<PAGE> 1
SUPPLEMENT DATED SEPTEMBER 15, 1995
TO PROSPECTUS DATED MAY 1, 1995 FOR
--------------------------------------------------------------------------------
PERIODIC PAYMENT
VARIABLE ANNUITY CONTRACTS
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KEMPER ADVANTAGE III
ISSUED BY
KEMPER INVESTORS LIFE INSURANCE COMPANY
Effective September 15, 1995, new Subaccounts are being added as investment
options under the Contracts. The new investment options are not available to all
Contract Owners. The new investment options are available only under Contracts
that are sold or serviced by broker-dealers that have entered into a selling
group agreement that authorizes the sale of Contracts with the new options.
Pending regulatory approval, the new options are not available in California.
The new Funds in which the Subaccounts invest are as follows:
JANUS ASPEN SERIES
Growth Portfolio
Aggressive Growth Portfolio
Worldwide Growth Portfolio
Balanced Portfolio
Short-Term Bond Portfolio
LEXINGTON NATURAL RESOURCES TRUST
LEXINGTON EMERGING MARKETS FUND
Prospectuses for the new Funds are attached to this Supplement.
The changes to the Prospectus follow with references to those parts of the
Prospectus that are modified by this Supplement.
All references in the Prospectus to the Fund are revised to refer to the Funds,
as appropriate.
INTRODUCTION
The second paragraph on the cover page of the Prospectus is revised to read as
follows:
"Purchase payments for the Contracts may be allocated to one or more of the
options under which Contract values accumulate on either a variable or
fixed basis. These options consist of the fourteen Subaccounts of the
Separate Account and the Fixed Accumulation Option of the General Account.
Each Subaccount invests in one of the Portfolios of the following
management investment companies; the Kemper Investors Fund which is managed
by Kemper Financial Services, Inc., the Janus Aspen Series which is managed
by Janus Capital Corporation and the Lexington Natural Resources Trust and
Lexington Emerging Markets Fund which are managed by Lexington Management
Corporation.
The Kemper Investors Fund currently consists of the following Portfolios:
Money Market, Total Return, High Yield, Equity, Government Securities,
International and Small Capitalization Equity ("Small Cap"). The following
Portfolios of the Janus Aspen Series are available under the Contracts:
Growth, Aggressive Growth, Worldwide Growth, Balanced and Short-Term Bond.
Lexington Natural Resources Trust and Lexington Emerging Markets Fund each
currently consist of only one Portfolio.
Subaccounts and Portfolios may be added in the future. Contract values
allocated to any of the Subaccounts will vary to reflect the investment
performance of the corresponding Portfolio. The accompanying Prospectus for
the Funds describe the investment objectives and the attendant risks of the
Funds. Contract values allocated to the Fixed Accumulation Option will
accumulate on a fixed basis."
<PAGE> 2
The fourth paragraph on the cover page of the Prospectus is revised to read as
follows:
"THIS PROSPECTUS IS VALID ONLY IF ACCOMPANIED OR PRECEDED BY A CURRENT
PROSPECTUS FOR THE KEMPER INVESTORS FUND, JANUS ASPEN SERIES, LEXINGTON
NATURAL RESOURCES TRUST AND LEXINGTON EMERGING MARKETS FUND. ALL
PROSPECTUSES SHOULD BE READ AND RETAINED FOR FUTURE REFERENCE."
DEFINITIONS
The definitions of "Fund" and "Subaccounts" on pages 1 and 2 of the Prospectus
are revised and a new definition of "Portfolio" is added as follows:
"Fund or Funds--The Kemper Investors Fund, the Janus Aspen Series, the
Lexington Natural Resources Trust and the Lexington Emerging Markets Fund,
including any Portfolios thereunder."
"Portfolio--A series of a Fund with its own objective and policies, which
represents shares of beneficial interest in a separate portfolio of
securities and other assets. Portfolio is sometimes referred to herein as a
Fund."
"Subaccounts--The fourteen subdivisions of the Separate Account, the assets
of which consist solely of shares of the corresponding Portfolios."
SUMMARY
The third paragraph under "Summary" on page 2 of the Prospectus is revised to
read as follows:
"KILICO provides for variable accumulations and benefits under the
Contracts by crediting purchase payments to one or more Subaccounts of the
Separate Account as selected by the Contract Owner. Each Subaccount invests
in one of the following corresponding Funds: the Kemper Investors Fund's
Money Market, Total Return, High Yield, Equity, Government Securities,
International and Small Cap Portfolios; the Janus Aspen Series' Growth,
Aggressive Growth, Worldwide Growth, Balanced and Short-Term Bond
Portfolios; the Lexington Natural Resources Trust; and the Lexington
Emerging Markets Fund. (See "The Funds" page 7.) The Contract Values
allocated to the Separate Account will vary with the investment performance
of the Portfolios and Funds selected by the Contract Owner."
The second sentence of the fourth paragraph appearing on page 3 is revised to
read as follows:
"In addition, the advisers of the Funds deduct varying charges against the
assets of the Funds for providing investment advisory services. (See the
Funds' Prospectuses for such information.)"
S-2
<PAGE> 3
The Summary of Expenses and Example Tables appearing on page 4 are revised as
follows:
SUMMARY OF EXPENSES
<TABLE>
<S> <C>
CONTRACT OWNER TRANSACTION EXPENSES
Sales Load Imposed on Purchases (as a percentage of purchase payments) ................................. None
Contingent Deferred Sales Load (as apercentage of amount surrendered)*
Year of Withdrawal After Purchase
---------------------------------
First year .................................................... 6%
Second year ................................................... 5%
Third year .................................................... 4%
Fourth year ................................................... 3%
Fifth year .................................................... 2%
Sixth year .................................................... 1%
Seventh year and following ................................... 0%
Surrender Fees ......................................................................................... None
Exchange Fee ......................................................................................... None
ANNUAL CONTRACT FEE (Records Maintenance Charge)** ...................................................... $36
</TABLE>
SEPARATE ACCOUNT ANNUAL EXPENSES
(as a percentage of average daily account value)
<TABLE>
<S> <C>
Mortality and Expense Risk 1.00%
Administration .......................... .30%
Account Fees and Expenses 0%
Total Separate Account
Annual Expenses ...................... 1.30%
</TABLE>
FUND ANNUAL EXPENSES
(as percentage of each Portfolio's average net assets for the period ended
December 31, 1994)
<TABLE>
<CAPTION>
KINF KINF KINF
MONEY TOTAL KINF KINF GOVERNMENT KINF KINF
MARKET RETURN HIGH YIELD EQUITY SECURITIES INTERNATIONAL SMALL CAP
--------- --------- --------- --------- ---------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Management Fees ...... 50% .55% .60% .60% .55% .75% .65%
Other Expenses ...... .03 .06 .05 .06 .09 .18 .60
--- --- --- --- --- --- ----
Total Portfolio
Annual Expenses ... .53% .61% .65% .66% .64% .93% 1.25%
=== === === === === === ====
<CAPTION>
JANUS JANUS JANUS LEXINGTON LEXINGTON
JANUS AGGRESIVE WORLDWIDE JANUS SHORT-TERM NATURAL EMERGING
GROWTH**** GROWTH**** GROWTH**** BALANCED**** BOND**** RESOURCES MARKETS
---------- ---------- ---------- ----------- ---------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Management Fees ...... 66% .77% .69% .83% 0% 1.00% .85%
Other Expenses ...... .22 .28 .49 .74 .65 .55 .45
--- ---- ---- ---- --- ---- ----
Total Portfolio
Annual Expenses ... .88% 1.05% 1.18% 1.57% .65% 1.55% 1.30%
=== ==== ==== ==== === ==== ====
</TABLE>
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EXAMPLE
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<TABLE>
<CAPTION>
Subaccount 1 year 3 years 5 years 10 years
---------- ------ ------- ------- --------
<S> <C> <C> <C> <C> <C>
If you surrender your contract at the end of the applicable KINF Money Market $ 83 $ 108 $ 134 $239
time period: KINF Total Return 84 111 138 248
You would pay the following expenses on a $1,000 KINF High Yield 84 112 140 252
investment, assuming 5% annual return on assets: KINF Equity 84 112 141 253
KINF Government Securities 84 111 139 250
KINF International 87 120 154 281
KINF Small Cap 90 130 -- --
Janus Growth 86 119 -- --
Janus Aggressive Growth 88 124 -- --
Janus Worldwide Growth 89 128 -- --
Janus Balanced 93 139 -- --
Janus Short-Term Bond 84 112 -- --
Lexington Natural Resources 93 138 -- --
Lexington Emerging Markets 90 131 -- --
If you do not surrender your contract: KINF Money Market 21 65 111 239
You would pay the following expenses KINF Total Return 22 67 115 248
on a $1,000 investment, assuming KINF High Yield 22 69 117 252
5% annual return on assets: KINF Equity 22 69 118 253
KINF Government Securities 22 68 116 250
KINF International 25 77 132 281
KINF Small Cap 28 87 -- --
Janus Growth 25 76 -- --
Janus Aggressive Growth 26 81 -- --
Janus Worldwide Growth 28 85 -- --
Janus Balanced 32 97 -- --
Janus Short-Term Bond 22 69 -- --
Lexington Natural Resources 31 96 -- --
Lexington Emerging Markets 29 88 -- --
</TABLE>
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The purpose of the preceding table is to assist Contract Owners in understanding
the various costs and expenses that a Contract Owner in a Subaccount will bear
directly or indirectly. The table reflects expenses of both the Separate Account
and the Fund. THE EXAMPLE SHOULD NOT BE CONSIDERED TO BE A REPRESENTATION OF
PAST OR FUTURE EXPENSES AND DOES NOT INCLUDE THE DEDUCTION OF STATE PREMIUM
TAXES, WHICH MAY BE ASSESSED BEFORE OR UPON ANNUITIZATION. ACTUAL EXPENSES MAY
BE GREATER OR LESS THAN THOSE SHOWN. The example assumes a 5% annual rate of
return pursuant to requirements of the Securities and Exchange Commission. This
hypothetical rate of return is not intended to be representative of past or
future performance of any Subaccount. The Records Maintenance Charge is a single
charge, it is not a separate charge for each Subaccount. In addition, the effect
of the Records Maintenance Charge has been reflected by applying the percentage
derived by dividing the total amounts of annual Records Maintenance Charge
collected by the total net assets of all the Subaccounts in the Separate
Account. See "Contract Charges and Expenses" for more information regarding the
various costs and expenses.
* A Contract Owner may withdraw up to 10% of the Contract Value less Debt in
any Contract Year without assessment of any charge. Under certain
circumstances the contingent deferred sales load may be reduced or waived,
including when certain annuity options are selected.
** Under certain circumstances the annual Records Maintenance Charge may be
reduced or waived by KILICO.
*** Annualized based on fund inception of March 30, 1994.
**** The expense figures shown are net of certain expense waivers from Janus
Capital Corporation. Without such waivers, Management Fees, Other Expenses
and Total Portfolio Operating Expenses for the Portfolios for the fiscal
year ended December 31, 1994 were: 1.00%, .22% and 1.22%, respectively, for
the Growth Portfolio; 1.00%, .28% and 1.28%, respectively, for the
Aggressive Growth Portfolio; 1.00%, .49% and 1.49%, respectively, for the
Worldwide Growth Portfolio; 1.00%, .74% and 1.74%, respectively, for the
Balanced Portfolio; and 0.65%, 0.75% and 1.40%, respectively, for the
Short-Term Bond Portfolio. See the prospectus and Statement of Additional
Information of Janus Aspen Series for a description of these waivers.
S-3
<PAGE> 4
THE FUNDS
The section titled "The Fund" beginning on page 7 of the Prospectus is revised
to read as follows:
"The Funds
The Separate Account invests in shares of the Kemper Investors Fund, the
Janus Aspen Series, the Lexington Natural Resources Trust and the Lexington
Emerging Markets Fund, open-end, management investment companies.
Registration of the Funds by the Securities and Exchange Commission does
not involve supervision of their management, investment practices or
policies by the Commission. The Funds are designed to provide investment
vehicles for variable life insurance and variable annuity contracts and, in
the case of the Janus Aspen Series, certain qualified retirement plans.
Shares of the Funds are sold only to insurance company separate accounts
and qualified retirement plans. In addition to selling shares to separate
accounts of KILICO and its affiliates, shares of the Funds may be sold to
separate accounts of insurance companies not affiliated with KILICO. It is
conceivable that in the future it may be disadvantageous for variable life
insurance separate accounts and variable annuity separate accounts of
companies unaffiliated with KILICO, or for variable life insurance separate
accounts, variable annuity separate accounts and qualified retirement plans
to invest simultaneously in the Funds. Currently, neither KILICO nor the
Funds foresee any such disadvantages to variable life insurance owners,
variable annuity owners or qualified retirement plans. Management of the
Funds has an obligation to monitor events to identify material conflicts
between such owners and determine what action, if any, should be taken. In
addition, if KILICO believes that a Fund's response to any of those events
or conflicts insufficiently protects the owners, it will take appropriate
action on its own.
A Fund may consist of separate Portfolios. The assets of each Portfolio are
held separate from the assets of the other Portfolios, and each Portfolio
has its own distinct investment objective and policies. Each Portfolio
operates as a separate investment fund, and the investment performance of
one Portfolio has no effect on the investment performance of any other
Portfolio.
The investment objectives and policies of the Funds and their Portfolios
are summarized below:
KEMPER INVESTORS FUND
Money Market Portfolio: This Portfolio seeks to provide maximum current
income to the extent consistent with stability of principal. It will
maintain a dollar weighted average portfolio maturity of 90 days or less.
This Portfolio pursues its objective of maximum income and stability of
principal by investing in money market securities such as U.S. Treasury
obligations, commercial paper, and certificates of deposit and bankers'
acceptances of domestic and foreign banks, including foreign branches of
domestic banks, and will enter into repurchase agreements.
Total Return Portfolio: This Portfolio seeks a high total return, a
combination of income and capital appreciation, by investing in a
combination of debt securities and common stocks. The Portfolio's
investments will normally consist of fixed-income and equity securities.
Fixed-income securities will include bonds and other debt securities and
preferred stocks, some of which may have a call on common stocks through
attached warrants or a conversion privilege. Equity investments normally
will consist of common stocks and securities convertible into or
exchangeable for common stocks; however the Portfolio may also make private
placement investments (which are normally restricted securities).
High Yield Portfolio: This Portfolio seeks to provide a high level of
current income by investing in fixed-income securities, including lower
rated and unrated securities which may entail relatively greater risk of
loss of income or principal but may offer a current yield or yield to
maturity which is higher. Lower and unrated securities, which are sometimes
referred to by the popular press as "junk bonds," have widely varying
characteristics and quality. The Portfolio invests in U.S. Government,
corporate, and other notes and bonds paying high current income.
Equity Portfolio: This Portfolio seeks maximum appreciation of capital
through diversification of investment securities having potential for
capital appreciation. Current income will not be a significant factor. This
Portfolio's investments normally will consist of common stocks and
securities convertible into or exchangeable for common stocks; however, it
may also make private placement investments (which are normally restricted
securities).
Government Securities Portfolio: This Portfolio seeks high current return
consistent with preservation of capital from a portfolio composed primarily
of U.S. Government securities. The Portfolio will also invest in
fixed-income
S-4
<PAGE> 5
securities other than U.S. Government securities, and will engage in
options and financial futures transactions. The Portfolio may purchase or
sell portfolio securities on a when-issued or delayed delivery basis. The
Portfolio's current return is sought from interest income and net
short-term gains on securities and options and futures transactions.
International Portfolio: This Portfolio seeks a total return, a combination
of capital growth and income, principally through an internationally
diversified portfolio of equity securities. While this Portfolio invests
principally in equity securities of non-United States issuers, this
Portfolio may also invest in convertible and debt securities of non-United
States issuers and foreign currencies.
Small Cap Portfolio: This Portfolio seeks maximum appreciation of capital.
At least 65% of its total assets normally will be invested in the equity
securities of smaller companies, i.e., those having a market capitalization
of $1 billion or less at the time of investment. Current income will not be
a significant factor. This Portfolio's investments normally will consist
primarily of common stocks and securities convertible into or exchangeable
for common stocks and to a limited degree in preferred stock and debt
securities.
JANUS ASPEN SERIES
Growth Portfolio: This Portfolio seeks long-term growth of capital by
investing primarily in common stocks, with an emphasis on companies with
larger market capitalizations.
Aggressive Growth Portfolio: This Portfolio is a nondiversified portfolio
that seeks long-term growth of capital by investing primarily in common
stocks. The common stocks held by the Portfolio will normally have an
average market capitalization between $1 billion and $5 billion.
Worldwide Growth Portfolio: This Portfolio seeks long-term growth of
capital by investing primarily in common stocks of foreign and domestic
companies.
Balanced Portfolio: This Portfolio seeks long-term growth of capital
balanced by current income. The Portfolio normally invests 40-60% of its
assets in equity securities selected for their growth potential and 40-60%
in fixed-income securities.
Short-Term Bond Portfolio: This Portfolio seeks a high level of current
income while minimizing interest rate risk by investing in shorter term
fixed-income securities. Its average-weighted maturity is normally less
than three years.
LEXINGTON NATURAL RESOURCES TRUST
This Fund seeks long-term growth of capital through investment primarily in
common stocks of companies that own or develop natural resources and other
basic commodities, or supply goods and services to such companies. Current
income will not be a factor. Total return will consist of capital
appreciation.
LEXINGTON EMERGING MARKETS FUND
This Fund seeks long-term growth of capital primarily through investment in
equity securities of companies domiciled in, or doing business in emerging
countries and emerging markets.
------------------
There is no assurance that any of the Funds or Portfolios will achieve its
stated objective. More detailed information, including a description of
risks involved in investing in each of the Subaccounts that invest in the
Funds, may be found in the corresponding prospectus for the Fund, which
must accompany or precede this Prospectus, and the Fund's Statement of
Additional Information available upon request. Read the prospectus
carefully before investing.
Kemper Financial Services, Inc., an affiliate of KILICO is the investment
adviser for the seven Portfolios of the Kemper Investors Fund. Janus
Capital Corporation is the investment adviser for the five available
Portfolios of the Janus Aspen Series. Lexington Management Corporation is
the investment adviser for the Lexington Natural Resources Trust and the
Lexington Emerging Markets Fund. The investment advisers are paid fees for
their services by the Funds they manage. KILICO may receive compensation
from the investment advisers of the Funds for services related to the
Funds. Such compensation will be consistent with the services rendered or
the cost savings resulting from the arrangement.
S-5
<PAGE> 6
For their advisory services to the Portfolios, the advisers receive
compensation at the following rates:
KEMPER INVESTORS FUND
Kemper Financial Services, Inc. receives compensation monthly at annual
rates equal to .50 of 1%, .55 of 1%, .60 of 1%, .60 of 1%, .55 of 1%, .75
of 1% and .65 of 1% of the average daily net asset values of the Money
Market Portfolio, the Total Return Portfolio, the High Yield Portfolio, the
Equity Portfolio, the Government Securities Portfolio, the International
Portfolio, and the Small Cap Portfolio, respectively.
JANUS ASPEN SERIES
Janus Capital Corporation receives a monthly advisory fee for the Growth
Portfolio, the Aggressive Growth Portfolio, the Worldwide Growth Portfolio
and the Balanced Portfolio based on the following schedule (expressed as an
annual rate):
<TABLE>
<CAPTION>
AVERAGE DAILY NET
ASSETS OF PORTFOLIO ANNUAL RATE
-------------------------------------- -----------
<S> <C>
First $30,000,000..................... 1.00%
Next $270,000,000..................... .75%
Next $200,000,000..................... .70%
Over $500,000,000..................... .65%
</TABLE>
However, Janus Capital Corporation has agreed to reduce each of the above
Portfolios' advisory fees to the extent that such fee exceeds the effective
rate of a fund managed by Janus Capital Corporation with similar investment
objective and policies.
Janus Capital Corporation receives a monthly advisory fee for the
Short-Term Bond Portfolio based on the following advisory fee schedule
(expressed as an annual rate): .65% of the first $300,000,000 of the
average daily net assets plus .55% of the average daily net assets in
excess of $300,000,000.
LEXINGTON NATURAL RESOURCES TRUST
Lexington Management Corporation receives a monthly investment advisory fee
at the annual rate of 1.00% of the Fund's average net assets.
LEXINGTON EMERGING MARKETS FUND
Lexington Management Corporation receives a monthly investment advisory fee
at the annual rate of 0.85% of the Fund's average net assets.
PERFORMANCE INFORMATION
The third sentence appearing under Performance Information on page 9 of the
Prospectus is revised to read as follows:
"The High Yield Subaccount, the Government Securities Subaccount and the
Janus Short-Term Bond Subaccount may also advertise 'yield'."
The following is added on page 10 of the Prospectus to the end of the paragraph
appearing under Performance Information:
"In addition, the Subaccounts may provide comparative information with
regard to the Standard & Poor's Midcap Index, Lehman Brothers
Government/Corporate 1-3 Year Bond Index, Lehman Brothers Long
Government/Corporate Bond Index, Russell 2000 Index and the NASDAQ
Composite, U.S. Treasury Obligations and the Morgan Stanley International
World Index and may provide Ibbotson Associates or Micropad performance
analysis rankings.
S-6
<PAGE> 7
DISTRIBUTION OF CONTRACTS
The section titled "Distribution of Contracts" appearing on page 22 of the
Prospectus is amended by adding the following sentence to the end thereof:
"The investment options described in the September 15, 1995 Supplement are
not available to all Contract Owners. These investment options are
available only under Contracts that are sold or serviced by broker-dealers
that have entered into a selling group agreement that authorizes the sale
of Contracts with these options."
S-7
<PAGE> 8
[LOGO]
Janus Aspen Series
Prospectus
May 1, 1995
This prospectus describes five mutual funds with a variety of investment
objectives, including growth of capital, current income and a combination of
growth and income (the "Portfolios"). Janus Capital Corporation ("Janus
Capital") serves as investment adviser to each Portfolio. Janus Capital has
been in the investment advisory business for 25 years and currently manages
over $22 billion in assets.
Each Portfolio is a series of Janus Aspen Series (the "Trust"). The Trust is
registered with the Securities and Exchange Commission ("SEC") as an open-end
management investment company. Shares of the Trust are issued and redeemed only
in connection with investment in and payments under variable annuity contracts
and variable life insurance contracts (collectively "variable insurance
contracts"), as well as certain qualified retirement plans. The Trust sells and
redeems its shares at net asset value without any sales charges, commissions or
redemption fees. Each variable insurance contract involves fees and expenses
not described in this Prospectus. Certain Portfolios may not be available in
connection with a particular contract and certain contracts may limit
allocations among the Portfolios. See the accompanying contract prospectus for
information regarding contract fees and expenses and any restrictions on
purchases or allocations.
This Prospectus contains information about the Portfolios that a prospective
purchaser of a variable insurance contract should consider before allocating
purchase payments or premiums to the Portfolios. It should be read carefully in
conjunction with the separate account prospectus of the specific insurance
product that accompanies this Prospectus and retained for future reference.
Additional information about the Portfolios is contained in a Statement of
Additional Information ("SAI") filed with the SEC. The SAI dated May 1, 1995 is
incorporated by reference into this Prospectus. Copies of the SAI are available
upon request and without charge by writing or calling your insurance company.
THESE SECURITIES HAVE NOT BEEN APPROVED BY THE SEC OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SEC OR ANY STATE SECURITIES COMMISSION PASSED ON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
This Prospectus does not constitute an offer to sell securities in any state or
other jurisdiction to any person to whom it is unlawful to make such an offer
in such state or other jurisdiction.
CONTENTS
<TABLE>
<S> <C>
PORTFOLIOS AT A GLANCE
Brief description of each Portfolio . . . . . . . . . . . . . . . . . . . . . . 2
FINANCIAL HIGHLIGHTS
A summary of financial data . . . . . . . . . . . . . . . . . . . . . . . . . . 3
PERFORMANCE TERMS
An Explanation of Performance Terms . . . . . . . . . . . . . . . . . . . . . . 4
THE PORTFOLIOS IN DETAIL
The Portfolios' Investment
Objectives and Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
General Portfolio Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Additional Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
MANAGEMENT OF THE PORTFOLIOS
Management & Investment Personnel . . . . . . . . . . . . . . . . . . . . . . . 12
Management Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Portfolio Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Other Service Providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
DISTRIBUTIONS AND TAXES
Distributions and Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
SHAREHOLDER'S GUIDE
Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Redemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Shareholder Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
APPENDIX A
Glossary of Investment Terms . . . . . . . . . . . . . . . . . . . . . . . . . . 17
</TABLE>
Janus Aspen Series Prospectus
<PAGE> 9
PORTFOLIOS AT A GLANCE
This section is designed to provide you with a brief overview of the Portfolios
and their investment emphasis. A more detailed discussion of the Portfolios'
investment objectives and policies begins on page 5.
GROWTH PORTFOLIO
FOCUS: A diversified portfolio that seeks long-term growth of capital by
investing primarily in common stocks, with an emphasis on companies with larger
market capitalizations.
INCEPTION: September 1993
MANAGER: James P. Craig
AGGRESSIVE GROWTH PORTFOLIO
FOCUS: A nondiversified portfolio that seeks long-term growth of capital by
investing primarily in common stocks. The common stocks held by the Portfolio
will normally have an average market capitalization between $1 billion and $5
billion.
INCEPTION: September 1993
MANAGER: James P. Goff
WORLDWIDE GROWTH PORTFOLIO
FOCUS: A diversified portfolio that seeks long-term growth of capital by
investing primarily in common stocks of foreign and domestic companies.
INCEPTION: September 1993
MANAGER: Helen Young Hayes
BALANCED PORTFOLIO
FOCUS: A diversified portfolio that seeks long-term growth of capital balanced
by current income. The Portfolio normally invests 40-60% of its assets in
equity securities selected for their growth potential and 40-60% in
fixed-income securities.
INCEPTION: September 1993
MANAGER: James P. Craig
SHORT-TERM BOND PORTFOLIO
FOCUS: A diversified portfolio that seeks a high level of current income while
minimizing interest rate risk by investing in shorter term fixed-income
securities. Its average-weighted maturity is normally less than three years.
INCEPTION: September 1993
MANAGER: Ronald V. Speaker
JANUS SPECTRUM
The spectrum below shows Janus Capital's assessment of the potential overall
risk of the Portfolios relative to one another and should not form a basis for
comparing the Portfolios to other mutual funds or other types of investments.
The spectrum was determined based on a number of factors such as the types of
securities in which the Portfolios intend to invest, the degree of
diversification intended and/or permitted, the sizes of the Portfolios and, in
addition, is significantly affected by the portfolio managers' investment
styles. These factors were considered as of the date of this prospectus and
will be reassessed with each new prospectus. Specific risks of certain types of
instruments in which some of the Portfolios may invest, including foreign
securities, junk bonds and derivative instruments such as futures contracts and
options, are described under "Additional Risk Factors" on page 9. THE SPECTRUM
IS NOT INDICATIVE OF THE FUTURE VOLATILITY OR PERFORMANCE OF A PORTFOLIO AND
RELATIVE POSITIONS OF PORTFOLIOS WITHIN THE SPECTRUM MAY CHANGE IN THE FUTURE.
<TABLE>
<CAPTION>
CONSERVATIVE MODERATE AGGRESSIVE
.........................................................
<S> <C> <C> <C> <C>
Growth Portfolio ..........
Aggressive Growth Portfolio ..........
Worldwide Growth Portfolio ..........
Balanced Portfolio ..........
Short-Term Bond Portfolio ..........
</TABLE>
2 Janus Aspen Series Prospectus May 1, 1995
<PAGE> 10
FINANCIAL HIGHLIGHTS
The information below is for fiscal periods ending on December 31 of each year,
and has been audited by the accounting firm of Price Waterhouse LLP. Their
report is included in the Portfolios' Annual Report, which is incorporated by
reference into the SAI. Expense and income ratios and portfolio turnover rates
have been annualized for periods of less than one year. Total returns for
periods of less than one year are not annualized. A DETAILED EXPLANATION OF THE
FINANCIAL HIGHLIGHTS CAN BE FOUND ON PAGE 4.
<TABLE>
<CAPTION>
AGGRESSIVE WORLDWIDE
GROWTH PORTFOLIO GROWTH PORTFOLIO GROWTH PORTFOLIO
1994 1993(1) 1994 1993(1) 1994 1993(1)
---- ------- ---- ------- ---- -------
<S> <C> <C> <C> <C> <C> <C>
1. Net asset value, beginning of period $10.32 $10.00 $11.80 $10.00 $11.89 $10.00
------ ------ ------ ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
2. Net investment income 0.09 0.03 0.11 0.01 0.04 0.02
3. Net gains or (losses) on securities
(both realized and unrealized) 0.20 0.32 1.82 1.80 0.14 1.89
------ ------ ------ ------ ------ ------
4. Total from investment operations 0.29 0.35 1.93 1.81 0.18 1.91
------ ------ ------ ------ ------ ------
LESS DISTRIBUTIONS:
5. Dividends
(from net investment income) (0.04) (0.03) (0.11) (0.01) -- (0.01)
6. Dividends
(in excess of net investment income) -- -- -- -- -- (0.01)
7. Distributions (from capital gains) -- -- -- -- -- --
------ ------ ------ ------ ------ ------
8. Total distributions (0.04) (0.03) (0.11) (0.01) -- (0.02)
------ ------ ------ ------ ------ ------
9. Net asset value, end of period $10.57 $10.32 $13.62 $11.80 $12.07 $11.89
------ ------ ------ ------ ------ ------
10. Total return 2.76% 3.50% 16.33% 18.05% 1.53% 19.10%
------ ------ ------ ------ ------ ------
11. Net assets, end of period
(in thousands) $43,549 $7,482 $41,289 $1,985 $37,728 $4,856
12. Ratio of expenses to average
net assets 0.88%(3) 0.25%(2) 1.05%(3) 0.25%(2) 1.18%(3) 0.25%(2)
13. Ratio of net investment income
to average net assets 1.45% 2.54% 2.18% 0.34% 0.50% 0.84%
14. Portfolio turnover rate 169% 162% 259% 31% 217% 57%
====== ====== ====== ====== ====== ======
</TABLE>
(1) September 13, 1993 (inception) to December 31, 1993.
(2) For the period from September 13, 1993 (inception) to December 31, 1993,
the ratio of expenses to average net assets was 1.82%, 3.26% and
2.44%, respectively, for Growth, Aggressive Growth and Worldwide
Growth Portfolios, before voluntary waiver of certain portfolio
expenses.
(3) Commissions payable by the Portfolio for transactions
effected by a broker-dealer affiliated with Janus Capital were
credited against the Portfolio's operating expenses.
The effect of such directed brokerage arrangement was de
minimis.
<TABLE>
<CAPTION>
BALANCED PORTFOLIO SHORT-TERM BOND PORTFOLIO
1994 1993(1) 1994 1993(1)
---- ------- ---- ------
<S> <C> <C> <C> <C>
1. Net asset value, beginning of period $10.64 $10.00 $9.93 $10.00
------ ------ ------ ------
INCOME PERIOD FROM INVESTMENT OPERATIONS
2. Net investment income 0.15 0.08 0.35 0.11
3. Net gains or (losses) on securities
(both realized and unrealized) (0.06) 0.64 (0.26) (0.08)
------ ------ ------ ------
4. Total from investment operations 0.09 0.72 (0.09) 0.03
------ ------ ------ ------
LESS DISTRIBUTIONS:
5. Dividends (from net investment income) (0.10) (0.08) (0.30) (0.10)
6. Dividends (in excess of net investment
income) -- -- -- --
7. Distributions (from capital gains) -- -- -- --
------ ------ ------ ------
8. Total distributions (0.10) (0.08) (0.30) (0.10)
------ ------ ------ ------
9. Net asset value, end of period $10.63 $10.64 $9.72 $9.93
------ ------ ------ ------
10. Total return 0.84% 7.20% 0.92% 0.30%
------ ------ ------ ------
11. Net assets, end of period (in thousands) $3,153 $537 $2,902 $502
12. Ratio of expenses to average net assets 1.57%(4) 0.25%(2) 0.65%(3) 0.65%(2)
13. Ratio of net investment income
to average net assets 1.90% 2.69% 5.00% 3.57%
14. Portfolio turnover rate 158% 126% 256% 91%
====== ====== ====== ======
</TABLE>
(1) September 13, 1993 (inception) to December 31, 1993.
(2) For the period from September 13, 1993 (inception) to December 31, 1993,
the ratio of expenses to average net assets was 5.46% and 5.33%,
respectively, for Balanced and Short-Term Bond Portfolios, before
voluntary waiver of certain Portfolio expenses.
(3) For the fiscal year ended December 31, 1994, the ratio of expenses to
average net assets was 1.40% for Short-Term Bond Portfolio, before
voluntary waiver of certain Portfolio expenses.
(4) Commissions payable by the Portfolio for transactions effected by a
broker-dealer affiliated with Janus Capital were credited against the
Portfolio's operating expenses. The effect of such directed brokerage
arrangement was de minimis.
JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995 3
<PAGE> 11
UNDERSTANDING THE FINANCIAL HIGHLIGHTS
This section is designed to help you better understand the information
summarized in the Financial Highlights tables. The tables contain important
historical operating information that may be useful in making your investment
decision or understanding how your investment has performed. The Portfolios'
Annual Report contains additional information about each Portfolio's
performance, including a comparison to an appropriate securities index. To
request a copy of the Annual Report, please call or write your insurance
company.
NET ASSET VALUE (NAV) is the value of a single share of a Portfolio. It is
computed by adding the value of all of a Portfolio's investments and other
assets, subtracting any liabilities and dividing the result by the number of
shares outstanding. The difference between line 1 and line 9 in the Financial
Highlights tables represents the change in value of a Portfolio's shares over
the fiscal period, but not its total return.
NET INVESTMENT INCOME is the per share amount of dividends and interest income
earned on securities held by a Portfolio, less Portfolio expenses. DIVIDENDS
(FROM NET INVESTMENT INCOME) is the per share amount that a Portfolio paid from
net investment income.
NET GAIN OR (LOSS) ON SECURITIES is the per share increase or decrease in value
of the securities a Portfolio holds. A gain (or loss) is realized when
securities are sold. A gain (or loss) is unrealized when securities increase or
decrease in value but are not sold. DISTRIBUTIONS (FROM CAPITAL GAINS) is the
per share amount that a Portfolio paid from net realized gains.
TOTAL RETURN is the percentage increase or decrease in the value of an
investment over a stated period of time. A total return percentage includes
both changes in NAV and income. For the purposes of calculating total return,
it is assumed that dividends and distributions are reinvested at the NAV on the
day of the distribution. A PORTFOLIO'S TOTAL RETURN CANNOT BE COMPUTED DIRECTLY
FROM THE FINANCIAL HIGHLIGHTS TABLES.
RATIO OF EXPENSES TO AVERAGE NET ASSETS is the total of a Portfolio's operating
expenses divided by its average net assets for the stated period.
RATIO OF NET INVESTMENT INCOME TO AVERAGE NET ASSETS is a Portfolio's net
investment income divided by its average net assets for the stated period.
PORTFOLIO TURNOVER RATE is a measure of the amount of a Portfolio's buying and
selling activity. It is computed by dividing total purchases or sales,
whichever is less, by the average monthly market value of a Portfolio's
securities.
PERFORMANCE TERMS
This section will help you understand various terms that are commonly used to
describe a Portfolio's performance. You may see references to these terms in
our newsletters or advertisements (or those published by participating
insurance companies) and in media articles. Newsletters and advertisements may
include comparisons of a Portfolio's performance to the performance of other
mutual funds, mutual fund averages or recognized stock market indices. Growth
Portfolio, Aggressive Growth Portfolio, Worldwide Growth Portfolio and Balanced
Portfolio generally measure performance in terms of total return, while
Short-Term Bond Portfolio generally uses yield.
CUMULATIVE TOTAL RETURN represents the actual rate of return on an investment
for a specified period. The Financial Highlights tables on page 3 show total
return for a single fiscal period. Cumulative total return is generally quoted
for more than one year (e.g., the life of a Portfolio). A cumulative total
return does not show interim fluctuations in the value of an investment.
AVERAGE ANNUAL TOTAL RETURN represents the average annual percentage change of
an investment over a specified period. It is calculated by taking the
cumulative total return for the stated period and determining what constant
annual return would have produced the same cumulative return. Average annual
returns for more than one year tend to smooth out variations in a Portfolio's
return and are not the same as actual annual results.
