract are incorporated in this Statement of
Additional Information.
THIS STATEMENT OF ADDITIONAL INFORMATION IS
NOT A PROSPECTUS AND SHOULD BE READ ONLY IN
CONJUNCTION WITH THE PROSPECTUS FOR THE CONTRACT.
Dated June 20, 1997
1
<PAGE> 47
TABLE OF CONTENTS
National Life Insurance Company.................................................
Additional Contract Provisions..................................................
The Contract...........................................................
Misstatement of Age or Sex.............................................
Dividends..............................................................
Assignment.............................................................
Calculation of Yields and Total Returns.........................................
Money Market Subaccount Yields.........................................
Other Subaccount Yields................................................
Average Annual Total Returns...........................................
Other Total Returns....................................................
Effect of the Annual Contract Fee on Performance Data..................
Distribution of the Contracts ..................................................
Safekeeping of Account Assets...................................................
State Regulation................................................................
Records and Reports.............................................................
Legal Matters...................................................................
Experts
Other Information...............................................................
Financial Statements
1996-1995 Financial Statements.........................................
1995-1994 Statutory Basis Financial Statements.........................
2
<PAGE> 48
NATIONAL LIFE INSURANCE COMPANY
National Life Insurance Company ("National Life") has operated as a
mutual life insurance company since 1848 under a charter granted by the State of
Vermont, and has done business continuously as "National Life Insurance
Company."
ADDITIONAL CONTRACT PROVISIONS
The Contract
The entire contract is made up of the Contract and the application. The
statements made in the application are deemed representations and not
warranties. National Life cannot use any statement in defense of a claim or to
void the Contract unless it is contained in the application and a copy of the
application is attached to the Contract at issue.
Misstatement of Age or Sex
If the age or sex of the Chosen Human Being has been misstated, the
amount which will be paid is that which is appropriate to the correct age
and sex.
Dividends
The Contract is participating; however, no dividends are expected to be
paid on the Contract. If dividends are ever declared, they will be paid in cash.
Assignment
Where permitted, the Owner may assign some or all of the rights under
the Contract at any time during the lifetime of the Annuitant prior to the
Annuitization Date. Such assignment will take effect upon receipt and recording
by National Life at its Home Office of a written notice executed by the Owner.
National Life assumes no responsibility for the validity or tax consequences of
any assignment. National Life shall not be liable as to any payment or other
settlement made by National Life before recording of the assignment. Where
necessary for the proper administration of the terms of the Contract, an
assignment will not be recorded until National Life has received sufficient
direction from the Owner and assignee as to the proper allocation of Contract
rights under the assignment.
Any portion of Contract Value which is pledged or assigned shall be
treated as a Distribution and shall be included in gross income to the extent
that the cash value exceeds the investment in the Contract for the taxable year
in which assigned or pledged. In addition, any Contract Values assigned may,
under certain conditions, be subject to a tax penalty equal to 10% of the amount
which is included in gross income.
3
<PAGE> 49
entire Contract Value may cause the portion of the Contract Value which exceeds
the total investment in the Contract and previously taxed amounts to be included
in gross income for federal income tax purposes each year that the assignment is
in effect. Qualified Contracts are not eligible for assignment.
CALCULATION OF YIELDS AND TOTAL RETURNS
From time to time, National Life may disclose yields, total returns,
and other performance data pertaining to the Contracts or a Subaccount. Such
performance data will be computed, or accompanied by performance data computed,
in accordance with the standards defined by the Securities and Exchange
Commission.
Because of the charges and deductions imposed under a Contract, the
yield for the Subaccounts will be lower than the yield for their respective
Portfolios. The calculations of yields, total returns, and other performance
data do not reflect the effect of any premium tax that may be applicable to a
particular Contract. Premium taxes currently rate from 0% to 3.5% of premium
based on the state in which the Contract is sold.
Money Market Subaccount Yields
From time to time, advertisements and sales literature may quote the
current annualized yield of the Money Market Subaccount for a seven-day period
in a manner which does not take into consideration any realized or unrealized
gains or losses on shares of the Market Street Money Market Portfolio or on its
portfolio securities.
This current annualized yield is computed by determining the net change
(exclusive of realized gains and losses on the sale of securities and unrealized
appreciation and depreciation) at the end of the seven-day period in the value
of a hypothetical account under a Contract having a balance of 1 unit of the
Money Market Subaccount at the beginning of the period, dividing such net change
in account value by the value of the hypothetical account at the beginning of
the period to determine the base period return, and annualizing this quotient on
a 365-day basis. The net change in account value reflects: 1) net income from
the Portfolio attributable to the hypothetical account; and 2) charges and
deductions imposed under the Contract which are attributable to the hypothetical
account. The charges and deductions include the per unit charges for the
hypothetical account for: 1) the Annual Contract Fee; 2) Administration Charge;
and 3) the Mortality and Expense Risk Charge. For purposes of calculating
current yields for a Contract, an average per unit Annual Contract Fee is used
based on the $30 Annual Contract Fee deducted at the beginning of each Contract
Year. For the class of Contracts with the Enhanced Death Benefit Rider, the
charge for that optional benefit will be included. Current Yield will be
calculated according to the following formula:
Current Yield = ((NCS - ES) /UV) x (365/7)
Where:
NCS = the net change in the value of the Portfolio
(exclusive of realized gains or losses on the sale of
securities and unrealized appreciation and
4
<PAGE> 50
depreciation) for the seven-day period attributable
to a hypothetical account having a balance of 1
Subaccount unit.
ES = per unit expenses attributable to the hypothetical
account for the seven-day period.
UV = The unit value on the first day of the seven-day period.
The effective yield of the Money Market Subaccount determined on a
compounded basis for the same seven-day period may also be quoted.
The effective yield is calculated by compounding the unannualized base
period return according to the following formula:
365/7
Effective Yield = (1 + (NCS - ES)/UV)) - 1
Where:
NCS = the net change in the value of the Portfolio (exclusive
of realized gains or losses on the sale of securities and
unrealized appreciation and depreciation) for the seven-
day period attributable to a hypothetical account having
a balance of 1 Subaccount unit.
ES = per unit expenses attributable to the hypothetical
account for the seven day period.
UV = The unit value on the first day of the seven-day period.
Because of the charges and deductions imposed under the Contract, the
yield for the Money Market Subaccount will be lower than the yield for the
Market Street Money Market Portfolio.
The current yield for the Money Market Subaccount as of December 31,
1996 was 3.66%, and the effective yield for that Subaccount as of the same date
was 3.72%. These yields were calculated based on the performance of the Market
Street Money Market Portfolio for the seven days ended December 31, 1996, and
the assumption that the Money Market Subaccount was in existence for this
period with the level of Contract charges that was in effect at the inception
of the Money Market Subaccount.
The current and effective yields on amounts held in the Money Market
Subaccount normally will fluctuate on a daily basis. THEREFORE, THE DISCLOSED
YIELD FOR ANY GIVEN PAST PERIOD IS NOT AN INDICATION OR REPRESENTATION OF FUTURE
YIELDS OR RATES OF RETURN. The Money Market Subaccount's actual yield is
affected by changes in interest rates on money market securities, average
portfolio maturity of the Market Street Money Market Portfolio, the types of
quality of portfolio securities held by the Market Street Money Market Portfolio
and the Market Street Money Market Portfolio's operating expenses. Yields on
amounts held in the Money Market Subaccount may also be presented for periods
other than a seven-day period.
Other Subaccount Yields
From time to time, sales literature or advertisements may quote the
current annualized yield of one or more of the Subaccounts (except the Money
Market Subaccount) for a Contract for 30-day or one-month periods. The
annualized yield of a Subaccount refers to income generated by the Subaccount
over a specific 30-day or one-month period. Because the yield is annualized, the
yield generated by a Subaccount during a 30-day or one-month period is assumed
to be generated each period over a 12-month period.
5
<PAGE> 51
The yield is computed by: 1) dividing the net investment income of the
Portfolio attributable to the Subaccount units less Subaccount expenses for the
period; by (2) the maximum offering price per unit on the last day of the period
times the daily average number of units outstanding for the period; by 3)
compounding that yield for a six-month period; and by 4) multiplying that result
by 2. Expenses attributable to the Subaccount include the Annual Contract Fee,
the Administration Charge and the Mortality and Expense Risk Charge. For the
class of Contracts with the Enhanced Death Benefit Rider, the charge for that
optional benefit will be included. For purposes of calculating the 30-day or
one -month yield, an average Annual Contract Fee per dollar of Contract Value
in the Variable Account is used to determine the amount of the charge
attributable to the Subaccount for the 30-day or one-month period. The 30-day
or one-month yield is calculated according to the following formula:
6
Yield = 2 x (((NI - ES)/(U x UV)) + 1) -1)
Where:
NI = net income of the Portfolio for the 30-day or one-month period
attributable to the Subaccount's units.
ES = expenses of the Subaccount for the 30-day or one-month period.
U = the average number of units outstanding.
UV = the unit value at the close (highest) of the last day in the
30-day or one-month period.
Because of the charges and deductions imposed under the Contracts, the
yield for the Subaccount will be lower than the yield for the corresponding
Fund.
The yield on the amounts held in the Subaccounts normally will
fluctuate over time. Therefore, the disclosed yield for any given past period is
not an indication or representation of future yields or rates of return. The
Subaccount's actual yield is affected by the types and quality of portfolio
securities held by the Portfolio and its operating expenses.
Yield calculations do not take into account the Surrender Charge under
the Contract equal to from 1% to 7% of premiums paid during the seven years
prior to the surrender or Withdrawal (including the year in which the surrender
is made) on amounts surrendered or withdrawn under the Contract. A Surrender
Charge will not be imposed on Withdrawals in any Contract Year on an amount up
to 15% of the Contract Value as of the most recent Contract Anniversary.
However, if a Contract is subsequently surrendered within a year after taking a
Withdrawal that benefits from the CDSC-free provision, then a CDSC will be
assessed at the time of the surrender as if the surrender had been taken as a
single step.
Average Annual Total Returns
6
<PAGE> 52
From time to time, sales literature or advertisements may also quote
average annual total returns for periods prior to the date the Variable Account
commenced operations. For those periods, performance information for the
Contracts will be calculated based on the performance of the Fund Portfolios and
the assumption that the Subaccounts were in existence for the same periods with
the level of Contract charges that were in effect at the inception of the
Subaccounts.
Average annual total returns represent the average annual compounded
rates of return that would equate an initial investment of $1,000 under a
Contract to the redemption value of that investment as of the last day of each
of the periods. The ending date for each period for which total return
quotations are provided will be for the most recent month-end practicable,
considering the type and media of the communication and will be stated in the
communication.
For purposes of calculating average annual total return, an average
per dollar Annual Contract fee attributable to the hypothetical account for the
period is used. The calculation also assumes surrender of the Contract at the
end of the period for the return quotation. Total returns will therefore
reflect a deduction of the CDSC for any period less than seven years. The
average annual total return will then be calculated according to the following
formula:
TR = ( ( ERV/P) 1/N) - 1
Where:
TR = the average annual total return net of Subaccount
recurring charges.