YIELD shows the rate of income a Portfolio earns on its investments as a
percentage of the Portfolio's share price. It is calculated by dividing a
Portfolio's net investment income for a 30-day period by the average number of
shares entitled to receive dividends and dividing the result by the Portfolio's
NAV per share at the end of the 30-day period. Yield does not include changes
in NAV.
Yields are calculated according to standardized SEC formulas and may not equal
the income on an investor's account. Yield is usually quoted on an annualized
basis. An annualized yield represents the amount you would earn if you remained
in a Portfolio for a year and that Portfolio continued to have the same yield
for the entire year.
THE PORTFOLIOS IMPOSE NO SALES OR OTHER CHARGES THAT WOULD AFFECT TOTAL RETURN
OR YIELD COMPUTATIONS. YIELD AND TOTAL RETURN FIGURES OF THE PORTFOLIOS INCLUDE
THE EFFECT OF DEDUCTING EACH PORTFOLIO'S EXPENSES, BUT MAY NOT INCLUDE CHARGES
AND EXPENSES ATTRIBUTABLE TO ANY PARTICULAR INSURANCE PRODUCT. PORTFOLIO
PERFORMANCE FIGURES ARE BASED UPON HISTORICAL RESULTS AND ARE NOT INTENDED TO
INDICATE FUTURE PERFORMANCE. INVESTMENT RETURNS AND NET ASSET VALUE WILL
FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR
LESS THAN THEIR ORIGINAL COST.
4 JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995
<PAGE> 12
THE PORTFOLIOS IN DETAIL
This section takes a closer look at the Portfolios' investment objectives,
policies and the securities in which they invest. Please carefully review the
"Additional Risk Factors" section of this Prospectus for a more detailed
discussion of the risks associated with certain investment techniques as well
as the risk spectrum on page 2. Appendix A contains a more detailed discussion
of instruments in which the Portfolios may invest. You should carefully
consider your investment goals, time horizon and risk tolerance before choosing
a Portfolio.
Each Portfolio has an investment objective and policies that are similar to
those of a Janus retail fund, as illustrated in the chart below. Although it
is anticipated that each Portfolio and its corresponding retail fund will hold
similar securities, differences in asset size and cash flow needs as well as
the relative weightings of securities selections may result in differences in
investment performance. Expenses of each Portfolio and its corresponding retail
fund are expected to differ. The variable contract owner will also bear various
insurance-related costs at the insurance company level. You should review the
accompanying separate account prospectus for a summary of contract fees and
expenses.
Policies that are noted as "fundamental" cannot be changed without a
shareholder vote. All other policies, including each Portfolio's investment
objective, are not fundamental and may be changed by the Portfolios' Trustees
without a shareholder vote. You will be notified of any such changes that are
material. If there is a material change in a Portfolio's objective or policies,
you should consider whether that Portfolio remains an appropriate investment
for your variable insurance contract or qualified retirement plan.
EACH OF THE PORTFOLIOS HAS A SIMILAR INVESTMENT OBJECTIVE AND SIMILAR
INVESTMENT POLICIES TO AN EXISTING JANUS RETAIL FUND.
<TABLE>
<S> <C>
Growth Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Janus Fund
Aggressive Growth Portfolio . . . . . . . . . . . . . . . . . . . . . Janus Enterprise Fund
Worldwide Growth Portfolio . . . . . . . . . . . . . . . . . . . . . . . Janus Worldwide Fund
Balanced Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . Janus Balanced Fund
Short-Term Bond Portfolio . . . . . . . . . . . . . . . . . . . . Janus Short-Term Bond Fund
</TABLE>
GROWTH PORTFOLIO, AGGRESSIVE GROWTH PORTFOLIO AND WORLDWIDE GROWTH PORTFOLIO ARE
DESIGNED FOR LONG-TERM INVESTORS WHO SEEK GROWTH OF CAPITAL ONLY AND WHO CAN
TOLERATE THE GREATER RISKS ASSOCIATED WITH COMMON STOCK INVESTMENTS.
GROWTH PORTFOLIO
The investment objective of this Portfolio is long-term growth of capital in a
manner consistent with the preservation of capital. It is a diversified
portfolio that pursues its objective by investing in common stocks of companies
of any size. This Portfolio generally invests in larger, more established
issuers.
AGGRESSIVE GROWTH PORTFOLIO
The investment objective of this Portfolio is long-term growth of capital in a
manner consistent with the preservation of capital. It is a nondiversified
Portfolio that, under normal circumstances, pursues its investment objective by
holding common stocks with an average market capitalization between $1 billion
and $5 billion.
WORLDWIDE GROWTH PORTFOLIO
The investment objective of this Portfolio is long-term growth of capital in a
manner consistent with the preservation of capital. It is a diversified
Portfolio that pursues its objective primarily through investments in common
stocks of foreign and domestic issuers. The Portfolio has the flexibility to
invest on a worldwide basis in companies and organizations of any size,
regardless of country of organization or place of principal business activity.
Worldwide Growth Portfolio normally invests in issuers from at least five
different countries, including the United States. The Portfolio may at times
invest in fewer than five countries or even a single country.
TYPES OF SECURITIES
Each of these Portfolios invests primarily in common stocks of foreign and
domestic companies. However, the percentage of each Portfolio's assets invested
in common stocks will vary and each Portfolio may at times hold substantial
positions in cash equivalents or interest bearing securities. See "General
Portfolio Policies" on page 8. Each Portfolio may invest to a lesser degree in
other types of securities including preferred stocks, warrants, convertible
securities and debt securities when its portfolio manager perceives an
opportunity for capital growth from such securities or to receive a return on
idle cash. Debt and other income-producing securities that the Portfolios may
purchase include those described with respect to the Short-Term Bond Portfolio
on page 7.
Although Worldwide Growth Portfolio is committed to foreign investing, Growth
Portfolio and Aggressive Growth Portfolio may also invest without limit in
foreign equity and debt securities. The Portfolios may invest directly in
foreign securities denominated in a foreign currency and not publicly traded in
the United States. Other ways of investing in foreign securities include
depositary receipts or shares, and passive foreign investment companies
("PFICs"). These Portfolios may use futures, options and other derivatives for
hedging purposes or as a means of enhancing return. See "Additional Risk
Factors" on page 9 for a discussion of the risks associated with foreign
investing and derivatives. Some securities that the Portfolios purchase may be
issued on a when-issued, delayed delivery or forward commitment basis.
JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995 5
<PAGE> 13
The following questions are designed to help you better understand an
investment in Growth Portfolio, Aggressive Growth Portfolio and Worldwide
Growth Portfolio.
HOW ARE COMMON STOCKS SELECTED?
Each of these Portfolios may invest substantially all of its assets in common
stocks to the extent its portfolio manager believes that the relevant market
environment favors profitable investing in those securities. Portfolio managers
take a "bottom up" approach to building their portfolios. In other words, they
seek to identify individual companies with earnings growth potential that may
not be recognized by the market at large. Although themes may emerge in any
Portfolio, securities are selected without regard to any defined industry
sector or other similarly defined selection procedure. Realization of income is
not a significant investment consideration. Any income realized on these
Portfolios' investments will be incidental to its objective.
ARE THE SAME CRITERIA USED TO SELECT FOREIGN STOCKS?
Generally, yes. Portfolio managers seek companies with earnings growth
potential, regardless of country of organization or place of principal business
activity. Foreign securities are selected on a stock-by-stock basis without
regard to any defined allocation among countries or geographic regions.
However, certain factors such as expected levels of inflation, government
policies influencing business conditions, the outlook for currency
relationships, and prospects for economic growth among countries, regions or
geographic areas may warrant greater consideration in selecting foreign stocks.
See "Additional Risk Factors" on page 9.
WHAT IS THE MAIN RISK OF INVESTING IN A COMMON STOCK FUND?
The fundamental risk associated with any common stock fund is the risk that the
value of the stocks it holds might decrease. Stock values may fluctuate in
response to the activities of an individual company or in response to general
market and economic conditions. Historically, common stocks have provided
greater long-term returns and have entailed greater short-term risks than other
investment choices. Smaller or newer issuers are more likely to realize more
substantial growth as well as suffer more significant losses than larger or
more established issuers. Investments in such companies can be both more
volatile and more speculative. See "Additional Risk Factors" on page 9.
WHAT IS MEANT BY "MARKET CAPITALIZATION"?
Market capitalization is the most commonly used measure of the size and value
of a company. It is computed by multiplying the current market price of a share
of the company's stock by the total number of its shares outstanding. As noted
previously, market capitalization is an important investment criteria for
Aggressive Growth Portfolio which may invest in small to medium sized companies
to a greater degree. Although Growth Portfolio and Worldwide Growth Portfolio
do not emphasize companies of any particular size, Portfolios with a larger
asset base are more likely to invest in larger, more-established issuers.
HOW DOES A DIVERSIFIED PORTFOLIO DIFFER FROM A NONDIVERSIFIED PORTFOLIO?
Diversification is a means of reducing risk by investing a Portfolio's assets
in a broad range of stocks or other securities. A "nondiversified" portfolio
has the ability to take larger positions in a smaller number of issuers.
Because the appreciation or depreciation of a single stock may have a greater
impact on the NAV of a nondiversified portfolio, its share price can be
expected to fluctuate more than a comparable diversified portfolio. Aggressive
Growth Portfolio is a nondiversified portfolio.
HOW DO THESE PORTFOLIOS TRY TO REDUCE RISK?
Diversification of a Portfolio's assets reduces the effect of any single
holding on its overall portfolio value. A Portfolio may also use futures,
options and other derivative instruments to protect its portfolio from
movements in securities prices and interest rates. The Portfolios may use a
variety of currency hedging techniques, including forward currency contracts,
to manage exchange rate risk when investing directly in foreign markets. See
"Additional Risk Factors" on page 9. In addition, to the extent that a
Portfolio holds a larger cash position, it may not participate in market
declines to the same extent as if the Portfolio remained more fully invested in
common stocks.
6 JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995
<PAGE> 14
BALANCED PORTFOLIO IS DESIGNED FOR INVESTORS WHO PRIMARILY SEEK GROWTH OF
CAPITAL WITH A DEGREE OF EMPHASIS ON INCOME. IT IS NOT DESIGNED FOR INVESTORS
WHO DESIRE A CONSISTENT LEVEL OF INCOME.
BALANCED PORTFOLIO
The investment objective of this Portfolio is long-term capital growth,
consistent with preservation of capital and balanced by current income. It is
a diversified Portfolio that, under normal circumstances, pursues its objective
by investing 40-60% of its assets in equity securities selected primarily for
their growth potential and 40-60% of its assets in fixed-income securities.
This Portfolio invests at least 25% of its assets in fixed-income senior
securities, which include corporate debt securities and preferred stocks.
TYPES OF SECURITIES
Balanced Portfolio may invest in the types of growth securities previously
described on page 6. The Portfolio may also invest in a wide variety of
income-producing securities including corporate bonds and notes, government
securities, preferred stock, income-producing common stock, debt securities
that are convertible or exchangeable into equity securities, and debt
securities that carry with them the right to acquire equity securities as
evidenced by warrants attached to or acquired with the securities. Debt
securities which Balanced Portfolio may purchase include those discussed below
for Short-Term Bond Portfolio. Balanced Portfolio may invest without limit in
foreign equity and debt securities.
The following questions are designed to help you better understand an
investment in Balanced Portfolio.
HOW ARE ASSETS ALLOCATED BETWEEN THE GROWTH AND INCOME COMPONENT OF BALANCED
PORTFOLIO?
Balanced Portfolio may invest in a combination of common stocks,
preferred stocks, convertible securities, debt securities and other
fixed-income securities. Balanced Portfolio may shift assets between the growth
and income components of its portfolio based on its portfolio manager's
analysis of relevant market, financial and economic conditions. If the
portfolio manager believes that growth securities will provide better returns
than the yields then available or expected on income-producing securities, then
the Portfolio will place a greater emphasis on the growth component.
WHAT TYPES OF SECURITIES MAKE UP THE GROWTH COMPONENT OF BALANCED PORTFOLIO?
The growth component of Balanced Portfolio is expected to consist primarily of
common stocks. The selection criteria for common stocks are described on page
6. Because income is a part of the investment objective of Balanced Portfolio,
the portfolio manager may consider dividend-paying characteristics to a greater
degree in selecting equity securities. Balanced Portfolio may also find
opportunities for capital growth from debt securities because of anticipated
changes in interest rates, credit standing, currency relationships or other
factors.
WHAT TYPES OF SECURITIES MAKE UP THE INCOME COMPONENT OF BALANCED PORTFOLIO?
The income component of Balanced Portfolio may consist of all types of
income-producing securities, including common stocks selected primarily for
their dividend payments, preferred stocks, convertible securities and all types
of debt securities. Income-producing securities are used to produce a more
consistent total return than the portfolio manager may attain through investing
solely in growth stocks. However, Balanced Portfolio is not designed to produce
a consistent level of income.
SHORT-TERM BOND PORTFOLIO IS DESIGNED FOR THOSE INVESTORS WHO PRIMARILY SEEK
CURRENT INCOME.
SHORT-TERM BOND PORTFOLIO
The investment objective of this Portfolio is to seek as high a level of
current income as is consistent with preservation of capital. The Portfolio
pursues its objective by investing primarily in short- and intermediate-term
fixed-income securities. Under normal circumstances, it is expected that this
Portfolio's dollar-weighted average portfolio maturity will not exceed three
years.
Short-Term Bond Portfolio will normally invest at least 65% of its assets
in debt securities. Subject to this policy and subject to its maturity
limits, the Portfolio may invest in the types of income-producing securities
previously described under Balanced Portfolio. Short-Term Bond Portfolio may
invest without limit in foreign securities, including those of corporate and
government issuers.
TYPES OF SECURITIES
Subject to the specific investment policies discussed above, Short-Term Bond
Portfolio may also invest in mortgage- and asset-backed securities (up to 25%
of assets); zero coupon bonds (up to 10% of assets); high-yield/high- risk
bonds (up to 35% of net assets); securities purchased on a when-issued, delayed
delivery or forward commitment basis; and indexed/structured securities. In
addition, Short-Term Bond Portfolio may use futures, options and other
derivatives for hedging purposes or for other purposes, such as enhancing
return. See "Additional Risk Factors" on page 9. When its portfolio manager is
unable to locate investment opportunities with favorable risk/reward
characteristics, the cash position of Short-Term Bond Portfolio may increase
and the Portfolio may have substantial holdings of cash or cash equivalent
short-term obligations. See "General Portfolio Policies" on page 8.
JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995 7
<PAGE> 15
The following questions are designed to help you better understand an
investment in Short-Term Bond Portfolio.
HOW DO INTEREST RATES AFFECT THE VALUE OF MY INVESTMENT?
A fundamental risk associated with any fund that invests in fixed-income
securities (e.g., a bond fund) is the risk that the value of the securities it
holds will rise or fall as interest rates change. Generally, a fixed-income
security will increase in value when interest rates fall and decrease in value
when interest rates rise. Longer-term securities are generally more sensitive
to interest rate changes than shorter-term securities, but they generally offer
higher yields to compensate investors for the associated risks. A bond fund's
average-weighted maturity and its duration are measures of how the portfolio
will react to interest rate changes.
WHAT IS MEANT BY A PORTFOLIO'S "AVERAGE-WEIGHTED MATURITY"?
The stated maturity of a bond is the date when the issuer must repay the bond's
entire principal value to an investor, such as a Portfolio. A bond's term to
maturity is the number of years remaining to maturity. A bond fund does not
have a stated maturity, but it does have an average-weighted maturity. This
number is calculated by averaging the terms to maturity of bonds held by a
Portfolio with each maturity "weighted" according to the percentage of net
assets that it represents.
WHAT IS MEANT BY A PORTFOLIO'S "DURATION"?
A bond's duration indicates the time it will take an investor to recoup his
investment. Unlike average maturity, duration reflects both principal and
interest payments. Generally, the higher the coupon rate on a bond, the lower
its duration will be. The duration of a bond fund is calculated by averaging
the duration of bonds held by a Portfolio with each duration "weighted"
according to the percentage of net assets that it represents. Because duration
accounts for interest payments, a Portfolio's duration is usually shorter than
its average maturity.
HOW DOES SHORT-TERM BOND PORTFOLIO MANAGE INTEREST RATE RISK?
Short-Term Bond Portfolio may vary the average-weighted maturity of its
portfolio to reflect its portfolio manager's analysis of interest rate trends
and other factors. The Portfolio's average-weighted maturity will tend to be
shorter when its portfolio manager expects interest rates to rise and longer
when its portfolio manager expects interest rates to fall. The Portfolio may
also use futures, options and other derivatives to manage interest rate risk.
See "Additional Risk Factors" on page 9.
WHAT IS MEANT BY "CREDIT QUALITY"?
Another fundamental risk associated with all fixed-income funds is credit risk,
which is the risk that an issuer will be unable to make principal and interest
payments when due. U.S. government securities are generally considered to be
the safest type of investment in terms of credit risk. Municipal obligations
generally rank between U.S. government securities and corporate debt securities
in terms of credit safety. Corporate debt securities, particularly those rated
below investment grade, present the highest credit risk.
HOW IS CREDIT QUALITY MEASURED?
Ratings published by nationally recognized rating agencies such as Standard &
Poor's Corporation ("Standard & Poor's") and Moody's Investor Services
("Moody's") are widely accepted measures of credit risk. The lower a bond issue
is rated by an agency, the more credit risk it is considered to represent.
Lower rated bonds generally pay higher yields to compensate investors for the
associated risk. Please refer to the SAI for a description of rating
categories.
GENERAL PORTFOLIO POLICIES
Unless otherwise stated, each of the following policies applies to all of the
Portfolios. The percentage limitations included in these policies and elsewhere
in this Prospectus apply only at the time of purchase of the security. For
example, if a Portfolio exceeds a limit as a result of market fluctuations or
the sale of other securities, it will not be required to dispose of any
securities.
CASH POSITION
When a Portfolio's manager believes that market conditions are not favorable
for profitable investing or when the portfolio manager is otherwise unable to
locate favorable investment opportunities, a Portfolio's investments may be
hedged to a greater degree and/or its cash or similar investments may increase.
In other words, the Portfolios do not always stay fully invested in stocks and
bonds. Cash or similar investments are a residual - they represent the assets
that remain after a portfolio manager has committed available assets to
desirable investment opportunities. Partly because the portfolio managers act
independently of each other, the cash positions of the Portfolios may vary
significantly. Larger hedged positions and/or larger cash positions may serve
as a means of preserving capital in unfavorable market conditions.
Securities that the Portfolios may invest in as means of receiving a return on
idle cash include high-grade commercial paper, certificates of deposit,
repurchase agreements or other short-term debt obligations. When a Portfolio's
investments in cash or similar investments increase, a Portfolio may not
participate in stock or bond market advances
8 JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995
<PAGE> 16
or declines to the same extent that it would if the Portfolio remained more
fully invested in stocks or bonds.
DIVERSIFICATION
The Investment Company Act of 1940 (the "1940 Act") classifies investment
companies as either diversified or nondiversified. All of the Portfolios
(except Aggressive Growth Portfolio) qualify as diversified funds under the
1940 Act. The Portfolios are subject to the following diversification
requirements:
. As a fundamental policy, no Portfolio may own more than 10% of the
outstanding voting shares of any issuer.
. As a fundamental policy, with respect to 50% of the total assets of
Aggressive Growth Portfolio and 75% of the total assets of the other
Portfolios, no Portfolio will purchase a security of any issuer (other than
cash items and U.S. government securities, as defined in the 1940 Act) if such
purchase would cause a Portfolio's holdings of that issuer to amount to more
than 5% of that Portfolio's total assets.
. No Portfolio will invest more than 25% of its assets in a single issuer.
INTERNAL REVENUE SERVICE (IRS) LIMITATIONS
In addition to the diversification requirements stated above, each Portfolio
intends to comply with the diversification requirements currently imposed by
the IRS on separate accounts of insurance companies as a condition of
maintaining the tax-deferred status of variable contracts. More specific
information may be contained in the participating insurance company's separate
account prospectus.
INDUSTRY CONCENTRATION
As a fundamental policy, no Portfolio will invest more than 25% of its total
assets in any particular industry. This policy does not apply to U.S.
government securities.
PORTFOLIO TURNOVER
Each Portfolio generally intends to purchase securities for long-term
investment rather than short-term gains. However, short-term transactions may
result from liquidity needs, securities having reached a price or yield
objective, changes in interest rates or the credit standing of an issuer, or by
reason of economic or other developments not foreseen at the time of the
initial investment decision. Changes are made in a Portfolio whenever its
portfolio manager believes such changes are desirable. Portfolio turnover rates
are generally not a factor in making buy and sell decisions.
To a limited extent, a Portfolio may purchase securities in anticipation of
relatively short-term price gains. A Portfolio may also sell one security and
simultaneously purchase the same or comparable security to take advantage of
short-term differentials in bond yields or securities prices. Increased
portfolio turnover may result in higher costs for brokerage commissions, dealer
mark- ups and other transaction costs and may also result in taxable capital
gains. Certain tax rules may restrict the Portfolios' ability to engage in
short-term trading if a security has been held for less than three months.
ILLIQUID SECURITIES
Each Portfolio may invest up to 15% of its net assets in illiquid securities,
including restricted securities or private placements. An illiquid security is
a security that cannot be sold quickly in the normal course of business. Some
securities cannot be sold to the U.S. public because of their terms or because
of SEC regulations. Janus Capital may determine that securities that cannot be
sold to the U.S. public but that can be sold to institutional investors ("Rule
144A Securities") or on foreign markets are liquid. Janus Capital will follow
guidelines established by the Trustees of the Trust in making liquidity
determinations for Rule 144A Securities and other securities, including
commercial paper.
BORROWING AND LENDING
Each Portfolio may borrow money and lend securities or other assets, as
follows:
. Each Portfolio may borrow money for temporary or emergency purposes in
amounts up to 25% of its total assets.
. Each Portfolio may mortgage or pledge securities as security for borrowings
in amounts up to 15% of its net assets.
. As a fundamental policy, each Portfolio may lend securities or other
assets if, as a result, no more than 25% of its total assets would be lent to
other parties.
Each Portfolio intends to seek permission from the SEC to borrow money
from or lend money to each other and other funds that permit such transactions
and for which Janus Capital serves as investment adviser. All such borrowing
and lending will be subject to the above percentage limits. There is no
assurance that such permission will be granted.
ADDITIONAL RISK FACTORS
FOREIGN SECURITIES
INVESTMENTS IN FOREIGN SECURITIES, INCLUDING THOSE OF FOREIGN GOVERNMENTS,
INVOLVE GREATER RISKS THAN INVESTING IN COMPARABLE DOMESTIC SECURITIES.
Securities of some foreign companies and governments may be traded in the
United States, but many foreign securities are traded primarily in foreign
markets. The risks of foreign investing include:
. CURRENCY RISK. A Portfolio must buy the local currency when it buys a foreign
security and sell the local currency when it sells the security. As long as a
Portfolio holds a foreign security, its value will be affected by the value of
the local currency relative to the U.S. dollar. In other words, when a
Portfolio sells a foreign security, its value may be worth less in U.S.
dollars
JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995 9
<PAGE> 17
even though the security increases in value in its home country.
. POLITICAL AND ECONOMIC RISK. Foreign investments are subject to
heightened political and economic risks, particularly in underdeveloped or
developing countries which may have relatively unstable governments and
economies based on only a few industries. In some countries, there is the risk
that the government may take over the assets or operations of a company or
that the government may impose taxes or limits on the removal of a Portfolio's
assets from that country.
. REGULATORY RISK. Generally, there is less government supervision of
foreign markets. Foreign issuers generally are not subject to the uniform
accounting, auditing and financial reporting standards and practices
applicable to domestic issuers. There may be less publicly available
information about foreign issuers than domestic issuers.
. MARKET RISK. Foreign securities markets, particularly those of
underdeveloped or developing countries, may be less liquid and more volatile
than domestic markets. Certain markets may require payment for securities
before delivery and delays may be encountered in settling securities
transactions. In some foreign markets, there may not be protection against
failure by other parties to complete transactions. There may be limited legal
recourse against an issuer in the event of a default on a debt instrument.
. TRANSACTION COSTS. Transaction costs of buying and selling foreign
securities, including brokerage, tax and custody costs, are generally higher
than those involved in domestic transactions.
INVESTMENTS IN SMALLER COMPANIES
SMALLER OR NEWER COMPANIES MAY SUFFER MORE SIGNIFICANT LOSSES AS WELL
AS REALIZE MORE SUBSTANTIAL GROWTH THAN LARGER OR MORE ESTABLISHED ISSUERS.
Smaller or newer companies may lack depth of management, they may be unable to
generate funds necessary for growth or potential development, or they may be
developing or marketing new products or services for which markets are not yet
established and may never become established. In addition, such companies may
be insignificant factors in their industries and may be subject to intense
competition from larger or more established companies. Securities of smaller or
newer companies may have more limited trading markets than the markets for
securities of larger or more established issuers, and may be subject to wider
price fluctuations. Investments in such companies tend to be more volatile and
somewhat more speculative.
FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS
Each Portfolio may enter into futures contracts on securities, financial
indices and foreign currencies and options on such contracts ("futures
contracts") and may invest in options on securities, financial indices and
foreign currencies ("options"), forward contracts and interest rate swaps and
swap-related products (collectively "derivative instruments"). The Portfolios
intend to use most derivative instruments primarily to hedge against potential
adverse movements in securities prices, foreign currency markets or interest
rates. To a limited extent, the Portfolios may also use derivative instruments
for non-hedging purposes such as increasing a Portfolio's income or otherwise
enhancing return. Please refer to Appendix A and the SAI for a more detailed
discussion of these instruments.
The use of derivative instruments exposes the Portfolios to additional
investment risks and transaction costs. Risks inherent in the use of derivative
instruments include:
. the risk that interest rates, securities prices and currency markets will not
move in the direction that a portfolio manager anticipates;
. imperfect correlation between the price of derivative instruments and
movements in the prices of the securities, interest rates or currencies being
hedged;
. the fact that skills needed to use these strategies are different from those
needed to select portfolio securities;
. inability to close out certain hedged positions to avoid adverse tax
consequences;
. the possible absence of a liquid secondary market for any particular
instrument and possible exchange-imposed price fluctuation limits, either of
which may make it difficult or impossible to close out a position when
desired;
. leverage risk, that is, the risk that adverse price movements in an
instrument can result in a loss substantially greater than a Portfolio's
initial investment in that instrument (in some cases, the potential loss is
unlimited); and
. particularly in the case of privately-negotiated instruments, the risk that
the counterparty will fail to perform its obligations, which could leave a
Portfolio worse off than if it had not entered into the position.
When a Portfolio invests in a derivative instrument, it may be required to
segregate cash and other high-grade liquid assets or certain portfolio
securities to "cover" the Portfolio's position. Assets segregated or set aside
generally may not be disposed of
10 JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995
<PAGE> 18
so long as the Portfolio maintains the positions requiring segregation or
cover. Segregating assets could diminish the Portfolio's return due to the
opportunity losses of foregoing other potential investments with the segregated
assets.
HIGH-YIELD/HIGH-RISK BONDS
High-yield/high-risk bonds (or "junk" bonds) are debt securities rated below
investment grade by the primary rating agencies (Standard & Poor's and
Moody's). The Portfolios expect that holdings of lower rated securities, if
any, will consist primarily of bonds rated in the highest two tiers of
noninvestment grade securities.
The value of lower rated securities generally is more dependent on the ability
of the company to meet interest and principal payments (i.e., credit risk) than
is the case for higher rated securities. Conversely, the value of higher rated
securities may be more sensitive to interest rate movements than lower rated
securities. In addition, companies issuing high-yield securities are more
vulnerable to real or perceived economic changes, political changes or other
developments adverse to the company, and lower rated securities may have less
liquid markets than higher rated securities. Investments in companies issuing
high-yield securities are considered to be more speculative than higher quality
investments.
Please refer to the SAI for a description of bond rating categories, including
the treatment of unrated securities and securities that have received different
ratings from different agencies.
SPECIAL SITUATIONS
Each Portfolio may invest in "special situations" from time to time. A special
situation arises when, in the opinion of a Portfolio's manager, the securities
of a particular issuer will be recognized and appreciate in value due to a
specific development with respect to that issuer. Developments creating a
special situation might include, among others, a new product or process, a
technological breakthrough, a management change or other extraordinary
corporate event, or differences in market supply of and demand for the
security. Investment in special situations may carry an additional risk of loss
in the event that the anticipated development does not occur or does not
attract the expected attention.
JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995 11
<PAGE> 19
MANAGEMENT OF THE PORTFOLIOS
TRUSTEES
The Trustees oversee the business affairs of the Trust and are responsible for
major decisions relating to each Portfolio's investment objective and policies.
The Trustees delegate the day-to-day management of the Portfolios to the
officers of the Trust and meet quarterly to review the Portfolios' investment
policies, performance, expenses and other business affairs.
INVESTMENT ADVISER
Janus Capital is the investment adviser to each of the Portfolios and is
responsible for the day-to-day management of the investment portfolios and
other business affairs of the Portfolios.
Janus Capital has served as investment adviser to Janus Fund since its
inception in 1970 and currently serves as investment adviser to all of the
Janus retail funds, as well as adviser or subadviser to other mutual funds and
individual, corporate, charitable and retirement accounts. Kansas City
Southern Industries, Inc. ("KCSI") owns approximately 83% of the outstanding
voting stock of Janus Capital, most of which it acquired in 1984. KCSI is a
publicly traded holding company whose primary subsidiaries are engaged in
transportation and financial services. Thomas H. Bailey, President and
Chairman of the Board of Janus Capital, owns approximately 12% of its voting
stock and, by agreement with KCSI, selects a majority of Janus Capital's Board.
Janus Capital furnishes continuous advice and recommendations concerning each
Portfolio's investments. Janus Capital also furnishes certain administrative,
compliance and accounting services for the Portfolios, and may be reimbursed by
the Portfolios for its costs in providing those services. In addition, Janus
Capital employees serve as officers of the Trust and Janus Capital provides
office space for the Portfolios and pays the salaries, fees and expenses of all
Portfolio officers and those Trustees who are affiliated with Janus Capital.
INVESTMENT PERSONNEL
THOMAS H. BAILEY founded Janus Capital in 1969 and has been active in the
advisory and securities business since that time. Mr. Bailey oversees the
investment management of all Portfolios. He holds a Bachelor of Arts in
Business from Michigan State University and Master of Business Administration
from the University of Western Ontario.
JAMES P. CRAIG is the portfolio manager of Growth Portfolio and Balanced
Portfolio. Mr. Craig has been active in the investment management business for
twelve years and has managed Janus Fund since 1986, Janus Venture Fund from its
inception to December 1993 and Janus Balanced Fund since December 1993. He
holds a Bachelor of Arts in Business from the University of Alabama and a
Master of Arts in Finance from the Wharton School of the University of
Pennsylvania.
JAMES P. GOFF is the portfolio manager of Aggressive Growth Portfolio. Mr. Goff
joined Janus Capital in 1988 and has managed Janus Enterprise Fund since its
inception and has co-managed Janus Venture Fund since December 1993. He holds a
Bachelor of Arts in Economics from Yale University and is a Chartered Financial
Analyst.
HELEN YOUNG HAYES is the portfolio manager of Worldwide Growth Portfolio. Ms.
Hayes joined Janus Capital in 1987 and has managed or co-managed Janus
Worldwide Fund and Janus Overseas Fund since their inceptions. She holds a
Bachelor of Arts in Economics from Yale University and is a Chartered Financial
Analyst.
RONALD V. SPEAKER is the portfolio manager of Short-Term Bond Portfolio. Mr.
Speaker joined Janus Capital in 1986. He has managed Janus Flexible Income Fund
since December 1991 and has managed each of Janus Intermediate Government
Securities Fund, Janus Short-Term Bond Fund and Janus Federal Tax-Exempt Fund
since inception. He holds a Bachelor of Arts in Finance from the University of
Colorado and is a Chartered Financial Analyst.
PERSONAL INVESTING
Janus Capital permits investment and other personnel to purchase and sell
securities for their own accounts, subject to Janus Capital's policy governing
personal investing. Janus Capital's policy requires investment and other
personnel to conduct their personal investment activities in a manner that
Janus Capital believes is not detrimental to the Portfolios or Janus Capital's
other advisory clients. See the SAI for more detailed information.
12 JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995
<PAGE> 20
BREAKDOWN OF MANAGEMENT EXPENSES AND EXPENSE LIMITS
Each Portfolio pays Janus Capital a management fee. The advisory agreement with
each Portfolio spells out the management fee and other expenses that the
Portfolios must pay. Each of the Portfolios is subject to the following
management fee schedule (expressed as an annual rate):
<TABLE>
<CAPTION>
AVERAGE DAILY NET ANNUAL RATE EXPENSE LIMIT
FEE SCHEDULE ASSETS OF FUND PERCENTAGE (%) PERCENTAGE (%)
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
GROWTH PORTFOLIO First $ 30 Million 1.00* 2.5**
AGGRESSIVE GROWTH PORTFOLIO Next $270 Million .75
WORLDWIDE GROWTH PORTFOLIO AND Next $200 Million .70
BALANCED PORTFOLIO Over $500 Million .65
---------------------------------------------------------------------------------------------------------------
SHORT-TERM BOND PORTFOLIO First $300 Million .65 .65
Over $300 Million .55
---------------------------------------------------------------------------------------------------------------
</TABLE>
* Janus Capital has agreed to reduce each Portfolio's advisory fee to the
extent that such fee exceeds the effective rate of the Janus retail fund
corresponding to such Portfolio. The effective rate is the advisory fee
calculated by the corresponding retail fund as of the last day of each
calendar quarter (expressed as an annual rate). The effective rate of
Janus Fund, Janus Enterprise Fund, Janus Worldwide Fund and Janus
Balanced Fund were 0.65%, 0.75%, 0.68%, and 0.82%, respectively, for the
quarter ended March 31, 1995.
** The expense limit percentage will decrease as a Portfolio's assets
increase. Please see the SAI for more information.
Differences in the actual management fees incurred by the Portfolios are due
primarily to variances in the asset sizes of the corresponding retail funds. As
asset size increases, the annual rate of the management fee rate declines in
accordance with the above schedule. The management fees paid by certain
Portfolios may be higher than those paid by most other mutual funds. In
addition, each Portfolio incurs expenses not assumed by Janus Capital,
including transfer agent and custodian fees and expenses, legal and auditing
fees, printing and mailing costs of sending reports and other information to
existing shareholders, and independent Trustees' fees and expenses.
Certain administrative services that would otherwise be provided by
Janus Capital and/or its affiliates may be performed by participating insurance
companies that purchase the Portfolios' shares and Janus Capital or the
Portfolios may pay that company for such services.
PORTFOLIO TRANSACTIONS
Purchases and sales of securities on behalf of each Portfolio are executed by
broker-dealers selected by Janus Capital. Broker-dealers are selected on the
basis of their ability to obtain best price and execution for a Portfolio's
transactions and recognizing brokerage, research and other services provided to
the Portfolio and to Janus Capital. Janus Capital may also consider payments
made by brokers effecting transactions for a Portfolio i) to the Portfolio or
ii) to other persons on behalf of the Portfolio for services provided to the
Portfolio for which it would be obligated to pay. The Trustees have authorized
Janus Capital to place portfolio transactions on an agency basis with a
broker-dealer affiliated with Janus Capital. When transactions for a Portfolio
are effected with that broker-dealer, the commissions payable by the Portfolio
are credited against certain Portfolio operating expenses. The SAI further
explains the selection of broker-dealers.
OTHER SERVICE PROVIDERS
The following parties provide the Portfolios with administrative and other
services.
DOMESTIC CUSTODIAN
Investors Fiduciary Trust Company
127 W. 10th Street
Kansas City, Missouri 64105
DOMESTIC SUBCUSTODIAN
United Missouri Bank, N.A.
Tenth and Grand Streets
Kansas City, Missouri 64105
FOREIGN CUSTODIAN
State Street Bank and Trust Company
P.O. Box 351
Boston, Massachusetts 02101
TRANSFER AGENT
Janus Service Corporation
P.O. Box 173375
Denver, Colorado 80217
Janus Service Corporation is a wholly-owned subsidiary of Janus Capital.
JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995 13
<PAGE> 21
OTHER INFORMATION
ORGANIZATION
The Trust is a "mutual fund" that was organized as a Delaware business trust on
May 20, 1993. A mutual fund is an investment vehicle that pools money from
numerous investors and invests the money to achieve a specified objective. The
Trust consists of eight separate series, five of which are offered by this
Prospectus.