ERV= the ending redeemable value (net of any applicable
surrender charge) of the hypothetical account at the end
of the period.
P = a hypothetical initial payment of $1,000.
N = the number of years in the period.
The Funds have provided the total return information, including the
Fund total return information used to calculate the total returns of the
Subaccounts for periods prior to the inception of the Subaccounts. The Alger
American Fund, Variable Insurance Products Fund, Variable Insurance Product
Fund II, Strong Special Fund II, Inc., Strong Variable Insurance Funds Inc. and
Van Eck Worldwide Insurance Trust are not affiliated with National Life.
Average annual total return may be calculated either taking into
account or not taking into account the impact of the Enhanced Death Benefit
Rider.
7
<PAGE> 53
Such average annual total return information for the Subaccounts is set
forth in the Prospectus.
Other Total Returns
From time to time, sales literature or advertisements may also quote
average annual total returns that do not reflect the Surrender Charge. These are
calculated in exactly the same way as average annual total returns described
above, except that the ending redeemable value of the hypothetical account for
the period is replaced with an ending value for the period that does not take
into account any charges on amounts surrendered or withdrawn, and that the
initial investment is assumed to be $10,000 rather than $1,000. Such information
is also set forth in the Prospectus.
National Life may disclose Cumulative Total Returns in conjunction with
the standard formats described above. The Cumulative Total Returns will be
calculated using the following formula:
CTR = (ERV/P) - 1
Where:
CTR = The Cumulative Total Return net of Subaccount recurring
charges for the period.
ERV = The ending redeemable value of the hypothetical investment
at the end of the period.
P = A hypothetical single payment of $1,000.
Effect of the Annual Contract Fee on Performance Data
The Contract provides, for all Contracts with a Contract Value of less
than $50,000 on the Date of Issue or any subsequent Contract Anniversary, for a
$30 Annual Contract Fee to be deducted annually at the beginning of each
Contract Year, from the Subaccounts and the unloaned portion of the Fixed
Account based on the proportion that the value of each such account bears to
the total Contract Value. For purposes of reflecting the Annual Contract Fee in
the yield and total return quotations, the Annual Contract Fee is converted
into a per-dollar per-day charge. The per-dollar per-day charge has been
estimated based on the distribution of National Life's non-variable single
premium deferred annuity block of business.
8
<PAGE> 54
The per-dollar per-day average charge will then be adjusted to reflect the
basis upon which the particular quotation is calculated.
DISTRIBUTION OF THE CONTRACTS
The principal underwriter for the Contracts is Equity Services, Inc., a
wholly-owned subsidiary of the Company. The Contracts will be offered on a
continuous basis and will be sold by licensed insurance agents in the states
where the Contracts may lawfully be sold. Such agents will be representatives of
broker-dealers registered under the Securities Exchange Act of 1934 who are
members of the National Association of Securities Dealers, Inc. Broker-dealers
other than Equity Services, Inc. will have executed Selling Agreements with
Equity Services, Inc.
SAFEKEEPING OF ACCOUNT ASSETS
National Life holds the title to the assets of the Variable Account. The
assets are kept physically segregated and held separate and apart from the
Company's General Account assets and from the assets in any other separate
account.
Records are maintained of all purchases and redemptions of Fund shares
held by each of the Subaccounts.
STATE REGULATION
National Life is subject to regulation and supervision by the Insurance
Department of the State of Vermont which periodically examines its affairs. It
is also subject to the insurance laws and regulations of all jurisdictions where
it is authorized to do business. A copy of the Contract form has been filed
with, and where required approved by, insurance officials in each jurisdiction
where the Contracts are sold. National Life is required to submit annual
statements of its operations, including financial statements, to the insurance
departments of the various jurisdictions in which it does business for the
purposes of determining solvency and compliance with local insurance laws and
regulations.
RECORDS AND REPORTS
National Life will maintain all records and accounts relating to the
Variable Account. As presently required by the Investment Company Act of 1940
and regulations promulgated thereunder, reports containing such information as
may be required under the Act or by any other applicable law or regulation will
be sent to Contract Owners semi-annually at the last address known to the
Company.
LEGAL MATTERS
All matters relating to Vermont law pertaining to the Contracts,
including the validity of the Contracts and National Life's authority to issue
the Contracts, have been passed upon by D. Russell Morgan, Counsel of
National Life. Sutherland, Asbill & Brennan L.L.P.
9
<PAGE> 55
of Washington, D.C. has provided advice on certain matters relating to the
Federal securities laws.
EXPERTS
The financial statements of National Life as of and for the years
ended December 31, 1996 and 1995, and the statutory basis financial statements
of National Life as of and for the years ended December 31, 1995 and 1994,
which are included in this Statement of Additional Information and in the
registration statement, have been audited by Price Waterhouse LLP, independent
auditors, of National Life Building - 2nd Floor, One National Life Drive,
Montpelier, Vermont 05602, as set forth in their report included herein, and
are included herein in reliance upon such report and upon the authority of such
firm as experts in accounting and auditing.
OTHER INFORMATION
A registration statement has been filed with the SEC under the
Securities Act of 1933 as amended, with respect to the Contracts discussed in
this Statement of Additional Information. Not all the information set forth in
the registration statement, amendments and exhibits thereto has been included in
this Statement of Additional Information. Statements contained in this Statement
of Additional Information concerning the content of the Contracts and other
legal instruments are intended to be summaries. For a complete statement of the
terms of these documents, reference should be made to the instruments filed with
the SEC at 450 Fifth Street, N.W., Washington, DC 20549.
FINANCIAL STATEMENTS
National Life's financial statements as of and for the years ended
December 31, 1996 and 1995 and the statutory basis financial statements as of
and for the years ended December 31, 1995 and 1994, which are included in this
Statement of Additional Information, should be considered only as bearing on
National Life's ability to meet its obligations under the Contracts. They
should not be considered as bearing on the investment performance of the assets
held in the Variable Account.
10
<PAGE> 56
NATIONAL LIFE INSURANCE COMPANY
* * * * *
FINANCIAL STATEMENTS
* * * * *
DECEMBER 31, 1996 AND 1995
F-1
<PAGE> 57
[PRICE WATERHOUSE LLP LETTERHEAD]
Report of Independent Accountants
April 15, 1997
To the Board of Directors and
Policyowners of National Life Insurance Company
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations and policyowners' equity, and cash flows
present fairly, in all material respects, the financial position of National
Life Insurance Company and its subsidiaries at December 31, 1996 and 1995, and
the results of their operations and their cash flows for the years then ended
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 Note 2, the Company changed its accounting policies to adopt
pronouncements of the Financial Accounting Standards Board, which are effective
for 1996 financial statements and require restatement of all prior periods
presented.
/s/ PRICE WATERHOUSE LLP
F-2
<PAGE> 58
NATIONAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Cash and cash equivalents $ 268,235 $ 310,905
Debt and equity securities
Available-for-sale, at fair value 4,393,046 3,240,480
Held-to-maturity, at amortized cost 590,700 477,708
Mortgage loans 907,024 649,892
Policy loans 796,193 735,852
Real estate investments 99,442 97,612
Other invested assets 78,596 25,733
- ---------------------------------------------------------------------------------------------------------
Total cash and invested assets 7,133,236 5,538,182
Deferred policy acquistion costs 421,584 327,629
Due and accrued investment income 120,753 96,852
Premiums and fees receivable 25,874 23,648
Deferred income taxes 33,514 1,924
Amounts recoverable from reinsurers 190,873 161,997
Present value of future profits of insurance acquired 80,957 -
Property and equipment, net 64,302 62,418
Other assets 51,453 49,810
Separate account assets 181,771 177,890
- ---------------------------------------------------------------------------------------------------------
Total assets $ 8,304,317 $ 6,440,350
=========================================================================================================
LIABILITIES:
Policy liabilities:
Policy benefit liabilities $ 3,701,597 $ 3,484,844
Policyowners' account balances 3,051,973 1,431,386
Policyowners' deposits 37,524 36,642
Policy claims payable 31,217 25,545
Policyowners' dividends 51,792 47,025
Other liabilities and accrued expenses 394,127 396,407
Debt 82,682 69,679
Separate account liabilities 165,234 167,162
- ---------------------------------------------------------------------------------------------------------
Total liabilities 7,516,146 5,658,690
- ---------------------------------------------------------------------------------------------------------
MINORITY INTERESTS 39,263 1,569
POLICYOWNERS' EQUITY:
Net unrealized gain on available-for-sale securities 28,867 77,173
Retained earnings 720,041 702,918
- ---------------------------------------------------------------------------------------------------------
Total policyowners' equity 748,908 780,091
- ---------------------------------------------------------------------------------------------------------
Total liabilities, minority interests and policyowners' equity $ 8,304,317 $ 6,440,350
=========================================================================================================
</TABLE>
F-3
The accompanying notes are an integral part of these financial statements.
<PAGE> 59
NATIONAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS AND POLICYOWNERS' EQUITY
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
REVENUES:
Insurance premiums $ 406,286 $ 418,227
Universal life and investment-type policy charges 41,745 36,900
Net investment income 517,268 396,079
Realized investment (losses) gains (2,070) 33,925
Investment advisory fees 42,256 34,278
Other income 21,278 19,845
- ----------------------------------------------------------------------------------------------------
Total revenue 1,026,763 939,254
- ----------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES:
Policy benefits 297,564 278,123
Policyowners' dividends 105,690 98,952
Interest credited to policyowners' account balances 170,955 90,037
Increase in reserves 166,668 187,433
Operating expenses 148,716 124,425
Commissions and expense allowances 95,517 80,050
Deferral of acquisition costs (53,600) (44,331)
Amortization of deferred policy acquisition costs 40,248 42,234
- ----------------------------------------------------------------------------------------------------
Total benefits and expenses 971,758 856,923
- ----------------------------------------------------------------------------------------------------
Income before income taxes and minority interests 55,005 82,331
Income taxes 31,957 31,365
Minority interests in subsidiary earnings 5,925 2,968
- ----------------------------------------------------------------------------------------------------
NET INCOME 17,123 47,998
RETAINED EARNINGS:
Beginning of year 702,918 654,920
- ----------------------------------------------------------------------------------------------------
End of year $ 720,041 $ 702,918
====================================================================================================
NET UNREALIZED GAIN (LOSS) ON AVAILABLE-FOR-SALE SECURITIES:
Beginning of year $ 77,173 $ (23,195)
Change during year (48,306) 100,368
- ----------------------------------------------------------------------------------------------------
End of year $ 28,867 $ 77,173
====================================================================================================
</TABLE>
F-4
The accompanying notes are an integral part of these financial statements.