SHAREHOLDER MEETINGS AND VOTING RIGHTS
The Trust does not intend to hold annual shareholder meetings. However, special
meetings may be called for a specific Portfolio or for the Trust as a whole for
purposes such as electing or removing Trustees, terminating or reorganizing the
Trust, changing fundamental policies, or for any other purpose requiring a
shareholder vote under the 1940 Act. Separate votes are taken by each Portfolio
only if a matter affects or requires the vote of only that Portfolio.
An insurance company issuing a variable contract invested in shares of a
Portfolio will request voting instructions from variable contract holders.
Under current law, the insurance company must vote all shares held by the
separate account in proportion to the voting instructions received.
CONFLICTS OF INTEREST
Each Portfolio's shares are available only to variable annuity and variable
life separate accounts of insurance companies that are unaffiliated with Janus
Capital and to certain qualified retirement plans. The Portfolios currently do
not foresee any disadvantages to policy owners arising out of the fact that
each Portfolio offers its shares to such entities. Nevertheless, the Trustees
monitor events in order to identify any material irreconcilable conflicts that
may arise and to determine what action, if any, should be taken in response to
such conflicts. If a conflict occurs, the Trustees may require one or more
insurance company separate accounts or plans to withdraw its investments in one
or more Portfolios and to substitute shares of another Portfolio. If this
occurs, a Portfolio may be forced to sell securities at disadvantageous prices.
In addition, the Trustees may refuse to sell shares of any Portfolio to any
separate account or may suspend or terminate the offering of a Portfolio's
shares if such action is required by law or regulatory authority or is in the
best interests of that Portfolio's shareholders.
COMBINED PROSPECTUS
In approving the use of a single combined prospectus, the Trustees considered
the possibility that one Portfolio might be liable for misstatements in this
Prospectus regarding information concerning another Portfolio.
MASTER/FEEDER OPTION
The Trust may in the future seek to achieve any Portfolio's investment
objective by investing all of that Portfolio's assets in another investment
company having the same investment objective and substantially the same
investment policies and restrictions as those applicable to that Portfolio. It
is expected that any such investment company would be managed by Janus Capital
in substantially the same manner as the existing Portfolio. The initial
shareholder(s) of each Portfolio voted to vest the authority to convert to a
master/feeder structure in the sole discretion of the Trustees. No further
approval of the shareholders of the Portfolios is required. You will receive at
least 30 days' prior notice of any such investment. Such investment would be
made only if the Trustees determine it to be in the best interests of a
Portfolio and its shareholders. In making that determination, the Trustees will
consider, among other things, the benefits to shareholders and/or the
opportunity to reduce costs and achieve operational efficiencies. Although
management of the Portfolios believes the Trustees will not approve an
arrangement that is likely to result in higher costs, no assurance is given
that costs will be materially reduced if this option is implemented.
THE VALUATION OF SHARES
The NAV of the shares of a Portfolio is determined at the close of the regular
trading session of the New York Stock Exchange (normally 4:00 p.m., New York
time) each day that the Exchange is open. NAV per share is determined by
dividing the total value of the securities and other assets, less liabilities,
by the total number of shares outstanding. Securities are valued at market
value or, if market information is not readily available, at their fair value
determined in good faith under procedures established by and under the
supervision of the Trustees. Money market instruments maturing within 60 days
are valued at amortized cost, which approximates market value.
14 JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995
<PAGE> 22
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
THE INTERNAL REVENUE CODE REQUIRES EACH PORTFOLIO TO DISTRIBUTE NET INCOME AND
ANY NET GAINS REALIZED BY ITS INVESTMENTS ANNUALLY. A PORTFOLIO'S INCOME FROM
DIVIDENDS AND INTEREST AND ANY NET REALIZED SHORT-TERM CAPITAL GAINS ARE PAID
TO SHAREHOLDERS AS DIVIDENDS. A PORTFOLIO REALIZES CAPITAL GAINS WHENEVER IT
SELLS SECURITIES FOR A HIGHER PRICE THAN IT PAID FOR THEM. NET REALIZED
LONG-TERM GAINS ARE PAID TO SHAREHOLDERS AS CAPITAL GAINS DISTRIBUTIONS. EACH
PORTFOLIO MAKES SEMIANNUAL DISTRIBUTIONS IN JUNE AND DECEMBER OF SUBSTANTIALLY
ALL OF ITS INVESTMENT INCOME AND AN ANNUAL DISTRIBUTION IN JUNE OF ITS NET
REALIZED CAPITAL GAINS, IF ANY. ALL DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
FROM A PORTFOLIO WILL BE AUTOMATICALLY REINVESTED INTO ADDITIONAL SHARES OF
THAT PORTFOLIO.
HOW DISTRIBUTIONS
AFFECT A PORTFOLIO'S NAV
Distributions are paid to shareholders as of the record date of the
distribution of a Portfolio, regardless of how long the shares have been held.
Dividends and capital gains awaiting distribution are included in each
Portfolio's daily NAV. The share price of a Portfolio drops by the amount of
the distribution, net of any subsequent market fluctuations. As an example,
assume that on December 31, Growth Portfolio declared a dividend in the amount
of $0.25 per share. If Growth Portfolio's share price was $10.00 on December
30, the Portfolio's share price on December 31 would be $9.75, barring market
fluctuations.
TAXES
TAXES ON DISTRIBUTIONS
Because shares of the Portfolios may be purchased only through variable
insurance contracts and qualified plans, it is anticipated that any income
dividends or capital gains distributions made by a Portfolio will be exempt
from current taxation if left to accumulate within the variable insurance
contract or qualified plan. Generally, withdrawals from such contracts may be
subject to ordinary income tax and, if made before age 591/2, a 10% penalty
tax. The tax status of your investment in the Portfolios depends on the
features of the variable insurance contracts purchased from a participating
insurance company. Further information may be found in the prospectus of the
separate account offering such contract.
TAXATION OF THE PORTFOLIOS
Dividends and interest received by the Portfolios on foreign securities may
give rise to withholding and other taxes imposed by foreign countries. It is
expected that foreign taxes paid by the Portfolios will be treated as expenses
of the Portfolios. Tax conventions between certain countries and the United
States may reduce or eliminate such taxes.
Because of their distribution policies and compliance with the provisions of
the Internal Revenue Code applicable to investment companies, it is not
expected that any of the Portfolios will be required to pay federal income
taxes. In addition, each Portfolio intends to qualify under the Internal
Revenue Code with respect to the diversification requirements related to the
tax-deferred status of insurance company separate accounts.
JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995 15
<PAGE> 23
SHAREHOLDER'S GUIDE
INVESTORS MAY NOT PURCHASE OR REDEEM SHARES OF THE PORTFOLIOS DIRECTLY. SHARES
MAY BE PURCHASED OR REDEEMED ONLY THROUGH VARIABLE INSURANCE CONTRACTS OFFERED
BY THE SEPARATE ACCOUNTS OF PARTICIPATING INSURANCE COMPANIES OR THROUGH
QUALIFIED RETIREMENT PLANS. REFER TO THE PROSPECTUS FOR THE PARTICIPATING
INSURANCE COMPANY'S SEPARATE ACCOUNT OR YOUR PLAN DOCUMENTS FOR INSTRUCTIONS ON
PURCHASING OR SELLING OF VARIABLE INSURANCE CONTRACTS AND ON HOW TO SELECT
SPECIFIC PORTFOLIOS AS INVESTMENT OPTIONS FOR A CONTRACT OR A QUALIFIED PLAN.
PURCHASES
Purchases of Portfolio shares may be made only by the separate accounts of
insurance companies for the purpose of funding variable insurance contracts or
by qualified plans. Refer to the prospectus of the appropriate insurance
company separate account or your plan documents for information on how to
invest in each Portfolio.
All investments in the Portfolios are credited to a participating insurance
company's separate account or a qualified plan immediately upon acceptance of
the investment by a Portfolio. Investments will be processed at the NAV next
determined after an order is received and accepted by a Portfolio.
Each Portfolio reserves the right to reject any specific purchase order.
Purchase orders may be refused if, in Janus Capital's opinion, they are of a
size that would disrupt the management of a Portfolio. Any Portfolio may
discontinue sales of its shares if management believes that a substantial
further increase may adversely affect that Portfolio's ability to achieve its
investment objective. In such event, however, it is anticipated that existing
policy owners and plan participants invested in that Portfolio would be
permitted to continue to authorize investment in such Portfolio and to reinvest
any dividends or capital gains distributions.
REDEMPTIONS
Redemptions, like purchases, may be effected only through the separate accounts
of participating insurance companies or through qualified plans. Please refer
to the appropriate separate account prospectus or plan documents for details.
Shares of any Portfolio may be redeemed on any business day. Redemptions are
processed at the NAV next calculated after receipt and acceptance of the
redemption order by the Portfolio. Redemption proceeds will normally be wired
to the participating insurance company the business day following receipt of
the redemption order, but in no event later than seven days after receipt of
such order.
SHAREHOLDER COMMUNICATIONS
Owners of variable insurance contracts and plan participants will receive
annual and semiannual reports including the financial statements of the
Portfolios that they have authorized for investment. Each report will show the
investments owned by each Portfolio and the market values thereof, as well as
other information about the Portfolios and their operations. The Trust's fiscal
year ends December 31.
16 JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995
<PAGE> 24
APPENDIX A
GLOSSARY OF INVESTMENT TERMS
This glossary provides a more detailed description of the types of securities
in which the Portfolios may invest. The Portfolios may invest in these
securities to the extent permitted by their investment objective and policies.
The Portfolios are not limited by this discussion and may invest in any type of
security unless precluded by the policies discussed elsewhere in this
Prospectus.
I. EQUITY AND DEBT SECURITIES
BONDS are debt securities issued by a company, municipality or government
agency. The issuer of a bond is required to pay the holder the amount of the
loan (or par value) at a specified maturity and to make scheduled interest
payments.
COMMERCIAL PAPER is a short-term obligation with a maturity ranging from 1 to
270 days issued by banks, corporations and other borrowers to investors seeking
to invest idle cash. The Portfolios may purchase commercial paper issued under
Section 4(2) of the Securities Act of 1933. Janus Capital may determine that
such securities are liquid under guidelines established by the Trustees.
COMMON STOCK represents a share of ownership in a company and usually carries
voting rights and earns dividends. Unlike preferred stock, dividends on common
stock are not fixed but are declared at the discretion of the board of
directors.
CONVERTIBLE SECURITIES are preferred stocks or bonds that pay a fixed dividend
or interest payment and are convertible into common stock at a specified price
or conversion ratio.
DEPOSITARY RECEIPTS are receipts for shares of a foreign-based corporation that
entitle the holder to dividends and capital gains on the underlying security.
Receipts include those issued by domestic banks (American Depositary Receipts),
foreign banks (Global or European Depositary Receipts) and broker-dealers
(depositary shares).
FIXED-INCOME SECURITIES are securities that pay a fixed rate of return. The
term generally includes short- and long-term government, corporate and
municipal obligations that pay a fixed rate of interest or coupons for a
specified period of time and preferred stock, which pays fixed dividends.
Coupon and dividend rates may be fixed for the life of the issue or, in the
case of adjustable and floating rate securities, for a shorter period.
HIGH-YIELD/HIGH-RISK BONDS are securities that are rated below investment grade
by the primary rating agencies (BB or lower by Standard & Poor's and Ba or
lower by Moody's). Other terms commonly used to describe such securities
include "lower rated bonds," "noninvestment grade bonds" and "junk bonds."
MORTGAGE- AND ASSET-BACKED SECURITIES are shares in an organized pool of
mortgages or other debt. These securities are generally pass-through
securities, which means that principal and interest payments on the underlying
securities (less servicing fees) are passed through to shareholders on a pro
rata basis. These securities involve prepayment risk, which is the risk that
the underlying mortgages or other debt may be refinanced or paid off prior to
their maturities during periods of declining interest rates. In that case, a
portfolio manager may have to reinvest the proceeds from the securities at a
lower rate. Potential market gains on a security subject to prepayment risk may
be more limited than potential market gains on a comparable security that is
not subject to prepayment risk.
PASSIVE FOREIGN INVESTMENT COMPANIES (PFICs) are foreign investment funds or
trusts. In addition to bearing their proportionate share of a Portfolio's
expenses, shareholders may indirectly bear similar expenses of PFICs and
similar trusts.
PREFERRED STOCK is a class of stock that generally pays dividends at a
specified rate and has preference over common stock in the payment of dividends
and liquidation. Preferred stock generally does not carry voting rights.
REPURCHASE AGREEMENTS involve the purchase of a security by a Portfolio and a
simultaneous agreement (generally with a bank or dealer) to repurchase the
security from the Portfolio at a specified date or upon demand. This technique
offers a method of earning income on idle cash. These securities involve the
risk that the seller will fail to repurchase the security, as agreed. In that
case, a Portfolio will bear the risk of market value fluctuations until the
security can be sold and may encounter delays and incur costs in liquidating
the security.
REVERSE REPURCHASE AGREEMENTS involve the sale of a security by a Portfolio to
another party (generally a bank or dealer) in return for cash and an agreement
by the Portfolio to buy the security back at a specified price and time. This
technique may be used to provide cash to satisfy unusually high redemption
requests or for other temporary or emergency purposes.
STANDBY COMMITMENTS are obligations purchased by a Portfolio from a dealer that
give the Portfolio the option to sell a security to the dealer at a specified
price.
TENDER OPTION BONDS are generally long-term securities that have been coupled
with an option to tender the securities to a bank, broker-dealer or other
financial institution at periodic intervals and receive the face value of the
bond. This type of security is commonly used as a means of enhancing the
liquidity of municipal securities.
U.S. GOVERNMENT SECURITIES include direct obligations of the U.S. government
that are supported by its full faith and credit. Treasury bills
have initial maturities of less than one year, Treasury notes have initial
maturities of one to ten years and Treasury bonds may be issued with any
maturity but generally have maturities of at least ten years. U.S. government
securities also include indirect obligations of the U.S. government that are
issued by federal agencies and government sponsored entities. Unlike Treasury
securities, agency securities generally are not backed by the full faith and
credit of the U.S. government. Some agency securities are supported by the
right of the issuer to borrow from the Treasury, others are supported by the
discretionary authority of the U.S. government to purchase the agency's
JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995 17
<PAGE> 25
obligations and others are supported only by the credit of the sponsoring
agency.
WARRANTS are securities, typically issued with preferred stock or bonds, that
give the holder the right to buy a proportionate amount of common
stock at a specified price, usually at a price that is higher than the market
price at the time of issuance of the warrant. The right may last for a period
of years or indefinitely.
WHEN-ISSUED, DELAYED DELIVERY AND FORWARD TRANSACTIONS generally involve the
purchase of a security with payment and delivery due at some time
in the future - i.e., beyond normal settlement. The Portfolios do not earn
interest on such securities until settlement and bear the risk of market value
fluctuations in between the purchase and settlement dates. New issues of stocks
and bonds, private placements and U.S. government securities may be sold in
this manner.
ZERO COUPON BONDS are debt securities that do not pay interest at regular
intervals, but are issued at a significant discount from face value.
The discount approximates the total amount of interest the security will accrue
from the date of issuance to maturity. Strips are debt securities that are
stripped of their interest (usually by a financial intermediary) after the
securities are issued. The market value of these securities generally
fluctuates more in response to changes in interest rates than interest-paying
securities of comparable maturity.
II. FUTURES, OPTIONS AND OTHER DERIVATIVES
FUTURES CONTRACTS are contracts that obligate the buyer to receive and the
seller to deliver an instrument or money at a specified price on a specified
date. The Portfolios may buy and sell futures contracts on foreign currencies,
securities and financial indices including interest rates or an index of U.S.
government, foreign government, equity or fixed income securities. An option on
a futures contract gives the buyer the right, but not the obligation, to buy or
sell a futures contract at a specified price on or before a specified date.
Futures contracts and options on futures are standardized and traded on
designated exchanges.
INDEXED/STRUCTURED SECURITIES are typically short- to intermediate-term debt
securities whose value at maturity or interest rate is linked to currencies,
interest rates, equity securities, indices or other financial indicators. Such
securities may be positively or negatively indexed (i.e., their value may
increase or decrease if the reference index or instrument appreciates).
Indexed/structured securities may have return characteristics similar to direct
investments in the underlying instruments and may be more volatile than the
underlying instruments. A Portfolio bears the market risk of an investment in
the underlying instruments, as well as the credit risk of the issuer.
INVERSE FLOATERS are debt instruments whose interest rate bears an inverse
relationship to the interest rate on another instrument.
OPTIONS are the right, but not the obligation, to buy or sell a specified
amount of securities or other assets on or before a fixed date at a
predetermined price. The Portfolios may purchase and write put and call options
on securities, securities indices and foreign currencies.
FORWARD CONTRACTS are contracts to purchase or sell a specified amount of
property for an agreed upon price at a specified time. Forward contracts are
not currently exchange traded and are typically negotiated on an individual
basis. The Portfolios may enter into forward currency contracts to hedge
against declines on the value of non-dollar denominated securities or to reduce
the impact of currency appreciation on purchases of non-dollar denominated
securities. They may also enter into forward contracts to purchase or sell
securities or other financial indices.
INTEREST RATE SWAPS involve the exchange by two parties of their respective
commitments to pay or receive interest (e.g., an exchange of floating rate
payments for fixed rate payments).
18 JANUS ASPEN SERIES PROSPECTUS MAY 1, 1995
<PAGE> 26
-----------------
L E X I N G T O N
-----------------
-----------------
LEXINGTON
NATURAL
RESOURCES
TRUST
-----------------
International
diversification
Free telephone
exchange privilege
No sales charge
No redemption fee
-----------------
The Lexington Group
of
No-Load
Investment Companies
P R O S P E C T U S
MAY 1, 1995
-----------------
Investment Adviser
--------------------------------------------------------------
LEXINGTON MANAGEMENT CORPORATION
P.O. Box 1515/Park 80 West Plaza Two
Saddle Brook, N.J. 07663
Distributor
--------------------------------------------------------------
LEXINGTON FUNDS DISTRIBUTOR, INC.
P.O. Box 1515/Park 80 West Plaza Two
Saddle Brook, N.J. 07663
All shareholder requests for services of any kind should be
sent to:
Transfer Agent
-----------------------------------------------------------
STATE STREET BANK AND TRUST COMPANY
c/o National Financial Data Services 1004
Baltimore Kansas City, Missouri 64105
Or call toll free:
Service: 1-800-526-0056
24 Hour Account Information: 1-800-526-0052
<TABLE>
<S> <C>
Table of Contents Page
-----------------------------------------------------------
Financial Highlights ................................... 2
Description of the Fund ................................ 3
Investment Objectives and Policies ..................... 3
Special Considerations and Risks ....................... 5
Investment Restrictions ................................ 5
Management of the Fund ................................. 6
Investment Adviser, Sub-Adviser, Distributor and
Administrator ........................................ 6
Portfolio Manager ...................................... 7
How to Purchase and Redeem Shares ...................... 7
Determination of Net Asset Value ....................... 8
Performance Calculation ................................ 8
Dividend, Distribution and Reinvestment Policy ......... 8
Tax Matters ............................................ 9
General Information .................................... 9
</TABLE>
<PAGE> 27
PROSPECTUS
May 1, 1995
Lexington Natural Resources Trust
P.O. Box 1515 / Park 80 West Plaza Two
Saddle Brook, New Jersey 07663
201-845-7300
--------------------------------------------------------------------------------
Lexington Natural Resources Trust (the "Fund"), is a no load
open-end non-diversified management investment company. The Fund's
investment objective is to seek long-term growth of capital through
investment primarily in common stocks of companies which own, or develop
natural resources and other basic commodities, or supply goods and
services to such companies. Current income will not be a factor. Total
return will consist primarily of capital appreciation. For a description
of the types of securities in which the Fund will invest, see
"Investment Objectives and Policies" on page 3.
Shares of the Fund may be purchased only by insurance companies for
the purpose of funding variable annuity contracts.
This Prospectus concisely sets forth information about the Fund that
you should know before investing. It should be read and retained for
future reference.
A Statement of Additional Information ("SAI") dated May 1, 1995, has
been filed with the Securities and Exchange Commission and is
incorporated herein by reference. The SAI further discusses certain
areas in this Prospectus and other matters which may be of interest to
some investors. For a free copy, call the telephone number above or
write to the address listed above.
Lexington Management Corporation (the "Investment Adviser") is the
Investment Adviser of the Fund. Lexington Funds Distributor, Inc. (the
"Distributor") is the Distributor of shares of the Fund. Market Systems
Research Advisors, Inc. (the "Sub-Adviser") is the Sub-Adviser to the
Fund.
-------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
-------------------------------------------------------------------------------
<PAGE> 28
FINANCIAL HIGHLIGHTS
The following Per Share and Capital Changes Information for each
of the years in the five year period ended December 31, 1994 has been audited
by KPMG Peat Marwick LLP, Independent Auditors, whose report thereon
appears in the Statement of Additional Information. This information
should be read in conjunction with the financial statements and related
notes thereto included in the Statement of Additional Information.
Financial Highlights
(for a share outstanding throughout the period)
<TABLE>
<CAPTION>
Period from Year
Ended December 31,
August 1, 1989
(Commencement of
Operations) to
December 31,
1994 1993 1992 1991 1990 1989
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Net asset value, beginning of period .... $10.30 $ 9.30 $9.01 $9.50 $11.49 $10.00
------ ------ ----- ----- ------ ------
Income (loss) from investment operations:
Net investment income (loss)........... 0.04 - - 0.02 (0.01) 0.01 -
Net realized and unrealized gain (loss)
on investments ........................ (0.59) 1.01 0.29 (0.49) (1.70) 1.48
------ ------ ----- ----- ------ ------
Total income (loss) from investment
operations ............................ (0.55) 1.01 0.29 (0.47) (1.71) 1.49
------ ------ ----- ----- ------ ------
Less distributions:
Dividends from net investment income .. (0.04) (0.01) - (0.02) - -
Dividends from capital gains............. - - - - (0.28) -
------ ------ ----- ----- ------ ------
Net asset value, end of period .......... $ 9.71 $10.30 $9.30 $9.01 $ 9.50 $11.49
====== ====== ===== ===== ====== ======
Total return ............................ (5.38%) 10.90% 3.22% (4.95%) (14.85%) 40.98%*
Ratio to average net assets:
Expenses, before reimbursement .......... 1.55% 2.26% 2.31% 2.97% 4.55% 19.76%*
Expenses, net of reimbursement .......... 1.55% 2.26% 2.31% 1.60% 1.54% 0.39%*
Net investment income (loss), before
reimbursement ......................... 0.49% 0.08% 0.02% (1.10%) (3.06%) (19.16%)*
Net investment income (loss) ............ 0.49% 0.08% 0.02% 0.27% (0.05%) 0.22%*
Portfolio turnover ...................... 87.40% 114.44% 65.50% 100.94% 50.43% 0.00%*
Net assets, end of period (000's omitted) $13,627 $5,325 $1,926 $1,393 $ 916 $ 280
</TABLE>
------------
*Annualized
2
<PAGE> 29
DESCRIPTION OF THE FUND
Lexington Natural Resources Trust is an open-end management
investment company organized as a business trust under the laws of
Massachusetts. The Fund is intended to be the funding vehicle for variable
annuity contracts to be offered by the separate accounts of certain
life insurance companies ("participating insurance companies"). The Fund
currently does not foresee any disadvantages to the holders of variable annuity
contracts arising from the fact that the interests of the holders of such
contracts may differ. Nevertheless, the Fund's Trustees intend to monitor
events in order to identify any material irreconcilable conflicts which may
possibly arise and to determine what action, if any, should be taken in
response thereto. If a conflict were to occur, an insurance company separate
account might be required to withdraw its investments in the Fund and the Fund
might be forced to sell securities at disadvantageous prices. The variable
annuity contracts are described in the separate prospectuses issued by the
Participating Insurance Companies. The Fund assumes no responsibility for such
prospectuses.
Individual variable annuity contract holders are not "shareholders" of
the Fund. The Participating Insurance Companies and their separate accounts are
the shareholders or investors, although such companies may pass through
voting rights to their variable annuity contract. Shares of the Fund are not
offered directly to the general public.
INVESTMENT OBJECTIVES AND POLICIES
The Fund's investment objective is to seek long-term growth of
capital through investment primarily in common stocks of companies that own or
develop natural resources and other basic commodities, or supply goods and
services to such companies. Current income will not be a factor. Total return
will consist primarily of capital appreciation.
Management attempts to achieve the investment objective of the
Fund by seeking to identify securities of companies that, in its
opinion, are undervalued relative to the value of natural resource holdings of
such companies in light of current and anticipated economic or financial
conditions. Natural resource assets are materials derived from natural sources
which have economic value. The Fund will consider a company to have
substantial natural resource assets when, in management's opinion, the
company's holdings of the assets are of such magnitude, when compared to the
capitalization, revenues or operating profits of the company, that changes in
the economic value of the assets will affect the market price of the equity
securities of such company. Generally, a company has substantial natural
resource assets when at least 50% of the non-current assets,
capitalization, gross revenues or operating profits of the company in the most
recent or current fiscal year are involved in or result from, directly or
indirectly through subsidiaries, exploring, mining, refining, processing,
fabricating, dealing in or owning natural resource assets. Examples of natural
resource assets include: companies that specialize in energy sources (e.g.,
coal, geothermal power, natural gas and oil), environmental technology (e.g.,
pollution control and waste recycling), forest products, agricultural
products, chemical products, ferrous and non-ferrous metals (e.g., iron,
aluminum and copper), strategic metals (e.g., uranium and titanium), precious
metals (e.g., gold, silver and platinum), and other basic commodities. The Fund
presently does not intend to invest directly in natural resource assets or
related contracts. The Fund may invest up to 25% of its total assets in
securities principally traded in markets outside the United States.
Management of the Fund believes that, based upon past performance,
the securities of specific companies that hold different types of
substantial natural resource assets may move relatively independently of one
another during different stages of inflationary cycles due to different degrees
of demand for, or market values of, their respective natural resource
holdings during particular portions of such inflationary cycles. The
Fund's fully-managed investment approach enables it to switch its emphasis
among various industry groups depending upon management's outlook with respect
to prevailing trends and developments. The investment objective and policies of
the Fund described in the first two
3
<PAGE> 30
paragraphs of this section are fundamental policies of the Fund and may not
be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities, as defined in the Investment Company
Act of 1940, as amended.
Except for defensive or liquidity purposes, at least 65% of the total
assets of the Fund will be invested in companies with substantial natural
resource assets. The remaining assets to the extent not invested in the common
stocks of natural resource companies may be invested in companies other than
the natural resource companies and in debt securities of natural resource
companies as well as other companies. At any time management deems it
advisable for temporary defensive or liquidity purposes, the Fund may hold
all its assets in cash or cash equivalents and invest in, or hold unlimited
amounts of, debt obligations of the United States government or its political
subdivisions, and money market instruments including repurchase agreements
with maturities of seven days or less and Certificates of Deposit.
The Fund's investment portfolio may include repurchase agreements with
banks and dealers in U.S. Government securities. A repurchase agreement
involves the purchase by the Fund of an investment contract from a bank or a
dealer in U.S. Government securities which contract is secured by debt
securities whose value is equal to or greater than the value of the repurchase
agreement including the agreed upon interest. The agreement provides that
the institution will repurchase the underlying securities at an agreed upon
time and price. The total amount received on repurchase would exceed the
price paid by the Fund, reflecting an agreed upon rate of interest for the
period from the date of the repurchase agreement to the settlement date, and
would not be related to the interest rate on the underlying securities. The
difference between the total amount to be received upon the repurchase of the
securities and the price paid by the Fund upon their acquisition is
accrued daily as interest. If the institution defaults on the repurchase
agreement, the Fund will retain possession of the underlying securities. In
addition, if bankruptcy proceedings are commenced with respect to the seller,
realization on the collateral by the Fund may be delayed or limited and the Fund
may incur additional costs. In such case the Fund will be subject to risks
associated with changes in the market value of collateral securities. The
Fund intends to limit repurchase agreements to transactions with institutions
believed by the Investment Adviser and Sub-Adviser to present minimal credit
risk.
Although the Fund's Board of Trustees present policy prohibits
investments in speculative securities trading at extremely low prices and in
relatively illiquid markets, investments in such securities can be made when
and if the Board determines such investments to be in the best interests of
the Fund and its shareholders. The policies set forth in this paragraph are
subject to change by the Board of Trustees of the Fund, in its sole
discretion (see "Special Considerations and Risks" and "Dividend, Distribution
and Reinvestment Policy").
The Fund anticipates that its annual portfolio turnover rate will
generally not exceed 150%. A 100% turnover rate would occur if all of the Fund's
portfolio investments were sold and either repurchased or replaced within one
year. High turnover may result in increased transaction costs to the Fund;
however, the rate of turnover will not be a limiting factor when the Fund deems
it desirable to purchase or sell portfolio investments. For the fiscal year
ended December 31, 1994, the portfolio turnover rate was 87.40%.
Generally, the primary consideration in placing portfolio
securities transactions with broker-dealers for execution is to obtain, and
maintain the availability of, execution at the best net price available
and in the most effective manner possible. The Fund's brokerage allocation
policy may permit the Fund to pay a broker-dealer which furnishes
research services a higher commission than that which might be charged by
another broker-dealer which does not furnish research services, provided
that such commission is deemed reasonable in relation to the value of
the services provided by such broker-dealer. For a complete discussion of
portfolio transactions and brokerage allocation, see "Portfolio Transactions
and Brokerage Commissions" in the Statement of Additional Information.
4
<PAGE> 31
SPECIAL CONSIDERATION AND RISKS
Because the Fund will invest a substantial portion of its portfolio in
the securities of companies with natural resources assets, the Fund
should be considered as a vehicle for diversification and not as a balanced
investment program. In addition, investments in foreign securities may
involve risks and considerations not present in domestic investments.
Investments in Foreign Securities
A portion of the Fund's security investments will be in the
securities of foreign issuers. Investments in foreign securities may involve
risks greater than those attendant to investments in securities of U.S.
issuers. Publicly available information concerning issuers located outside
the U.S. may not be comparable in scope or depth of analysis to that
generally available for publicly held U.S. corporations. Accounting and
auditing practices and financial reporting requirements vary significantly from
country to country and generally are not comparable to those applicable to
publicly held U.S. corporations. Government supervision and regulation of
foreign securities exchanges and markets, securities listed on such
exchanges or traded in such markets and brokers, dealers, banks and other
financial institutions who trade the securities in which the Fund may invest
is generally less extensive than in the U.S., and trading customs and
practices may differ substantially from those prevailing in the U.S. The Fund
may trade in certain foreign securities markets which are less developed than
comparable U.S. markets, which may result in reduced liquidity of securities
traded in such markets. Investments in foreign securities are also subject to
currency fluctuations. For example, when the Fund's assets are invested
primarily in securities denominated in foreign currencies, an investor
can expect that the Fund's net asset value per share will tend to increase
when the value of U.S. dollars is decreasing as against such currencies.
Conversely, a tendency toward decline in net asset value can be expected when
the value of U.S. dollars is increasing as against such currencies.
Changes in net asset value per share as a result of foreign exchange rate
fluctuations will be determined by the composition of the Fund's portfolio at
any given time. Further, it is not possible to avoid altogether the risks of
expropriation, burdensome or confiscatory taxation, moratoriums, exchange and
investment controls or political or diplomatic events which might adversely
affect the Fund's investments in foreign securities or restrict the Fund's
ability to dispose of such investments.
INVESTMENT RESTRICTIONS
The Fund has adopted a number of investment restrictions which may
not be changed without shareholder approval. These are set forth under
"Investment Restrictions" in the Statement of Additional Information.
Some of these restrictions provide that the Fund shall not:
*Invest more than 5% of its total assets in the securities of any one
issuer (except securities issued or guaranteed by the U.S. Government,
or its agencies and instrumentalities);
*Purchase any securities if such purchase would cause the Fund to own at
the time of purchase more than 10% of the outstanding voting securities of
one issuer;
*Borrow money; except that the Fund may borrow from a bank as a
temporary measure for extraordinary purposes or to meet redemptions in
amounts not exceeding 10% (taken at market value) of its total assets and
pledge its assets to secure such borrowings. The Fund may not purchase
additional securities when money borrowed exceeds 5% of the Fund's total
assets;
*Purchase any security restricted as to disposition under Federal
securities laws or securities that are not readily marketable or
purchase any securities if such a purchase would cause the Fund to own
at the time of such
5
<PAGE> 32
purchase, illiquid-securities, including repurchase agreements with
an agreed upon repurchase date in excess of seven days from the date
of acquisition by the Fund, having aggregate market value in excess of 10%
of the value of the Fund's total assets.
MANAGEMENT OF THE FUND
The business affairs of the Fund are managed under the direction of
its Board of Trustees. There are currently seven Trustees (of whom four
are non-affiliated persons) who meet four times each year. The Statement
of Additional Information contains additional information regarding the
Trustees and officers of the Fund.
INVESTMENT ADVISER, SUB-ADVISER, DISTRIBUTOR AND ADMINISTRATOR
Lexington Management Corporation, P.O. Box 1515/Park 80 West Plaza
Two, Saddle Brook, New Jersey 07663, is the investment adviser to the Fund,
and, as such, advises and makes recommendations to the Fund with respect
to its investments and investment policies. Lexington Funds Distributor,
Inc. is a registered broker-dealer and is the distributor of shares of the Fund.
The Investment Adviser has entered into a sub-advisory management
contract with Market Systems Research Advisors, Inc., 80 Maiden Lane, New York,
New York 10038, a registered investment adviser, under which the Sub-Adviser
will provide the Fund with certain investment management and administrative
services. The Sub-Adviser serves as investment adviser to private and
institutional accounts.
The Investment Adviser is paid an investment advisory fee at the annual
rate of 1.00% of the net assets of the Fund which is higher than that paid by
most other investment companies. This fee is computed on the basis of the
Fund's average daily net assets and is payable on the last business day of each
month. For the year ended December 31, 1994, the Investment Adviser received
$107,760 in investment advisory fees from the Fund and paid the Sub-Adviser
$53,880.
From time to time, the Investment Adviser may pay amounts from its
past profits to participating insurance companies or insurance companies or
other financial institutions that provide administrative services for the Fund
or that provide to contract holders other services relating to the Fund. These
services may include, among other things, sub-accounting services, answering
inquiries of contract holders regarding the Fund, transmitting, on behalf of
the Fund, proxy statements, annual reports, updated prospectus and other
communications to contract holders regarding the Fund, and such other related
services as the Fund or a contract holder may request. The Investment Adviser
will not pay more than 0.25% of the average daily net assets of the Fund
represented by shares of the Fund held in the separate account of any
participating insurance company. Payment of such amounts by the Investment
Adviser will not increase the fees paid by the Fund or its shareholders.
The Investment Adviser serves as investment adviser to other
investment companies and private institutional investment accounts. Included
among these clients are persons and organizations which own significant
amounts of capital stock of the Investment Adviser's parent. The clients
pay fees which the Investment Adviser considers comparable to the fee levels
for similarly served clients.
The Investment Adviser also acts as administrator to the Fund and
performs certain administrative and internal accounting services, including
but not limited to, maintaining general ledger accounts, regulatory
compliance, preparation of financial information for semiannual and
annual reports, preparing registration statements, calculating net asset
values, shareholder communications and supervision of the custodian,
transfer agent and provides facilities for such services. The Fund shall
reimburse the Administrator for its actual cost in providing such services,
facilities and expenses.
6
<PAGE> 33
The Investment Adviser and the Distributor are wholly-owned
subsidiaries of Piedmont Management Company Inc., a Delaware corporation
with offices at 80 Maiden Lane, New York, New York 10038. Piedmont Management
Company Inc. holds a controlling interest in the Sub-Adviser. Descendants of
Lunsford Richardson, Sr., their spouses, trusts and other related entities
have a majority voting control of outstanding shares of Piedmont Management
Company Inc. common stock. See "Investment Adviser and Distributor" in the
Statement of Additional Information.
PORTFOLIO MANAGERS
The Fund is managed by an investment management team. Frank A.
Peluso, Robert M. DeMichele and Robert W. Radsch are the lead managers.
Frank A. Peluso is a Portfolio Manager of the Fund. He has 32
years investment experience. Mr. Peluso is President and Chief Executive
Officer of Market Systems Research Advisors, Inc. (MSR), the sub-adviser to
the Fund. Mr. Peluso utilizes a proprietary analytical system to identify
securities with performance potential which he believes to be exceptional.