<PAGE> 60
NATIONAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOW
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------
(In Thousands) 1996 1995
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 17,123 $ 47,998
Adjustments to reconcile net income to net cash provided by operations:
Change in due and accrued investment income (1,502) (4,785)
Realized investment gains (2,070) (33,925)
Change in policy benefit liabilities 144,723 146,727
Change in deferred policy acquisition costs (9,956) (2,097)
Depreciation 4,283 3,709
Change in policyowners' dividends 4,975 (5,102)
Change in deferred income taxes (13,646) (9,771)
Other (8,538) 30,154
- ------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 135,392 172,908
- ------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investments 2,157,236 1,814,927
Investment maturities and repayments 340,412 89,919
Cost of investments acquired (2,714,560) (2,126,075)
Acquisition of LSW National Holdings, net (81,551) -
Other 4,793 27,587
- ------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (293,670) (193,642)
- ------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Policyowners' account balances:
Deposits, including interest credited 535,932 279,889
Withdrawals, including policy charges (418,775) (239,354)
Net (decrease) increase in borrowings under repurchase agreements (51,013) 51,013
Net increase in securities lending liabilities 31,717 31,489
Other 17,747 3,012
- ------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 115,608 126,049
- ------------------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (42,670) 105,315
CASH AND CASH EQUIVALENTS:
Beginning of year 310,905 205,590
- ------------------------------------------------------------------------------------------------------------
End of year $ 268,235 $ 310,905
============================================================================================================
</TABLE>
F-5
The accompanying notes are an integral part of these financial statements.
<PAGE> 61
NATIONAL LIFE INSURANCE COMPANY and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 and 1995
NOTE 1 - NATURE OF OPERATIONS
National Life Insurance Company (National Life) was chartered in 1848 and is
among ten oldest insurance companies and the 25 largest mutual life insurance
companies in the United States. National Life is also known by its registered
trade name "National Life of Vermont". National Life employs about 1,000 people
in its home office in Montpelier, Vermont. As a mutual life insurance company,
National Life has no shareholders. With its affiliates and subsidiaries,
National Life offers a broad range of financial services and products,
including life insurance, annuities, disability income insurance and mutual
funds.
National Life primarily develops and distributes traditional and universal
individual life insurance and annuity products. National Life markets its
products primarily to small business owners, professionals and high net worth
individuals by providing financial solutions in the form of estate, business
succession and retirement planning, deferred compensation and other key
executive fringe benefit plans. Insurance and annuity products are primarily
distributed through about 50 general agencies in major metropolitan areas
throughout the United States. National Life also distributes its products
through brokers and banks. National Life has more than 250,000 policyowners and
is licensed to do business in all 50 states and the District of Columbia.
About 27% of National Life's total collected premiums are from residents of New
York and California.
Through affiliates National Life also distributes and provides investment
advisory and administrative services to the Sentinel Funds, a family of twelve
mutual funds that is one of America's oldest mutual funds. The Sentinel Funds'
$2.3 billion of net assets are managed on behalf of about 102,300 individual,
corporate and institutional shareholders worldwide.
During 1996, National Life acquired a majority interest in Life Insurance
Company of the Southwest (LSW), a Dallas, Texas based financial services
company specializing in annuities. LSW is licensed in all states but New York.
LSW's customer focus has been mainly on teachers and employees of non-profit
institutions, with particular concentration in the west and the southwest.
About 60% of LSW's total collected premiums are from residents of California,
Texas and Florida.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements of National Life and
subsidiaries have been prepared in conformity with generally accepted
accounting principles (GAAP).
The consolidated financial statements include the accounts of National Life
Insurance Company and its subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
The preparation of financial statements in conformity with GAAP 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 amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
F-6
<PAGE> 62
ACCOUNTING CHANGES
Prior to these 1996 financial statements, National Life prepared its financial
statements in accordance with statutory accounting practices prescribed or
permitted by the State of Vermont Department of Banking, Insurance, Securities
and Health Care Administration, its domicillary insurance regulator. Prior to
1996, statutory basis financial statements were considered in conformity with
GAAP for mutual life insurance companies.
In 1993 through 1995, the Financial Accounting Standards Board and the American
Institute of Certified Public Accountants issued certain pronouncements that
redefined generally accepted accounting principles for mutual life insurance
companies. Beginning in 1996, statutory basis financial statements are no
longer considered in conformity with GAAP.
The accompanying GAAP financial statements apply all applicable authoritative
accounting pronouncements required to meet the new standards. The 1995
information included in these financial statements has been restated on a GAAP
basis to enhance comparability with the 1996 information, consistent with the
transition provisions of the new accounting standards. The cumulative effect on
1995 beginning policyowners' equity was as follows (in thousands):
<TABLE>
<CAPTION>
Effect on beginning
policyowners' equity
- --------------------------------------------------------------------------------------------
<S> <C>
Asset valuation reserve $ 49,681
Interest maintenance reserve 31,663
Surplus notes (69,675)
Non-admitted assets 16,492
Investments 7,294
Deferred policy acquisition costs 437,516
Deferred income taxes 33,292
Policy liabilities (174,976)
Policyowners' dividends 60,945
Benefit plans (40,113)
Net unrealized loss on available-for-sale securities (23,195)
Other changes, net (14,133)
- --------------------------------------------------------------------------------------------
Increase in policyowners' equity from conversion to GAAP 314,791
Statutory surplus, December, 31, 1994; as previously reported 316,934
- --------------------------------------------------------------------------------------------
GAAP policyowners' equity, January 1, 1995 $ 631,725
============================================================================================
January 1, 1995:
Net unrealized loss on available-for-sale securities $ (23,195)
Retained earnings 654,920
- --------------------------------------------------------------------------------------------
Total policyowners' equity $ 631,725
============================================================================================
</TABLE>
INVESTMENTS
Cash and cash equivalents include highly liquid debt instruments purchased with
remaining maturities of three months or less.
Debt and equity securities are designated as available-for-sale or
held-to-maturity where the company has the ability and intent to hold
securities to maturity. Available-for-sale securities are reported at estimated
fair value. Held-to-maturity securities are reported at amortized cost. Debt
and equity securities that experience declines in value that are other than
temporary are written down with a corresponding charge to realized losses.
Mortgage loans are reported at amortized cost, less valuation allowances for
the excess, if any, of the
F-7
<PAGE> 63
amortized cost of impaired loans over the estimated fair value of the related
collateral. Changes in valuation allowances are included in realized gains and
losses.
Policy loans are reported at their unpaid balance and are fully collateralized
by related cash surrender values.
Real estate investments are reported at depreciated cost. Real estate acquired
in satisfaction of debt is transferred to real estate at the lower of the
recorded investment in the loan, including accrued interest, or estimated fair
value.
Realized investment gains and losses are recognized using the specific
identification method and include changes in valuation allowances. Changes in
the estimated fair values of available-for-sale debt and equity securities are
reflected in policyowners' equity after adjustments for related deferred policy
acquisition costs, present value of future profits of insurance acquired and
income taxes.
DEFERRED POLICY ACQUISITION COSTS
Commissions and other costs of acquiring new business that vary with and are
primarily related to the production of new business are generally deferred.
Deferred policy acquisition costs for participating life insurance, universal
life insurance and investment-type annuities are amortized in relation to
estimated gross margins or profits. Amortization is adjusted retrospectively
for actual experience and when estimates of future gross margins or profits are
revised. Balances of deferred policy acquisition costs for these products are
adjusted for related unrealized gains and losses on available-for-sale
securities through policyowners' equity, net of related income taxes.
Deferred policy acquisition costs for non-participating term life insurance and
disability income insurance is amortized in relation to premium income using
assumptions consistent with those used in computing policy benefit liabilities.
Balances of deferred policy acquisition costs are regularly evaluated for
recoverability from product margins or profits.
PRESENT VALUE OF FUTURE PROFITS OF INSURANCE ACQUIRED
Present value of future profits of insurance acquired is the
actuarially-determined present value of future projected profits from policies
in force at the date of their acquisition, and is amortized in relation to
gross profits of those policies.
PROPERTY AND EQUIPMENT
Property and equipment is reported at depreciated cost. Real property is
depreciated over 40 years using the straight line method. Furniture and
equipment is depreciated using accelerated depreciation methods over 7 years
and 5 years, respectively.
SEPARATE ACCOUNTS
Separate accounts are segregated funds relating to certain variable annuity and
variable life policies, and National Life's pension plans. Separate account
assets are primarily common stocks, bonds, mortgage loans, and real estate and
are carried at estimated fair value. Separate account liabilities reflect
separate account policyowners' interests in separate account assets, include
the actual investment performance of the respective accounts and are not
guaranteed. Separate account results relating to these policyowners' interests
are excluded from revenues and expenses.
F-8
<PAGE> 64
POLICY LIABILITIES
Policy benefit liabilities for participating life insurance are developed using
the net level premium method, with interest and mortality assumptions used in
calculating policy cash surrender values. Participating life insurance terminal
dividends are accrued in relation to gross margins.
Policy benefit liabilities for non-participating life insurance, disability
income insurance and certain annuities are developed using the net level
premium method, with assumptions for interest, mortality, morbidity,
withdrawals and expenses based principally on company experience.
Policyowners' account balances for universal life insurance and investment-type
annuities represent amounts that inure to the benefit of the policyowners
(before surrender charges).
POLICYOWNERS' DIVIDENDS
Policyowners' dividends are the pro-rata amount of dividends earned that will
be paid or credited at the next policy anniversary. Dividends are based on a
scale that seeks to reflect the relative contribution of each group of policies
to National Life's overall operating results. The dividend scale is approved
annually by National Life's Board of Directors.
RECOGNITION OF INSURANCE INCOME AND RELATED EXPENSES
Premiums from traditional life and certain annuities are recognized as revenue
when due from the policyowner. Benefits and expenses are matched with income by
providing for policy benefit liabilities and the deferral and amortization of
policy acquisition costs so as to recognize profits over the life of the
policies.
Premiums from universal life and investment-type annuities are reported as
increases in policyowners' account balances. Revenues for these policies
consist of mortality charges, policy administration charges and surrender
charges deducted from policyowners' account balances. Policy benefits charged
to expense include benefit claims in excess of related policyowners' account
balances.
Premiums from disability income policies are recognized as revenue over the
period to which the premiums relate.
FEDERAL INCOME TAXES
National Life files a consolidated federal income tax return that includes all
of its wholly-owned subsidiaries. Current federal income taxes are charged or
credited to operations based upon amounts estimated to be payable or
recoverable as a result of taxable operations for the current year. Deferred
income tax assets and liabilities are recognized based on temporary differences
between financial statement carrying amounts and income tax bases of assets and
liabilities using enacted income tax rates and laws.
F-9
<PAGE> 65
NOTE 3 - INVESTMENTS
DEBT AND EQUITY SECURITIES
The amortized cost and estimated fair values of debt and equity securities at
December 31 were as follows (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Amortized Cost Unrealized Unrealized Estimated Fair
1996 Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. government obligations $ 180,646 $ 3,336 $ 187 $ 183,795
Government agencies, authorities and
subdivisions 222,867 9,165 3,693 228,339
Public utilities 427,426 12,354 7,270 432,510
Corporate 2,176,977 72,482 20,581 2,228,878
Private placements 199,061 4,923 2,349 201,635
Mortgage-backed securities 1,089,434 16,244 10,142 1,095,536
- --------------------------------------------------------------------------------------------------------------------
4,296,411 118,504 44,222 4,370,693
Preferred stocks 9,719 739 359 10,099
Common stocks 9,705 2,560 11 12,254
- --------------------------------------------------------------------------------------------------------------------
Total $ 4,315,835 $ 121,803 $ 44,592 $ 4,393,046
====================================================================================================================
Held-to-maturity:
U.S. government obligations $ 2,052 $ 14 $ 2 $ 2,064
Government agencies, authorities and
subdivisions 20,970 1,264 208 22,026
Public utilities 9,953 359 1 10,311
Corporate 30,669 1,593 40 32,222
Private placements 527,056 21,799 3,059 545,794
- --------------------------------------------------------------------------------------------------------------------
Total $ 590,700 $ 25,029 $ 3,310 $ 612,417
====================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
1995
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
U.S. government obligations $ 310,430 $ 15,105 $ 12 $ 325,523
Government agencies, authorities and
subdivisions 97,474 9,502 87 106,889
Public utilities 245,525 23,935 524 268,936
Corporate 1,515,959 143,525 674 1,658,810
Private placements 150,866 11,439 1,753 160,552
Mortgage-backed securities 667,827 29,203 535 696,495
- --------------------------------------------------------------------------------------------------------------------
2,988,081 232,709 3,585 3,217,205
Preferred stocks 14,217 453 423 14,247
Common stocks 7,428 1,637 37 9,028
- --------------------------------------------------------------------------------------------------------------------
Total $ 3,009,726 $ 234,799 $ 4,045 $ 3,240,480
====================================================================================================================
Held-to-maturity:
Government agencies, authorities and
subdivisions $ 21,708 $ 1,276 $ 6 $ 22,978
Public utilities 9,839 778 - 10,617
Corporate 32,358 3,353 - 35,711
Private placements 413,803 38,629 1,951 450,481
- --------------------------------------------------------------------------------------------------------------------
Total $ 477,708 $ 44,036 $ 1,957 $ 519,787
====================================================================================================================
</TABLE>
F-10
<PAGE> 66
Unrealized gains and losses on available-for-sale debt and equity securities
included as a component of policyowners' equity and changes therein for the
years ended December 31 were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Net unrealized (losses) gains on available-for-sale securities $ (153,543) $ 305,859
Net unrealized gains on separate account seed money 1,225 -
Related minority interests 2,474 -
Related deferred policy acquisition costs 61,726 (151,447)
Related present value of future profits on insurance acquired 11,639 -
Related deferred income taxes 28,173 (54,044)
- ---------------------------------------------------------------------------------------------------
Increase (decrease) in net unrealized gains (losses) (48,306) 100,368
Balance, beginning of year 77,173 (23,195)
- ---------------------------------------------------------------------------------------------------
Balance, end of year $ 28,867 $ 77,173
===================================================================================================
Balance, end of year includes:
Net unrealized gains on available-for-sale securities $ 77,211 $ 230,754
Net unrealized gains on separate account seed money 1,225 -
Related minority interests 2,474 -
Related deferred policy acquisition costs (50,300) (112,026)
Related present value of future profits on insurance acquired 11,639 -
Related deferred income taxes (13,382) (41,555)
- ---------------------------------------------------------------------------------------------------
Balance, end of year $ 28,867 $ 77,173
===================================================================================================
</TABLE>
In December 1995, securities with an estimated fair value and an amortized cost
of $70.7 million and $67.7 million, respectively were reclassified from
held-to-maturity to available-for-sale consistent with the transition
provisions of the Financial Accounting Standards Board Special Report "A Guide
to Implementation of Statement 115 on Accounting for Certain Debt and Equity
Securities".
The amortized cost and estimated fair values of debt securities by contractual
maturity at December 31, 1996 are shown below (in thousands). Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
Available-for-sale Held-to-maturity
-----------------------------------------------------------------------
Amortized Estimated Fair Amortized Estimated Fair
Cost Value Cost Value
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $ 47,136 $ 47,520 $ 9,562 $ 9,727
Due after one year through five years 384,967 396,911 122,675 125,576
Due after five years through ten years 1,607,585 1,616,822 260,462 271,399
Due after ten years 1,163,295 1,209,956 198,001 205,715
Mortgage-backed securities 1,093,428 1,099,484 - -
- --------------------------------------------------------------------------------------------------------------------
Total $ 4,296,411 $ 4,370,693 $ 590,700 $ 612,417
====================================================================================================================
</TABLE>
Information relating to debt security sale transactions for the years ended
December 31 are shown below (in thousands):
<TABLE>
<CAPTION>
Available-for-sale
------------------------------------
1996 1995
- ---------------------------------------------------------------------------------
<S> <C> <C>
Proceeds from sales $ 1,990,175 $ 1,575,695
Gross realized gains $ 46,092 $ 54,877
Gross realized losses $ 42,759 $ 12,216
</TABLE>
There were no sales of held-to-maturity securities in 1996 or 1995.
F-11
<PAGE> 67
National Life periodically lends certain U.S. government or corporate bonds to
approved counterparties to enhance the yield of its bond portfolio. National
Life receives cash collateral slightly higher than the market value of
securities loaned. Collateral adequacy is evaluated daily and periodically
adjusted for changes in the market value of securities loaned. The carrying
values of securities loaned are unaffected by the transaction. Collateral held
(included in cash and cash equivalents) and the corresponding liability for
collateral held (included in other liabilities) were $159.4 million and $127.7
million at December 31, 1996 and 1995, respectively.
National Life also periodically enters into repurchase agreements on U.S.
Treasury securities to enhance the yield of its bond portfolio. These
transactions are accounted for as financings because the securities received at
the end of the repurchase period are identical to the securities transferred.
The repurchase liability is included in other liabilities and was $51.0 million
at December 31, 1995. There were no open transactions at December 31, 1996.
MORTGAGE LOANS AND REAL ESTATE
The distributions of mortgage loans and real estate at December 31 were as
follows:
<TABLE>
<CAPTION>
Mortgage Loans Real Estate
-----------------------------------------------------------
1996 1995 1996 1995
-----------------------------------------------------------
<S> <C> <C> <C> <C>
GEOGRAPHIC REGION
-----------------
New England 5.0% 8.9%
Middle Atlantic 10.1 14.6 - 0.1%
East North Central 9.4 12.0 19.6% 20.5
West North Central 3.9 2.8 0.1 0.1
South Atlantic 28.9 29.2 42.0 48.6
East South Central 4.4 5.1 4.2 -
West South Central 11.5 2.4 29.5 27.0
Mountain 17.6 15.8
Pacific 9.2 9.2 4.6 3.7
-----------------------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0%
=================================================================================================================
PROPERTY TYPE
-------------
Residential 0.3% -
Apartment 23.4 27.3%
Retail 19.5 27.7 10.5% 10.7%
Office Building 34.9 27.0 11.3 10.2
Industrial 19.9 15.3 71.6 73.4
Hotel/Motel 1.1 1.4
Other Commercial 0.9 1.3 6.6 5.7
-----------------------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0%
=================================================================================================================
</TABLE>
F-12
<PAGE> 68
Mortgage loans and related valuation allowances at December 31 were as follows
(in thousands):
<TABLE>
<CAPTION>
1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C>
Unimpaired loans $ 876,994 $ 615,359
Impaired loans without valuation allowances 6,146 13,667
--------------------------------
Subtotal 883,140 629,026
--------------------------------
Impaired loans with valuation allowances 31,167 29,341
Related valuation allowances (7,283) (8,475)
--------------------------------
Subtotal 23,884 20,866
- -----------------------------------------------------------------------------------
Total $ 907,024 $ 649,892
===================================================================================
Impaired loans:
Average recorded investment $ 40,161 $ 41,483
Interest income recognized $ 5,026 $ 4,856
Interest received $ 5,170 $ 4,900
</TABLE>
Impaired loans are mortgage loans where it is not probable that all amounts due
under the contractual terms of the loan will be received. Impaired loans
without valuation allowances are mortgage loans where the estimated fair value
of the collateral exceeds the recorded investment in the loan. For these
impaired loans, interest income is recognized on an accrual basis, subject to
recoverability from the estimated fair value of the loan collateral. For
impaired loans with valuation allowances, interest income is recognized on a
cash basis.
Activity in the valuation allowances for impaired mortgage loans for the years
ended December 31 were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
-------------------------------------------------------------------------------------------------
<S> <C> <C>
Additions for impaired loans charged to realized losses $ 3,944 $ 2,240
Impairment losses charged to valuation allowances (7,559) (6,671)
Changes to previously established valuation allowances 2,423 3,367
-----------------------------------------------------------------------------------------------
Decrease in valuation allowances (1,192) (1,064)
Balance, beginning of year 8,475 9,539
-----------------------------------------------------------------------------------------------
Balance, end of year $ 7,283 $ 8,475
===============================================================================================
</TABLE>
NET INVESTMENT INCOME
Net investment income is presented net of related investment expenses of
$31.4 million and $32.5 million for the years ended December 31, 1996 and
1995, respectively.
NOTE 4 - INSURANCE IN-FORCE AND REINSURANCE
National Life reinsures certain risks assumed in the normal course of business.
For individual life products, National Life generally retains no more than $3.0
million of risk on any person (excluding accidental death benefits and dividend
additions). Reinsurance for life products is ceded under yearly renewable term,
coinsurance, and modified coinsurance. National Life has assumed a small amount
of yearly renewable term reinsurance from non-affiliated insurers. Disability
income products are significantly reinsured under coinsurance and modified
coinsurance.
National Life remains liable in the event any reinsurer is unable to meet its
assumed obligations. National Life regularly evaluates the financial condition
of its reinsurers and concentrations of credit risk of reinsurers to minimize
its exposure to significant losses from reinsurer insolvencies.
F-13
<PAGE> 69
The effects of reinsurance for the years ended December 31, were as follows (in
thousands):
<TABLE>
<CAPTION>
1996 1995
----------------------------------------------------------------------------------
<S> <C> <C>
Insurance premiums:
Direct premiums $ 474,998 $ 487,411
Reinsurance assumed 959 672
Reinsurance ceded (69,671) (69,856)
----------------------------------------------------------------------------------
$ 406,286 $ 418,227
==================================================================================
Policy benefits:
Direct policy benefits $ 363,405 $ 351,635
Reinsurance assumed 62 -
Reinsurance ceded (65,903) (73,512)
----------------------------------------------------------------------------------
$ 297,564 $ 278,123
==================================================================================
Policyowners' dividends:
Direct policyowners' dividends $ 112,050 $ 104,845
Reinsurance ceded (6,360) (5,893)
----------------------------------------------------------------------------------
$ 105,690 $ 98,952
==================================================================================
Increase in policy liabilities:
Direct increase in policy liabilities $ 164,233 $ 181,145
Reinsurance assumed (20) -
Reinsurance ceded 2,455 6,288
----------------------------------------------------------------------------------
$ 166,668 $ 187,433
==================================================================================
</TABLE>
NOTE 5 - INCOME TAXES
The components of income taxes and a reconciliation of the expected and actual
income taxes and marginal and effective federal income tax rates for the years
ended December 31 were as follows ($ in thousands):
<TABLE>
<CAPTION>
1996 1995
------------------------------------------------------------------------------------------------------------------
Amount Rate Amount Rate
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Current $ 45,603 $ 41,136
Deferred (13,646) (9,771)
------------------------------------------------------------------- --------------
Income taxes $ 31,957 $ 31,365
=================================================================== ==============
Expected income taxes $ 17,178 35.0% $ 27,777 35.0%
Differential earnings amount 6,007 12.2 - -
Net change in tax reserves 10,290 21.0 4,233 5.3
Other (1,518) (3.1) (645) (.8)
------------------------------------------------------------------------------------------------------------------
Income taxes $ 31,957 $ 31,365
=================================================================== =============
Effective federal income tax rate 65.1% 39.5%
=================================================== =============== ==============
</TABLE>
F-14
<PAGE> 70
Components of net deferred income tax assets at December 31 were as follows (in
thousands):
<TABLE>
<CAPTION>
1996 1995
-------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Policy liabilities $ 160,933 $ 122,832
Other liabilities and accrued expenses 47,703 44,960
Other 10,495 10,873
-------------------------------------------------------------------------------------------------------------
Total deferred income tax assets 219,131 178,665
-------------------------------------------------------------------------------------------------------------
Deferred income tax liabilities:
Deferred policy acquisition costs 125,454 120,081
Present value of future profits of insurance acquired 24,262 -
Net unrealized gain on available-for-sale debt and equity securities 13,382 41,555
Debt and equity securities 9,352 4,678
Other 13,167 10,427
-------------------------------------------------------------------------------------------------------------
Total deferred income tax liabilities 185,617 176,741
-------------------------------------------------------------------------------------------------------------
Net deferred income tax assets $ 33,514 $ 1,924
=============================================================================================================
</TABLE>
Management believes it is more likely than not that National Life will realize
the benefit of deferred tax assets.