In addition, Mr. Peluso's proprietary data is used by professional money
managers, insurance companies, brokerage firms, banks, mutual fund companies and
pension funds.
Mr. Peluso is a graduate of Princeton University and has completed a
year of post-graduate study at Columbia University.
Robert M. DeMichele is Chairman and Chief Executive Officer of
Lexington Management Corporation. He is also the Chairman of the Investment
Strategy Group. In addition, he is President of Piedmont Management Company
Inc., LMC's parent company. He holds similar offices in other companies owned
by Piedmont, as well as, the Lexington Funds.
Prior to joining LMC in 1981, Mr. DeMichele was a Vice President at
A.G. Becker, Inc. the securities division of Warburg, Paribas,
Becker, an international investment banking firm. From 1973 to 1981, Mr.
DeMichele held several positions, the most recent managing A.G. Becker's Funds
Evaluation and Consulting Group for both the East and West coasts.
Mr. DeMichele is a graduate of Union College with a B.A. Degree
in Economics and an M.B.A. in Finance from Cornell University.
Robert W. Radsch, CFA, is a Portfolio Manager of the Fund and is a
Vice President of Lexington Management Corporation. Prior to joing Lexington in
July, 1994, he was Senior Vice President, Portfolio Manager and Chief
Economist for the Bull & Bear Group. He has extensive experience managing
gold, silver and platinum on an international basis, having managed
precious metals and international funds for more than 12 years.
Mr. Radsch is a graduate of Yale University with a B.A. Degree and holds
an M.B.A. in Finance from Columbia University.
HOW TO PURCHASE AND REDEEM SHARES
With the exception of shares held in connection with initial capital of
the Fund, shares of the Fund are currently available for purchase solely
by participating insurance companies for the purpose of funding variable
annuity contracts. Shares of the Fund are purchased and redeemed at net asset
value next calculated after a purchase or redemption order is received by the
Fund in good order. There are no minimum investment requirements. Payment for
shares redeemed will be made as soon as possible, but in any event within
seven days after the order for redemption is received by the Fund. However,
payment may be postponed under unusual circumstances, such as when normal
trading is not taking place on the New York Stock Exchange.
7
<PAGE> 34
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of the Fund is computed as of the
close of trading on each day the New York Stock Exchange is open, by dividing
the value of the Fund's securities plus any cash and other assets
(including accrued dividends and interest) less all liabilities (including
accrued expenses) by the number of shares outstanding, the result being
adjusted to the nearest whole cent. A security listed or traded on a recognized
stock exchange is valued at its last sale price prior to the time when assets
are valued on the principal exchange on which the security is traded. If no
sale is reported at that time, the mean between the current bid and asked
price will be used. All other securities for which the over-the-counter
market quotations are readily available are valued at the mean between the
last current bid and asked price. Short-term securities having maturity of 60
days or less are valued at cost when it is determined by the Fund's Board of
Trustees that amortized cost reflects the fair value of such securities.
Securities for which market quotations are not readily available and other
assets are valued at fair value as determined by the management and approved in
good faith by the Board of Trustees.
Generally, trading in foreign securities markets is substantially
completed each day at various times prior to the close of the New York Stock
Exchange. The values of foreign securities used in computing the net asset value
of the shares of the Fund are determined as of the earlier of such market close
or the closing time of the New York Stock Exchange (the "Exchange"). Foreign
currency exchange rates are also generally determined prior to the close
of the Exchange. Occasionally, events affecting the value of such securities
and such exchange rates may occur between the times at which they are
determined and the close of the Exchange, which will not be reflected in the
computation of net asset value. If during such periods, events occur which
materially affect the value of such securities, the securities will be
valued at their fair market value as determined by the investment adviser
and approved in good faith by the Trustees.
In order to determine net asset value per share, the aggregate
value of portfolio securities is added to the value of the Fund's other assets,
such as cash and receivables; the total of the assets thus obtained, less
liabilities, is then divided by the number of shares outstanding.
PERFORMANCE CALCULATION
Advertisements and communications with shareholders and others may cite
the Fund's performance calculated on a total return basis. All such
advertisements and communications will portray the value of an assumed initial
investment of $1,000 at the end of one, five and ten year periods. These
values will be calculated by multiplying the compounded average annual total
return for each time period by the amount of the assumed initial investment and
will reflect all recurring charges against Fund income.
Advertisements and communications may compare the Fund's performance
to major market indices. Quotations of historical total returns are not
indicative of future dividend income or total return, but are an indication of
the return to shareholders only for the limited historical period used. The
Fund's total return will depend on the particular investments in its
portfolio, its total operating expenses and other conditions. For further
information, including the formula and an example of the total return
calculation, see the Statement of Additional Information.
DIVIDEND, DISTRIBUTION AND REINVESTMENT POLICY
The Fund intends to declare or distribute a dividend from its net
investment income and/or net capital gain income to shareholders
annually or more frequently if necessary in order to comply with distribution
requirements of the Code to avoid the imposition of regular Federal income tax,
and if applicable, a 4% excise tax.
Any dividends and distribution payments will be reinvested at net
asset value, without sales charge, in additional full and fractional shares
of the Fund. Dividend and capital gain distributions are generally not
currently taxable to owners of variable contracts.
8
<PAGE> 35
TAX MATTERS
The Fund. The Fund intends to qualify as a regulated investment
company by satisfying the requirements under subchapter M of the Internal
Revenue Code of 1986, as amended (the "Code") concerning diversification of
assets, distribution of income and sources of income. When the Fund
qualifies as a regulated investment company and all of its taxable income is
distributed in accordance with the timing requirements imposed by the Code,
it will not be subject to federal income tax. If, however, for any taxable year
the Fund does not qualify as a regulated investment company, then all of its
taxable income will be subject to tax at regular corporate rates
(without any deduction for distributions to the separate accounts of
the Participating Insurance Companies), and the accounts will be subject to
tax on such distributions to the extent that the distributing Fund has
current and accumulated earnings and profits.
Fund Distributions. Capital gain and ordinary income dividends from the
Fund are not currently taxable when left to accumulate within a variable
annuity contract.
Share Redemptions. Gain or loss realized on redemptions of shares
held by the separate accounts of Participating Insurance Companies generally
will not be taxable to the separate accounts or to the contract holders.
Summary. The foregoing discussion of federal income tax consequences
is based on tax laws and regulations in effect on the date of this Prospectus,
and is subject to change by legislative or administrative action. The
discussion assumes that the separate accounts of the Participating Insurance
Companies are the owners of the shares and that the underlying variable
annuity contracts qualify as annuities under the Code. If these requirements
are not met then the contract owners will be treated as recognizing income
(from distributions or otherwise) related to the ownership of Fund shares. The
foregoing discussion is for general information only; a more detailed
discussion of federal income tax considerations is contained in the Statement of
Additional Information. Holders of variable annuity contracts must consult the
prospectuses of their respective contracts or policies for information
concerning the federal income tax consequences of owning such contracts.
GENERAL INFORMATION
The Fund was organized as a Massachusetts business trust on October 7,
1988 under the name Lexington Gold Trust. At a meeting held on September 30,
1991, the shareholders of the Fund approved a change in the Fund's
fundamental investment objective and policies. In connection with the change
of investment objective and policies, the Fund also changed its name to
"Lexington Natural Resources Trust." The capitalization of the Fund consists
solely of an unlimited number of shares of beneficial interest, no par value.
When issued, shares of the Fund are fully paid, non-assessable and freely
transferable.
Unlike the stockholder of a corporation, shareholders could under
certain circumstances be held personally liable for the obligations of
the Fund. However, the Declaration of Trust disclaims liability of the
shareholders, Trustees, or officers of the Fund for acts or obligations of the
Fund, which are binding only on the assets and property of the Fund. The
Declaration of Trust provides for indemnification out of Fund property for
all loss and expense of any shareholder held personally liable for the
obligations of the Fund. The risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which the Fund
itself would be unable to meet its obligations and thus should be considered
remote.
Voting Rights
Shareholders of the Fund are given certain voting rights. Each share of
the Fund will be given one vote, unless a different allocation of voting
rights is required under applicable law for a mutual fund that is an investment
medium for variable life insurance or annuity contracts. Participating
insurance companies provide variable annuity Contract
9
<PAGE> 36
Holders and Participants the right to direct the voting of Fund
shares at shareholder meetings to the extent required by law. See the
Separate Account Prospectus for the Variable Contract for more
information regarding the pass-through of these voting rights.
Massachusetts business trust law does not require the Fund to hold
annual shareholder meetings, although special meetings may be called for the
Fund, for purposes such as electing or removing Trustees, changing fundamental
policies or approving an investment management contract. A shareholders'
meeting will be held after the Fund begins operations for the purpose of
electing the initial Board of Trustees. In addition, the Fund will be
required to hold a meeting to elect Trustees to fill any existing vacancies
on the Board if, at any time, fewer than a majority of the Trustees have been
elected by the shareholders of the Fund. In addition, the holders of not
less than two-thirds of the outstanding shares or other voting interests
of the Fund may remove a person serving as Trustee either by declaration in
writing or at a meeting called for such purpose. The Trustees are required
to call a meeting for the purpose of considering the removal of a person serving
as trustee, if requested in writing to do so by the holders of not less than
10% of the outstanding shares of other voting interests of the Fund. The Fund
is required to assist in shareholders' communications. In accordance with
current laws, an insurance company issuing a variable life insurance or annuity
contract that participates in the Fund will request voting instructions from
Contract Holders and will vote shares or other voting interests in the
Separate Account in proportion to the voting instructions received.
Counsel and Independent Auditors
Kramer, Levin, Naftalis, Nessen, Kamin & Frankel will pass upon
legal matters for the Fund in connection with the shares offered by this
Prospectus.
KPMG Peat Marwick LLP, New York, New York has been selected as
independent auditors for the Fund for the fiscal year ending December 31, 1995.
Custodians, Transfer Agent and Dividend Disbursing Agent
Chase Manhattan Bank, N.A., 1211 Avenue of the Americas, New York,
New York 10036 has been retained to act as the Custodian for the Fund's
investments and assets. In addition, Chase Manhattan Bank, N.A. may appoint
foreign banks and securities depositories to act as sub-custodians for the
Fund's portfolio securities subject to their qualification as eligible foreign
custodians under the rules adopted by the SEC. State Street Bank & Trust
Company, 225 Franklin Street, Boston, Massachusetts 02110 has been retained
to act as the Transfer Agent and Dividend Disbursing Agent for the Fund.
Neither Chase Manhattan Bank, N.A. nor State Street Bank and Trust Company have
any part in determining the investment policies of the Fund or in determining
which portfolio securities are to be purchased or sold by the Fund or in the
declaration of dividends and distributions.
10
<PAGE> 37
-----------------
L E X I N G T O N
-----------------
LEXINGTON
EMERGING
MARKETS
FUND, INC.
-----------------
P R O S P E C T U S
MAY 1, 1995
Investment Adviser
--------------------------------------------
LEXINGTON MANAGEMENT CORPORATION
P.O. Box 1515/Park 80 West Plaza Two
Saddle Brook, N.J. 07663
Distributor
--------------------------------------------
LEXINGTON FUNDS DISTRIBUTOR, INC.
P.O. Box 1515/Park 80 West Plaza Two
Saddle Brook, N.J. 07663
Transfer Agent
--------------------------------------------
STATE STREET BANK AND TRUST COMPANY
c/o National Financial Data Services
1004 Baltimore
Kansas City, Missouri 64105
Table of Contents Page
--------------------------------------------------
Financial Highlights .......................... 2
Description of the Fund ....................... 2
Investment Objective and Policies ............. 3
Investment Restrictions ....................... 6
Management of the Fund ........................ 7
Portfolio Manager ......................... 8
How to Purchase and Redeem Shares ............. 8
Determination of Net Asset Value .............. 9
Performance Calculation ....................... 9
Dividend, Distribution and Reinvestment Policy. 9
Tax Matters ................................... 10
Organization and Description of Common Stock .. 10
Custodian, Transfer Agent and
Dividend Disbursing Agent ................... 11
Counsel and Independent Auditors .............. 11
Other Information ............................. 11
<PAGE> 38
PROSPECTUS
May 1, 1995
Lexington Emerging Markets Fund, Inc.
P.O. Box 1515 / Park 80 West Plaza Two, Saddle Brook, New Jersey 07663
(201) 845-7300
A NO-LOAD MUTUAL FUND WHOSE INVESTMENT OBJECTIVE IS TO SEEK LONG-TERM
GROWTH OF CAPITAL PRIMARILY THROUGH INVESTMENT IN EQUITY SECURITIES OF
COMPANIES DOMICILED IN, OR DOING BUSINESS IN EMERGING COUNTRIES AND
EMERGING MARKETS.
--------------------------------------------------------------------------------
Lexington Emerging Markets Fund, Inc. is a no-load open-end
diversified management investment company. The Fund's investment
objective is to seek long-term growth of capital primarily through
investment in equity securities of companies domiciled in, or doing
business in emerging countries and emerging markets.
Shares of the Fund may be purchased only by insurance companies for
the purpose of funding variable annuity contracts and variable life
insurance policies.
Lexington Management Corporation ("LMC") is the Fund's investment
adviser. Lexington Funds Distributor, Inc. ("LFD") is the distributor of
Fund shares.
This Prospectus sets forth information about the Fund you should
know before investing. It should be read and retained for future
reference.
A Statement of Additional Information dated May 1, 1995 which
provides a further discussion of certain matters in this Prospectus and
other matters that may be of interest to some investors, has been filed
with the Securities and Exchange Commission and is incorporated herein
by reference. For a free copy, call the telephone number above or write
to the address listed above.
--------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
--------------------------------------------------------------------------------
Investors Should Read and Retain this Prospectus for Future Reference
<PAGE> 39
FINANCIAL HIGHLIGHTS
The following Per Share Income and Capital Changes Information
for the period March 30, 1994 (commencement of operations) to December 31, 1994
has been audited by KPMG Peat Marwick LLP, Independent Auditors, whose
report thereon appears in the Statement of Additional Information. This
information should be read in conjunction with the Financial Statements
and related notes thereto included in the Statement of Additional Information.
The Fund's annual report, which contains additional performance information, is
available upon request and without charge.
Selected Per Share Data for a share outstanding throughout the period:
<TABLE>
<CAPTION>
January 3, 1994
(commencement of
operations) to
December 31, 1994
-----------------
<S> <C>
Net asset value, beginning of period .................................................. $10.00
------
Income from investment operations:
Net investment loss ................................................................. 0.03
Net realized and unrealized gain on investments ..................................... 0.04
------
Total income from investment operations ....................................... 0.07
------
Less distributions:
Distributions from net realized capital gains ....................................... (0.02)
Distributions in excess of net realized capital gains (Temporary book-tax difference) (0.19)
------
Total distributions ........................................................... (0.21)
------
Net asset value, end of period ........................................................ $ 9.86
======
Total return .......................................................................... 0.76%
Ratio to average net assets:
Expenses, before reimbursement ...................................................... 6.28%*
Expenses, net of reimbursement ...................................................... 1.30%*
Net investment income (loss), before reimbursement .............................. (4.29)%*
Net investment income (loss) ....................................................... 0.70%*
Portfolio turnover ................................................................... 0.70%*
Net assets at end of period (000's omitted) ........................................... $4,624
</TABLE>
*Annualized
DESCRIPTION OF THE FUND
Lexington Emerging Markets Fund is an open-end management investment
company organized as a corporation under the laws of Maryland. The Fund is
intended to be the funding vehicle for variable annuity contracts and
variable life insurance policies to be offered by the separate accounts of
certain life insurance companies ("participating insurance companies"). The
Fund currently does not foresee any disadvantages to the holders of variable
annuity contracts and variable life insurance policies arising from the fact
that the interests of the holders of such contracts and policies may differ.
Nevertheless, the Fund's Directors intend to monitor events in order
to identify any material irreconcilable conflicts which may possibly arise
and to determine what action, if any, should be taken in response thereto. If
a conflict were to occur, an insurance company separate account might be
required to withdraw its investments in the Fund and the Fund might be forced to
sell securities at disadvantageous prices. The variable annuity contracts and
variable life insurance policies are described in the separate prospectuses
issued by the Participating Insurance Companies. The Fund assumes no
responsibility for such prospectuses.
2
<PAGE> 40
Individual variable annuity contract holders and variable life
insurance policy holders are not "shareholders" of the Fund. The Participating
Insurance Companies and their separate accounts are the shareholders or
investors, although such companies may pass through voting rights to their
variable annuity contract or variable life insurance policy. Shares of the
Fund are not offered directly to the general public.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to seek long-term growth of
capital primarily through investment in equity securities and equivalents of
companies domiciled in, or doing business in, emerging countries and emerging
markets, as defined below.
Due to the risks inherent in international investments generally, the
Fund should be considered as a vehicle for investing a portion of an
investor's assets in foreign securities markets and not as a complete investment
program.
The investment objective of the Fund is long-term growth of capital.
The Fund seeks to achieve this objective by investing primarily in emerging
country and emerging market equity securities. Equity securities will
consist of all types of common stocks and equivalents (the following
constitute equivalents: convertible debt securities and warrants.) The Fund may
also invest in preferred stocks, bonds, money market instruments of foreign and
domestic companies, U.S. government, and governmental agencies. There can be
no assurance that the Fund will be able to achieve its investment
objective. The Fund's investment objective is a fundamental policy that may
not be changed without the approval of a "majority of the Fund's outstanding
voting securities" which means the lesser of (i) 67% of the shares
represented at a meeting at which more than 50% of the outstanding shares are
represented, or (ii) more than 50% of the outstanding shares.
Under normal conditions, at least 65% of the Fund's total assets
will be invested in emerging country and emerging market equity securities in
at least three countries outside of the United States. For purposes of its
investment objective, the Fund considers emerging country equity
securities to be any country whose economy and market the World Bank or United
Nations considers to be emerging or developing. The Fund may also invest in
equity securities and equivalents traded in any market, of companies that
derive 50% or more of their total revenue from either goods or services produced
in such emerging countries and emerging markets or sales made in such
countries. Determinations as to eligibility will be made by LMC based on
publicly available information and inquiries made to the companies. It is
possible in the future that sufficient numbers of emerging country or emerging
market equity securities would be traded on securities markets in
industrialized countries so that a major portion, if not all, of the Fund's
assets would be invested in securities traded on such markets, although
such a situation is unlikely at present. The Fund will maintain
investments at all times in a minimum of three countries outside of the United
States.
Currently, investing in many of the emerging countries and emerging
markets is not feasible or may involve political risks. Accordingly, LMC
currently intends to consider investments only in those countries in which
it believes investing is feasible and does not involve such risks. The list of
acceptable countries will be reviewed by LMC and approved by the Board of
Directors on a periodic basis and any additions or deletions with respect to
such list will be made in accordance with changing economic and political
circumstances involving such countries. (See Appendix).
The Fund's investments in emerging country equity securities are
not subject to any maximum limit, and it is the intention of LMC to
invest substantially all of the Fund's assets in emerging country and emerging
market equity securities. However, to the extent that the Fund's assets
are not invested in emerging country and emerging market equity
securities, the remaining 35% of the assets may be invested in (i) other
equity securities without regard to whether they qualify as emerging country
or emerging market equity securities, (ii) debt securities denominated in
the currency of an emerging market or issued or guaranteed by an emerging
market company or the government of an
3
<PAGE> 41
emerging country, and (iii) short-term and medium-term debt securities of the
type described below under "Temporary Investments." The Fund's assets may be so
invested in debt securities when LMC believes that, based upon factors such as
relative interest rate levels and foreign exchange rates, such debt securities
offer opportunities for long-term growth of capital. It is likely that many of
the debt securities in which the Fund will invest will be unrated, and whether
or not rated, such securities may have speculative characteristics. All unrated
debt securities purchased by the Fund will be comparable to, or the issuers of
such unrated securities will have the capacity to meet its debt obligations
comparable to those issuers of rated securities. In addition, for temporary
defensive purposes, the Fund may invest less than 65% of its assets in emerging
country and emerging market equity securities, in which case the Fund may invest
in other equity securities or may invest in debt securities of the sort
described under "Temporary Investments" below.
The Fund intends to purchase and hold securities for long-term
growth of capital and does not expect to trade for short-term gain.
Accordingly, it is anticipated that the annual portfolio turnover rate
normally will not exceed 75%. A 100% turnover rate would occur if all of the
Fund's portfolio investments were sold and either repurchased or replaced in a
year. A higher turnover rate results in correspondingly greater brokerage
commissions and other transactional expenses which are borne by the Fund. The
Fund's portfolio turnover rate for the year ended December 31, 1994 was 71.21%.
High portfolio turnover may result in the realization of net short-term
capital gains by the Fund which, when distributed to shareholders, will
be taxable as ordinary income. See "Tax Matters."
The operating expenses of the Fund can be expected to be greater than
that of an investment company investing exclusively in United States securities.
Temporary Investments
For temporary defensive purposes, the Fund may invest up to 100% of
its total assets in money market securities, denominated in dollars in the
currency of any emerging country, issued by entities organized in the
U.S. or any emerging country, such as: short-term (less than twelve months to
maturity) and medium-term (not greater than five years to maturity)
obligations issued or guaranteed by the U.S. Government or the government
of an emerging country, their agencies or instrumentalities; finance company
and corporate commercial paper, and other short-term corporate obligations, in
each case rated Prime-1 by Moody's Investors Services, Inc. or A or better by
Standard & Poor's Corporation or, if unrated, of comparable quality as
determined by LMC, obligations (including certificates of deposit, time
deposits and banker's acceptances) of banks; and repurchase agreements with
banks and broker-dealers with respect to such securities.
Repurchase agreements with respect to the securities described in
the preceding paragraph are contracts under which the Fund would acquire a
security for a relatively short period (usually not more than 7 days)
subject to the obligations of the seller to repurchase and the Fund to resell
such security at a fixed time and price (representing the Fund's cost plus
interest). Although the Fund may enter into repurchase agreements with
respect to any portfolio securities which it may acquire consistent with its
investment policies and restrictions, it is the Fund's present intention
to enter into repurchase agreements only with respect to obligations of the
United States Government or its agencies or instrumentalities to meet
anticipated redemptions or pending investments or reinvestments of Fund assets
in portfolio securities. The Fund will enter into repurchase agreements
only with member banks of the Federal Reserve System and with "primary
dealers" in United States Government securities. Repurchase agreements are
considered loans which must be fully collateralized including interest
earned thereon during the entire term of the agreement. If the institution
defaults on the repurchase agreement, the Fund will retain possession of the
underlying securities. In addition if bankruptcy proceedings are commenced
with respect to the seller, realization on the collateral by the Fund may
be delayed or limited and the Fund may incur additional costs. In such
case the Fund will be subject to risks associated with changes in market value
of the collateral securities. The Fund intends to limit repurchase agreements
to institutions believed by LMC to present minimal credit risk. The Fund will
not enter into repurchase agreements maturing in more
4
<PAGE> 42
than seven days if the aggregate of such repurchase agreements and all
other illiquid securities when taken together would exceed 10% of the total
assets of the Fund.
Certain Investment Methods-The Fund may from time to time engage in
the following investment practices:
Settlement Transactions-The Fund may, for a fixed amount of United States
dollars, enter into a foreign exchange contract for the purchase or sale of
the amount of foreign currency involved in the underlying securities
transaction. In so doing, the Fund will attempt to insulate itself against
possible losses and gains resulting from a change in the relationship
between the United States dollar and the foreign currency during the period
between the date a security is purchased or sold and the date on which
payment is made or received. This process is known as "transaction hedging".
To effect the translation of the amount of foreign currencies
involved in the purchase and sale of foreign securities and to effect the
"transaction hedging" described above, the Fund may purchase or sell foreign
currencies on a "spot" (i.e. cash) basis or on a forward basis whereby the
Fund purchases or sells a specific amount of foreign currency, at a price set
at the time of the contract, for receipt or delivery at a specified date
which may be any fixed number of days in the future.
Such spot and forward foreign exchange transactions may also be
utilized to reduce the risk inherent in fluctuations in the exchange rate
between the United States dollar and the relevant foreign currency when
foreign securities are purchased or sold for settlement beyond customary
settlement time (as described below). Neither type of foreign currency
transaction will eliminate fluctuations in the prices of the Fund's portfolio or
securities or prevent loss if the price of such securities should decline.
Portfolio Hedging-When, in the opinion of LMC, it is desirable to limit or
reduce exposure in a foreign currency in order to moderate potential changes in
the United States dollar value of the portfolio, the Fund may enter into a
forward foreign currency exchange contract by which the United States
dollar value of the underlying foreign portfolio securities can be
approximately matched by an equivalent United States dollar liability. The
Fund, for hedging purposes only, may also enter into forward currency
exchange contracts to increase its exposure to a foreign currency that LMC
expects to increase in value relative to the United States dollar. The Fund
will not attempt to hedge all of its portfolio positions and will enter into
such transactions only to the extent, if any, deemed appropriate by LMC.
Hedging against a decline in the value of currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. The Fund will not enter into forward
foreign currency exchange transactions for speculative purposes. The Fund
intends to limit such transactions to not more than 70% of total Fund assets.
Forward Commitments-The Fund may make contracts to purchase securities for a
fixed price at a future date beyond customary settlement time ("forward
commitments") because new issues of securities are typically offered to
investors, such as the Fund, on that basis. Forward commitments involve a
risk of loss if the value of the security to be purchased declines prior
to the settlement date. This risk is in addition to the risk of decline in value
of the Fund's other assets. Although the Fund will enter into such contracts
with the intention of acquiring the securities, the Fund may dispose of a
commitment prior to settlement if LMC deems it appropriate to do so. The Fund
may realize short-term profits or losses upon the sale of forward commitments.
When the Fund engages in a forward commitment transaction, the custodian will
set aside cash, U.S. Government securities or other high quality debt
obligations equal to the amount of the commitment in a separate account.
Except as otherwise specifically noted, the Fund's investment objective
and its investment restrictions are fundamental and may not be changed without
the approval of a majority of the outstanding voting securities of the Fund.
The Statement of Additional Information contains a complete description of
the Fund's restrictions and additional information on policies relating to
the investment of its assets and its activities.
5
<PAGE> 43
Risk Considerations
Investments in emerging market and emerging country equity securities
may involve risks and considerations not present in domestic investments.
Since foreign securities generally are denominated and pay interest or
dividends in foreign currencies, the value of the assets of the Fund as
measured in United States dollars will be affected favorably or unfavorably
by changes in the relationship of the United States dollar and other currency
rates. The Fund may incur costs in connection with the conversion or transfer
of foreign currencies. In addition, there may be less publicly available
information about foreign companies than United States companies. Foreign
companies may not be subject to accounting, auditing, and financial
reporting standards, practices and requirements comparable to those
applicable to United States companies. Foreign securities markets, while
growing in volume, have for the most part substantially less volume than
United States securities markets and securities of foreign companies are
generally less liquid and at times their prices may be more volatile than
securities of comparable United States companies. Foreign stock exchanges,
brokers and listed companies are generally subject to less government
supervision and regulation than in the United States. The customary settlement
time for foreign securities may be longer than the 5 day customary settlement
time for United States securities. Although the Fund will try to invest in
companies and governments of countries having stable political
environments, there is the possibility of expropriation or confiscatory
taxation, seizure or nationalization or foreign government restrictions or other
adverse political, social or diplomatic developments that could affect
investment in these nations. (See "Risk Considerations" in the Statement of
Additional Information for further information.)
Income from foreign securities held by the Fund may, and in some cases
will be reduced by a withholding tax at the source or other foreign
taxes. A shareholder of the Fund will, subject to certain restrictions, be
entitled to claim a credit or deduction for United States Federal income tax
purposes for the shareholder's pro rata share of such foreign taxes paid by
the Fund. (See "Tax Matters.")
INVESTMENT RESTRICTIONS
The Fund's investment program is subject to a number of
investment restrictions which reflect self imposed standards as well as
federal and state regulatory limitations. These restrictions are designed to
minimize certain risks associated with investing in certain types of
securities or engaging in certain transactions. The most significant of these
restrictions provide that:
(1) The Fund will not borrow money, except that (a) the Fund may
enter into certain futures contracts and options related thereto;
(b) the Fund may enter into commitments to purchase securities
in accordance with the Fund's investment program, including
delayed delivery and when-issued securities and reverse
repurchase agreements; (c) for temporary emergency purposes,
the Fund may borrow money in amounts not exceeding 5% of the value
of its total assets at the time when the loan is made; (d) The
Fund may pledge its portfolio securities or receivables or
transfer or assign or otherwise encumber them in an amount not
exceeding one-third of the value of its total assets; and (e)
for purposes of leveraging, the Fund may borrow money from
banks (including its custodian bank), only if, immediately after
such borrowing, the value of the Fund's assets, including the
amount borrowed, less its liabilities, is equal to at least 300% of
the amount borrowed, plus all outstanding borrowings. If at any
time, the value of the Fund's assets fails to meet the 300% asset
coverage requirement relative only to leveraging, the Fund
will, within three days (not including Sundays and holidays),
reduce its borrowings to the extent necessary to meet the 300%
test. The Fund will only invest up to 5% of its total assets in
reverse repurchase agreements.
6
<PAGE> 44
(2) The Fund will not make loans, except that, to the extent
appropriate under its investment program, the Fund may (a)
purchase bonds, debentures or other debt securities, including
short-term obligations, (b) enter into repurchase transactions and
(c) lend portfolio securities provided that the value of such
loaned securities does not exceed one-third of the Fund's total
assets.
(3) The Fund will not concentrate its investments in any one
industry, except that the Fund may invest up to 25% of its
total assets in securities issued by companies principally
engaged in any one industry. The Fund considers foreign
government securities and supranational organizations to be
industries. This limitation, however, will not apply to securities
issued or guaranteed by the U.S. Government, its agencies and
instrumentalities.
(4) The Fund will not purchase securities of an issuer, if (a) more
than 5% of the Fund's total assets taken at market value would
at the time be invested in the securities of such issuer, except
that such restriction shall not apply to securities issued or
guaranteed by the United States govemment or its agencies or
instrumentalities or, with respect to 25% of the Fund's total
assets, to securities issued or guaranteed by the government of
any country other than the United States which is a member of the
Organization for Economic Cooperation and Development ("OECD").
The member countries of OECD are at present: Australia,
Austria, Belgium, Canada, Denmark, Germany, Finland, France,
The forgoing investment restrictions (as well as certain others set
forth in the Statement of Additional Information) are matters of fundamental
policy which may not be changed without the affirmative vote of the
majority of the shareholders of the Fund.
The investment policies described below are non-fundamental,
therefore, changes to such policies may be made in the future by the Board of
Directors without the approval of the shareholders of the Fund:
(1) The Fund may purchase and sell futures contracts and related
options under the following conditions: (a) the then-current
aggregate futures market prices of financial instruments
required to be delivered and purchased under open futures
contracts shall not exceed 30% of the Fund's total assets, at
market value; and (b) no more than 5% of the assets, at market
value at the time of entering into a contract, shall be committed
to margin deposits in relation to futures contracts.
(2) The Fund will not invest more than 15% of its total assets in
illiquid securities. Illiquid securities are securities that
are not readily marketable or cannot be disposed of promptly
within seven days and in the usual course of business without
taking a materially reduced price. Such securities include, but
are not limited to, time deposits and repurchase agreements
with maturities longer than seven days. Securities that may be
resold under Rule 144A or securities offered pursuant to
Section 4(2) of the Securities Act of 1933, as amended, shall
not be deemed illiquid solely by reason of being unregistered.
The Investment Adviser shall determine whether a particular
security is deemed to be liquid based on the trading markets for
the specific security and other factors.
MANAGEMENT OF THE FUND
The Fund has a Board of Directors which establishes the Fund's policies
and supervises and reviews the operations and management of the Fund.
Lexington Management Corporation ("LMC"), P.O. Box 1515, Park 80 West Plaza
Two, Saddle Brook, New Jersey 07663, is the investment adviser of the
Fund. For its investment management services to the Fund, under its
investment advisory agreement, LMC will receive a monthly fee at the annual
rate of 0.85% of the Fund's
7
<PAGE> 45
average daily net assets. LMC has agreed to voluntarily limit the total expenses
of the Fund (excluding interest, taxes, brokerage, and extraordinary expenses
but including management fee and operating expenses) to an annual rate of
1.30% of the Fund's average net assets.
Lexington Funds Distributor, Inc. ("LFD"), a registered broker-dealer,
is the Fund's distributor. LMC also acts as administrator to the Fund and
performs certain administrative and accounting services, including but not
limited to, maintaining general ledger accounts, regulatory compliance,
preparation of financial information for semiannual and annual reports,
preparing registration statements, calculating net asset values,
shareholder communications and supervision of the custodian, transfer agent
and provides facilities for such services. The Fund shall reimburse the
Administrator for its actual cost in providing such services, facilities and
expenses.
From time to time, LMC may pay amounts from its past profits
to participating insurance companies or insurance companies or other
financial institutions that provide administrative services for the Fund or
that provide to contract holders other services relating to the Fund. These
services may include, among other things, sub-accounting services, answering
inquiries of contract holders regarding the Fund, transmitting, on behalf of
the Fund, proxy statements, annual reports, updated prospectus and other
communications to contract holders regarding the Fund, and such other related
services as the Fund or a contract holder may request. LMC will not pay
more than 0.25% of the average daily net assets of the Fund represented by
shares of the Fund held in the separate account of any participating insurance
company. Payment of such amounts by LMC will not increase the fees paid by the
Fund or its shareholders.
LMC was established in 1938 and currently manages and administers over
$3.8 billion in assets. LMC serves as investment adviser to other
investment companies and private and institutional investment accounts.
Included among these clients are persons and organizations that own
significant amounts of capital stock of LMC's parent, Piedmont Management
Company Inc. The clients pay fees that LMC considers comparable to the fees paid
by similarly served clients.
LMC and LFD are wholly-owned subsidiaries of Piedmont Management
Company Inc., a Delaware corporation with offices at 80 Maiden Lane, New York,
New York 10038. Descendants of Lunsford Richardson, Sr., their spouses, trusts
and other related entities are the beneficial owners of a majority of the
shares of Piedmont Management Company Inc. common stock. See "Investment
Adviser and Distributor" in the Statement of Additional Information.
Portfolio Manager
The Fund is managed by an investment management team. Richard T.
Saler is lead manager. Richard T. Saler is Senior Vice President,
Director of International Investment Strategy of LMC. Mr. Saler is
responsible for international investment analysis and portfolio management at
LMC. He has nine years of investment experience. Mr. Saler has focused on
international markets since first joining Lexington in 1986. In 1991 he was an
investment strategist with Nomura Securities and rejoined Lexington in 1992.
Mr. Saler is a graduate of New York University with a B.S. Degree in Marketing
and an M.B.A. in Finance from New York University's Graduate School of Business
Administration.
HOW TO PURCHASE AND REDEEM SHARES
With the exception of shares held in connection with initial capital of
the Fund, shares of the Fund are currently available for purchase solely
by insurance companies for the purpose of funding variable annuity
contracts. Shares of the Fund are purchased and redeemed at net asset value next
calculated after a purchase or redemption order is received by the Fund in
good order. There are no minimum investment requirements. Payment for shares
redeemed will be made as soon as possible, but in any event within seven days
after the order for redemption is received by the Fund. However, payment may be
postponed under unusual circumstances, such as when normal trading is not
taking place on the New York Stock Exchange.
8
<PAGE> 46
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of the Fund is computed as of the
close of trading on each day the New York Stock Exchange is open, by dividing
the value of the Fund's securities plus any cash and other assets
(including accrued dividends and interest) less all liabilities (including
accrued expenses) by the number of shares outstanding, the result being
adjusted to the nearest whole cent. A security listed or traded on a recognized
stock exchange is valued at its last sale price prior to the time when assets
are valued on the principal exchange on which the security is traded. If no
sale is reported at that time, the mean between the current bid and asked
price will be used. All other securities for which the over-the-counter
market quotations are readily available are valued at the mean between the
last current bid and asked price. Short-term securities having maturity of 60
days or less are valued at amortized cost when it is determined by the Fund's
Board of Directors that amortized cost reflects the fair value of such
securities. Securities for which market quotations are not readily
available and other assets are valued at fair value as determined by the
management and approved in good faith by the Board of Directors.