National Life's federal income tax returns are routinely audited by the IRS.
The IRS has examined tax returns through 1993 and is currently examining the
years 1994 and 1995. In management's opinion adequate tax liabilities have been
established for all open years.
NOTE 6 - BENEFIT PLANS
National Life sponsors a qualified defined benefit pension plan covering
substantially all employees. The plan is administered by National Life's
Benefits Committee and is non-contributory, with benefits based on an
employee's retirement age, years of service and compensation near retirement.
National Life makes annual contributions to the plan of the maximum amount
deductible for income tax purposes. Plan assets are primarily bonds and common
stocks held in a National Life separate account and funds invested in an
annuity contract issued by National Life.
National Life also sponsors other non-qualified pension plans, including a
non-contributory defined benefit plan for general agents that provides benefits
based on years of service and sales levels, a contributory defined benefit plan
for certain employees, agents and general agents and a non-contributory defined
supplemental benefit plan for certain executives. These non-qualified plans are
not funded.
F-15
<PAGE> 71
The status of the defined benefit plans at December 31, were as follows (in
thousands):
<TABLE>
<CAPTION>
1996 1995
--------------------------------------------------------
Funded plan Unfunded Funded plan Unfunded
plans plans
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Actuarial present value of benefit obligation:
Vested $ 83,362 $ 63,255 $ 76,764 $ 62,981
Non-vested 476 19 444 15
---------------------------------------------------------------------------------------------------------------------
Accumulated benefit obligation $ 83,838 $ 63,274 $ 77,208 $ 62,996
---------------------------------------------------------------------------------------------------------------------
Projected benefit obligation $ 108,564 $ 66,402 $ 102,525 $ 67,473
Plan assets at fair value (97,566) - (90,095) -
---------------------------------------------------------------------------------------------------------------------
Projected benefit obligation in excess of plan assets 10,998 66,402 12,430 67,473
Unrecognized net gain (loss) 512 (1,292) (2,527) (2,538)
---------------------------------------------------------------------------------------------------------------------
Accrued pension cost (included in other liabilities) $ 11,510 $ 65,110 $ 9,903 $ 64,935
=====================================================================================================================
</TABLE>
The components of net periodic pension cost for the years ended December 31,
were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Service cost (benefits earned during the current period) $ 4,384 $ 3,706
Interest cost on projected benefit obligation 11,788 11,331
Actual return on plan assets (10,230) (15,090)
Net amortization and deferrals (99) 5,438
---------------------------------------------------------------------------------------------------------
Net periodic pension cost (included in operating expenses) $ 5,843 $ 5,385
==========================================================================================================
</TABLE>
The actuarial assumptions used in determining pension benefit obligations at
December 31, were as follows:
<TABLE>
<CAPTION>
1996 1995
---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Discount rate 7.00% 7.75%
Rate of increase in future compensation levels 5.00% 5.00%
Expected long term return on plan assets 7.00% 7.75%
---------------------------------------------------------------------------------------------------------
</TABLE>
National Life uses the straight-line method of amortization for prior service
cost and unrecognized gains and losses.
National Life provides employee savings and 401(k) plans where up to 3% of an
employee's compensation may be invested by the employee in either plan with
matching funds contributed by the company. National Life also contributes
various amounts of an employee's compensation (up to certain levels) to a
401(k) account. Additional voluntary employee contributions may be made to the
plans subject to certain limits. Company contributions to these plans generally
vest within two years.
National Life also sponsors four defined benefit postretirement plans. The
plans provide medical and dental benefits and life insurance benefits to
employees and agents. Substantially all employees and agents may be eligible
for retiree benefits if they reach normal retirement age and meet certain
minimum service requirements while working for National Life. Most of the plans
are contributory, with retiree contributions adjusted annually, and contain
cost sharing features such as deductibles and coinsurance. The plans are not
funded and National Life pays for plan benefits on a current basis. The cost
of these benefits is recognized as earned.
F-16
<PAGE> 72
The plans' combined status at December 31, were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Accumulated postretirement benefit obligation (APBO):
Retirees $ 13,902 $ 14,003
Fully eligible active plan participants 3,365 2,951
Other active plan participants 7,084 6,456
------------------------------------------------------------------------------------------------------------------
Total accumulated postretirement benefit obligation 24,351 23,410
Unrecognized actuarial gain 930 338
Unrecognized prior service cost (1,296) (1,368)
------------------------------------------------------------------------------------------------------------------
Accrued postretirement benefit cost (included in other liabilities) $ 23,985 $ 22,380
==================================================================================================================
</TABLE>
The components of net periodic postretirement benefit cost for the years ended
December 31, were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Service cost (benefits earned during the current period) $ 667 $ 444
Interest cost on accumulated postretirement benefit obligation 1,652 1,518
Amortization of prior service cost over 10 years 72 72
----------------------------------------------------------------------------------------------------------------
Net periodic postretirement benefit cost (included in operating expenses) $ 2,391 $ 2,034
================================================================================================================
</TABLE>
The discount rate used in determining the APBO was 7.0% for 1996 and 1995. The
health care cost trend rates for 1997 are 6.8% and 7.2% for the employee and
agent medical plans, respectively, and grade to 5% in year 2000 and remain
level thereafter. Increasing the assumed health care trend rates by one
percentage point in each year would increase the APBO by about $1.1 million and
the 1996 service and interest cost components of net periodic postretirement
benefit cost by about $0.1 million.
During 1995 plan amendments were enacted which increased some of the medical
plan benefits for active and retired employees. These changes increased the
APBO by approximately $1.4 million, which is amortized over the average
remaining years of service of the plan participants of ten years.
NOTE 7 - DERIVATIVES
National Life purchases option contracts on the Standard & Poor's 500 (S&P 500)
index to hedge obligations relating to equity indexed annuity products. When
the S&P 500 index increases, increases in the intrinsic value of the purchased
options are offset by increases in equity indexed annuities account values.
When the S&P 500 index decreases, National Life's loss is limited to the
premium paid for the options.
National Life purchases options only from highly rated institutions. However,
in the event a counterparty failed to perform, National Life's loss would be
equal to the fair value of the net options held from that counterparty.
The option premium is expensed over the term of the option. The amortization of
the option premium and increases in the intrinsic value of purchased options
are reflected in investment income. Interest credited includes amounts that
would be credited on the next policy anniversary based on the S&P 500 index's
value at the reporting date.
At December 31, 1996, National Life held purchased options with a notional
amount of $61.1 million. These options had a net book value of $6.5 million,
consisting of $3.0 million of net amortized cost and $3.5 million of intrinsic
value.
F-17
<PAGE> 73
NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values and estimated fair values of financial instruments at
December 31 were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------------------------------------------------------
Estimated Fair Estimated Fair
Carrying Value Value Carrying Value Value
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 268,235 $ 268,235 $ 310,905 $ 310,905
Debt and equity securities:
Available-for-sale 4,393,046 4,393,046 3,240,480 3,240,480
Held-to-maturity 590,700 612,417 477,708 519,787
Mortgage loans 907,024 924,732 649,892 706,309
Policy loans 796,193 715,914 735,852 665,151
Derivatives 6,496 5,123 - -
Investment products 2,341,273 2,336,171 872,551 832,013
Debt 82,682 80,149 69,679 70,771
</TABLE>
For cash and cash equivalents carrying value approximates estimated fair value.
Debt and equity securities estimated fair values are based on quoted values
where available. Where quoted values are not available, estimated fair values
are based on discounted cash flows using current interest rates of similar
securities.
Mortgage loan fair values are estimated as the average of discounted cash flows
under different scenarios of future mortgage interest rates (including
appropriate provisions for default losses and borrower prepayments).
For variable rate policy loans the unpaid balance approximates fair value.
Fixed rate policy loan fair values are estimated based on discounted cash flows
using the current variable policy loan rate (including appropriate provisions
for mortality and repayments).
Derivatives estimated fair values are based on quoted values.
Investment products include flexible premium annuities, single premium deferred
annuities and supplementary contracts not involving life contingencies.
Investment product fair values are estimated as the average of discounted cash
flows under different scenarios of future interest rates of A-rated corporate
bonds and related changes in premium persistency and surrenders.
Debt fair values are estimated values are based on discounted cash flows using
current interest rates of similar securities.
F-18
<PAGE> 74
NOTE 9 - DEBT
Debt consists of the following (in thousands):
<TABLE>
<CAPTION>
1996 1995
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
National Life - 8 1/4% Surplus Notes:
$70 million, maturing March 1, 2024 with interest payable semi-annually on
March 1 and September 1. The notes are unsecured and subordinated to all
present and future indebtedness, policy claims and prior claims. The notes
may be redeemed in whole or in part any time after March 1, 2004 at
predetermined redemption prices. All interest and principal payments require
prior written approval by the State of Vermont Department of Banking,
Insurance, Securities and Health Care Administration.
$ 69,682 $ 69,679
LSW National Holdings, Inc. - 6.1% Term Note:
maturing March 1, 2000 with interest payable semi-annually on
March 1 and September 1. The note is secured by subsidiary stock,
includes certain restrictive covenants and requires annual
payments of principal (see below). 13,000
- ---------------------------------------------------------------------------------------------------------------------
Total debt $ 82,682 $ 69,679
=====================================================================================================================
</TABLE>
The aggregate annual maturities of debt for the next five years are as follows:
<TABLE>
<S> <C>
1997 $ 2,600
1998 4,400
1999 3,000
2000 3,000
2001 -
</TABLE>
NOTE 10 - ACQUISITION
National Financial Services, Inc., a wholly-owned subsidiary of National Life,
acquired a two-thirds interest in Life Insurance Company of the Southwest (LSW)
located in Dallas, Texas on February 8, 1996. LSW is a financial services
company specializing in annuities that is licensed in all states but New York
and has assets of $1.8 billion. LSW's customer focus has been mainly on
teachers and employees of non-profit institutions, with particular
concentration in the west and the southwest.