Generally, trading in foreign securities markets is substantially
completed each day at various times prior to the close of the New York Stock
Exchange. The values of foreign securities used in computing the net asset value
of the shares of the Fund are determined as of the earlier of such market close
or the closing time of the New York Stock Exchange (the "Exchange"). Foreign
currency exchange rates are also generally determined prior to the close
of the Exchange. Occasionally, events affecting the value of such securities
and such exchange rates may occur between the times at which they are
determined and the close of the Exchange, which will not be reflected in the
computation of net asset value. If, during such periods, events occur which
materially affect the value of such securities, the securities will be
valued at their fair market value as determined by the investment
adviser and approved in good faith by the Directors.
In order to determine net asset value per share, the aggregate
value of portfolio securities is added to the value of the Fund's other assets,
such as cash and receivables; the total of the assets thus obtained, less
liabilities, is then divided by the number of shares outstanding.
PERFORMANCE CALCULATION
The Fund will calculate performance on a total return basis for
various periods. The total return basis combines changes in principal and
dividends for the periods shown. Principal changes are based on the
difference between the beginning and closing net asset value for the period and
assumes reinvestment of dividends paid by the Fund. Dividends are comprised of
net investment income and net realized capital gains, respectively.
Performance will vary from time to time and past results are not
necessarily representative of future results. A shareholder should remember that
performance is a function of portfolio management in selecting the type
and quality of portfolio securities and is affected by operating expenses.
Comparative performance information may be used from time to
time in advertising or marketing of the Fund's shares, including data from
Lipper Analytical Services, Inc. or major market indices such as the Dow
Jones Industrial Average Index, Standard & Poor's 500 Composite Stock Price
Index and Morgan Stanley Capital International World Index. Such comparative
performance information will be stated in the same terms in which the
comparative data and indices are stated. Further information about the
Fund's performance is contained in the annual report, which may be obtained
without charge.
DIVIDEND, DISTRIBUTION AND REINVESTMENT POLICY
The Fund intends to declare or distribute a dividend from its net
investment income and/or net capital gain income to shareholders
annually or more frequently if necessary in order to comply with distribution
requirements of the Code to avoid the imposition of regular Federal income tax,
and if applicable, a 4% excise tax.
9
<PAGE> 47
Any dividends and distribution payments will be reinvested at net
asset value, without sales charge, in additional full and fractional shares
of the Fund. Dividend and capital gain distributions are generally not
currently taxable to owners of variable contracts.
TAX MATTERS
The Fund. The Fund intends to qualify as a regulated investment company by
satisfying the requirements under Subchapter M of the Internal Revenue Code, as
amended (the "Code"), concerning the diversification of assets, distribution
of income, and sources of income. When a Fund qualifies as a regulated
investment company and all of its taxable income is distributed in
accordance with the timing requirements imposed by the Code, the Fund will not
be subject to Federal income tax. If, however, for any taxable year a Fund
does not qualify as a regulated investment company, then all of its taxable
income will be subject to tax at regular corporate rates (without any deduction
for distributions to the separate accounts of the Participating Insurance
Companies), and the receipt of such distributions will be taxable to the
extent that the distributing Fund has current and accumulated earnings and
profits.
Fund distributions. Distributions by the Fund are taxable, if at all, to the
separate accounts of the Participating Insurance Companies, and not to variable
annuity contract holders and variable life insurance policy holders.
Distributions will be included in the taxable income of the separate accounts of
the Participating Insurance Companies in the year in which they are received
(whether paid in cash or reinvested).
Share redemptions. Redemptions of the shares held by the separate accounts of
the Participating Insurance Companies generally will not result in gain or loss
for the separate accounts of the Participating Insurance Companies and will not
result in gain or loss for the variable annuity contract holders and variable
life insurance policy holders.
Summary. The foregoing discussion of Federal income tax consequences is based on
tax laws and regulations in effect on the date of this Prospectus, and is
subject to change by legislative or administrative action. The foregoing
discussion also assumes that the separate accounts of the Participating
Insurance Companies are the owners of the shares and that policies or contracts
qualify as life insurance policies or annuities, respectively, under the Code.
If the foregoing requirements are not met then the variable annuity contract
holders and variable life insurance policy holders will be treated as
recognizing income (from distributions or otherwise) related to the ownership of
Fund shares. The foregoing discussion is for general information only; a more
detailed discussion of Federal income tax considerations is contained in the
Statement of Additional Information. Variable annuity contract holders and
variable life insurance policy holders must consult the prospectuses of their
respective contracts or policies for information concerning the Federal income
tax consequences of owning such contracts or policies.
ORGANIZATION AND DESCRIPTION OF COMMON STOCK
The Company is an open-end, diversified management investment
company organized as a corporation under the laws of the State of Maryland on
December 27, 1993, and has authorized capital of 1,000,000,000 shares of
common stock, par value $.001 of which 500,000,000 have been designated
Lexington Emerging Markets Fund Series. Each share of common stock has one vote
and shares equally in dividends and distributions when and if declared by the
Company and in the Company's net assets upon liquidation. All shares, when
issued, are fully paid and non-assessable. There are no preemptive, conversion
or exchange rights. Fund shares do not have cumulative voting rights and, as
such, holders of at least 50% of the shares voting for Directors can elect all
Directors and the remaining shareholders would not be able to elect any
Directors.
Voting Rights
Shareholders of the Fund are given certain voting rights. Each share of
the Fund will be given one vote. Participating insurance companies provide
variable annuity contracts holders and variable life insurance policy holders
the right to
10
<PAGE> 48
direct the voting of Fund shares at shareholder meetings to the extent required
by law. See the Separate Account Prospectus for the Variable Annuity Contract or
Variable Life Insurance Policy Section for more information regarding the
pass through of these voting rights.
The Fund will not normally hold annual shareholder meetings
except as required by Maryland General Corporation Law or the Investment
Company Act of 1940. However, meetings of shareholders may be called at
any time by the Secretary upon the written request of shareholders holding in
the aggregate not less than 10% of the outstanding shares, such request
specifying the purposes for which such meeting is to be called. In addition, the
Directors will promptly call a meeting of shareholders for the purpose of
voting upon the question of removal of any Director when requested to do so in
writing by the recordholders of not less than 10% of the Fund's outstanding
shares. The Fund will assist shareholders in any such communication between
shareholders and Directors.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
Chase Manhattan Bank, N.A., 1211 Avenue of the Americas, New York, New
York 10036 has been retained to act as custodian for the Fund's portfolio
securities including those to be held by foreign banks and foreign securities
depositories that qualify as eligible foreign custodians under the rules
adopted by the SEC and for the Fund's domestic securities and other assets.
State Street Bank and Trust Company, c/o National Financial Data Services,
1004 Baltimore, Kansas City, Missouri 64105, has been retained to act as
the transfer agent and dividend disbursing agent for the Fund. Neither Chase
Manhattan Bank, N.A. nor State Street Bank and Trust Company have any part in
determining the investment policies of the Fund or in determining which
portfolio securities are to be purchased or sold by the Fund or in the
declaration of dividends and distributions.
COUNSEL AND INDEPENDENT AUDITORS
Kramer, Levin, Naftalis, Nessen, Kamin & Frankel, 919 Third Avenue,
New York, New York 10022 will pass upon legal matters for the Fund in
connection with the shares offered by this Prospectus. KPMG Peat Marwick
LLP, 345 Park Avenue, New York, New York 10154, has been selected as
independent auditors for the Fund for the fiscal year ending December 31, 1995.
OTHER INFORMATION
This prospectus omits certain information contained in the
registration statement filed with the SEC. Copies of the registration
statement, including items omitted herein, may be obtained from the SEC by
paying the charges prescribed under its rules and regulations. The
Statement of Additional Information included in such registration statement
may be obtained without charge from the Fund.
No person has been authorized to give any information or to make
any representation other than those contained in this Prospectus, and
information or representations not herein contained, if given or made, must not
be relied upon as having been authorized by the Fund. This Prospectus does
not constitute an offer or solicitation in any jurisdiction in which such
offering may not lawfully be made.
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<PAGE> 49
KEMPER ADVANTAGE III
PROSPECTUS - MAY 1, 1995
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY SECURITIES IN ANY STATE, TO ANY PERSON, TO WHOM IT IS NOT LAWFUL
TO MAKE SUCH AN OFFER IN SUCH STATE. A FIXED AND VARIABLE ANNUITY ISSUED BY
KEMPER INVESTORS LIFE INSURANCE COMPANY.
<PAGE> 50
PROSPECTUS--MAY 1, 1995
--------------------------------------------------------------------------------
PERIODIC PAYMENT
VARIABLE ANNUITY CONTRACTS
--------------------------------------------------------------------------------
ISSUED BY
KEMPER INVESTORS LIFE INSURANCE COMPANY
IN CONNECTION WITH
KILICO VARIABLE ANNUITY SEPARATE ACCOUNT
HOME OFFICE: 1 KEMPER DRIVE, LONG GROVE, ILLINOIS 60049 (708) 320-4500
The types of Periodic Payment Deferred Variable Annuity Contracts ("Periodic
Payment Contract" or "Contracts") offered by this Prospectus are issued by
Kemper Investors Life Insurance Company ("KILICO") and are designed to provide
annuity benefits under retirement plans which may or may not qualify for the
Federal tax advantages available under Section 401, 403, 408 or 457 of the
Internal Revenue Code of 1986, as amended.
Purchase payments for the Contracts may be allocated to one or more of the
investment options under which Contract values accumulate on either a variable
or fixed basis. These options consist of the seven Subaccounts of the Separate
Account and the Fixed Accumulation Option of the General Account. Each
Subaccount invests in one of the portfolios of the Kemper Investors Fund (the
"Fund") which is managed by Kemper Financial Services, Inc. ("KFS"). The Fund
currently consists of the following Portfolios: Money Market, Total Return, High
Yield, Equity, Government Securities, International and Small Capitalization
Equity ("Small Cap"). Subaccounts and Portfolios may be added in the future.
Contract values allocated to any of the Subaccounts will vary to reflect the
investment performance of the corresponding Portfolio. The accompanying
Prospectus for the Fund describes the investment objectives and the attendant
risks of the Portfolios of the Fund. Contract values allocated to the Fixed
Accumulation Option will accumulate on a fixed basis.
This Prospectus is designed to provide you with certain essential information
that you should know before investing. A Statement of Additional Information
dated May 1, 1995 has been filed with the Securities and Exchange Commission and
is incorporated herein by reference. A Statement of Additional Information is
available upon request from KILICO by writing or calling the address or
telephone number listed above. A table of contents for the Statement of
Additional Information is on page 25 of this Prospectus.
THIS PROSPECTUS IS VALID ONLY IF ACCOMPANIED OR PRECEDED BY A CURRENT PROSPECTUS
FOR THE KEMPER INVESTORS FUND. ALL PROSPECTUSES SHOULD BE READ AND RETAINED FOR
FUTURE REFERENCE.
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 THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<PAGE> 51
TABLE OF CONTENTS
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
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<S> <C>
DEFINITIONS................................................................................. 1
SUMMARY..................................................................................... 2
SUMMARY OF EXPENSES......................................................................... 4
CONDENSED FINANCIAL INFORMATION............................................................. 5
KILICO, THE SEPARATE ACCOUNT AND THE FUND................................................... 7
FIXED ACCUMULATION OPTION................................................................... 10
THE CONTRACTS............................................................................... 10
CONTRACT CHARGES AND EXPENSES............................................................... 14
THE ANNUITY PERIOD.......................................................................... 16
FEDERAL INCOME TAXES........................................................................ 19
DISTRIBUTION OF CONTRACTS................................................................... 22
VOTING RIGHTS............................................................................... 22
REPORTS TO CONTRACT OWNERS AND INQUIRIES.................................................... 22
DOLLAR COST AVERAGING....................................................................... 23
SYSTEMATIC WITHDRAWAL PLAN.................................................................. 23
PROVISIONS OF PRIOR CONTRACTS............................................................... 23
LEGAL PROCEEDINGS........................................................................... 25
TABLE OF CONTENTS--STATEMENT OF ADDITIONAL INFORMATION...................................... 25
</TABLE>
<PAGE> 52
DEFINITIONS
The following terms as used in this Prospectus have the indicated meanings:
ACCUMULATION PERIOD--The period between the Date of Issue of a Contract and
the Annuity Date.
ACCUMULATION UNIT--A unit of measurement used to determine the value of
each Subaccount during the Accumulation Period.
ANNUITANT--The person designated to receive or who is actually receiving
annuity payments and upon the continuation of whose life annuity payments
involving life contingencies depend.
ANNUITY DATE--The date on which annuity payments are to commence.
ANNUITY OPTION--One of several forms in which annuity payments can be made.
ANNUITY PERIOD--The period starting on the Annuity Date.
ANNUITY UNIT--A unit of measurement used to determine the amount of
Variable Annuity payments.
BENEFICIARY--The person designated to receive any benefits under a Contract
upon the death of the Annuitant or the Owner prior to the Annuity Period.
CONTRACT--A Variable Annuity Contract offered by this Prospectus. With
respect to a Contract issued on a group basis, the certificate issued to an
individual shall be deemed for the purposes of this Prospectus to be a
Contract.
CONTRACT OWNER OR OWNER--The person designated in the Contract as having
the privileges of ownership defined in the Contract.
CONTRACT VALUE--The sum of the values of the Owner's Contract interest in
the Subaccount(s) of the Separate Account and the General Account.
CONTRACT YEAR--Period between anniversaries of the Date of Issue of a
Contract, or with respect to a Contract issued on a group basis, the period
between anniversaries of the date of issue of a certificate.
CONTRACT QUARTER--Periods between quarterly anniversaries of the Date of
Issue of the Contract, or with respect to a Contract issued on a group
basis, the period between quarterly anniversaries of the date of issue of a
certificate.
CONTRIBUTION YEAR--Each Contract Year in which a Purchase Payment is made
and each succeeding year measured from the end of the Contract Year during
which such Purchase Payment was made. For example, if a Contract Owner
makes an initial payment of $15,000 and then makes a subsequent payment of
$10,000 during the fourth Contract Year, the fifth Contract Year will be
the fifth Contribution Year for the purpose of Accumulation Units
attributable to the initial payment and the second Contribution Year with
respect to Accumulation Units attributable to the subsequent $10,000
payment.
DATE OF ISSUE--The date on which the first Contract Year commences.
DEBT--The principal of any outstanding loan from the General Account
Contract Value, plus any accrued interest. Requests for loans must be made
in writing to KILICO.
FIXED ANNUITY--An annuity under which the amount of each annuity payment
does not vary with the investment experience of a Subaccount and is
guaranteed by KILICO.
FUND--The Kemper Investors Fund, an open-end management investment company
consisting of seven portfolios in which the Separate Account invests.
GENERAL ACCOUNT--All the assets of KILICO other than those allocated to any
Separate Account. KILICO guarantees a minimum rate of interest on Purchase
Payments allocated to the General Account.
GENERAL ACCOUNT CONTRACT VALUE--The value of the Owner's Contract interest
in the General Account.
KILICO--Kemper Investors Life Insurance Company, whose Home Office is at 1
Kemper Drive, Long Grove, Illinois 60049.
NON-QUALIFIED PLAN CONTRACT--A Contract issued in connection with a
retirement plan which does not receive favorable tax treatment under
Section 401, 403, 408 or 457 of the Internal Revenue Code.
PURCHASE PAYMENTS--Amounts paid to KILICO by or on behalf of a Contract
Owner.
QUALIFIED PLAN CONTRACT--A Contract issued in connection with a retirement
plan which receives favorable tax treatment under Section 401, 403, 408 or
457 of the Internal Revenue Code.
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<PAGE> 53
SEPARATE ACCOUNT--A unit investment trust registered with the Securities
and Exchange Commission under the Investment Company Act of 1940 known as
the KILICO Variable Annuity Separate Account.
SEPARATE ACCOUNT CONTRACT VALUE--The sum of the Owner's Contract interest
in the Subaccount(s).
SUBACCOUNTS--The seven subdivisions of the Separate Account, the assets of
which consist solely of shares of the corresponding portfolio of the Fund.
SUBACCOUNT VALUE--The value of the Owner's Contract interest in each
Subaccount.
UNITHOLDER--The person holding the voting rights with respect to an
Accumulation or Annuity Unit.
VALUATION DATE--Each day when the New York Stock Exchange is open for
trading, as well as each day otherwise required. (See "Accumulation Unit
Value.")
VALUATION PERIOD--The interval of time between two consecutive Valuation
Dates.
VARIABLE ANNUITY--An annuity with payments varying in amount in accordance
with the investment experience of the Subaccount(s) in which the Owner's
Contract has an interest.
WITHDRAWAL CHARGE--The "contingent deferred sales charge" assessed against
certain withdrawals of Accumulation Units in their first six Contribution
Years or against certain annuitization of Accumulation Units in their first
six Contribution Years.
WITHDRAWAL VALUE--Contract Value less Debt, and any premium tax payable if
the Contract is being annuitized, minus any Withdrawal Charge applicable to
that Contract.
SUMMARY
The Contracts described in the Prospectus provide a way to invest on a
tax-deferred basis and to receive annuity benefits in accordance with the
annuity option selected and the retirement plan under which the Contract has
been purchased. The Prospectus offers both Non-Qualified Plan and Qualified Plan
Contracts. KILICO makes several underlying investment options, including seven
variable Subaccounts and a Fixed Accumulation Option, available for the Contract
Owner to pursue his or her investment objectives.
The minimum initial Purchase Payment for a Non-Qualified Plan Contract is $2,500
and the minimum subsequent payment is $500. The minimum Purchase Payment for a
Qualified Plan Contract is $50. However, so long as annualized contribution
amounts from a payroll or salary deduction plan are equal to or greater than
$600, a periodic payment for a Qualified Plan Contract under $50 will be
accepted. For a Non-Qualified Plan Contract a minimum of $500 in Contract Value
must be allocated to an investment option before another investment option can
be selected. For a Qualified Plan Contract, as long as contribution amounts to a
new investment option from a payroll or salary reduction plan are equal to or
greater than $50 per month, another such investment option may be selected. The
maximum Purchase Payment for a Qualified Plan Contract is the maximum permitted
under the plan pursuant to which the Contract is issued. (See "The Contracts,"
page 10.)
KILICO provides for variable accumulations and benefits under the Contracts by
crediting purchase payments to one or more Subaccounts of the Separate Account
as selected by the Contract Owner. The Subaccounts invest in one of the seven
corresponding Portfolios (the "Portfolios") of the Kemper Investors Fund (the
"Fund"), a series mutual fund which is managed by KFS. The Money Market
Portfolio invests in U.S. dollar denominated money market instruments that
mature in twelve months or less. The Total Return Portfolio invests in a
combination of debt securities and common stocks. The High Yield Portfolio
invests in fixed-income securities, including lower rated and unrated securities
which may entail relatively greater risk of loss of income or principal but may
offer a current yield or yield to maturity which is higher. The Equity Portfolio
invests primarily in common stock or securities convertible into or exchangeable
for common stocks. The Government Securities Portfolio invests primarily in
direct obligations of the U.S. Treasury or obligations issued or guaranteed by
agencies and instrumentalities of the United States. The International Portfolio
invests principally in common stocks of established non-United States companies
believed to have potential for capital growth, income or both. The Small Cap
Portfolio invests primarily in the equity securities of smaller companies, i.e.,
those having a market capitalization of $1 billion or less at the time of
investment. (See "The Fund," page 7.) The Contract Values allocated to the
Separate Account will vary with the investment performance of the Portfolios
selected by the Contract Owner.
KILICO also provides for fixed accumulations and benefits under the Contracts in
the Fixed Accumulation Option of the General Account. Any portion of the
purchase payment allocated to the Fixed Accumulation Option is credited with
interest daily at a rate periodically declared by KILICO in its sole discretion,
but not less than 3%. (See "Fixed Accumulation Option," page 10.)
2
<PAGE> 54
The investment risk under the Contracts is borne by the Contract Owner, except
to the extent that Contract Values are allocated to the Fixed Accumulation
Option and are guaranteed to earn at least 3% interest.
Transfers between Subaccounts are permitted before and after annuitization, if
allowed by the applicable retirement plan and subject to certain limitations.
Restrictions apply to transfers out of the Fixed Accumulation Option. (See
"Transfer During Accumulation Period" and "Transfer During Annuity Period,"
pages 12 and 17, respectively.)
No sales charge is deducted from any Purchase Payment. A Contract Owner may
withdraw up to 10% of the Contract Value less Debt in any Contract Year without
assessment of any charge. If the Contract Owner withdraws an amount in excess of
10% of the Contract Value less Debt in any Contract Year, the amount withdrawn
in excess of 10% is subject to a contingent deferred sales charge ("Withdrawal
Charge"). The Withdrawal Charge starts at 6% in the first Contribution Year and
reduces by 1% each Contribution Year so that there is no charge in the seventh
and later Contribution Years. (See "Withdrawal Charge," page 15.) The Withdrawal
Charge also applies at the annuitization of Accumulation Units in their sixth
Contribution Year or earlier, except as set forth under "Withdrawal Charge."
However, in no event shall the aggregate Withdrawal Charges assessed against a
Contract exceed 7.25% of the aggregate Purchase Payments made under the
Contract. Please note that adverse tax consequences may occur with respect to
certain withdrawals. (See "Tax Treatment of Withdrawals, Loans and Assignments,"
page 20.)
KILICO makes charges under the Contract for assuming the mortality and expense
risk and administrative expenses under the Contract, for records maintenance,
and for any applicable premium taxes. (See "Charges Against the Separate
Account," page 14.) In addition, KFS makes a charge against the assets of each
of the Portfolios for providing investment advisory services. (See the Fund
prospectus for such information).
The Contracts may be purchased in connection with retirement plans which qualify
either under Section 401 or 403(b) of the Internal Revenue Code of 1986, as
amended (the "Code") or as individual retirement account plans established under
Section 408 of the Code. The Contracts are also available in connection with
state and municipal deferred compensation plans and other entities qualified
under Section 457 of the Code and under other deferred compensation
arrangements, and are also offered under other retirement plans which may not
qualify for similar tax advantages. (See "Non-Qualified Plan Contracts," page 19
and "Qualified Plans," page 20.)
A Contract Owner has the right within the "free look" period (generally ten
days, subject to state variation) after receiving the Contract to cancel the
Contract by delivering or mailing it to KILICO. Upon receipt by KILICO, the
Contract will be cancelled and a refund will be made. The amount of the refund
will depend on the state in which the Contract is issued; however, it generally
will be an amount at least equal to the Contract Value. (See "The Contracts,"
page 10.)
3
<PAGE> 55
--------------------------------------------------------------------------------
SUMMARY OF EXPENSES
--------------------------------------------------------------------------------
CONTRACT OWNER TRANSACTION EXPENSES
<TABLE>
<CAPTION>
<S> <C>
Sales Load Imposed on Purchases (as a percentage of purchase payments)......................................... None
Contingent Deferred Sales Load (as a percentage of amount surrendered)*
Year of Withdrawal After Purchase
---------------------------------
First year...................................... 6%
Second year..................................... 5%
Third year...................................... 4%
Fourth year..................................... 3%
Fifth year...................................... 2%
Sixth year...................................... 1%
Seventh year and following...................... 0%
Surrender Fees................................................................................................. None
Exchange Fee................................................................................................... None
ANNUAL CONTRACT FEE (Records Maintenance Charge)**............................................................. $36
</TABLE>
<TABLE>
<CAPTION>
SEPARATE ACCOUNT ANNUAL EXPENSES
(as a percentage of average daily account value)
<S> <C>
Mortality and Expense Risk... 1.00%
Administration............... .30%
Account Fees and Expenses.... 0%
Total Separate Account
Annual Expenses............ 1.30%
</TABLE>
FUND ANNUAL EXPENSES
(as percentage of each Portfolio's average net assets)
<TABLE>
<CAPTION>
MONEY TOTAL GOVERNMENT
MARKET RETURN HIGH YIELD EQUITY SECURITIES INTERNATIONAL SMALL CAP
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
--------- --------- ---------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Management Fees...... .50% .55% .60% .60% .55% .75% .65%
Other Expenses....... .03 .06 .05 .06 .09 .18 .60
Total Portfolio ------ ------ ------ ------ ------ ------ ------
Annual Expenses.... .53% .61% .65% .66% .64% .93% 1.25%
====== ====== ====== ====== ====== ====== ======
</TABLE>
--------------------------------------------------------------------------------
EXAMPLE
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SUBACCOUNT 1 YEAR 3 YEARS 5 YEARS 10 YEARS
---------- ------ ------- ------- --------
<S> <C> <C> <C> <C> <C>
If you surrender your contract at the end of the applicable Money Market $ 83 $ 108 $ 134 $ 239
time period: Total Return 84 111 138 248
You would pay the following expenses on a $1,000 High Yield 84 112 140 252
investment, assuming 5% annual return on assets: Equity 84 112 141 253
Government Securities 84 111 139 250
International 87 120 154 281
Small Cap 90 130 -- --
If you do not surrender your contract: Money Market 21 65 111 239
You would pay the following expenses Total Return 22 67 115 248
on a $1,000 investment, assuming High Yield 22 69 117 252
5% annual return on assets: Equity 22 69 118 253
Government Securities 22 68 116 250
International 25 77 132 281
Small Cap 28 87 -- --
</TABLE>
--------------------------------------------------------------------------------
The purpose of the preceding table is to assist Contract Owners in understanding
the various costs and expenses that a Contract Owner in a Subaccount will bear
directly or indirectly. The table reflects expenses of both the Separate Account
and the Fund. THE EXAMPLE SHOULD NOT BE CONSIDERED TO BE A REPRESENTATION OF
PAST OR FUTURE EXPENSES AND DOES NOT INCLUDE THE DEDUCTION OF STATE PREMIUM
TAXES, WHICH MAY BE ASSESSED BEFORE OR UPON ANNUITIZATION. ACTUAL EXPENSES MAY
BE GREATER OR LESS THAN THOSE SHOWN. The example assumes a 5% annual rate of
return pursuant to requirements of the Securities and Exchange Commission. This
hypothetical rate of return is not intended to be representative of past or
future performance of any Subaccount. The Records Maintenance Charge is a single
charge, it is not a separate charge for each Subaccount. In addition, the effect
of the Records Maintenance Charge has been reflected by applying the percentage
derived by dividing the total amounts of annual Records Maintenance Charge
collected by the total net assets of all the Subaccounts in the Separate
Account. See "Contract Charges and Expenses" for more information regarding the
various costs and expenses.
* A Contract Owner may withdraw up to 10% of the Contract Value less Debt in
any Contract Year without assessment of any charge. Under certain
circumstances the contingent deferred sales load may be reduced or waived,
including when certain annuity options are selected.
** Under certain circumstances the annual Records Maintenance Charge may be
reduced or waived by KILICO.
4
<PAGE> 56
CONDENSED FINANCIAL INFORMATION
The following condensed financial information is derived from the financial
statements of the Separate Account. The data should be read in conjunction with
the financial statements, related notes and other financial information included
in the Statement of Additional Information.
Selected data for the last ten years for accumulation units outstanding as of
the year ended December 31st for each period:
<TABLE>
<CAPTION>
Flexible Payment Contracts
--------------------------------------------------------------------------------------------------
1994*** 1993 1992** 1991 1990 1989* 1988 1987 1986 1985
------ ------ ------ ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
TAX QUALIFIED
Accumulation unit value at
beginning of period
Money Market Subaccount... $2.051 2.014 1.966 1.875 1.751 1.621 1.523 1.443 1.367 1.277
Total Return Subaccount... 4.236 3.816 3.790 2.776 2.669 2.174 1.960 1.967 1.726 1.357
High Yield Subaccount..... 4.517 3.802 3.261 2.169 2.591 2.651 2.311 2.204 1.891 1.569
Equity Subaccount......... 3.520 3.102 3.025 1.916 1.923 1.515 1.524 1.513 1.399 1.129
Government Securities
Subaccount*.............. 1.388 1.317 1.256 1.101 1.013
International
Subaccount**............. 1.293 .983 1.000
Accumulation unit value at
end of period
Money Market Subaccount... $2.111 2.051 2.014 1.966 1.875 1.751 1.621 1.523 1.443 1.367
Total Return Subaccount... 3.796 4.236 3.816 3.790 2.776 2.669 2.174 1.960 1.967 1.726
High Yield Subaccount..... 4.372 4.517 3.802 3.261 2.169 2.591 2.651 2.311 2.204 1.891
Equity Subaccount......... 3.345 3.520 3.102 3.025 1.916 1.923 1.515 1.524 1.513 1.399
Government Securities
Subaccount*.............. 1.337 1.388 1.317 1.256 1.101 1.013
International
Subaccount**............. 1.234 1.293 .983
Small Cap Subaccount***... 1.033
Number of accumulation
units outstanding at end
of period
(000's omitted)
Money Market Subaccount... 733 844 1,081 1,720 2,388 2,417 3,127 4,394 4,455 5,801
Total Return Subaccount... 1299 1,511 1,859 1,924 2,355 2,888 3,652 5,546 5,673 5,687
High Yield Subaccount..... 532 657 670 723 885 1,587 2,104 1,854 3,402 2,353
Equity Subaccount......... 238 222 303 255 251 578 489 1,022 1,423 1,785
Government Securities
Subaccount*.............. 237 257 267 288 170 168
International
Subaccount**............. 625 284 91
Small Cap Subaccount***... 14
<CAPTION>
Periodic Payment Contracts
------------------------------------------------------------------------------------------------------
1994*** 1993 1992** 1991 1990 1989* 1988 1987 1986 1985
------- ------- ------- ------ ------ ------ ------ ------ ------ ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
TAX QUALIFIED
Accumulation unit value at
beginning of period
Money Market Subaccount... 1.981 1.950 1.910 1.827 1.712 1.589 1.498 1.423 1.352 1,266
Total Return Subaccount... 4.092 3.696 3.682 2.705 2.609 2.131 1.927 1.940 1.707 1,346
High Yield Subaccount..... 4.363 3.683 3.168 2.114 2.533 2.599 2.272 2.174 1.871 1,557
Equity Subaccount......... 3.417 3.020 2.954 1.876 1.889 1.492 1.506 1.500 1.390 1,126
Government Securities
Subaccount*.............. 1.371 1.305 1.248 1.097 1.012
International
Subaccount**............. 1.285 .980 1.000
Accumulation unit value at
end of period
Money Market Subaccount... 2.033 1.981 1.950 1.910 1.827 1.712 1.589 1.498 1.423 1,352
Total Return Subaccount... 3.656 4.092 3.696 3.682 2.705 2.609 2.131 1.927 1.940 1,707
High Yield Subaccount..... 4.210 4.363 3.683 3.168 2.114 2.533 2.599 2.272 2.174 1,871
Equity Subaccount......... 3.238 3.417 3.020 2.954 1.876 1.889 1.492 1.506 1.500 1,390
Government Securities
Subaccount*.............. 1.317 1.371 1.305 1.248 1.097 1.012
International
Subaccount**............. 1.223 1.285 .980
Small Cap Subaccount***... 1.031
Number of accumulation
units outstanding at end
of period
(000's omitted)
Money Market Subaccount... 15,997 14,891 12,605 14,973 21,581 14,185 16,953 20,296 10,799 6,774
Total Return Subaccount... 110,428 108,395 100,100 81,776 70,620 68,024 63,669 68,367 47,935 30,984
High Yield Subaccount..... 26,546 26,749 22,202 19,861 22,623 28,032 22,281 14,320 23,972 7,532
Equity Subaccount......... 58,845 50,289 42,078 28,271 22,451 19,163 17,780 17,000 10,278 13,170
Government Securities
Subaccount*.............. 24,332 31,898 28,368 23,035 12,918 7,794
International
Subaccount**............. 61,490 38,844 10,372
Small Cap Subaccount***... 8.304
</TABLE>
(Continued on next page)
5
<PAGE> 57
CONDENSED FINANCIAL INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
Flexible Payment Contracts
--------------------------------------------------------------------------------------------------------
1994*** 1993 1992** 1991 1990 1989* 1988 1987 1986 1985
------ ------ ----- ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NON-TAX
QUALIFIED
Accumulation unit value at
beginning of period
Money Market Subaccount... $2.051 $2.014 1.966 1.875 1.751 1.621 1.523 1.443 1.367 1.277
Total Return Subaccount... 3.922 3.533 3.509 2.570 2.471 2.013 1.815 1.822 1.598 1.256
High Yield Subaccount..... 4.325 3.640 3.122 2.077 2.481 2.538 2.213 2.110 1.811 1.503
Equity Subaccount......... 3.508 3.091 3.014 1.909 1.917 1.509 1.518 1.508 1.394 1.125
Government Securities
Subaccount*.............. 1.388 1.317 1.256 1.101 1.013
International
Subaccount**............. 1.293 .983 1.000
Accumulation unit value at
end of period
Money Market Subaccount... $2.111 $2.051 2.014 1.966 1.875 1.751 1.621 1.523 1.443 1.367
Total Return Subaccount... 3.515 3.922 3.533 3.509 2.570 2.471 2.013 1.815 1.822 1.598
High Yield Subaccount..... 4.186 4.325 3.640 3.122 2.077 2.481 2.538 2.213 2.110 1.811
Equity Subaccount......... 3.334 3.508 3.091 3.014 1.909 1.917 1.509 1.518 1.508 1.394
Government Securities
Subaccount*.............. 1.337 1.388 1.317 1.256 1.101 1.013
International
Subaccount**............. 1.234 1.293 .983
Small Cap Subaccount***... 1.033
Number of accumulation
units outstanding at end
of period
(000's omitted)
Money Market Subaccount... 6,914 7,153 8,495 11,926 15,563 19,006 22,047 28,702 36,072 56,027
Total Return Subaccount... 6,613 8,042 8,853 9,586 10,291 12,244 15,032 20,329 21,648 22,557
High Yield Subaccount..... 3,621 4,517 4,876 5,240 6,652 11,895 14,871 16,264 25,551 24,295
Equity Subaccount......... 1,370 1,671 2,032 1,773 1,955 1,931 2,890 3,890 4,469 8,828
Government Securities
Subaccount*.............. 1,465 2,101 2,317 2,728 2,442 1,494
International
Subaccount**............. 2,450 1.712 1,041
Small Cap Subaccount***... 227
<CAPTION>
Periodic Payment Contracts
------------------------------------------------------------------------------------------------------
1994*** 1993 1992** 1991 1990 1989* 1988 1987 1986 1985
------ ------ ------ ------ ------ ------ ------ ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NON-TAX
QUALIFIED
Accumulation unit value at
beginning of period
Money Market Subaccount... 1.981 1.950 1.910 1.827 1.712 1.589 1.498 1.423 1.352 1.266
Total Return Subaccount... 3.812 3.444 3.431 2.520 2.431 1.986 1.796 1.808 1.591 1.254
High Yield Subaccount..... 4.250 3.588 3.086 2.059 2.467 2.532 2.214 2.117 1.822 1.517
Equity Subaccount......... 3.412 3.015 2.949 1.873 1.887 1.490 1.503 1.498 1.388 1.124
Government Securities
Subaccount*.............. 1.371 1.305 1.248 1.097 1.012
International
Subaccount**............. 1.285 .980 1.000
Accumulation unit value at
end of period
Money Market Subaccount... 2.033 1.981 1.950 1.910 1.827 1.712 1.589 1.498 1.423 1.352
Total Return Subaccount... 3.406 3.812 3.444 3.431 2.520 2.431 1.986 1.796 1.808 1.591
High Yield Subaccount..... 4.101 4.250 3.588 3.086 2.059 2.467 2.532 2.214 2.117 1.822
Equity Subaccount......... 3.233 3.412 3.015 2.949 1.873 1.887 1.490 1.503 1.498 1.388
Government Securities
Subaccount*.............. 1.317 1.371 1.305 1.248 1.097 1.012
International
Subaccount**............. 1.223 1.285 .980
Small Cap Subaccount***... 1.031
Number of accumulation
units outstanding at end
of period
(000's omitted)
Money Market Subaccount... 7,343 6,204 9,820 10,507 11,618 9,243 7,783 7,202 6,864 1,734
Total Return Subaccount... 24,773 26,640 26,043 19,953 18,485 18,671 15,835 18,807 7,053 2,702
High Yield Subaccount..... 12,416 14,735 14,424 12,799 11,858 18,281 14,589 10,186 9,306 4,723
Equity Subaccount......... 19,776 17,851 15,849 9,577 7,812 5,542 9,303 8,919 3,820 9,192
Government Securities
Subaccount*.............. 23,487 28,787 28,286 18,252 10,338 2,109
International
Subaccount**............. 14,546 15,713 3,646
Small Cap Subaccount***... 1,242
</TABLE>
* The Government Securities Subaccount commenced business on November 6, 1989.
** The International Subaccount commenced business on January 6, 1992.
*** The Small Cap Subaccount commenced business on May 2, 1994.
The financial statements and report of independent auditors of KILICO are also
contained in the Statement of Additional Information.
6
<PAGE> 58
KILICO, THE SEPARATE ACCOUNT AND THE FUND
KEMPER INVESTORS LIFE INSURANCE COMPANY
Kemper Investors Life Insurance Company ("KILICO"), 1 Kemper Drive, Long Grove,
Illinois 60049, was organized in 1947 and is a stock life insurance company
organized under the laws of the State of Illinois. KILICO is a wholly-owned
subsidiary of Kemper Financial Companies, Inc. ("KFC"), a nonoperating holding
company. KFC is a subsidiary of Kemper Corporation ("Kemper"), another public
financial services holding company. KILICO offers life insurance and annuity
products and is admitted to do business in the District of Columbia and all
states except New York. KILICO's financial statements appear in the Statement of
Additional Information.
On April 11, 1995, Kemper and an investor group comprised of Zurich Insurance
Company ("Zurich") and Insurance Partners, L.P. and Insurance Partners Offshore
(Bermuda), L.P. announced that they reached an agreement in principle pursuant
to which Kemper, including KILICO, would be acquired in a merger transaction.
Following the transaction, Zurich, or an affiliate, would be the majority owner
of Kemper, including KILICO. A definitive agreement is expected in early May,
subject to the completion of the investor group's due diligence. Consummation of
the transaction is subject to, among other things, stockholder and regulatory
approvals. The transaction is expected to close early in the fourth quarter of
1995.
THE SEPARATE ACCOUNT
KILICO originally established the KILICO Variable Annuity Separate Account (the
"Separate Account") on May 29, 1981 pursuant to Illinois law as the KILICO Money
Market Separate Account, registered with the Securities and Exchange Commission
("Commission") as an open-end, diversified management investment company under
the Investment Company Act of 1940 ("1940 Act"). On November 2, 1989, Contract
Owners approved a Reorganization under which the Separate Account was
restructured as a unit investment trust registered with the Commission under the
1940 Act. Such registration does not involve supervision by the Commission of
the management, investment practices or policies of the Separate Account or
KILICO.
The Separate Account is administered and accounted for as part of the general
business of KILICO, but the income and capital gains or capital losses, whether
or not realized, for assets allocated to the Separate Account are credited to or
charged against the assets held in the Separate Account, without regard to any
other income, capital gains or capital losses of any other separate account or
arising out of any other business which KILICO may conduct. The benefits
provided under the Contracts are obligations of KILICO. The assets of the
Separate Account are not chargeable with liabilities arising out of the business
conducted by any other separate account or out of any other business KILICO may
conduct.
The Separate Account holds assets that are segregated from all of KILICO's other
assets. The Separate Account is used to support the variable annuity contracts
described herein. The obligations to Contract Owners and beneficiaries arising
under the Contracts are general corporate obligations of KILICO.
The Separate Account is currently divided into seven Subaccounts. Each
Subaccount invests exclusively in shares of one of the corresponding Portfolios
of the Fund. Additional Subaccounts may be added in the future.
The Separate Account will purchase and redeem shares from the Fund at net asset
value. KILICO will redeem Fund shares as necessary to provide benefits, to
deduct charges under the Contracts and to transfer assets from one Subaccount to
another as requested by Contract Owners. All dividends and capital gains
distributions received by the Separate Account from a Portfolio of the Fund will
be reinvested in such Portfolio at net asset value and retained as assets of the
corresponding Subaccount.
The Separate Account's financial statements appear in the Statement of
Additional Information.
THE FUND
The Separate Account invests in shares of the Kemper Investors Fund, a series
type mutual fund registered with the Commission as an open-end, diversified
management investment company. Registration of the Fund does not involve
supervision of its management, investment practices or policies by the
Commission. The Fund is designed to provide an investment vehicle for variable
life insurance and variable annuity contracts. Shares of the Fund are sold only
to insurance company separate accounts. In addition to selling shares to
variable annuity and variable life separate accounts of KILICO and its
affiliates (currently, the Separate Account and KILICO Variable Separate
Account), shares of the Fund may be sold to variable life insurance and variable
annuity separate accounts of
7
<PAGE> 59
insurance companies not affiliated with KILICO. It is conceivable that in the
future it may be disadvantageous for variable life insurance separate accounts
and variable annuity separate accounts of companies unaffiliated with KILICO, or
for both variable life insurance separate accounts and variable annuity separate
accounts, to invest simultaneously in the Fund. Currently, neither KILICO nor
the Fund foresees any such disadvantages to either variable life insurance or
variable annuity owners. Management of the Fund has an obligation to monitor
events to identify material conflicts between such owners and determine what
action, if any, should be taken. In addition, if KILICO believes that the Fund's
response to any of those events or conflicts insufficiently protects the Owners,
it will take appropriate action on its own.
The Fund currently consists of the following Portfolios: Money Market, Total
Return, High Yield, Equity, Government Securities, International and Small Cap.
The assets of each Portfolio are held separate from the assets of the other
Portfolios, and each Portfolio has its own distinct investment objective and
policies. Each Portfolio operates as a separate investment fund, and the
investment performance of one Portfolio has no effect on the investment
performance of any other Portfolio.
The investment objectives and policies of the Fund's Portfolios are summarized
below:
MONEY MARKET PORTFOLIO: This Portfolio seeks to provide maximum current income
to the extent consistent with stability of principal. It will maintain a dollar
weighted average portfolio maturity of 90 days or less. This Portfolio pursues
its objective of maximum income and stability of principal by investing in money
market securities such as U.S. Treasury obligations, commercial paper, and
certificates of deposit and bankers' acceptances of domestic and foreign banks,
including foreign branches of domestic banks, and will enter into repurchase
agreements.
TOTAL RETURN PORTFOLIO: This Portfolio seeks a high total return, a combination
of income and capital appreciation, by investing in a combination of debt
securities and common stocks. The Portfolio's investments will normally consist
of fixed-income and equity securities. Fixed-income securities will include
bonds and other debt securities and preferred stocks, some of which may have a
call on common stocks through attached warrants or a conversion privilege.
Equity investments normally will consist of common stocks and securities
convertible into or exchangeable for common stocks; however the Portfolio may
also make private placement investments (which are normally restricted
securities).
HIGH YIELD PORTFOLIO: This Portfolio seeks to provide a high level of current
income by investing in fixed-income securities, including lower rated and
unrated securities which may entail relatively greater risk of loss of income or
principal but may offer a current yield or yield to maturity which is higher.
Lower and unrated securities, which are sometimes referred to by the popular
press as "junk bonds," have widely varying characteristics and quality. The
Portfolio invests in U.S. Government, corporate, and other notes and bonds
paying high current income.
EQUITY PORTFOLIO: This Portfolio seeks maximum appreciation of capital through
diversification of investment securities having potential for capital
appreciation. Current income will not be a significant factor. This Portfolio's
investments normally will consist of common stocks and securities convertible
into or exchangeable for common stocks; however, it may also make private
placement investments (which are normally restricted securities).
GOVERNMENT SECURITIES PORTFOLIO: This Portfolio seeks high current return
consistent with preservation of capital from a portfolio composed primarily of
U.S. Government securities. The Portfolio will also invest in fixed-income
securities other than U.S. Government securities, and will engage in options and
financial futures transactions. The Portfolio may purchase or sell portfolio
securities on a when-issued or delayed delivery basis. The Portfolio's current
return is sought from interest income and net short-term gains on securities and
options and futures transactions.
INTERNATIONAL PORTFOLIO: This Portfolio seeks a total return, a combination of
capital growth and income, principally through an internationally diversified
portfolio of equity securities. While this Portfolio invests principally in
equity securities of non-United States issuers, this Portfolio may also invest
in convertible and debt securities of non-United States issuers and foreign
currencies.
SMALL CAP PORTFOLIO: This Portfolio seeks maximum appreciation of capital. At
least 65% of its total assets normally will be invested in the equity securities
of smaller companies, i.e., those having a market capitalization of $1 billion
or less at the time of investment. Current income will not be a significant
factor. This Portfolio's investments normally will consist primarily of common
stocks and securities convertible into or exchangeable for common stocks and to
a limited degree in preferred stocks and debt securities.
There is no assurance that any of the Portfolios of the Fund will achieve its
stated objective. More detailed information, including a description of risks
involved in investing in each of the Portfolios, may be found in the prospectus
for the Fund, which must accompany or precede this Prospectus, and the Fund's
Statement of Additional
8
<PAGE> 60
Information available upon request from Kemper Investors Life Insurance Company,
1 Kemper Drive, Long Grove, Illinois 60049, or Kemper Financial Services, Inc.,
120 South LaSalle Street, Chicago, Illinois 60603. Read the prospectus carefully
before investing.
Kemper Financial Services, Inc., ("KFS" or the "Adviser"), an affiliate of
KILICO is the investment adviser to the Fund and manages its daily investments
and business affairs, subject to the policies established by the trustees of the
Fund. For its advisory services to the Portfolios, the Adviser receives
compensation monthly at annual rates equal to .50 of 1%, .55 of 1%, .60 of 1%,
.60 of 1%, .55 of 1%, .75 of 1% and .65 of 1% of the average daily net asset
values of the Money Market Portfolio, the Total Return Portfolio, the High Yield
Portfolio, the Equity Portfolio, the Government Securities Portfolio, the
International Portfolio, and the Small Cap Portfolio, respectively.
CHANGE OF INVESTMENTS
KILICO reserves the right, subject to applicable law, to make additions to,
deletions from, or substitutions for the shares held by the Separate Account or
that the Separate Account may purchase. KILICO reserves the right to eliminate
the shares of any of the portfolios of the Fund and to substitute shares of
another portfolio of the Fund or of another investment company, if the shares of
a portfolio are no longer available for investment, or if in its judgment
further investment in any portfolio becomes inappropriate in view of the
purposes of the Separate Account. KILICO will not substitute any shares
attributable to a Contract Owner's interest in a Subaccount of the Separate
Account without notice to the Contract Owner and prior approval of the
Commission, to the extent required by the 1940 Act or other applicable law.
Nothing contained in this Prospectus shall prevent the Separate Account from
purchasing other securities for other series or classes of policies, or from
permitting a conversion between series or classes of policies on the basis of
requests made by Contract Owners.
KILICO also reserves the right to establish additional subaccounts of the
Separate Account, each of which would invest in a new portfolio of the Fund, or
in shares of another investment company, with a specified investment objective.
New subaccounts may be established when, in the sole discretion of KILICO,
marketing needs or investment conditions warrant, and any new subaccounts may be
made available to existing Contract Owners as determined by KILICO. KILICO may
also eliminate or combine one or more subaccounts, transfer assets, or it may
substitute one subaccount for another subaccount, if, in its sole discretion,
marketing, tax, or investment conditions warrant. KILICO will notify all
Contract Owners of any such changes.
If deemed by KILICO to be in the best interests of persons having voting rights
under the Policy, the Separate Account may be: (a) operated as a management
company under the 1940 Act; (b) deregistered under that Act in the event such
registration is no longer required; or (c) combined with other KILICO separate
accounts. To the extent permitted by law, KILICO may also transfer the assets of
the Separate Account associated with the Contract to another separate account,
or to the General Account.
PERFORMANCE INFORMATION
From time to time, the Separate Account may advertise several types of
performance information for the Subaccounts. All Subaccounts may advertise
"average annual total return" and "total return," except "average annual total
return" is not shown for the Money Market Subaccount. The High Yield Subaccount
and the Government Securities Subaccount may also advertise "yield." The Money
Market Subaccount may advertise "yield" and "effective yield." Each of these
figures is based upon historical earnings and is not necessarily representative
of the future performance of a Subaccount. Average annual total return and total
return calculations measure the net income of a Subaccount plus the effect of
any realized or unrealized appreciation or depreciation of the underlying
investments in the Subaccount for the period in question. Average annual total
return will be quoted for periods of at least one year, five years if
applicable, and the life of Subaccount, ending with the most recent calendar
quarter. Average annual total return figures are annualized and, therefore,
represent the average annual percentage change in the value of an investment in
a Subaccount over the applicable period. Total return figures are not annualized
and represent the actual percentage change over the applicable period. Yield is
a measure of the net dividend and interest income earned over a specific one
month or 30-day period (seven-day period for the Money Market Subaccount)
expressed as a percentage of the value of the Subaccount's Accumulation Units.
Yield is an annualized figure, which means that it is assumed that the
Subaccount generates the same level of net income over a one year period which
is compounded on a semi-annual basis. The effective yield for the Money Market
Subaccount is calculated similarly but includes the effect of assumed
compounding calculated under rules prescribed by the Securities and Exchange
Commission. The Money Market Subaccount's effective yield will be slightly
higher than its yield due to this compounding effect. The Subaccounts' units are
sold at Accumulation Unit value. The Subaccounts' performance figures and
Accumulation Unit values will fluctuate. Units of the Subaccount are redeemable
by an
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<PAGE> 61
investor at Accumulation Unit value, which may be more or less than original
cost. The performance figures include the deduction of all expenses and fees,
including a prorated portion of the Records Maintenance Charge. Redemptions
within the first six years after purchase may be subject to a Withdrawal Charge
that ranges from 6% the first year to 0% after six years; however, the aggregate
Withdrawal Charge will not exceed 7.25% of aggregate Purchase Payments under the
Contract. Yield, effective yield and total return figures do not include the
effect of any Withdrawal Charge that may be imposed upon the redemption of
units, and thus may be higher than if such charges were deducted. Average annual
total return figures include the effect of the applicable Withdrawal Charge that
may be imposed at the end of the period in question. Additional information
concerning a Subaccount's performance appears in the Statement of Additional
Information. The Subaccounts may provide comparative information with regard to
the Dow Jones Industrial Average, the Standard & Poor's 500 Stock Index, the
Consumer Price Index, the CDA Certificate of Deposit Index, the Lehman Brothers
Government and Corporate Bond Index, the Salomon Brothers High Grade Corporate
Bond Index and the Merrill Lynch Government/Corporate Master Index, the CDA
Mutual Fund--International Index, and the Morgan Stanley Capital International
Europe, Australia, Far East Index and may provide Lipper Analytical Services,
Inc., the VARDS Report and Morningstar, Inc. performance analysis rankings. From
time to time, the Separate Account may quote information from publications such
as MORNINGSTAR, INC., THE WALL STREET JOURNAL, MONEY MAGAZINE, FORBES,
BARRON'S, FORTUNE, THE CHICAGO TRIBUNE, USA TODAY, INSTITUTIONAL INVESTOR,
REGISTERED REPRESENTATIVE, INVESTMENT ADVISOR AND VARDS.
FIXED ACCUMULATION OPTION
CONTRIBUTIONS UNDER THE FIXED PORTION OF THE CONTRACT AND TRANSFERS TO THE
FIXED PORTION BECOME PART OF THE GENERAL ACCOUNT OF THE INSURANCE COMPANY,
WHICH SUPPORTS 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 ("1933 ACT") NOR IS THE GENERAL
ACCOUNT REGISTERED AS AN INVESTMENT COMPANY UNDER THE INVESTMENT COMPANY ACT OF
1940 ("1940 ACT"). ACCORDINGLY, NEITHER THE GENERAL ACCOUNT NOR ANY INTERESTS
THEREIN GENERALLY ARE SUBJECT TO THE PROVISIONS OF THE 1933 OR 1940 ACTS AND
KILICO HAS BEEN ADVISED THAT THE STAFF OF THE SECURITIES AND EXCHANGE
COMMISSION HAS NOT REVIEWED THE DISCLOSURES IN THIS PROSPECTUS WHICH RELATE TO
THE FIXED PORTION. DISCLOSURES REGARDING THE FIXED 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 Contracts offer a Fixed Accumulation Option (the General Account) under
which KILICO allocates payments to its General Account and pays a fixed interest
rate for stated periods. This Prospectus describes only the element of the
Contract pertaining to the Separate Account except where it makes specific
reference to fixed accumulation and annuity elements.
The Contracts guarantee that payments allocated to the General Account will earn
a minimum fixed interest rate of 3%. KILICO, at its discretion, may credit
interest in excess of 3%. KILICO reserves the right to change the rate of excess
interest credited as provided under the terms of the Contract. KILICO also
reserves the right to declare separate rates of excess interest for Purchase
Payments or amounts transferred at designated times, with the result that
amounts at any given designated time may be credited with a higher or lower rate
of excess interest than the rate or rates of excess interest previously credited
to such amounts and Purchase Payments paid or amounts transferred at any other
designated time.
THE CONTRACTS
A. GENERAL INFORMATION.
This Prospectus offers both Qualified Plan Contracts and Non-Qualified Plan
Contracts. The minimum Purchase Payment for a Qualified Plan is $50. However, so
long as annualized contribution amounts from a payroll or salary deduction plan
are equal to or greater than $600, a periodic payment under $50 will be
accepted. The maximum annual amount of Purchase Payments may be limited by the
provisions of the retirement plan pursuant to which the Contract has been
purchased. For a Non-Qualified Plan Contract the minimum initial Purchase
Payment is $2,500 and the minimum subsequent payment is $500. An initial
allocation of less than $500 may be made to the General Account or to a
Subaccount, or to the General Account and one Subaccount. For a Non-Qualified
Plan, no subsequent allocations of Purchase Payments may be made to any
additional Subaccount until allocations total at least $500 to each Subaccount
in which the Contract has an interest. For a Qualified Plan Contract, as long as
annualized contribution amounts to a new Subaccount from a payroll or salary
reduction plan are equal to or greater than $25 per month, allocations to
another such Subaccount may be made.
KILICO may at any time amend the Contract in accordance with changes in the law,
including applicable tax laws, regulations or rulings, and for other purposes.
Contracts permitting flexible payments are no longer offered, although Purchase
Payments are still permitted under previously issued flexible payment contracts.
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<PAGE> 62
A Contract Owner is allowed a "free look" period (generally 10 days, subject to
state variation) after receiving the Contract, to review it and decide whether
or not to keep it. If the Contract Owner decides to return the Contract, it may
be cancelled by delivering or mailing it to KILICO. Upon receipt by KILICO, the
Contract will be cancelled and a refund will be made. The amount of the refund
will depend on the state in which the Contract is issued; however, it generally
will be an amount at least equal to the Contract Value on the date of receipt by
KILICO, without any deduction for withdrawal charges or Records Maintenance
charges. However, in some states applicable law requires that the amount of the
Purchase Payment be returned.
During the Accumulation Period, the Contract Owner may assign the Contract or
change a Beneficiary at any time by filing such assignment or change with
KILICO's home office at 1 Kemper Drive, Long Grove, Illinois 60049. No
assignment or Beneficiary change shall be binding on KILICO until received by
KILICO. KILICO assumes no responsibility for the validity of such assignment or
Beneficiary change. An assignment may subject the Owner to immediate tax
liability. (See "Tax Treatment of Withdrawals, Loans and Assignments.")
Amounts payable during the Annuity Period may not be assigned or encumbered and,
to the extent permitted by law, are not subject to levy, attachment or other
judicial process for the payment of the payee's debts or obligations.
The original Beneficiary may be named in the application for the Contract. If a
Beneficiary is not named, or if no named Beneficiary survives the Annuitant, the
Beneficiary shall be the Annuitant's or Owner's estate.
Assignment of interest in the Contract or change of Beneficiary designation
under a Qualified Plan Contract may be prohibited by the provisions of the
applicable plan.
B. THE ACCUMULATION PERIOD.
1. APPLICATION OF PURCHASE PAYMENTS.
Purchase Payments are allocated to the Subaccount(s) or General Account as
selected by the Contract Owner. The amount of each Purchase Payment credited to
a Subaccount will be based on the next computed value of an Accumulation Unit
following receipt of payment in proper form by KILICO. The value of an
Accumulation Unit is determined when the net asset values of the Portfolios of
the Fund are calculated, which is generally at 3:00 p.m. Chicago time (11:00
a.m. and 3:00 p.m. Chicago time for the Money Market Portfolio) on each day that
the New York Stock Exchange is open for trading. Purchase Payments allocated to
the General Account will begin earning interest one day after receipt in proper
form. However, with respect to initial Purchase Payments, the amount will be
credited only after an affirmative determination by KILICO to issue the
Contract, but no later than the second day following receipt of the Purchase
Payment. After the initial purchase, the number of Accumulation Units credited
is determined by dividing the Purchase Payment amount allocated to a Subaccount
by the Accumulation Unit value which is next computed following receipt by
KILICO of any Purchase Payment in good funds. Purchase Payments will not be
received except on those days when the New York Stock Exchange is open for
trading.
The number of Accumulation Units will not change because of a subsequent change
in value. The dollar value of an Accumulation Unit will vary to reflect the
investment experience of the Subaccount and the assessment of charges against
the Subaccount other than the Records Maintenance Charge. The number of
Accumulation Units will be reduced upon assessment of the Records Maintenance
Charge.
If KILICO has not been provided with information sufficient to establish a
Contract or to properly credit such Purchase Payment, it will promptly request
that the necessary information be furnished. If the requested information is not
furnished within five (5) business days of initial receipt of the Purchase
Payment, or if KILICO determines that it cannot otherwise issue the Contract
within the five (5) day period, the Purchase Payment will be returned to the
Owner.
2. ACCUMULATION UNIT VALUE.
Each Subaccount has an Accumulation Unit value. When Purchase Payments or other
amounts are allocated to a Subaccount, a number of units are purchased based on
the Subaccount's Accumulation Unit value at the end of the Valuation Period
during which the allocation is made. When amounts are transferred out of or
deducted from a Subaccount, units are redeemed in a similar manner.
The Accumulation Unit value for each subsequent Valuation Period is the
investment experience factor for that period multiplied by the Accumulation Unit
value for the immediately preceding period. Each Valuation Period has a single
Accumulation Unit value which is applied to each day in the period.
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<PAGE> 63
Each Subaccount has its own investment experience factor. The investment
experience of the Separate Account is calculated by applying the investment
experience factor to the Accumulation Unit value in each Subaccount during a
Valuation Period.
The investment experience factor of a Subaccount for a Valuation Period is
determined by dividing (1) by (2) and subtracting (3) from the result, where:
(1) is the net result of:
a. the net asset value per share of the investment held in the
Subaccount determined at the end of the current Valuation Period; plus
b. the per share amount of any dividend or capital gain distributions
made by the investments held in the Subaccount, if the "ex-dividend"
date occurs during the current Valuation Period; plus or minus
c. a charge or credit for any taxes reserved for the current Valuation
Period which KILICO determines to have resulted from the investment
operations of the Subaccount;
(2) is the net asset value per share of the investment held in the
Subaccount, determined at the end of the last prior Valuation Period;
(3) is the factor representing the mortality and expense risk and
administrative cost charge stated in the Contract for the number of days in
the Valuation Period.
3. CONTRACT VALUE.
Separate Account Contract Value on any Valuation Date can be determined by
multiplying the total number of Accumulation Units credited to the Contract for
a Subaccount by the value of an Accumulation Unit for that Subaccount on that
Valuation Date, then adding the values of the Owner's Contract interest in each
Subaccount in which the Contract is participating. That amount, when added to
the Owner's Contract interest in the General Account, equals the Contract Value.
4. TRANSFER DURING ACCUMULATION PERIOD.
During the Accumulation Period, a Contract Owner may transfer the Contract Value
among the Subaccounts and the Fixed Accumulation Option subject to the following
provisions: (i) No transfer can be made until the initial Purchase Payment has
been in a Subaccount or the General Account for fifteen days; (ii) Once all or
part of the Owner's Separate Account Contract Value has been transferred to the
General Account or from one Subaccount to another Subaccount another transfer
may not be made within the next fifteen day period; (iii) Once all or part of
the Owner's General Account Contract Value has been transferred to a Subaccount
another transfer may not be made within the next fifteen day period; and (iv)
The General Account Contract Value, less Debt, may be transferred one time
during the Contract Year to one or more Subaccounts in the thirty day period
following an anniversary of a Contract Year or the thirty day period following
the date of the confirmation statement provided for the period through the
anniversary date, if later.
KILICO will make transfers pursuant to proper written or telephone instructions
which specify in detail the requested changes. Before telephone transfer
instructions will be honored by KILICO, a telephone transfer authorization must
be completed by the Contract Owner. The minimum partial transfer amount is $500.
No partial transfer may be made if the value of the Contract Owner's remaining
Contract interest in a Subaccount or the General Account, from which amounts are
to be transferred, would be less than $500 after such transfer. Transfers
involving a Subaccount will be based upon the Accumulation Unit values next
determined following receipt of valid, complete transfer instructions by KILICO.
The transfer privilege may be suspended, modified or terminated at any time
(subject to state requirements). KILICO disclaims all liability for acting in
good faith in following instructions which are given in accordance with
procedures established by KILICO, including requests for personal identifying
information, that are designed to limit unauthorized use of the privilege.
Therefore, a Contract Owner would bear the risk of loss in the event of a
fraudulent telephone transfer.
5. WITHDRAWAL DURING ACCUMULATION PERIOD.
The Contract Owner may redeem all or a portion of the Contract Value less Debt
and previous withdrawals. Contract Owners should be aware that such withdrawals
may, under certain circumstances, be subject to adverse tax consequences under
the Internal Revenue Code. (See "Tax Treatment of Withdrawals, Loans and
Assignments.") A withdrawal of the entire Contract Value is called a surrender.
A Contract Owner may withdraw up to 10% of the Contract Value less Debt in any
Contract Year without assessment of any charge. If the Contract Owner withdraws
an amount in excess of 10% of the Contract Value in
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<PAGE> 64
any Contract Year, the amount withdrawn in excess of 10% is subject to a
Withdrawal Charge. The Withdrawal Charge starts at 6% in the first Contribution
Year and reduces by 1% each Contribution Year, so that there is no charge
against Accumulation Units withdrawn in their seventh and later Contribution
Years. However, in no event shall the aggregate Withdrawal Charges assessed
against a Contract exceed 7.25% of the aggregate Purchase Payments made under
the Contract.
In the case of a Contract invested other than solely in one Subaccount, a
Contract Owner requesting a partial withdrawal must specify what portion of the
Owner's Contract interest is to be redeemed. If a Contract Owner does not
specify what portion of the Owner's Contract interest is to be redeemed, KILICO
will redeem Accumulation Units from all Subaccounts in which the Contract Owner
has an interest and the General Account. The number of Accumulation Units
redeemed from each Subaccount and the amount redeemed from the General Account
will be in approximately the proportion which the Owner's Contract interest in
each Subaccount and in the General Account bears to the Contract Value. In all
cases, the Accumulation Units attributable to the earliest Contribution Years
will be redeemed first.
The Contract Owner may request a partial withdrawal subject to the following
conditions:
(1) The amount requested must be at least $500, or the Owner's entire
interest in the Subaccount or the General Account from which withdrawal is
requested.
(2) The Owner's Contract interest in the Subaccount, or the General Account
from which the withdrawal is requested must be at least $500 after the
withdrawal is completed.
Election to withdraw shall be made in writing to KILICO at its home office at 1
Kemper Drive, Long Grove, Ill. 60049 and should be accompanied by the Contract
if the request is for total withdrawal. Withdrawal requests will not be received
except on KILICO business days which are those days when the New York Stock
Exchange is open for trading. The Withdrawal Value attributable to the
Subaccounts is determined on the basis of the Accumulation Unit values next
computed following receipt of the request in proper order. The Withdrawal Value
attributable to the Subaccounts will be paid within seven (7) days after the
date a proper written request is received by KILICO at its home office provided,
however, that KILICO may suspend the right of withdrawal or delay payment more
than seven (7) days (a) during any period when the New York Stock Exchange is
closed (other than customary weekend and holiday closings), (b) when trading in
the markets a Portfolio of the Fund normally utilizes is restricted or an
emergency exists as determined by the Securities and Exchange Commission, so
that disposal of the Subaccount's investments or determination of its
Accumulation Unit value is not reasonably practicable, or (c) for such other
periods as the Securities and Exchange Commission by order may permit for the
protection of Contract Owners or Unitholders.
A participant in the Texas Optional Retirement Program ("ORP") is required to
obtain a certificate of termination from the participant's employer before a
Contract can be redeemed. This requirement is imposed because the Attorney
General of Texas has ruled that participants in the ORP may redeem their
interest in a Contract issued pursuant to the ORP only upon termination of
employment in Texas public institutions of higher education, or upon retirement,
death or total disability. In those states adopting identical requirements for
optional retirement programs, KILICO will follow the same procedures. See
"Qualified Plans" for information on tax-sheltered annuities.
6. DEATH BENEFIT.
If the Annuitant dies during the Accumulation Period, prior to attaining age 75,
the Contract Value less Debt as computed at the end of the Valuation Period next
following receipt by KILICO of due proof of death and the return of the
Contract, or the total amount of Purchase Payments less Debt, whichever is
greater, will be paid to the designated Beneficiary. If a Contract has been
subject to any partial withdrawal, the death benefit will be the greater of (a)
the Contract Value less Debt or (b) the total amount of Purchase Payments, less
both Debt and the aggregate dollar amount of all previous partial withdrawals.
If death occurs at age 75 or later, the death benefit will be the Contract Value
less Debt. The Owner or Beneficiary, as appropriate, may elect to have all or a
part of the death proceeds paid to the Beneficiary under one of the Annuity
Options described under "Annuity Options" below.
For Non-Qualified Plan Contracts issued on and after January 19, 1985, if the
Owner is not the Annuitant and the Owner dies before the Annuitant, the death
benefit will be paid to the designated Beneficiary. The death benefit is
determined as stated above, except that the age of the Owner at death is used in
determining the amount payable. If the Beneficiary is the surviving spouse of
the Owner, the surviving spouse may elect to be treated as the successor Owner
of the Contract with no requirement to begin Death Benefit distribution. The
issue age of the deceased Owner applies in computing the Death Benefit, payable
at the death of a spouse who has elected to be treated as the successor Owner.
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<PAGE> 65
CONTRACT CHARGES AND EXPENSES
Charges and deductions under the Contracts are made for KILICO's assumption of
mortality and expense risk and administrative expenses, and for an annual
Records Maintenance Charge. Subject to certain expense limitations, investment
management fees and other expenses of the Fund are indirectly borne by the
Contract Owner. KILICO will deduct state premium taxes from Contract Value when
paid by KILICO. Where applicable, the dollar amount of state premium taxes
previously paid or paid upon annuitization by KILICO will be charged back
against the Contract Value when and if the Contract is annuitized. Additionally,
where applicable, a Withdrawal Charge may be assessed by KILICO in the event of
early withdrawal or early annuitization.
A. CHARGES AGAINST THE SEPARATE ACCOUNT.
During the Accumulation Period and the Annuity Period, KILICO assesses that
portion of each Subaccount representing assets under Periodic Payment Contracts
with a daily asset charge for mortality and expense risks and administrative
costs, which amounts to an aggregate of one and three-tenths percent (1.30%) per
annum (consisting of approximately .70% for mortality risks, approximately .30%
for expense risks and approximately .30% for administrative costs). Flexible
Payment Contracts, which are no longer offered, have a daily asset charge of
1.00%. The administrative charge is intended to cover the average anticipated
administrative expenses to be incurred over the period the Contracts are in
force. With an administrative charge based on a percentage of assets, however,
there is not necessarily a direct relationship between the amount of the charge
and the administrative costs of a particular account. Additionally, KILICO
deducts an annual Records Maintenance Charge of $36 (assessed ratably each
quarter) for each Contract as described below. The Records Maintenance Charge is
not assessed during the Annuity Period.
These charges may be decreased by KILICO without notice but may not exceed the
rate or amount shown above. If the daily asset charge is insufficient to cover
the risks and costs, any loss or deficiency will fall on KILICO. Conversely, if
the charges prove more than sufficient, the gain will accrue to KILICO, creating
a profit which would be available for any proper corporate purpose including,
among other things, payment of distribution expenses.
1. RECORDS MAINTENANCE CHARGE.
KILICO will assess an annual Records Maintenance Charge of $36 (assessed ratably
each quarter) during the Accumulation Period against each Contract which has
participated in one or more of the Subaccounts during the calendar year whether
or not any Purchase Payments have been made during the year. This charge is to
reimburse KILICO for expenses incurred in establishing and maintaining the
records relating to a Contract's participation in the Separate Account. This
charge has been set at a level not greater than its costs. The imposition of the
Records Maintenance Charge will be made at the end of each calendar quarter and
will constitute a reduction in the net assets of each Subaccount.
At any time the Records Maintenance Charge is assessed, an equal portion of the
applicable charge will be assessed against each Subaccount in which the Contract
is participating and a number of Accumulation Units sufficient to equal the
proper portion of the charge will be redeemed from each Subaccount, or from the
General Account Contract Value if necessary to meet the assessment.
2. MORTALITY RISK.
Variable Annuity payments reflect the investment experience of each Subaccount
but are not affected by changes in actual mortality experience or by actual
expenses incurred by KILICO.
The mortality risk assumed by KILICO arises from two contractual obligations.
First, in case of the death of the Contract Owner or of the Annuitant prior to
the Annuitant's 75th birthday, and prior to the Annuity Date, KILICO will return
to the Beneficiary the Contract Value minus Debt, or the total amount of
Purchase Payments minus Debt, whichever is greater. If a Contract has been
subject to a partial withdrawal, the death benefit shall be the greater of (a)
Contract Value minus Debt, or (b) the total amount of Purchase Payments, minus
both Debt and the aggregate dollar amount of all previous partial withdrawals.
The second contractual obligation assumed by KILICO is to continue to make
annuity payments to each Annuitant for the entire life of the Annuitant under
Annuity Options involving life contingencies.
The latter assures each Annuitant that neither the Annuitant's own longevity nor
an improvement in life expectancy generally will have an adverse effect on the
annuity payments received under a Contract and relieves the Annuitant from the
risk of outliving the amounts accumulated for retirement.
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<PAGE> 66
3. EXPENSE RISK.
KILICO also assumes the risk that all actual expenses involved in administering
the Contracts including Contract maintenance costs, administrative costs, data
processing costs and costs of other services may exceed the amount recovered
from the Records Maintenance Charge or the amount recovered from the
administrative cost portion of the daily asset charge.
4. ADMINISTRATIVE COSTS.
The daily asset charge for administrative costs is imposed to reimburse KILICO
for the expenses it incurs for administering the Contracts, which include, among
other things, responding to Contract Owner inquiries, processing changes in
Purchase Payment allocations and providing reports to Contract Owners.
B. WITHDRAWAL CHARGE.
No sales charge is deducted from any Purchase Payment. However, a contingent
deferred sales charge ("Withdrawal Charge") will be used to cover expenses
relating to the sale of the Contracts, including commissions paid to sales
personnel, and other promotion and acquisition expenses. Also, withdrawals
(which may include certain loans) may be subject to certain adverse tax
consequences. (See "Tax Treatment of Withdrawals, Loans and Assignments.")
A Contract Owner may withdraw up to 10% of the Contract Value less Debt
determined at the time the withdrawal is requested in any Contract Year without
assessment of any charge. If the Contract Owner withdraws an amount in excess of
10% of the Contract Value in any Contract Year, the amount withdrawn in excess
of 10% subjects the Contract to a Withdrawal Charge. The Withdrawal Charge
starts at 6% in the first Contribution Year and reduces by 1% each Contribution
Year, so that there is no charge against Accumulation Units withdrawn or
annuitized in their seventh and later Contribution Years as shown below:
<TABLE>
<CAPTION>
YEAR OF
WITHDRAWAL
AFTER WITHDRAWAL
PURCHASE CHARGE
--------- ----------
<S> <C>
First......................................... 6%
Second........................................ 5%
Third......................................... 4%
Fourth........................................ 3%
Fifth......................................... 2%
Sixth......................................... 1%
Seventh and following......................... 0%
</TABLE>
When a withdrawal is requested, the recipient will receive a check in the amount
requested. To the extent that any Withdrawal Charge is applicable, the Contract
Value will be reduced by the amount of the Withdrawal Charge in addition to the
actual dollar amount sent to the Owner.
Because the Contribution Years are Contract Years in which a Purchase Payment is
made, Contract Owners may be subject to a Withdrawal Charge as indicated above,
even though the Contract may have been issued many years earlier. However, in no
event shall the aggregate Withdrawal Charges assessed against a Contract exceed
7.25% of the aggregate Purchase Payments made under the Contract. (For
additional details, see "Withdrawal During Accumulation Period.")
The Withdrawal Charges are intended to compensate KILICO for expenses in
connection with distribution of the Contracts. Under current assumptions, KILICO
anticipates Withdrawal Charges will not fully cover distribution expenses. To
the extent that distribution expenses are not recovered from Withdrawal Charges,
those expenses may be recovered from KILICO's general assets. Those assets may
include proceeds from the mortality and expense charge described above.