The acquisition was accomplished by purchasing two-thirds of LSW Holdings
Corporation, the owner of LSW. LSW Holdings Corporation was renamed LSW
National Holdings, Inc. concurrent with the purchase. The purchase price was
about $102 million in cash. The purchase resulted in the recording of an
intangible asset for the present value of future profits of insurance acquired
of $67.2 million.
The minority shareholders have the right to put their shares to National Life
at specified prices in the event of certain contingencies during the first five
years subsequent to closing and generally thereafter. Similarly, National Life
has the right to call the minority shareholders' shares at specified prices.
The specified prices are generally a function of GAAP equity or the original
purchase price.
F-19
<PAGE> 75
These consolidated financial statements include the financial position and
operations of LSW National Holdings since the purchase, along with appropriate
adjustments for minority interests, using the purchase method. Pro forma
results had the acquisition occurred as of January 1, 1996 and 1995 are shown
in the table below. These pro forma results are not necessarily indicative of
the actual results which might have occurred had National Life owned LSW since
that date.
<TABLE>
<CAPTION>
1996 1995
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Revenues $ 1,026,763 $ 1,060,948
Net income 17,356 45,905
</TABLE>
Noncash investing activities relating to the acquisition that are not reflected
in the consolidated statement of cash flow were as follows (in thousands):
<TABLE>
<S> <C>
Fair value of assets acquired, excluding cash acquired $ 1,144,694
Liabilities assumed (1,063,143)
- ------------------------------------------------------------------------
Cash paid (net of cash acquired) $ 81,551
========================================================================
</TABLE>
NOTE 11 - STATUTORY INFORMATION
National Life prepares statutory basis financial statements for regulatory
filings with insurance regulators in all 50 states and the District of
Columbia. A reconciliation of National Life Insurance Company's statutory
surplus to GAAP retained earnings at December 31 and statutory net income to
GAAP net income for the years ended December 31 were as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
-----------------------------------------------------------------------
Surplus/ Surplus/
Retained Retained
Earnings Net Income Earnings Net Income
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Statutory surplus/net income (loss) $ 305,611 $ 11,684 $ 312,488 $ (3,757)
Asset valuation reserve 57,054 - 55,570 -
Interest maintenance reserve 57,169 1,540 55,629 23,966
Surplus notes (69,681) (3) (69,678) (3)
Non-admitted assets 18,391 - 18,352 -
Investments 18,504 290 5,043 5,191
Deferred policy acquisition costs 443,583 3,970 439,613 2,097
Deferred income taxes 58,737 9,179 42,934 9,341
Policy liabilities (193,798) (9,874) (179,310) (4,335)
Policyowners' dividends 62,528 (1,142) 63,670 2,725
Benefit plans (36,094) 4,403 (38,869) 1,244
Other changes, net (1,963) (2,924) (2,524) 11,529
- --------------------------------------------------------------------------------------------------------------------
GAAP retained earnings/net income $ 720,041 $ 17,123 $ 702,918 $ 47,998
====================================================================================================================
</TABLE>
The New York Insurance Department recognizes only statutory accounting
practices for determining and reporting the financial condition and results of
operations of an insurance company and for determining solvency under the New
York Insurance Law. No consideration is given by the Department to financial
statements prepared in accordance with generally accepted accounting principles
in making such determinations.
F-20
<PAGE> 76
NATIONAL LIFE INSURANCE COMPANY
* * * * *
FINANCIAL STATEMENTS
(STATUTORY BASIS)
* * * * *
DECEMBER 31, 1995 AND 1994
F-21
<PAGE> 77
REPORT OF INDEPENDENT ACCOUNTANTS
February 19, 1996, except for Notes 1, 8, 9, and 11 as to which the date is May
28, 1997
To the Board of Directors and Policyowners
of National Life Insurance Company
We have audited the accompanying statutory balance sheet of National Life
Insurance Company as of December 31, 1995 and 1994, and the related statutory
statements of operations and surplus, and of cash flows for the years then
ended. 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. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, 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 our
opinion.
As described in Note 1, these financial statements were prepared in conformity
with accounting practices prescribed or permitted by the State of Vermont
Department of Banking, Insurance, Securities and Health Care Administration,
which differ from generally accepted accounting principles. The effects on the
financial statements of the differences between such practices and generally
accepted accounting principles are material and are disclosed in Note 11.
In our report dated February 19, 1996, we expressed an opinion that the 1995
and 1994 financial statements, prepared using accounting practices prescribed
or permitted by the State of Vermont Department of Banking, Insurance,
Securities and Health Care Administration (statutory basis of accounting), were
presented fairly, in all material respects, in conformity with generally
accepted accounting principles. Pursuant to pronouncements of the Financial
Accounting Standards Board, financial statements prepared on the statutory
basis of accounting are no longer considered in conformity with generally
accepted accounting principles. Accordingly, our present report on the
presentation of the 1995 and 1994 financial statements is different from our
previous report.
F-22
<PAGE> 78
In our opinion, because of the effects of the matters referred to in the
preceding paragraphs, the financial statements referred to above do not present
fairly, in conformity with generally accepted accounting principles, the
financial position of National Life Insurance Company at December 31, 1995 and
1994, and the results of its operations and its cash flows for the years then
ended.
Also, in our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of National Life
Insurance Company at December 31, 1995 and 1994, and the results of its
operations and its cash flows for the years then ended, on the basis of
accounting described in Note 1.
F-23
<PAGE> 79
NATIONAL LIFE INSURANCE COMPANY
BALANCE SHEET (STATUTORY BASIS)
DECEMBER 31,
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
(In Thousands) 1995 1994
- --------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Cash and short-term investments $ 330,753 $ 237,032
Bonds 3,391,467 3,201,369
Preferred stocks 14,217 15,677
Common stocks 13,807 9,295
Mortgage loans 656,532 581,910
Policy loans 730,561 758,511
Real estate investments 93,719 100,219
Home office properties 45,438 45,016
Other invested assets 66,221 67,307
- --------------------------------------------------------------------------------------
Total cash and invested assets 5,342,715 5,016,336
Due and deferred premiums 102,370 101,059
Due and accrued investment income 96,712 94,940
Other assets 41,322 40,788
Separate account assets 176,531 159,821
- --------------------------------------------------------------------------------------
Total assets $ 5,759,650 $ 5,412,944
======================================================================================
LIABILITIES:
Policy and other contract reserves $ 4,578,326 $ 4,391,860
Policyowners' deposits 105,400 100,368
Claims in process of settlement 23,254 28,026
Policyowners' dividends 116,051 117,905
Interest maintenance reserve 55,629 31,663
Federal income taxes payable (recoverable) 31,074 (1,293)
Asset valuation reserve 55,570 49,681
Other liabilities 314,696 227,827
Separate account liabilities 167,162 149,973
- --------------------------------------------------------------------------------------
Total liabilities 5,447,162 5,096,010
- --------------------------------------------------------------------------------------
SURPLUS:
Surplus notes 69,678 69,675
Policyowners' contingency reserves 242,810 247,259
- --------------------------------------------------------------------------------------
Total surplus 312,488 316,934
- --------------------------------------------------------------------------------------
Total liabilities and surplus $ 5,759,650 $ 5,412,944
======================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-24
<PAGE> 80
NATIONAL LIFE INSURANCE COMPANY
STATEMENT OF OPERATIONS AND SURPLUS (STATUTORY BASIS)
FOR THE YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
(In Thousands) 1995 1994
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
INCOME:
Insurance income $ 564,969 $ 540,779
Net investment income 392,344 367,458
Other income 20,294 21,277
- ------------------------------------------------------------------------------------------------
Total income 977,607 929,514
- ------------------------------------------------------------------------------------------------
EXPENSES:
Benefits 428,220 399,044
Increase in reserves 221,986 223,196
Commissions and operating expenses 173,797 164,009
- ------------------------------------------------------------------------------------------------
Total expenses 824,003 786,249
- ------------------------------------------------------------------------------------------------
Net gain from operations before dividends and federal income
taxes 153,604 143,265
Dividends to policyowners 112,387 111,535
- ------------------------------------------------------------------------------------------------
Net gain from operations before federal income taxes 41,217 31,730
Federal income tax expense 36,752 16,540
- ------------------------------------------------------------------------------------------------
Net gain from operations 4,465 15,190
Net realized losses (9,081) (1,190)
- ------------------------------------------------------------------------------------------------
NET (LOSS) INCOME (4,616) 14,000
Unrealized gains (losses) 7,442 (9,743)
(Increase) decrease in asset valuation reserve (5,889) 2,049
Surplus notes issued - 69,674
Other adjustments to surplus, net (1,383) (2,417)
- ------------------------------------------------------------------------------------------------
(Decrease) increase in surplus (4,446) 73,563
SURPLUS:
Beginning of year 316,934 243,371
- ------------------------------------------------------------------------------------------------
End of year $ 312,488 $ 316,934
================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-25
<PAGE> 81
NATIONAL LIFE INSURANCE COMPANY
STATEMENT OF CASH FLOWS (STATUTORY BASIS)
FOR THE YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
(In Thousands) 1995 1994
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Insurance income received $ 565,189 $ 534,306
Net investment and other income received 398,253 366,056
Benefits paid (430,088) (387,809)
Commissions and operating expenses paid (205,439) (164,580)
Net decrease in policy loans 27,950 4,852
Net transfers from separate accounts 10,431 9,314
Federal income taxes paid (18,393) (23,555)
Dividends paid to policyowners (114,136) (111,812)
- ----------------------------------------------------------------------------------------------
Net cash provided by operations 233,767 226,772
- ----------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from investments sold, matured or repaid:
Bonds 1,757,542 1,283,224
Stocks 4,421 16,558
Mortgage loans 61,849 78,295
Real estate and other investments 40,596 39,493
Cost of investments acquired:
Bonds (1,901,838) (1,476,151)
Stocks (5,771) (4,000)
Mortgage loans (143,309) (108,307)
Real estate and other investments (44,847) (61,417)
- ----------------------------------------------------------------------------------------------
Net cash used for investing activities (231,357) (232,305)
- ----------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of surplus notes - 69,674
Funds borrowed 51,013 -
OTHER SOURCES AND APPLICATIONS, NET 40,298 70,669
- ----------------------------------------------------------------------------------------------
Net increase in cash
and short-term investments 93,721 134,810
CASH AND SHORT-TERM INVESTMENTS:
Beginning of year 237,032 102,222
- ----------------------------------------------------------------------------------------------
End of year $ 330,753 $ 237,032
==============================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE> 82
NATIONAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (STATUTORY BASIS)
DECEMBER 31, 1995 and 1994
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying financial statements of National Life Insurance Company (the
Company) have been prepared in conformity with statutory accounting practices
prescribed or permitted by the State of Vermont Department of Banking,
Insurance, Securities and Health Care Administration, which is a comprehensive
basis of accounting other than generally accepted accounting principles.
NATURE OF OPERATIONS AND CUSTOMER CONCENTRATIONS
The Company is primarily engaged in the development and distribution of
traditional and universal individual life insurance and annuity products.
Through affiliates it also provides distribution and investment advisory
services to the Sentinel Group Funds, Inc., a family of twelve mutual funds.
The Company's insurance and annuity products are primarily marketed through a
general agency system. The Company is licensed in all 50 states and the
District of Columbia. Approximately 25% of total collected premiums are from
residents of the states of New York and California.
INVESTMENTS
Bonds and preferred stocks are generally carried at amortized cost and cost,
respectively. Bonds in or near default are carried at the lower of amortized
cost or fair value. Common stocks are carried at market value. Mortgage loans
in good standing are valued at their unpaid principal balance. Mortgage loans
that are delinquent or in process of foreclosure are valued at the lower of
their principal balance or the estimated fair value of the underlying
collateral. The maximum ratio of loan to collateral value at the time a loan
is made is generally 75%. Policy loans are reported at their unpaid balances
and are fully collateralized by policy cash values. Real estate investments
are generally depreciated over 40 years using the straight line method, and are
reflected at the lower of depreciated cost or fair value, net of encumbrances.
Realized gains and losses are determined using the specific identification
method and are reported net of related income taxes.
SHORT-TERM INVESTMENTS
Short-term investments are carried at amortized cost, which approximates fair
value. For purposes of the statement of cash flows, the Company considers all
highly liquid investments purchased with a remaining maturity of one year or
less to be short-term investments.
ASSET VALUATION RESERVE AND INTEREST MAINTENANCE RESERVE
The Asset Valuation Reserve (AVR) is designed to stabilize policyowners'
contingency reserves from default losses on bonds, preferred stocks, mortgages,
real estate and other invested assets and from fluctuations in the value of
common stocks. The AVR is calculated as prescribed by the National Association
of Insurance Commissioners.
F-27
<PAGE> 83
The Interest Maintenance Reserve (IMR) defers interest rate related after-tax
capital gains and losses on fixed income investments and amortizes them into
income over the remaining lives of the securities sold. IMR amortization is
included in net investment income. The Company uses the seriatim method for
the amortization of IMR.
NON-ADMITTED ASSETS
In accordance with regulatory requirements, certain assets, including amounts
due from agents and furniture and equipment, are excluded from the balance
sheet. The net change in these assets is included in other adjustments to
surplus.
POLICY AND OTHER CONTRACT RESERVES
Policy reserves for life, annuity and disability income contracts are developed
using accepted actuarial methods. Actuarial factors used in determining life
insurance reserves are based primarily upon the 1941, 1958, and 1980
Commissioners' Standard Ordinary (CSO) mortality tables. Methods used to
calculate life reserves consist principally of net level premium,
Commissioners' Reserve Valuation Method, and modified preliminary term, with
valuation interest rates ranging from 2.0% to 6.0%.
Reserves for individual annuities are determined principally using the
Commissioners' Annuity Reserve Valuation Method, based on A-1949, and 1983
annuity tables with valuation interest rates from 2.0% to 9.0%. Active life
disability income reserves are determined primarily using Commissioners'
Disability 1964 with the 1958 CSO mortality table and Disability Termination
Study 1985 and Commissioners' Individual Disability Table A morbidity tables
with the 1980 CSO mortality tables. Valuation interest rates for active life
reserves range from 3.0% to 6.0%. Disabled life reserves are based on expected
experience at 8.0% interest and exceed statutory minimum reserves.
PREMIUMS AND RELATED EXPENSES
Annual premiums and related reserve increases on life insurance policies are
recorded at each policy anniversary. Premiums and related reserve increases on
annuity contracts are recorded when premiums are collected. Commissions and
other policy costs are expensed as incurred. First-year policy costs and
required additions to policy reserves generally exceed first-year premiums.
DIVIDENDS TO POLICYOWNERS
The Company issues all of its traditional life insurance and certain annuity
policies on a participating basis. The Company's universal life and disability
income policies are issued on a non-participating basis. Policyowners'
dividends liabilities primarily represent amounts estimated to be paid or
credited in the subsequent year. The amount of dividends to be distributed is
based upon a scale which seeks to reflect the relative contribution of each
group of policies to the Company's overall operating results. The dividend
scale is approved at least annually by the Company's Board of Directors.
SEPARATE ACCOUNTS
Separate account assets represent segregated funds held for the benefit of
certain variable annuity, variable life, pension policyowners, and the
Company's pension plans. Separate account liabilities represent the
policyowners' share of separate account assets. The Company also participates
in certain separate accounts. Separate account investment results are excluded
from operations. Policy values funded by separate accounts reflect the actual
investment performance of the respective accounts and are not
F-28
<PAGE> 84
guaranteed. Investments held in the separate accounts are primarily common
stocks, bonds, mortgage loans, and real estate and are carried at fair value.
FEDERAL INCOME TAXES
The Company files a consolidated federal income tax return that includes all of
its wholly owned subsidiaries. The Company's federal income tax liability is
estimated based on the federal taxable income to be reported in its
consolidated return.
The major differences between pre-tax statutory net income and taxable income
relate to policyowner dividends, investments, differential earnings
adjustments, differences between book and tax policy reserves, and the deferral
of deductions for certain acquisition costs for tax purposes.
USE OF ESTIMATES
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, liabilities, income, and expenses,
and related disclosures in the notes to consolidated financial statements.
Actual results could differ from estimates.
NOTE 2 - INSURANCE INFORCE AND REINSURANCE
For individual life products, the Company generally retains no more than $3.0
million of risk on any person (excluding accidental death benefits and dividend
additions). Reinsurance for life products is ceded under yearly renewable
term, coinsurance, and modified coinsurance agreements. Total individual life
premiums ceded were $20.7 million and $22.8 million for the years ended
December 31, 1995 and 1994, respectively. Total individual life insurance
ceded was $3.7 billion and $3.5 billion of the $33.5 billion and $32.6 billion
in force at December 31, 1995 and 1994, respectively. The Company has assumed
a small amount of yearly renewable term reinsurance from non-affiliated
insurers.
Disability income products are significantly reinsured under coinsurance and
modified coinsurance agreements. Total disability income premiums ceded in
1995 and 1994 were $51.9 million and $52.1 million, respectively. Reserve
transfers and related interest on disability income reserves were $7.1 million
and $7.0 million in 1995 and 1994, respectively, and are included in increase
in reserves. Disability income reinsurance effects included in other income in
1995 and 1994 were $18.6 million and $20.5 million, respectively.
The Company is contingently liable with respect to ceded insurance should any
reinsurer be unable to meet its assumed obligations.
F-29
<PAGE> 85
NOTE 3 - FEDERAL INCOME TAXES
The federal income tax provisions for 1995 and 1994 were $36.8 million and
$16.5 million respectively, including taxes on realized capital gains of $13.7
million and $0.9 million.
The Internal Revenue Service has examined the Company's returns through 1991
and the Company has paid all assessed deficiencies. The Company is currently
litigating the disallowance of certain policyowner dividend deductions taken in
1984 under the 1984 Tax Act.
The Company believes that it has adequately provided for all material pending
tax matters.
NOTE 4 - BENEFIT PLANS
The Company has pension programs covering substantially all employees and
full-time agents. The Company funds the pension cost accrued. The Company's
aggregate expense for pension plans was $7.3 million in 1995 and $7.0 million
in 1994.
The annual contributions to the Company's defined benefit plan covering home
office employees are based on the Aggregate Actuarial Cost Method. The accrued
plan benefits and net assets for this plan at December 31, 1995 and 1994 are
presented below (in thousands):
<TABLE>
<CAPTION>
1995 1994
------------------------------------
<S> <C> <C>
Actuarial present value of accrued plan benefits:
Vested $67,933 $64,287
Non-vested 403 440
------------------------------------
Total $68,336 $64,727
====================================
Net assets available for plan benefits $94,125 $77,514
====================================
</TABLE>
The discount rate used in determining the actuarial present value of accrued
plan benefits at December 31, 1995 and 1994 was 8.0%. Mortality assumptions
are based on the 1983 Group Annuity Mortality Table. Plan assets are invested
in the general account and various separate accounts of the Company.
The Company provides employee savings and 401(k) plans where up to 3% of an
employee's compensation may be invested by the employee in either plan with
matching funds contributed by the Company. The Company also contributes a
foundation of 1.5% of an employee's compensation (up to certain levels) to a
401(k) account. Additional voluntary employee contributions may be made to the
plans subject to certain limits. Company contributions to these plans
generally vest within two years.
The Company also sponsors four defined benefit postretirement plans. The plans
provide medical and dental benefits and life insurance benefits to employees
and agents, respectively. Substantially all Company employees and agents may
become eligible for retiree benefits if they reach normal retirement age and
meet certain minimum service requirements while working for the Company. Most
of the plans are contributory, with retiree contributions adjusted annually,
and contain other cost sharing features such as deductibles and coinsurance.
The plans are not funded and the Company pays for plan benefits on a current
basis. The cost of these benefits is recognized as they are earned by fully
eligible employees.
F-30
<PAGE> 86
The following table shows the plans' combined funded status at December 31,
1995 and 1994 (in thousands):
<TABLE>
<CAPTION>
1995 1994
---------------------------
<S> <C> <C>
Accumulated postretirement benefit obligation (APBO):
Retirees $ 15,597 $ 13,676
Fully eligible active plan participants 3,195 3,036
---------------------------
Total APBO 18,792 16,712
Unrecognized actuarial gain 354 480
Unrecognized prior service cost (774) -
Unrecognized transition obligation (13,358) (14,144)
---------------------------
Accrued post retirement benefit liability $ 5,014 $ 3,048
===========================
</TABLE>
The accrued postretirement benefit liability is included in other liabilities.
The net periodic postretirement benefit cost for 1995 and 1994 is included in
operating expenses and consists of the following components (in thousands):
<TABLE>
<CAPTION>
1995 1994
---------------------------
<S> <C> <C>
Estimated eligibility cost $ 667 $ 278
Interest cost on APBO 1,238 1,210
Amortization of prior service cost over 10 years 86 -
Amortization of transition obligation over 20 years 786 786
---------------------------
Net periodic postretirement benefit cost $ 2,777 $ 2,274
===========================
</TABLE>
The health care cost trend rates for 1996 are 7.4% and 7.9% for the employee
and agent medical plans, respectively, and grade to 5% in year 2000 and remain
level thereafter. Increasing the assumed health care cost trend rates by one
percentage point in each year would increase the APBO by about $1.2 million and
the 1995 eligibility and interest cost components of net periodic
postretirement benefit cost by about $0.1 million.
During 1995 plan amendments were enacted which increased some of the medical
plan benefits for active and retired employees. These changes increased the
APBO by approximately $.9 million, which is amortizable over the average
remaining years of service of the plan participants of ten years.
The discount rate used in determining the accumulated postretirement benefit
obligation was 7.0% and 7.5% in 1995 and 1994, respectively.