The Withdrawal Charge also applies at the time of annuitization to amounts
attributable to Accumulation Units in their sixth Contribution Year or earlier.
The amount annuitized is subject to the Withdrawal Charge, as applicable. There
shall be no Withdrawal Charge assessed upon annuitization so long as annuity
payments provide for payment under Annuity Options 2, 3 or 4, or payments under
Annuity Option 1 are scheduled to continue for at least five years. Effective
September 4, 1990, for Qualified Plan Contracts, Withdrawal Charges will be
waived if a Contract is
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<PAGE> 67
surrendered in the sixth Contract Year or later when the Annuitant is at least
59 1/2 years old at the time of such surrender.
The Withdrawal Charge may be reduced or eliminated, but only to the extent
KILICO anticipates that it will incur lower sales expenses or perform fewer
services because of economies arising from the size of the particular group, the
average contribution per participant, or the use of mass enrollment procedures.
Units of a Subaccount sold to officers, directors and employees of KILICO and
the Fund, the Fund's investment adviser, and principal underwriter or certain
affiliated companies, or to any trust, pension, profit-sharing or other benefit
plan for such persons may be withdrawn without any Withdrawal Charge.
C. FUND INVESTMENT MANAGEMENT FEE AND OTHER EXPENSES.
The net asset value of each of the Portfolios of the Fund reflects investment
management fees and certain general operating expenses already deducted from the
assets of the Portfolios. Subject to certain limitations, these fees and
expenses are indirectly borne by the Contract Owners. Investment management fees
are described on page 9. Further detail about fees and expenses of the
Portfolios is provided in the attached Prospectus for the Fund and in the Fund's
Statement of Additional Information.
D. STATE PREMIUM TAXES.
Certain state and local governments impose a premium tax ranging from 0% to 3.5%
on the amount of Purchase Payments. Where applicable, the dollar amount of state
premium taxes previously paid or payable upon annuitization by KILICO may be
charged against the Contract Value if not previously assessed, when and if the
Contract is annuitized. See "Appendix--State Premium Tax Chart" in the Statement
of Additional Information.
THE ANNUITY PERIOD
Contracts may be annuitized under one of several Annuity Options. Annuity
payments will begin on the Annuity Date under the Annuity Option selected by the
Owner.
1. ANNUITY PAYMENTS.
Annuity payments will be determined on the basis of (i) the annuity table
specified in the Contract, (ii) the Annuity Option selected, and (iii) the
investment performance of the Subaccount selected. The Annuitant receives the
value of a fixed number of Annuity Units each month. The value of an Annuity
Unit will reflect the investment performance of the Subaccounts selected, and
the amount of each annuity payment will vary accordingly. Annuity payments may
be subject to a Withdrawal Charge if made within the sixth Contribution Year or
earlier. If the Owner elects an annuity which provides either an income benefit
period of five years or more, or a benefit under which payment is contingent
upon the life of the payee(s), any applicable Withdrawal Charges will be waived.
2. ANNUITY OPTIONS.
The Contract Owner may elect to have annuity payments made under any one of the
Annuity Options specified in the Contract and described below. The Contract
Owner may decide at any time (subject to the provisions of any applicable
retirement plan) to commence annuity payments. A change of Annuity Option is
permitted if made before the date annuity payments are to commence. For a
Non-Qualified Plan Contract, if no other Annuity Option is elected, monthly
annuity payments will be made in accordance with Option 3 below with a ten (10)
year period certain. For a Qualified Plan Contract, if no other Annuity Option
is elected, monthly annuity payments will be made in the form of a qualified
joint and survivor annuity with a monthly income at two-thirds of the full
amount payable during the lifetime of the surviving payee. Generally, annuity
payments will be made in monthly installments. However, if the net proceeds
available to apply under an Annuity Option are less than $2,000, KILICO shall
have the right to pay the annuity in one lump sum. In addition, if the first
payment provided would be less than $25, KILICO shall have the right to change
the frequency of payments to quarterly, semiannual or annual intervals resulting
in an initial payment of at least $25.
The amount of periodic annuity payments will depend upon (a) the type of annuity
option selected; (b) the age of the payee; and (c) the investment experience of
the Subaccounts selected. For example, if the annuity option selected is income
for a specified period, the shorter the period selected the fewer payments will
be made and those payments will have a higher value. If the annuity option
selected is life income, it is likely the payments will be in a smaller amount
than income for a short specified period. If an individual selects the life
income with installments guaranteed option, the payments will probably be in a
smaller amount than for the life income option. If an individual selects the
joint and survivor annuity option, the payments will be smaller than those
measured by an
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individual life income option. The age of the payee will also influence the
amount of periodic annuity payments because presumably the older the payee, the
shorter the life expectancy and the larger the payments. Finally, if the
Contract Owner participates in a Subaccount with higher investment performance,
it is likely the Contract Owner will receive a higher periodic payment.
For Non-Qualified Plan Contracts issued on and after January 19, 1985, if the
Owner dies before the Annuity Date, Annuity Options which may be elected are
limited. The Annuity Options available are (a) Option 2 or (b) Option 1 or 3 for
a period no longer than the life expectancy of the Beneficiary (but not less
than 5 years from the Owner's death). If the Beneficiary is not an individual,
the entire interest must be distributed within 5 years of the Owner's death. The
Death Benefit distribution must begin no later than one year from the Owner's
death or such later date as prescribed by federal regulation.
OPTION 1--INCOME FOR SPECIFIED PERIOD.
An annuity payable monthly for a selected number of years ranging from five to
thirty. Upon payee's death, if the Beneficiary is a natural person, KILICO will
automatically continue payments for the remainder of the certain period to the
Beneficiary. If the Beneficiary is either an estate or trust, KILICO will pay a
commuted value of the remaining payments. Variable Annuity payments under Option
1 reflect the payment of the mortality and expense risk charge, even though
there is no life contingency risk associated with Option 1.
OPTION 2--LIFE INCOME.
An annuity payable monthly during the lifetime of the payee, terminating with
the last monthly payment due prior to the death of the payee. If this Option is
elected, annuity payments terminate automatically and immediately on the death
of the payee without regard to the number or total amount of payments made.
Thus, it is possible for an individual to receive only one payment if death
occurred prior to the date the second payment was due.
OPTION 3--LIFE INCOME WITH INSTALLMENTS GUARANTEED.
An annuity payable monthly during the lifetime of the payee with the provision
that if, at the death of the payee, payments have been made for less than five,
ten, fifteen or twenty years as elected, and the Beneficiary is a natural
person, KILICO will automatically continue payments for the remainder of the
elected period to the Beneficiary. If the Beneficiary is either an estate or
trust, KILICO will pay a commuted value of the remaining payments.
OPTION 4--JOINT AND SURVIVOR ANNUITY.
An annuity payable monthly while both payees are living. Upon the death of
either payee, the monthly income payable will continue during the lifetime of
the surviving payee at the percentage of such full amount chosen at the time of
election of this Option. Annuity payments terminate automatically and
immediately upon the death of the surviving payee without regard to the number
or total amount of payments received.
Payees under Option 1 by written notice to KILICO may cancel all or part of the
remaining payments due and receive that part of the remaining value of the
Contract.
3. ALLOCATION OF ANNUITY.
The Contract Owner may elect to have payments made on a fixed or variable basis,
or a combination of both. An Owner may exercise the transfer privilege during
the Accumulation Period for the purposes of such allocation. Any General Account
Contract Value will be annuitized on a fixed basis. Any Separate Account
Contract Value will be annuitized on a variable basis. Transfers during the
Annuity Period are permitted subject to stated limitations.
4. TRANSFER DURING ANNUITY PERIOD.
During the Annuity Period, the payee may transfer the value of the payee's
Contract interest in a Subaccount(s) to another Subaccount or to the General
Account by written request to KILICO subject to the following limitations:
a. No transfer to a Subaccount may be made during the first year of the
Annuity Period; subsequent transfers are limited to one per year during the
Annuity Period.
b. A Contract's entire interest in a Subaccount must be transferred.
c. A transfer to a Subaccount, if notice to KILICO is received more than
seven (7) days prior to any annuity payment date, shall be effective during
the Valuation Period next succeeding the date such notice is received. If
received fewer than seven (7) days before any annuity payment date, the
transfer shall be effective during the Valuation Period next succeeding
that annuity payment date.
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d. A transfer to the General Account may be made effective only on an
anniversary of the first Annuity Date and upon not less than thirty (30)
days prior written notice to KILICO.
The Annuity Unit value of a Subaccount shall be determined as of the end of the
Valuation Period next preceding the effective date of the transfer. The transfer
privilege may be suspended, modified or terminated at any time (subject to state
requirements). Payees should consider the appropriateness of each Subaccount's
investment objectives and risks as an investment during the Annuity Period.
5. ANNUITY UNIT VALUE.
The value of an Annuity Unit is determined independently for each of the
Subaccounts.
For each Subaccount, the Annuity Unit value for any Valuation Period is
determined by multiplying the Annuity Unit value for the immediately preceding
Valuation Period by the net investment factor for the Valuation Period for which
the Annuity Unit value is being calculated, and multiplying the result by an
interest factor which offsets the effect of the assumed investment earnings rate
of 2.5% per annum which is assumed in the annuity tables contained in the
Contract.
The net investment factor for each Subaccount for any Valuation Period is
determined by dividing (a) by (b) where:
(a) Is the value of an Accumulation Unit for the applicable Subaccount as
of the end of the current Valuation Period, plus or minus the per share
charge or credit for taxes reserved.
(b) Is the value of an Accumulation Unit for the applicable Subaccount as
of the end of the immediately preceding Valuation Period, plus or minus the
per share charge or credit for taxes reserved.
6. FIRST PERIODIC PAYMENT.
At the time annuity payments begin, the value of the Owner's Contract interest
is determined by multiplying the applicable Accumulation Unit values at the end
of the Valuation Period immediately preceding the date the first annuity payment
is due by the respective number of Accumulation Units credited to the Owner's
Contract interest as of the end of such Valuation Period, less the dollar amount
of premium taxes not previously deducted, if applicable, and less the amount of
the Withdrawal Charge, if applicable.
There is no withdrawal charge assessed so long as annuity payments provide for
payments under Annuity Options 2, 3 or 4 or payments under Annuity Option 1 are
scheduled to continue for at least five years.
The first annuity payment is determined by multiplying the benefit per $1,000 of
value shown in the applicable annuity table by the number of thousands of
dollars of Contract Value less deduction for Debt and premium taxes, if
applicable.
A 2.5% per annum assumed investment rate is built into the annuity tables
contained in the Contracts. If the actual net investment rate exceeds 2.5% per
annum, payments will increase at a rate equal to the amount of such excess.
Conversely, if the actual rate is less than 2.5% per annum, annuity payments
will decrease.
7. SUBSEQUENT PERIODIC PAYMENTS.
The amount of the second and subsequent annuity payments is determined by
multiplying the number of Annuity Units by the Annuity Unit value as of the
Valuation Period next preceding the date on which each annuity payment is due.
The dollar amount of the first annuity payment as determined above is divided by
the Annuity Unit value as of the Annuity Date to establish the number of Annuity
Units representing each annuity payment. The number of Annuity Units determined
for the first annuity payment remains constant for the second and subsequent
monthly payments.
8. FIXED ANNUITY PAYMENTS.
The amount of each payment under a Fixed Annuity will be determined from tables
prepared by KILICO. Such tables show the monthly payment for each $1,000 of
Contract Value allocated to provide a Fixed Annuity. Fixed Annuity payments will
not change regardless of investment, mortality or expense experience.
9. DEATH BENEFIT.
If the payee dies after the Annuity Date while the Contract is in force, the
death proceeds, if any, will depend upon the form of annuity payment in effect
at the time of death. (See "Annuity Options.")
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FEDERAL INCOME TAXES
The ultimate effect of Federal income taxes on Contract Value, on annuity
payments and on the economic benefit to the Contract Owner, Annuitant or
Beneficiary depends on KILICO's tax status, the type of retirement plan for
which the Contract is purchased and upon the tax status of the individual
concerned. Each individual Contract Owner should consult a competent tax
advisor.
A. KILICO'S TAX STATUS.
KILICO is taxed as a life insurance company under the current Internal Revenue
Code. The operations of the Separate Account are taxed as part of the total
operations of KILICO. However, the determination of tax charges and credits to
the Separate Account will be independent of the tax actually paid by KILICO.
Under current interpretations of existing Federal income tax law, investment
income of the Separate Account, to the extent that it is applied to increase an
individual Contract Owner's equity, is not taxed. Thus, a Subaccount may realize
net investment income and dividends, and the Subaccount may receive and reinvest
them, all without Federal income tax consequences for the Separate Account.
However, as a result of the Tax Reform Act of 1986, if the Contract Owner is not
an individual, income attributable to Purchase Payments made after February 28,
1986 generally is taxed to the Contract Owner.
B. AMOUNTS RECEIVED AS AN ANNUITY.
A fixed portion of each annuity payment is excludable from gross income as a
return of investment in the Contract and the balance is taxed as ordinary
income. For payments made on a fixed basis, the excludable amount is generally
the same for each payment. For payments made on a variable basis, the excludable
amount may be recalculated if any payment is less than the excludable amount.
The excludable amount of each Annuity Unit is determined by dividing the
investment in the Contract as of the Annuity Date by the number of Annuity Units
to be received under the payment option chosen.
For a Non-Qualified Plan Contract, the investment in the Contract is equal to
the Purchase Payments minus any withdrawals thereof. For a Qualified Plan
Contract, the investment in the Contract is equal to the employee's non-
deductible contributions, minus any prior distributions thereof.
For Annuity Dates after December 31, 1986, the excludable amount of any payment
may not exceed the unrecovered investment in the Contract immediately before
such payment. For Annuity Dates after July 1, 1986, the amount of the
unrecovered investment is allowed as a deduction on the final return of a
deceased Annuitant where annuity payments cease before the investment in the
Contract has been fully recovered.
C. NON-QUALIFIED PLAN CONTRACTS.
1. DIVERSIFICATION REQUIREMENTS.
While Section 72 of the Code governs the taxation of annuities in general,
Section 817(h) of the Code provides that nonqualified annuity contracts will not
be treated as annuities unless the underlying investments are "adequately
diversified" in accordance with regulations prescribed by the Secretary of the
Treasury. Such regulations require, among other things, that a mutual fund
underlying an annuity contract, such as those underlying the Contracts, may
invest no more than 55% of the value of its assets in one investment; 70% in two
investments; 80% in three investments; and 90% in four investments. If the above
diversification requirements are not met by each and every Portfolio, the
annuity contract could lose its overall tax status as an annuity, resulting in
current taxation of the excess of cash value over the "investment in the
contract" (as defined above) to the Contract Owner. KILICO has reviewed the
diversification regulations and believes that the Contracts are in compliance
with these regulations and that there is no threat to their current favorable
tax status as annuities. Furthermore, KILICO intends to make whatever changes
may be necessary and appropriate to these Contracts in the future in order to
maintain their continued favorable tax treatment.
In connection with the earlier issuance of temporary regulations relating to
diversification requirements, the Treasury Department announced that such
regulations do not provide guidance concerning the extent to which owners may
direct their investments to particular Subaccounts. Moreover any additional rule
may apply to pension plan contracts. It is possible that when such guidance is
available, the Contract may need to be modified to comply with such guidance.
Accordingly, KILICO reserves the right to modify the Contract as necessary to
prevent the
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Contract Owner from being considered the owner of the assets of the Subaccount.
Because the guidance has not been published, there can be no assurance as to
content or even whether application will be prospective only.
2. TAX TREATMENT OF WITHDRAWALS, LOANS AND ASSIGNMENTS.
Withdrawals from Non-Qualified Plan Contracts will be allocable first to any
investment in the Contract made prior to August 14, 1982 (if any), then to
ordinary income attributable to such investment, then to ordinary income
attributable to investment in the Contract made after August 13, 1982, and
finally to investment in the Contract made after August 13, 1982. Loans under a
Contract or collateral assignments or pledges of any portion of the value of
such Contract attributable to investment in the Contract after August 13, 1982
or income attributable to such investment are treated as withdrawals.
If the Owner transfers a Non-Qualified Plan Contract issued after April 22, 1987
by gift, the Owner must include in gross income the excess of the Contract Value
over the investment in the Contract as of the date of transfer.
Non-Qualified Plan Contracts entered into after October 21, 1988 which were
issued by KILICO (or an affiliate) during a calendar year are to be aggregated
and considered a single contract for purposes of determining the amount of any
withdrawal, loan, or assigned or pledged cash value includible in the Owner's
gross income.
3. 10-PERCENT PENALTY TAX ON PREMATURE DISTRIBUTIONS.
A 10% penalty is imposed on the taxable portion of any distribution to a
participant in a qualified pension or profit sharing plan, tax sheltered annuity
or individual retirement annuity ("IRA"), or under a Non-Qualified Plan
Contract, prior to age 59 1/2, death or disability of the participant or
Non-Qualified Plan Contract Owner.
The 10% penalty does not apply to any distribution which is part of a series of
substantially equal periodic payments (not less frequently than annually) made
for the life or life expectancy of the qualified plan participant or Non-
Qualified Plan Contract Owner, provided that there is no change in such payments
before the later of (i) the close of the 5-year period beginning on the date of
the first payment, or (ii) age 59 1/2, death or disability of such participant
or Owner. Further, the 10% penalty does not apply to any distribution from a
qualified pension or profit sharing plan or tax sheltered annuity on account of
retirement after age 55, or to any distribution from a Non-Qualified Plan
Contract: (i) attributable to investment in the Contract before August 14, 1982,
or (ii) where the Contract is an "immediate annuity" under the Internal Revenue
Code ("Code").
D. QUALIFIED PLANS.
The Contracts offered by this Prospectus are designed to be suitable for use
under Qualified Plans. Such contracts are commonly referred to as "Qualified
Plan Contracts." KILICO, in its sole discretion, reserves the right to waive
certain minimums with respect to large group contracts. Taxation of participants
in such Qualified Plans varies with the type of plan and the terms and
conditions of the specific plan. Qualified Plan Contract Owners, Annuitants and
Beneficiaries are cautioned that benefits under a Qualified Plan may be subject
to the terms and conditions of the plan regardless of the terms and conditions
of the Contracts issued pursuant to the plan. Following are general descriptions
of the types of Qualified Plans and of the use of the Contracts in connection
therewith. Purchasers intending to use the Contracts in connection with
Qualified Plans should seek competent tax advice.
(A) PENSION AND PROFIT-SHARING PLANS.
Sections 401(a) of the Code permits employers to establish qualified
retirement plans for employees. Taxation of plan participants depends on
the specific plan. Such plans are limited by law as to maximum permissible
contributions, distribution dates, non-forfeitability of interests and tax
rates applicable to distributions. In order to establish such a plan, a
plan document is adopted and implemented by the employer. Such retirement
plans may permit the purchase of the Contracts in order to provide benefits
under the plans.
(b) TAX-SHELTERED ANNUITIES.
Section 403(b) of the Code permits public school employees and employees of
certain types of charitable, educational and scientific organizations
specified in Section 501(c)(3) of the Code to purchase annuity contracts
and, subject to certain limitations, exclude the amount of purchase
payments from gross income for tax purposes. Generally, the annual
contribution limit is 20% of an employee's includible compensation times
the number of years of service, less previously excluded contributions. For
salary reduction plans the maximum contribution is $9,500. These annuity
contracts are commonly referred to as "tax-sheltered annuities."
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To the extent attributable to contributions to your tax-sheltered annuity
contract under a salary reduction agreement (or to transfers of such
amounts from other contracts), contributions made or earnings credited
after December 31, 1988 may not be withdrawn until separation from service,
attainment of age 59 1/2, death or disability. Salary reduction
contributions after December 31, 1988 may also be withdrawn in the case of
hardship within the meaning of section 403(b)(11) of the Internal Revenue
Code. Further, all amounts transferred to your contract from a Section
403(b)(7) custodial account are subject to such restrictions on withdrawal.
Under your employer's tax-sheltered annuity plan, you may be allowed to
transfer your contract value to other types of options, such as other fixed
or variable annuity contracts or Section 403(b)(7) custodial accounts.
(C) TREATMENT OF CERTAIN DISTRIBUTIONS FROM PENSION AND PROFIT SHARING
PLANS AND TAX-SHELTERED ANNUITIES.
Distributions from Pension and Profit Sharing Plans and Tax-Sheltered
Annuities which are eligible to be rolled over to an IRA or another
employer's retirement plan are generally subject to 20% withholding, unless
the participant exercises the right to a "direct rollover." A "direct
rollover" may be accomplished when the sponsor of a participant's existing
pension or profit sharing plan or tax-sheltered annuity makes a
distribution payable to the sponsor of the new IRA or new employer plan for
the participant's benefit.
If the participant does not exercise the right to a "direct rollover," in
general, 20% will be withheld from the distribution and credited against
the participant's income taxes incurred in the taxable year of the
distribution. Other rules may apply, therefore, KILICO suggests that
participants consult their tax advisors before making a decision.
(D) INDIVIDUAL RETIREMENT ANNUITIES.
Section 408(b) of the Code permits eligible individuals to make deductible
contributions to an individual retirement program known as an "Individual
Retirement Annuity" ("IRA"). Generally, the maximum contribution is $2,000
for an individual and $2,250 for an individual and spouse eligible for a
spousal IRA. In addition, certain distributions from qualified pension and
profit sharing plans, tax-sheltered annuities and other IRA's may be placed
on a tax-deferred basis into an IRA. When issued in connection with an IRA,
the Contract will be amended to conform to the requirements under such
plans. Purchasers have the right to revoke an IRA Contract within seven (7)
days of the receipt of the IRA disclosure statement which is attached to
the application used for IRA Contracts. The IRA disclosure statement also
provides more information on contribution limits. A purchaser can revoke
the IRA Contract within seven (7) days of the date the application was
signed by notifying KILICO.
PLEASE NOTE THAT AN IRA DISCLOSURE STATEMENT IS INCLUDED IN THIS PROSPECTUS
AS AN APPENDIX.
(E) DEFERRED COMPENSATION PLANS.
Section 457 of the Code allows a State defined to also include a political
subdivision of a State, and an agency or instrumentality of a State or a
political subdivision of a State, and any other tax exempt organization to
establish a deferred compensation plan ("Section 457 Plan") for the benefit
of its employees. Contracts issued under such a plan are owned by the
employer.
An employee electing to participate in a Section 457 Plan should understand
that all rights and benefits are governed strictly by the terms of the
plan. The employer is legal owner of any Contracts issued under the plan.
The employee is, in fact, a general creditor of the employer under the
terms of the plan. The employer, as owner of the Contracts, also retains
all voting and redemption rights which may accrue through the Contracts
issued under the plan.
The participating employee should look to the terms of the plan for any
charges in regard to participating in such plan other than those disclosed
in this Prospectus. Section 457 of the Code places limitations on
contributions to such plans. A participant must look to the terms of the
plan for an explanation of this limitation.
E. TAX WITHHOLDING.
KILICO is required to withhold federal income tax on the taxable portion of all
distributions under the Contracts unless the individual elects under a
nonqualified plan not to be subject to withholding. The rate of withholding will
depend on the type of distribution.
F. OTHER CONSIDERATIONS.
Because of the complexity of the law and its application to a specific
individual, tax advice may be needed by a person contemplating purchase of a
Contract or the exercise of elections under a Contract. The above comments
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concerning the Federal income tax consequences are not exhaustive, and special
rules are provided with respect to situations not discussed in this Prospectus.
The preceding description is based upon KILICO's understanding of current
Federal income tax law. KILICO cannot assess the probability that changes in tax
laws, particularly affecting annuities, will be made.
The preceding comments do not take into account state income or other tax
considerations which may be involved in the purchase of a Contract or the
exercise of elections under the Contract. For complete information on such
Federal and state tax considerations, a qualified tax adviser should be
consulted.
Legislation has been considered which would prohibit insurers from using
sex-distinct factors in determining annuity benefit payments. If "unisex"
requirements are adopted, KILICO may be required to utilize annuity tables which
do not differentiate the amount of annuity benefits on the basis of sex. This
might result in a change providing for either an increase in the initial amount
of monthly benefits applied for females or a decrease in such amount for males
or a combination of both. KILICO is using "unisex" annuity tables on Qualified
Plan Contracts.
DISTRIBUTION OF CONTRACTS
The Contracts are sold by licensed insurance agents, where the Contracts may be
lawfully sold, who are registered representatives of broker-dealers which are
registered under the Securities Exchange Act of 1934 and are members of the
National Association of Securities Dealers, Inc. In addition to commissions,
KILICO may, from time to time, pay or allow additional promotional incentives,
in the form of cash or other compensation, to broker-dealers that sell the
Contracts. In some instances, such other incentives may be offered only to
certain licensed broker-dealers that sell or are expected to sell during
specified time periods certain minimum amounts of the Contracts or other
contracts issued by KILICO. The Contracts are distributed through the principal
underwriter for the Separate Account, which is Investors Brokerage Services,
Inc. ("IBS"), a wholly owned subsidiary of KILICO, which enters into selling
group agreements with affiliated and unaffiliated broker-dealers.
VOTING RIGHTS
Proxy materials in connection with any shareholder meeting of the Fund will be
delivered to each Contract Owner with Subaccount interests invested in the Fund
as of the record date for voting at such meeting. Such proxy materials will
include an appropriate form which may be used to give voting instructions.
KILICO will vote Fund shares held in each Subaccount in accordance with
instructions received from persons having a Subaccount interest in such Fund
shares. Fund shares as to which no timely voting instructions are received will
be voted by KILICO in proportion to the voting instructions received from all
persons in a timely manner. KILICO will also vote any Fund shares attributed to
amounts it has accumulated in the Subaccounts in the same proportion that
Contract Owners vote. As a trust, the Fund is not required to hold annual
shareholders' meetings. It will, however, hold special meetings as required or
deemed desirable for such purposes as electing trustees, changing fundamental
policies or approving an investment advisory agreement.
Contract Owners of all Contracts participating in each Subaccount shall have
voting rights with respect to the Portfolio invested in by that Subaccount,
based upon each Contract Owner's proportionate interest in that Subaccount as
measured by units. The person having such voting rights will be the Contract
Owner before surrender, the Annuity Date or the death of the Annuitant, and
thereafter, the payee entitled to receive Variable Annuity payments under the
Contract. During the Annuity Period, voting rights attributable to a Contract
will generally decrease as Annuity Units attributable to an Annuitant decrease.
REPORTS TO CONTRACT OWNERS AND INQUIRIES
Immediately after each Contract anniversary, Contract Owners will be sent
statements for their own Contract showing the amount credited to each Subaccount
and to the Fixed Accumulation Option. It will also show the interest rate(s)
that KILICO is crediting upon amounts then held under the Fixed Accumulation
Option. In addition, Contract Owners transferring amounts among the investment
options or making additional payments will receive written confirmation of such
transactions. Upon request, any Contract Owner will be sent a current statement
in a form similar to that of the annual statement described above. Each Contract
Owner will also be sent an annual and a semi-annual report for the Fund and a
list of the securities held in each Portfolio of the Fund, as required by the
1940 Act.
A Contract Owner may direct inquiries to the individual who sold him or her the
Contract or may call 1-800-621-5001 or write to Kemper Investors Life Insurance
Company, Customer Service, 1 Kemper Drive, Long Grove, Illinois 60049.
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DOLLAR COST AVERAGING
A Contract Owner may predesignate a portion of the Contract Value under a
Contract attributable to the Money Market or Government Securities Subaccount to
be automatically transferred on a monthly basis to one or more of the other
Subaccounts and the General Account during the Accumulation Period. A Contract
Owner may enroll in this program at the time the Contract is issued or anytime
thereafter by properly completing the Dollar Cost Averaging enrollment form and
returning it to KILICO at its home office at least five (5) business days prior
to the second Tuesday of a month which is the date that all dollar cost
averaging transfers will be made ("Transfer Date").
Transfers will be made in the amounts designated by the Contract Owner and must
be at least $500 per Subaccount or General Account. The total Contract Value in
the Money Market or Government Securities Subaccount at the time Dollar Cost
Averaging is elected must be at least equal to the amount designated to be
transferred on each Transfer Date multiplied by the duration selected. Dollar
Cost Averaging will cease automatically if the Contract Value does not equal or
exceed the amount designated to be transferred on each Transfer Date and the
remaining amount will be transferred.
Dollar Cost Averaging will terminate when (i) the number of designated monthly
transfers has been completed, (ii) the Contract Value attributable to the Money
Market or Government Securities Subaccount is insufficient to complete the next
transfer, (iii) the Contract Owner requests termination in writing and such
writing is received by KILICO at its home office at least five (5) business days
prior to the next Transfer Date in order to cancel the transfer scheduled to
take effect on such date, or (iv) the Contract is surrendered or annuitized.
If the General Account has a balance of at least $10,000, a Contract Owner may
elect automatic calendar quarter transfers of interest accrued in the General
Account to one or more of the Subaccounts. A Contract Owner may enroll in this
program at any time by completing the proper Dollar Cost Averaging enrollment
form and returning it to KILICO at its home office at least ten (10) days prior
to the end of the calendar quarter. The Transfer Date will be within five
business days of the end of the calendar quarter.
Following the Issue Date, a Contract Owner may initiate, reinstate or change
Dollar Cost Averaging or change existing Dollar Cost Averaging terms by properly
completing the new enrollment form and returning it to KILICO at its home office
at least five (5) business days, ten (10) business days for General Account
transfers, prior to the next Transfer Date such transfer is to be made.
When utilizing Dollar Cost Averaging, a Contract Owner must be invested in the
Money Market or Government Securities Subaccount or the General Account and may
be invested in the General Account and a maximum of five other Subaccounts at
any given time. Election of Dollar Cost Averaging is not available during the
Annuity Period.
SYSTEMATIC WITHDRAWAL PLAN
KILICO administers a Systematic Withdrawal Plan ("SWP") which allows certain
Contract Owners to pre-authorize periodic withdrawals during the Accumulation
Period. Contract Owners entering into a SWP agreement instruct KILICO to
withdraw selected amounts from the General Account, or from any of the
Subaccounts on a monthly, quarterly, semi-annual or annual basis. Currently the
SWP is available to Contract Owners who request a minimum $100.00 periodic
payment. If the amounts distributed under the SWP exceed the amount free of
surrender charge (currently 10% of Contract Value) then the surrender charge
will be applied on any amounts exceeding the 10% free withdrawal. WITHDRAWALS
TAKEN UNDER THE SWP MAY BE SUBJECT TO THE 10% FEDERAL TAX PENALTY ON EARLY
WITHDRAWALS AND TO INCOME TAXES AND WITHHOLDING. SEE "FEDERAL INCOME TAXES."
Contract owners interested in SWP may obtain an application and full information
concerning this program and its restrictions from their representative or
KILICO's home office. The right is reserved to amend the SWP on thirty days'
notice. The SWP may be terminated at any time by the Contract Owner or KILICO.
PROVISIONS OF PRIOR CONTRACTS
Certain provisions of the Contract became effective upon the later of June 1,
1993 or the date of state approval. If the provisions are not yet approved in
your state, you will receive an earlier version of the Contract and the
following provisions will apply:
FIXED ACCUMULATION OPTIONS. Fixed accumulations and benefits under the
contracts are provided in two Fixed Accumulation Options of the General Account.
Any portion of the purchase payment allocated to a Fixed
23
<PAGE> 75
Accumulation Option is credited with interest daily at a rate declared by KILICO
in its sole discretion, but not less than 4%.
TRANSFER DURING ACCUMULATION PERIOD. During the Accumulation Period, a Contract
Owner may transfer the Contract Value among the Subaccounts and the Fixed
Accumulation Options subject to the following provisions: (i) No transfer can be
made until the initial Purchase payment has been in a Subaccount or General
Account I or II for fifteen days; (ii) Once all or part of the Owner's Separate
Account Contract value has been transferred to General Account I or II or from
one Subaccount to another Subaccount another transfer may not be made within the
next fifteen day period; (iii) Once all or part of the Owner's General Account I
Contract Value has been transferred to General Account II or to a Subaccount
another transfer may not be made within the next fifteen day period; and (iv)
General Account II Contract value, less Debt may be transferred one time during
the Contract Year to one or more Subaccounts or to General Account I in the
thirty day period following the anniversary of a Contract year or the thirty day
period following the date of the confirmation statement provided for the period
through the anniversary date, if later.
WITHDRAWALS DURING ACCUMULATION PERIOD. The Contract owner may request a
partial withdrawal subject to the following conditions:
(1) The amount requested must be at least $500 or the Owner's entire interest in
the Subaccount, General Account I or General Account II from which withdrawal is
requested.
(2) The Owner's Contract interest in the Subaccount, General Account I or
General Account II from which the withdrawal is requested must be at least $500
after the withdrawal is completed.
RECORDS MAINTENANCE CHARGE. KILICO will assess an annual Records Maintenance
Charge of $25 during the Accumulation period against each contract which has
participated in one or more of the Subaccounts during the calendar year whether
or not any purchase payments have been made during the year. The imposition of
the Records Maintenance Charge will be made on December 31st of each year.
ANNUITY UNIT VALUE AND FIRST PERIODIC PAYMENT. For purposes of determining the
value of an Annuity Unit and the amount of the first annuity payment, the
assumed interest rate is 4%, which is also reflected in the annuity tables
contained in the Contracts.
DOLLAR COST AVERAGING. A Contract Owner may predesignate a portion of the
Contract value under a Contract attributable to General Account I, Money Market
or Government Securities Subaccount to be automatically transferred on a monthly
basis to one or more of the other Subaccounts and the General Account II. A
Contract Owner may enroll in this program at the time the Contract is issued or
any time thereafter by properly completing the Dollar Cost Averaging enrollment
form and returning it to KILICO at its home office at least five (5) business
days prior to the second Tuesday of a month which is the date that all dollar
cost averaging transfers will be made ("Transfer Date").
Transfers will be made in the amounts designated by the Contract Owner and must
be at least $500 per Subaccount or General Account I or II. The total Contract
Value in General Account I, the Money Market or Government Securities Subaccount
at the time Dollar Cost Averaging is elected must be at least equal to the
amount designated to be transferred on each transfer date multiplied by the
duration selection. Dollar Cost Averaging will cease automatically if the
Contract value does not equal or exceed the amount designated to be transferred
on each Transfer Date and the remaining amount will be transferred.
Dollar Cost Averaging will terminate when (i) the number of designated monthly
transfers has been completed, (ii) the Contract Value attributable to General
Account I, Money Market or Government Securities Subaccount is insufficient to
complete the next transfer, (iii) the Contract Owner requests termination in
writing and such writing is received by KILICO at its home office at least five
(5) days prior to the next Transfer Date in order to cancel the transfer
scheduled to take effect on such date, or (iv) the Contract is surrendered.
If General Account II has a balance of at least $10,000, a Contract Owner may
elect automatic calendar quarter transfers of interest accrued in General
Account II to one or more of the Subaccounts. A Contract Owner may enroll in
this program at any time by completing the proper Dollar Cost Averaging
enrollment form and returning it to KILICO at its home office at least ten (10)
days prior to the end of the calendar quarter. The transfer will occur within
five business days of the end of the calendar quarter.
Following the Issue Date, a Contract Owner may initiate, reinstate or change
Dollar Cost Averaging or change existing Dollar Cost Averaging terms by properly
completing the new enrollment form and returning it to KILICO at
24
<PAGE> 76
its home office at least five (5) business days, ten (10) business days for
General Account II transfers prior to the next transfer Date such transfer is to
be made.
When utilizing Dollar Cost Averaging, a Contract owner must be invested in
either the General Account or the Money Market or Government Securities
Subaccount and be invested in a maximum of five other Subaccounts at any given
time. Election of Dollar Cost Averaging is not available during the annuity
period.
Systematic withdrawals may be done from General Account I or II or from any of
the Subaccounts.
LEGAL PROCEEDINGS
There are no material legal proceedings pending to which the Separate Account,
KILICO or KFS is a party. With respect to KILICO, in 1992, the Staff of the
Securities and Exchange Commission commenced an investigation into certain of
Kemper Corporation's ("Kemper's") real estate-related accounting practices and
related disclosures. KILICO's accounting and disclosure practices are consistent
with those of Kemper. Kemper fully cooperated throughout the Staff's
investigation which has now concluded. Kemper and the Staff have had settlement
discussions respecting this matter, and KILICO anticipates that this matter will
be resolved with respect to Kemper in 1995 with the filing of an administrative
proceeding.