F-31
<PAGE> 87
NOTE 5 - INVESTMENTS
BONDS
The amortized cost and estimated fair value of the Company's bond investments
at December 31, 1995 and 1994 were as follows (in thousands):
<TABLE>
<CAPTION>
Estimated Gross Unrealized
Amortized Fair -------------------------------
Cost Value Gains (Losses)
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1995
U.S. government obligations
(including obligations guaranteed by
the U.S. government) $ 450,464 $ 470,832 $ 20,738 $ (370)
Foreign government obligations 21,673 24,171 2,498 -
Special revenue and special
assessment obligations and all
non-guaranteed obligations of
government agencies, authorities and
subdivisions 539,837 567,812 28,246 (271)
Public utilities 329,018 359,564 31,070 (524)
Industrial & miscellaneous 2,050,475 2,237,780 191,685 (4,380)
------------------------------------------------------------------------------------------------------
Total $3,391,467 $3,660,159 $274,237 $(5,545)
======================================================================================================
1994
U.S. government obligations
(including obligations guaranteed by
the U.S. government) $ 428,323 $ 415,052 $ 368 $ (13,639)
Foreign government obligations 21,440 21,567 652 (525)
Special revenue and special
assessment obligations and all
non-guaranteed obligations of
government agencies, authorities and
subdivisions 433,739 414,384 5,267 (24,622)
Public utilities 406,065 395,194 5,013 (15,884)
Industrial & miscellaneous 1,911,802 1,883,098 33,327 (62,031)
------------------------------------------------------------------------------------------------------
Total $3,201,369 $3,129,295 $44,627 $(116,701)
======================================================================================================
</TABLE>
F-32
<PAGE> 88
The amortized cost and estimated fair value of the Company's bond investments
at December 31, 1995 and 1994, by contractual maturity, are shown below (in
thousands). Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
<TABLE>
<CAPTION>
Estimated Gross Unrealized
Amortized Fair -------------------------------
Cost Value Gains (Losses)
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1995
Due - in one year or less $ 65,478 $ 67,978 $ 2,510 $ (10)
Due - one year through five years 553,929 584,596 30,925 (258)
Due - five years through ten years 1,232,894 1,312,884 82,205 (2,215)
Due - after ten years 1,539,166 1,694,701 158,597 (3,062)
------------------------------------------------------------------------------------------------------
Total $3,391,467 $3,660,159 $274,237 $(5,545)
======================================================================================================
1994
Due - in one year or less $ 57,935 $ 58,133 $ 288 $ (90)
Due - one year through five years 473,643 467,554 6,204 (12,293)
Due - five years through ten years 1,137,069 1,103,541 13,391 (46,919)
Due - after ten years 1,532,722 1,500,067 24,744 (57,399)
------------------------------------------------------------------------------------------------------
Total $3,201,369 $3,129,295 $44,627 $(116,701)
======================================================================================================
</TABLE>
Proceeds from bond sales during 1995 and 1994 were $1,757.5 million and
$1,283.2 million, respectively. Gross gains of $54.0 million and $29.6 million
and gross losses of $2.6 million and $35.8 million were realized on these sales
in 1995 and 1994, respectively.
The carrying value of preferred stocks at December 31, 1995 and 1994 was $14.2
million and $15.7 million, and the related fair value of preferred stocks was
$14.9 million and $15.0 million, respectively.
The cost of common stocks at December 31, 1995 and 1994 was $9.2 million and
$4.4 million, respectively. The market value of common stocks at December 31,
1995 and 1994 was $13.8 million and $9.3 million, respectively.
F-33
<PAGE> 89
MORTGAGE LOANS AND REAL ESTATE
At December 31, 1995 and 1994 the Company's mortgage loans and real estate
investments (excluding home office properties) were distributed as follows:
<TABLE>
<CAPTION>
Mortgage Loans Real Estate
---------------------------------- --------------------------------
1995 1994 1995 1994
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
GEOGRAPHIC REGION
-----------------
New England 8.9% 9.6% - -
Middle Atlantic 14.6 11.8 0.1% -
East North Central 12.0 12.0 20.5 17.8%
West North Central 2.8 0.4 0.1 0.1
South Atlantic 29.2 30.7 48.6 40.9
East South Central 5.1 5.8 - 5.8
West South Central 2.4 3.9 27.0 32.0
Mountain 15.8 14.9 - -
Pacific 9.2 10.9 3.7 3.4
-------------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0%
=======================================================================================================
PROPERTY TYPE
-------------
Residential - 0.1% - -
Apartment 27.3% 23.4 - -
Retail 27.7 30.6 10.7% 16.8%
Office Building 27.0 28.4 10.2 8.8
Industrial 15.3 11.0 73.4 73.5
Hotel/Motel 1.4 1.6 - -
Mixed Use - 2.7 - -
Other Commercial 1.3 2.2 5.7 0.9
-------------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0%
=======================================================================================================
</TABLE>
The book value of mortgages, classified by scheduled year of contractual
maturity, as of December 31, 1995 and 1994 are shown below. Expected
maturities will differ because of scheduled principal payments and mortgage
prepayments.
<TABLE>
<CAPTION>
1995 1994
--------------------------------------------------------------
<S> <C> <C>
1 year or less 9.2% 6.6%
Over 1 through 3 years 12.3 15.1
Over 3 through 5 years 21.3 24.2
Over 5 through 10 years 35.6 39.4
Over 10 through 15 years 14.6 11.0
Over 15 through 20 years 6.3 3.7
Over 20 years 0.7 -
--------------------------------------------------------------
Total 100.0% 100.0%
==============================================================
</TABLE>
F-34
<PAGE> 90
The estimated fair value of mortgages at December 31, 1995 and 1994, was $706.3
million and $577.0 million, respectively. The fair value of mortgages was
estimated as the average of the present value of future cash flows under
different scenarios of future mortgage interest rates (including appropriate
provisions for default losses) and related changes in borrower prepayments.
POLICY LOANS
The estimated fair value of policy loans at December 31, 1995 and 1994, was
$665.2 million and $654.2 million, respectively. The book value of variable
rate policy loans approximates fair value. The fair value of fixed rate policy
loans was estimated as the present value of future cash flows using reasonable
assumptions for mortality and repayments, discounted at the current variable
policy loan rate.
NOTE 6 - INVESTMENT INCOME
Investment income is presented net of related investment expenses of $38.3
million and $26.3 million for the years ended December 31, 1995 and 1994,
respectively.
NOTE 7 - INVESTMENT PRODUCTS
The Company issues several different investment products, including flexible
premium annuities, single premium deferred annuities and supplementary
contracts not involving life contingencies. The book value of liabilities for
these investment products was $842.8 million and $820.4 million, respectively,
at December 31, 1995 and 1994. The fair value of liabilities for these
investment products was $805.0 million and $763.0 million at December 31, 1995
and 1994, respectively. The fair value of these liabilities was estimated as
the average of the present value of future cash flows under different scenarios
of future interest rates of A-rated corporate bonds and related changes in
premium persistency and surrenders.
NOTE 8 - SUBSEQUENT EVENT
In February 1996, National Financial Services, Inc. (a wholly owned subsidiary
of the Company) purchased a controlling interest in LSW Holdings Corporation,
parent company of Life Insurance Company of the Southwest (LSW), a Texas
domiciled life insurance company. LSW Holdings Corporation was renamed LSW
National Holdings, Inc. concurrent with the purchase. LSW primarily markets
annuities, with approximately 60% of total 1995 premiums collected from
residents of California, Texas, and Florida. The purchase price was $103
million. LSW's audited statutory assets and surplus were $1.6 billion and
$90.4 million, respectively, at December 31, 1995.
NOTE 9 - CHANGES IN ACCOUNTING POLICY
In April 1993 the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 40, "Applicability of Generally Accepted Accounting
Principles to Mutual Life Insurance and Other Enterprises" (Interpretation 40).
The interpretation clarified that beginning in 1995 mutual life insurance and
other enterprises are required to apply all applicable authoritative accounting
pronouncements when issuing financial statements prepared in conformity with
generally accepted accounting principles.
F-35
<PAGE> 91
In January 1995, the FASB issued Statement of Financial Accounting Standards
No. 120, "Accounting and Reporting for Mutual Life Insurance Enterprises and by
Insurance Enterprises for Certain Long-Duration Participating Contracts"
(Statement 120). Statement 120 extends the effective date of Interpretation 40
from 1995 to 1996, and defines accounting principles to be used in accounting
for long duration participating contracts by reference to the American
Institute of Certified Public Accountants' Statement of Position 95-1,
"Accounting for Certain Insurance Activities of Mutual Life Insurance
Enterprises" (Statement of Position 95-1).
The effect of these pronouncements was that financial statements prepared on
the basis of statutory accounting principles could no longer be described as
prepared in conformity with generally accepted accounting principles beginning
in 1996.
The changes required by Interpretation 40, Statement 120 and Statement of
Position 95-1 have resulted in an increase in reported equity.
NOTE 10 - SURPLUS NOTES
On March 1, 1994, the Company issued $70.0 million of 8 1/4% Surplus Notes (the
Notes) scheduled to mature on March 1, 2024, with semiannual interest payments
commencing September 1, 1994. The Notes are unsecured and subordinated to all
present and future indebtedness, policy claims and prior claims of the Company.
The Notes may be redeemed in whole or in part at any time after March 1, 2004
at predetermined redemption prices. All interest and principal payments are
subject to prior written approval by the Commissioner of Banking, Insurance,
and Securities of the State of Vermont (the Commissioner).
Liability for interest payments cannot be recorded in the financial statements
until approval for the payments is received from the Commissioner. Total
interest paid during 1995 and 1994 was $5.8 million and $2.9 million,
respectively. Prorata interest accrued but not recorded at December 31, 1995
and 1994 was $1.9 million.
The Notes were sold at a discount of $.3 million. None of the Notes
outstanding at December 31, 1995 were held by any affiliate of the Company.
F-36
<PAGE> 92
NOTE 11 - GAAP INFORMATION
Subsequent to the original issuance of these financial statements, the Company
prepared fully consolidated generally accepted accounting principles (GAAP)
basis financial statements for general purpose public reporting of its
financial position and financial results for 1995. A reconciliation of the
Company's statutory surplus and net income to GAAP basis retained earnings and
net income at December 31, 1995 and for the year then ended was as follows (in
thousands):
<TABLE>
<CAPTION>
1995
----------------------------------------
Surplus/
Retained
Earnings Net Income
-------------------------------------------------------------------------------
<S> <C> <C>
Statutory surplus/net income (loss) $ 312,488 $ (4,616)
Asset valuation reserve 55,570 -
Interest maintenance reserve 55,629 23,966
Surplus notes (69,678) (3)
Non-admitted assets 18,352 -
Investments 5,043 5,191
Deferred policy acquisition costs 439,613 2,097
Deferred income taxes 42,934 9,341
Policy liabilities (179,310) (4,335)
Policyowners' dividends 63,670 2,725
Benefit plans (38,869) 1,244
Other changes, net (2,524) 12,388
-------------------------------------------------------------------------------
GAAP retained earnings/net income $ 702,918 $ 47,998
===============================================================================
</TABLE>
F-37