TABLE OF CONTENTS--STATEMENT OF ADDITIONAL INFORMATION
The Statement of Additional Information, Table of Contents is: Services to the
Separate Account; Performance Information of Subaccounts; State Regulation;
Experts; Report of Independent Auditors, Financial Statements of the Separate
Account, Report of Independent Auditors and Financial Statements of KILICO. The
Statement of Additional Information should be read in conjunction with this
Prospectus.
25
<PAGE> 77
APPENDIX
KEMPER INVESTORS LIFE INSURANCE COMPANY DEFERRED FIXED AND
VARIABLE ANNUITY IRA DISCLOSURE STATEMENT
This Disclosure Statement describes the statutory and regulatory provisions
applicable to the operation of Individual Retirement Annuities. Internal Revenue
Service regulations require that this be given to each person desiring to
establish an IRA.
A. REVOCATION
Within 7 days of the date you signed your enrollment application, you may revoke
it and receive back 100% of your money. To do so, wire Kemper Investors Life
Insurance Company, 1 Kemper Drive, Long Grove, Illinois 60049, or call
1-800-621-5001.
B. STATUTORY REQUIREMENTS
The provisions of this contract meet the requirements of Section 408(b) of the
Internal Revenue Code as to form for use as an IRA annuity contract described in
Items 1 through 5 below. The contract has received a favorable determination
letter from the Internal Revenue Service as to the form of the annuity. However,
this is not a determination by the IRS of the IRA's merits. If you set up an IRA
using an annuity contract it must meet the following requirements:
1. The amount in your IRA must be fully vested at all times.
2. The contract must provide that you cannot transfer it to someone else.
3. The contract must have flexible premiums.
4. You must start receiving distributions by April 1 of the year following the
year in which you reach age 70 1/2 (see "Required Distributions").
5. The contract must provide that you cannot contribute more than $2,000 for any
year. (This requirement does not apply to rollovers. See "Rollovers and Direct
Transfers").
C. ROLLOVERS AND DIRECT TRANSFERS
1. A rollover is a tax-free transfer of cash or other assets from one retirement
program to another. There are two kinds of rollover payments. In one, you
transfer amounts from one IRA to another. With the other, you transfer amounts
from a qualified employee benefit plan or tax-sheltered annuity to an IRA. A
rollover is an allowable payment that you cannot deduct on your tax return.
2. You must complete the transfer by the 60th day after the day you receive the
distribution from your IRA or other qualified employee benefit plan.
3. A rollover distribution from an IRA may be made to you only once a year. The
one-year period begins on the date you receive the IRA distribution, not on the
date you roll it over (reinvest it) into another IRA.
4. A direct transfer of funds in an IRA from one trustee or insurance company to
another is not a rollover. It is a transfer that is not affected by the one-year
waiting period.
5. All or a part of the premium for this contract may be paid from a rollover
from an IRA, qualified pension or profit-sharing plan or tax-sheltered annuity,
or from a direct transfer from another IRA. The proceeds from this contract may
be used as a rollover contribution to another IRA.
6. Beginning January 1, 1993, a distribution that is eligible for rollover
treatment from a qualified employee benefit plan or tax-sheltered annuity will
be subject to 20% withholding by the Internal Revenue Service even if you roll
the distribution over to an IRA within the 60-day rollover period. To avoid
withholding, the distribution should be made as a direct transfer to the IRA
trustee or insurance company.
D. ALLOWANCE OF DEDUCTION
1. In general, the amount you can contribute each year is the lesser of $2,000
or your taxable compensation for the year. If you have more than one IRA, the
limit applies to the total contributions made to your own IRAs for the year.
26
<PAGE> 78
Generally, if you work the amount that you earn is compensation. Wages,
salaries, tips, professional fees, bonuses and other amounts you receive for
providing personal services are compensation. If you own and operate your own
business as a sole proprietor, your net earnings reduced by your deductible
contributions on your behalf to self-employed retirement plans is compensation.
If you are an active partner in a partnership and provide services to the
partnership, your share of partnership income reduced by deductible
contributions made on your behalf to self-employed retirement plans is
compensation. All taxable alimony and separate maintenance payments received
under a decree of divorce or separate maintenance is compensation.
2. If neither you nor your spouse are covered for any part of the year by an
employer retirement plan, you can deduct the lesser of $2,000 or your taxable
compensation. If either you or your spouse are covered by a retirement plan at
work, the $2,000 limit is reduced $10 for each $50 that your adjusted gross
income exceeds $40,000 (married filing jointly), $25,000 (single) or zero
(married filing separately).
3. Contributions to your IRA can be made at any time. If you make the
contribution between January 1 and April 15, however, you may elect to treat the
contribution as made either in that year or in the preceding year. You may file
a tax return claiming deduction for your IRA contribution before the
contribution is actually made. You must, however, make the contribution by the
due date of your return not including extensions.
4. You cannot make a contribution other than a rollover contribution to your IRA
for the year in which you reach age 70 1/2 or thereafter.
5. If both you and your spouse have compensation, you can each set up your own
IRA. The contribution for each of you is figured separately and depends on how
much each earns. Both of you cannot participate in the same IRA account or
contract.
6. If you file a joint return, you can contribute up to the lesser of $2,000 or
your taxable compensation to an IRA for a spouse who has not reached age 70 1/2
(even if you have reached age 70 1/2) and who has no compensation or elects to
be treated as having no compensation for the year. The total combined amount you
can contribute each year to your own IRA and the spousal IRA is the lesser of
$2,250 or your taxable compensation for the year.
7. If neither you nor your spouse are covered for any part of the year by an
employer retirement plan, you can deduct the lesser of $2,250 or your taxable
compensation. If you or your spouse is covered by a retirement plan, the $2,250
limit is reduced $10 for each $44.44 that your adjusted gross income exceeds
$40,000.
E. SEP-IRA'S
1. The maximum deductible contribution for a Simplified Employee Pension (SEP)
IRA is the lesser of $30,000 or 15% of compensation.
2. A SEP must be established and maintained by an employer (corporation,
partnership, sole proprietor). Information about the Kemper SEP is available
upon request.
F. TAX STATUS OF THE CONTRACT AND DISTRIBUTIONS
1. Earnings of your IRA annuity contract are not taxed until they are
distributed to you.
2. In general, taxable distributions are included in your gross income in the
year you receive them.
3. Distributions are non-taxable to the extent they represent a return of
non-deductible contributions. The non-taxable percentage of a distribution is
determined by dividing your total undistributed, non-deductible IRA
contributions by the value of all your IRAs (including SEPs and rollovers).
4. You cannot choose the special five-year or ten-year averaging that may apply
to lump sum distributions from qualified employer plans.
G. REQUIRED DISTRIBUTIONS
You must start receiving minimum distributions from your IRA starting with the
year you reach age 70 1/2 (your 70 1/2 year). Ordinarily, you must receive the
minimum distribution for any year by December 31. However, you may delay the
minimum distribution for your 70 1/2 year until April 1 of the following year.
Figure your required minimum distribution for each year by dividing the value of
your IRA as of the close of business on December 31 of the preceding year by the
applicable life expectancy. The applicable life expectancy is your remaining
life expectancy or the remaining joint life and last survivor expectancy of you
and your designated
27
<PAGE> 79
beneficiary. Life expectancies are determined using the expected return multiple
tables shown in IRS Publication 590 "Individual Retirement Arrangements." If a
designated beneficiary is more than 10 years younger than you, that beneficiary
is assumed to be exactly 10 years younger. To obtain a free copy of IRS
Publication 590 and other IRS forms, phone the IRS toll free at 1-800-829-3676
or write the IRS Forms Distribution Center for your area as shown in your income
tax return instructions.
Annuity payments which begin by April 1 of the year following your 70 1/2 year
satisfy the minimum distribution requirement if they provide for non-increasing
payments over the life or the lives of you and your spouse, provided that, if
installments are guaranteed, the guaranty period does not exceed the lesser of
20 years or the applicable life expectancy.
If you have more than one IRA, you must determine the required minimum
distribution separately for each IRA; however, you can total up these minimum
amounts and take the total from any one or more of the IRAs.
If the actual distribution from your IRA during a year after you die or reach
age 70 1/2 is less than the minimum amount that should be distributed in
accordance with the rules set forth at Items 5, 6 and 7 above, the difference is
an excess accumulation. There is a 50% excise tax on any excess accumulations.
However, if you have a good reason for having an excess accumulation in your IRA
you may not have to pay the tax. For example, if you have been given wrong
advice or you made a mistake in using or did not understand the excess
accumulation rules, you may request the IRS to excuse the tax.
H. TAX ON EXCESS CONTRIBUTIONS
1. You must pay a 6% excise tax each year on excess contributions that remain in
your IRA. Generally, an excess contribution is the amount contributed to your
IRA that is more than you can contribute or roll over. The excess is taxed for
the year of the excess contribution and for each year after that until you
correct it.
2. You will not have to pay the 6% excise tax if you withdraw the excess amount
by the date your tax return is due including extensions for the year of the
contribution. You do not have to include in your gross income an excess
contribution that you withdraw from your IRA before your tax return is due if
the income earned on the excess was also withdrawn and no deduction was allowed
for the excess contribution.
3. If an excess contribution in your IRA is a result of a rollover and the
excess occurred because information required to be supplied by the payor of the
distribution was incorrect, you may withdraw the excess amount attributable to
the incorrect information after the date your return is due and still not
include the amount withdrawn in your gross income. It is not necessary to
withdraw the income earned on the excess. You will, however, have to pay the 6%
tax on the excess amount for each year the excess contribution was in the IRA at
the end of the year.
I. TAX ON PREMATURE DISTRIBUTIONS
There is an additional tax on premature distributions equal to 10% of the amount
of the premature distribution that you must include in your gross income.
Premature distributions are generally amounts you withdraw from your IRA before
you are age 59 1/2. However, the tax on premature distributions does not apply:
1. To amounts that are rolled over tax free.
2. To a series of substantially equal periodic payments made over your life or
life expectancy, or the joint life or life expectancy of you and your
beneficiary.
3. If you are permanently disabled. You are considered disabled if you cannot do
any substantial gainful activity because of your physical or mental condition. A
physician must determine that the condition has lasted or can be expected to
last continuously for 12 months or more or that the condition can be expected to
lead to death.
J. IRA EXCISE TAX REPORTING
Use Form 5329, Return for Individual Retirement Arrangement Taxes, to report the
excise taxes on excess contributions, premature distributions, and excess
accumulations. If you do not owe any IRA excise taxes, you do not need Form
5329. Further information can be obtained from any district office of the
Internal Revenue Service.
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<PAGE> 80
K. BORROWING
If you borrow money against your IRA contract or use it as security for a loan,
you must include in gross income the fair market value of the IRA contract as of
the first day of your tax year. (Note: This contract does not allow borrowings
against it, nor may it be assigned or pledged as collateral for a loan.)
L. FINANCIAL DISCLOSURE
1. If this is a regular contribution IRA, the following information, based on
the charts shown at the back of this form, which assumes you were to make a
level contribution to the fixed account at the beginning of each year of $1,000,
must be completed prior to your signing the enrollment application.
<TABLE>
<CAPTION>
END
OF LUMP SUM TERMINATION AT LUMP SUM TERMINATION
YEAR VALUE OF CONTRACT * AGE VALUE OF CONTRACT *
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1 60
------------------------------------------------------------------------------------------------------
2 65
------------------------------------------------------------------------------------------------------
3 70
------------------------------------------------------------------------------------------------------
4
------------------------------------------------------------------------------------------------------
5
------------------------------------------------------------------------------------------------------
</TABLE>
* Includes applicable withdrawal charges as described in Item M below.
2. If this is a rollover IRA, the following information, based on the charts
shown at the back of this form, and all of which assumes you make one
contribution to the fixed account of $1,000 at the beginning of this year, must
be completed prior to your signing the enrollment application.
<TABLE>
<CAPTION>
END
OF LUMP SUM TERMINATION AT LUMP SUM TERMINATION
YEAR VALUE OF CONTRACT * AGE VALUE OF CONTRACT *
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1 60
------------------------------------------------------------------------------------------------------
2 65
------------------------------------------------------------------------------------------------------
3 70
------------------------------------------------------------------------------------------------------
4
------------------------------------------------------------------------------------------------------
5
------------------------------------------------------------------------------------------------------
</TABLE>
* Includes applicable withdrawal charges as described in Item M below.
M. FINANCIAL DISCLOSURE FOR THE SEPARATE ACCOUNT (VARIABLE ACCOUNT)
1. If on the enrollment application you indicated an allocation to a Subaccount,
this contract will be assessed a daily charge of an amount which will equal an
aggregate of 1.30% per annum for Periodic Payment Contracts.
2. An annual records maintenance charge of $36.00 will be assessed ratably each
quarter against the Separate Account value, if you have participated in a
Subaccount during the year. If insufficient values are in the Subaccounts when
the charge is assessed, the charge will be assessed against General Account
value.
3. Withdrawal (early annuitization) charges as follows will be assessed based on
the years elapsed since purchase payments (in a given contract year) were
received by the Company; under 1 year, 6%; over 1 to 2 years, 5%; over 2 to 3
years, 4%; over 3 to 4 years, 3%; over 4 to 5 years, 2%; over 5 to 6 years, 1%;
6th year and thereafter, 0%.
4. The method used to compute and allocate the annual earnings is contained in
the prospectus under the heading "Accumulation Unit Value."
5. The growth in value of your contract is neither guaranteed nor projected but
is based on the investment experience of the Separate Account.
29
<PAGE> 81
GUARANTEED LUMP SUM TERMINATION OF DEFERRED FIXED AND VARIABLE ANNUITY
COMPLETELY ALLOCATED TO THE GENERAL ACCOUNT WITH 3% GUARANTEED EACH YEAR.
(TERMINATION VALUES ARE BASED ON $1,000 ANNUAL CONTRIBUTIONS AT THE BEGINNING OF
EACH YEAR.)
<TABLE>
<CAPTION>
END OF TERMINATION END OF TERMINATION END OF TERMINATION END OF TERMINATION
YEAR VALUES* YEAR VALUES* YEAR VALUES* YEAR VALUES*
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1 $ 1,000 14 $17,371 27 $41,703 40 $ 77,436
---------------------------------------------------------------------------------------------------
2 2,000 15 18,929 28 43,991 41 80,796
---------------------------------------------------------------------------------------------------
3 3,038 16 20,534 29 46,348 42 84,256
---------------------------------------------------------------------------------------------------
4 4,130 17 22,187 30 48,775 43 87,821
---------------------------------------------------------------------------------------------------
5 5,264 18 23,889 31 51,275 44 91,492
---------------------------------------------------------------------------------------------------
6 6,442 19 25,643 32 53,850 45 95,274
---------------------------------------------------------------------------------------------------
7 7,665 20 27,449 33 56,503 46 99,169
---------------------------------------------------------------------------------------------------
8 8,932 21 29,309 34 59,235 47 103,181
---------------------------------------------------------------------------------------------------
9 10,236 22 31,225 35 62,048 48 107,313
---------------------------------------------------------------------------------------------------
10 11,580 23 33,199 36 64,947 49 111,569
---------------------------------------------------------------------------------------------------
11 12,965 24 35,232 37 67,932 50 115,953
---------------------------------------------------------------------------------------------------
12 14,390 25 37,326 38 71,007
---------------------------------------------------------------------------------------------------
13 15,859 26 39,482 39 74,174
---------------------------------------------------------------------------------------------------
</TABLE>
GUARANTEED LUMP SUM TERMINATION OF DEFERRED FIXED AND VARIABLE ANNUITY
COMPLETELY ALLOCATED TO THE GENERAL ACCOUNT WITH 3% GUARANTEED EACH YEAR.
(TERMINATION VALUES ARE BASED ON $1,000 SINGLE PREMIUM.)
<TABLE>
<CAPTION>
END OF TERMINATION END OF TERMINATION END OF TERMINATION END OF TERMINATION
YEAR VALUES* YEAR VALUES* YEAR VALUES* YEAR VALUES*
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1 $ 1,000 14 $ 1,513 27 $ 2,221 40 $ 3,262
---------------------------------------------------------------------------------------------------
2 1,013 15 1,558 28 2,288 41 3,360
---------------------------------------------------------------------------------------------------
3 1,053 16 1,605 29 2,357 42 3,461
---------------------------------------------------------------------------------------------------
4 1,095 17 1,653 30 2,427 43 3,565
---------------------------------------------------------------------------------------------------
5 1,138 18 1,702 31 2,500 44 3,671
---------------------------------------------------------------------------------------------------
6 1,183 19 1,754 32 2,575 45 3,782
---------------------------------------------------------------------------------------------------
7 1,230 20 1,806 33 2,652 46 3,895
---------------------------------------------------------------------------------------------------
8 1,267 21 1,860 34 2,732 47 4,012
---------------------------------------------------------------------------------------------------
9 1,305 22 1,916 35 2,814 48 4,132
---------------------------------------------------------------------------------------------------
10 1,344 23 1,974 36 2,898 49 4,256
---------------------------------------------------------------------------------------------------
11 1,384 24 2,033 37 2,985 50 4,384
---------------------------------------------------------------------------------------------------
12 1,426 25 2,094 38 3,075
---------------------------------------------------------------------------------------------------
13 1,469 26 2,157 39 3,167
---------------------------------------------------------------------------------------------------
</TABLE>
* Includes applicable withdrawal charges.
30
<PAGE> 82
TABLE OF CONTENTS
<TABLE>
<S> <C>
Summary.................................. 2
Financial Highlights..................... 3
Investment Objectives, Policies and Risk
Factors................................ 7
Investment Techniques.................... 16
Net Asset Value.......................... 20
Purchase and Redemption.................. 21
Dividends and Taxes...................... 22
Capital Structure and General
Information............................ 22
Investment Manager....................... 23
Distributor.............................. 25
Appendix................................. 26
</TABLE>
This prospectus contains information about the Fund that you should know before
investing and should be retained for future reference. A Statement of Additional
Information dated May 1, 1995, has been filed with the Securities and Exchange
Commission and is incorporated herein by reference. It is available upon request
without charge from the Fund at the address or telephone number shown above.
AN INVESTMENT IN THE MONEY MARKET PORTFOLIO IS NEITHER INSURED NOR GUARANTEED BY
THE U.S. GOVERNMENT. THERE CAN BE NO ASSURANCE THAT THE PORTFOLIO WILL BE ABLE
TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
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 THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
KEMPER
INVESTORS
FUND
PROSPECTUS MAY 1, 1995
KEMPER INVESTORS FUND
120 SOUTH LASALLE STREET
CHICAGO, ILLINOIS 60603
1-800-621-1048
Kemper Investors Fund (the "Fund") offers a choice of seven investment
portfolios to investors applying for certain variable life insurance and
variable annuity contracts offered by Participating Insurance Companies.
The seven investment portfolios are:
MONEY MARKET PORTFOLIO
TOTAL RETURN PORTFOLIO
HIGH YIELD PORTFOLIO
EQUITY PORTFOLIO
GOVERNMENT SECURITIES PORTFOLIO
INTERNATIONAL PORTFOLIO
SMALL CAPITALIZATION EQUITY PORTFOLIO
Shares of the Portfolios are available exclusively as pooled funding vehicles
for the variable life insurance and variable annuity contracts of Participating
Insurance Companies.
<PAGE> 83
SUMMARY
FUND INVESTMENT CONCEPT. Kemper Investors Fund (the "Fund") is an open-end
management investment company established on March 24, 1987 as a Massachusetts
business trust. The Fund is a series fund consisting of seven portfolios
("Portfolios"): Money Market, Total Return, High Yield, Equity, Government
Securities, International and Small Capitalization Equity ("Small Cap").
Additional Portfolios may be created from time to time. The Fund is the funding
vehicle for variable life insurance contracts ("VLI contracts") and variable
annuity contracts ("VA contracts") offered by the separate accounts of certain
life insurance companies ("Participating Insurance Companies"). The Fund
currently does not foresee any disadvantages to the holders of VLI contracts and
VA contracts arising from the fact that the interests of the holders of such
contracts may differ. Nevertheless, the Fund's Trustees intend to monitor events
in order to identify any material irreconcilable conflicts that may arise and to
determine what action, if any, should be taken. The VLI contracts and VA
contracts are described in the separate prospectuses issued by the Participating
Insurance Companies. The Fund assumes no responsibility for such prospectuses.
Individual VLI contract holders and VA contract holders are not the
"shareholders" of the Fund. Rather, the Participating Insurance Companies and
their separate accounts are the shareholders or investors (the "Shareholders"),
although such companies may pass through voting rights to their VLI and VA
contract holders.
INVESTMENT OBJECTIVES. The Money Market Portfolio seeks maximum current income
to the extent consistent with stability of principal from a portfolio of high
quality money market instruments. The Total Return Portfolio seeks a high total
return, a combination of income and capital appreciation, by investing in a
combination of debt securities and common stocks. The High Yield Portfolio seeks
to provide a high level of current income by investing in fixed-income
securities. The Equity Portfolio seeks maximum appreciation of capital through
diversification of investment securities having potential for capital
appreciation. The Government Securities Portfolio seeks high current return
consistent with preservation of capital from a portfolio composed primarily of
U.S. Government securities. The International Portfolio seeks total return, a
combination of capital growth and income, principally through an internationally
diversified portfolio of equity securities. The Small Cap Portfolio seeks
maximum appreciation of investors' capital. All portfolios except the Money
Market Portfolio may engage in options and financial futures transactions. The
Total Return, High Yield, Equity and Small Cap Portfolios each may invest a
portion of its assets in foreign securities and engage in related foreign
currency transactions. The International Portfolio will invest a substantial
portion of its assets in foreign securities and engage in related foreign
currency transactions. Foreign securities may include investments in developing
countries. The High Yield Portfolio will, and the Total Return and Government
Securities Portfolios may, invest in high yield (high risk) bonds. All of the
Portfolios are diversified. See "Investment Objectives, Policies and Risk
Factors."
RISK FACTORS. There is no assurance that the investment objective of any
Portfolio will be achieved and investment in each Portfolio includes risks that
vary in kind and degree depending upon the investment policies of the Portfolio.
The returns and net asset value of a Portfolio will fluctuate (except that the
Money Market Portfolio seeks to maintain a net asset value of $1.00 per share).
Investors should note that investments in high yield securities by certain
portfolios (principally the Total Return and High Yield Portfolios) entail
relatively greater risk of loss of income and principal than investments in
higher rated securities; and market prices of high yield securities may
fluctuate more than market prices of higher rated securities. The government
guarantee of the U.S. Government securities in which the Government Securities
Portfolio may invest does not guarantee the market value of the shares of the
Portfolio. Normally the value of investments in U.S. Government securities
varies inversely with changes in interest rates. Foreign investments by certain
Portfolios (principally the International Portfolio) involve risk and
opportunity considerations not typically associated with investing in U.S.
companies. The return of such a Portfolio can be adversely affected by changes
in currency exchange rates. Investment by the Small Cap Portfolio primarily in
smaller companies involves greater risk than investment in larger, more
established companies. There are special risks associated with options,
financial futures and foreign currency transactions and there is no assurance
that use of those investment techniques will be successful. Some of the
Portfolios may experience high portfolio turnover which would involve
correspondingly greater brokerage commissions or other transaction costs. See
"Investment Objectives, Policies and Risk Factors."
PURCHASES AND REDEMPTIONS. The separate accounts of the Participating Insurance
Companies place orders to purchase and redeem shares of each Portfolio based on,
among other things, the amount of premium payments to be invested and surrender
and transfer requests to be effected on that date pursuant to VLI and VA
contracts. See "Purchase and Redemption."
INVESTMENT MANAGER. Kemper Financial Services, Inc. ("KFS" or "investment
manager") serves as investment manager for each of the Portfolios at an
effective annual rate, payable monthly, of .50%, .55%, .60%, .60%, .55%, .75%
and .65% of average daily net assets of the Money Market, Total Return, High
Yield, Equity, Government Securities, International and Small Cap Portfolios,
respectively. See "Investment Manager."
GENERAL INFORMATION AND CAPITAL. Since the Fund offers multiple Portfolios, it
is known as a "series company." Shares of each Portfolio have equal
non-cumulative voting rights and equal rights with respect to dividends, assets
and liquidation of such Portfolio. Each Portfolio has its own objective,
policies and restrictions. The Fund is not required to hold annual shareholder
meetings, but will hold special shareholder meetings as required or deemed
desirable. See "Capital Structure and General Information."
2
<PAGE> 84
FINANCIAL HIGHLIGHTS
The tables below show financial information for each Portfolio expressed in
terms of one share outstanding throughout the period. The information for the
Money Market, Total Return, High Yield and Equity Portfolios for fiscal periods
prior to 1990 reflects the operations of certain Separate Accounts as discussed
under "Capital Structure and General Information." The information in the tables
for the years ended December 31, 1990 through 1994 is covered by the report of
the Fund's independent auditors. The report is contained in the Fund's
Registration Statement and is available from the Fund. The financial statements
contained in the Fund's 1994 Annual Report to Shareholders are incorporated
herein by reference and may be obtained by writing or calling the Fund.
MONEY MARKET PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year $1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
---------------------------------------------------------------------------------------------------------------------------------
Net investment
income and
dividends
declared .04 .03 .03 .06 .08 .09 .07 .06 .06 .08
---------------------------------------------------------------------------------------------------------------------------------
Net asset value,
end of year $1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%) 3.96 2.83 3.43 5.89 8.08 9.11 7.47 6.58 6.61 8.13
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE
NET ASSETS (%):
Expenses .53 .56 .57 .56 .58 .57 .56 .55 .56 .58
---------------------------------------------------------------------------------------------------------------------------------
Net investment
income 3.95 2.79 3.38 5.80 7.78 8.75 7.19 6.43 6.44 7.86
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end
of year (in
thousands) $83,821 68,177 75,270 76,479 95,759 78,683 80,362 92,130 83,793 96,270
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE TO MONEY MARKET PORTFOLIO:
The total return for 1994 includes the effect of a capital contribution from the
investment manager. Without the capital contribution, the total return would
have been 3.47%.
TOTAL RETURN PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year $2.586 2.473 2.658 2.071 2.021 1.707 1.605 1.661 1.496 1.214
---------------------------------------------------------------------------------------------------------------------------------
Income from
investment
operations:
Net investment
income .069 .069 .061 .080 .113 .102 .086 .075 .060 .057
---------------------------------------------------------------------------------------------------------------------------------
Net realized and
unrealized gain
(loss) on
investments (.313) .214 (.026) .677 (.013) .298 .102 (.056) .165 .282
---------------------------------------------------------------------------------------------------------------------------------
Total from
investment
operations (.244) .283 .035 .757 .100 .400 .188 .019 .225 .339
---------------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distributions
from net
investment
income .060 .050 .080 .110 .020 .086 .086 .075 .060 .057
---------------------------------------------------------------------------------------------------------------------------------
Distributions
from net
realized gain
on investments .168 .120 .140 .060 .030 -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
Distributions in
excess of net
realized gain
on investments .002 -- -- -- -- -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
Total dividends .230 .170 .220 .170 .050 .086 .086 .075 .060 .057
---------------------------------------------------------------------------------------------------------------------------------
Net asset value,
end of year $2.112 2.586 2.473 2.658 2.071 2.021 1.707 1.605 1.661 1.496
---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%) (9.50) 12.13 1.69 37.90 5.04 24.16 11.98 .62 15.13 28.42
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE
NET ASSETS (%):
Expenses .61 .59 .60 .61 .61 .58 .61 .58 .60 .66
---------------------------------------------------------------------------------------------------------------------------------
Net investment
income 3.13 3.19 3.41 3.46 5.94 5.43 5.19 4.04 3.59 4.23
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end
of year (in
thousands) $ 586,594 643,830 528,007 412,772 272,747 262,652 206,262 214,203 146,324 103,249
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover
rate (%) 128 191 160 187 139 102 152 129 136 117
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
3
<PAGE> 85
HIGH YIELD PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year $1.338 1.209 1.144 .914 1.122 1.258 1.225 1.290 1.226 1.143
---------------------------------------------------------------------------------------------------------------------------------
Income from investment
operations:
Net investment income .116 .120 .125 .140 .170 .151 .152 .139 .142 .150
---------------------------------------------------------------------------------------------------------------------------------
Net realized and
unrealized gain
(loss) on investments (.149) .109 .070 .300 (.338) (.163) .033 (.065) .064 .083
---------------------------------------------------------------------------------------------------------------------------------
Total from investment
operations (.033) .229 .195 .440 (.168) (.012) .185 .074 .206 .233
---------------------------------------------------------------------------------------------------------------------------------
Less dividends from net
investment income .120 .100 .130 .210 .040 .124 .152 .139 .142 .150
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of
year $1.185 1.338 1.209 1.144 .914 1.122 1.258 1.225 1.290 1.226
=================================================================================================================================
TOTAL RETURN (%) (2.25) 20.00 17.76 51.83 (15.45) (1.22) 15.66 5.82 17.63 21.58
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS (%):
Expenses .65 .63 .64 .67 .68 .63 .66 .62 .66 .69
---------------------------------------------------------------------------------------------------------------------------------
Net investment income 9.49 9.54 10.44 12.95 16.27 12.50 11.98 10.81 11.06 12.56
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of year
(in thousands) $ 219,415 233,964 162,158 121,608 88,566 150,674 138,461 95,502 143,605 71,282
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate
(%) 98 84 57 31 28 81 52 122 158 130
=================================================================================================================================
</TABLE>
EQUITY PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
year $2.935 2.631 2.642 1.681 1.692 1.348 1.374 1.377 1.283 1.058
---------------------------------------------------------------------------------------------------------------------------------
Income from investment
operations:
Net investment income .018 .004 .007 .017 .032 .039 .032 .030 .024 .036
---------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized
gain (loss) on investments (.138) .370 .082 .974 (.023) .338 (.026) (.003) .094 .225
---------------------------------------------------------------------------------------------------------------------------------
Total from investment
operations (.120) .374 .089 .991 .009 .377 .006 .027 .118 .261
---------------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distributions from net
investment income -- .010 .005 .030 .010 .033 .032 .030 .024 .036
---------------------------------------------------------------------------------------------------------------------------------
Distributions from net
realized gain on
investments .150 .060 .095 -- .010 -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
Total dividends .150 .070 .100 .030 .020 .033 .032 .030 .024 .036
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $2.665 2.935 2.631 2.642 1.681 1.692 1.348 1.374 1.377 1.283
=================================================================================================================================
TOTAL RETURN (%) (4.02) 14.63 3.57 59.47 0.60 27.87 .40 1.67 9.10 25.08
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
(%):
Expenses .66 .64 .64 .67 .68 .70 .71 .64 .70 .72
---------------------------------------------------------------------------------------------------------------------------------
Net investment income .69 .30 .65 .83 2.23 2.49 2.34 1.85 1.82 3.11
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of year (in
thousands) $ 321,708 284,461 203,624 118,983 61,621 51,961 45,833 46,474 30,228 45,913
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 106 78 78 106 135 93 301 165 262 95
=================================================================================================================================
</TABLE>
4
<PAGE> 86
GOVERNMENT SECURITIES PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990(a) 1989(a) 1988 1987(c)
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $1.267 1.277 1.287 1.175 1.091 1.053 1.020 1.000
---------------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .067 .060 .064 .090 .093 .092 .089 --
---------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments (.102) .020 .006 .082 .011 .036 (.056) .020
---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations (.035) .080 .070 .172 .104 .128 .033 .020
---------------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distributions from net investment income .060 .060 .050 .060 .020 .090 -- --
---------------------------------------------------------------------------------------------------------------------------------
Distributions from net realized gain on
investments .024 .030 .030 -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
Distributions in excess of net realized gain
on investments .006 -- -- -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
Total dividends .090 .090 .080 .060 .020 .090 -- --
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $1.142 1.267 1.277 1.287 1.175 1.091 1.053 1.020
=================================================================================================================================
TOTAL RETURN (%) (2.74) 6.48 5.90 15.22 9.81 13.14 3.27 --
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses .63 .60 .61 .63 .58 .53 1.81 --(b)
---------------------------------------------------------------------------------------------------------------------------------
Net investment income 5.69 5.05 6.08 7.42 8.48 8.73 7.94 --(b)
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of year (in thousands) $95,782 121,912 98,814 59,064 31,929 14,878 1,170 311
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 606 534 492 141 174 28 25 --
=================================================================================================================================
</TABLE>
NOTES TO GOVERNMENT SECURITIES PORTFOLIO:
(a) KFS waived its investment management fee from March 1, 1989 to March 1,
1990. Absent this waiver, the ratio of expenses to average net assets and
the ratio of net investment income to average net assets would have been
1.04% and 8.22%, respectively, in 1989 and .66% and 8.40%, respectively, in
1990.
(b) Because of the short start-up period from the Government Securities
Portfolio's initial public offering to December 31, 1987, ratios of expenses
and net investment income to average net assets for 1987 are not meaningful.
(c) For the period from September 3, 1987 (inception) through December 31, 1987.
INTERNATIONAL PORTFOLIO
<TABLE>
<CAPTION>
Year ended
December 31,
-------------------
1994 1993 1992(a)
-------- ------ -------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $1.306 .993 1.000
---------------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .009 .010 .010
---------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments (.056) .313 (.017 )
---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations (.047) .323 (.007 )
---------------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distributions from net investment income -- .009 --
---------------------------------------------------------------------------------------------------------------------------------
Distributions from net realized gain on investments .015 .001 --
---------------------------------------------------------------------------------------------------------------------------------
Total dividends .015 .010 --
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $1.244 1.306 .993
=================================================================================================================================
TOTAL RETURN (%) (3.59) 32.83 (.72 )
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses .93 .92 1.11
---------------------------------------------------------------------------------------------------------------------------------
Net investment income .74 .86 1.01
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of period (in thousands) $122,710 88,880 19,447
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 107 116 129
=================================================================================================================================
</TABLE>
NOTE TO INTERNATIONAL PORTFOLIO:
(a) For the period from January 6, 1992 (inception) through December 31, 1992.
5
<PAGE> 87
SMALL CAPITALIZATION EQUITY PORTFOLIO
<TABLE>
<CAPTION>
December 31, 1994(a)
--------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $1.000
---------------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .008
---------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain on investments .031
---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations .039
---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $1.039
---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%) 3.95
---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.25
---------------------------------------------------------------------------------------------------------------------------------
Net investment income .91
---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of period (in thousands) $12,909
---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 58
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE TO SMALL CAPITALIZATION EQUITY PORTFOLIO:
(a) For the period from May 2, 1994 (inception) through December 31, 1994.
NOTE:
Ratios for all Portfolios have been determined on an annualized basis. Total
return is not annualized.
6
<PAGE> 88
INVESTMENT OBJECTIVES, POLICIES AND RISK FACTORS
The Fund has adopted for each Portfolio certain fundamental investment
restrictions which, together with the investment objective and policies, cannot
be changed with respect to a Portfolio without approval by holders of a majority
of the outstanding voting shares as defined in the Investment Company Act of
1940 ("1940 Act"). See "Investment Restrictions" in the Statement of Additional
Information.
Each Portfolio has a different investment objective which it pursues through
separate investment policies, as described below. The differences in objectives
and policies among the Portfolios can be expected to affect the degree of market
and financial risk to which each Portfolio is subject and the return of each
Portfolio. There are market risks in any investment and therefore there can be
no assurance that the objective of any Portfolio will be achieved. The actual
return of a holder of a variable life or variable annuity contract will be
affected by charges imposed by the separate accounts of Participating Insurance
Companies.
MONEY MARKET PORTFOLIO. The Money Market Portfolio seeks maximum current income
to the extent consistent with stability of principal from a portfolio of the
following types of U.S. Dollar denominated money market instruments that mature
in twelve months or less:
1. Obligations of, or guaranteed by, the U.S. or Canadian Governments,
their agencies or instrumentalities. The two broad categories of U.S.
Government debt instruments are: (a) direct obligations of the U.S.
Treasury and (b) securities issued or guaranteed by agencies and
instrumentalities of the U.S. Government. Some obligations issued or
guaranteed by agencies or instrumentalities of the U.S. Government are
backed by the full faith and credit of the United States and others are
backed exclusively by the agency or instrumentality with limited rights of
the issuer to borrow from the U.S. Treasury.
2. Bank certificates of deposit, time deposits or bankers' acceptances
limited to U.S. banks or Canadian chartered banks having total assets in
excess of $1 billion.
3. Bank certificates of deposit, time deposits or bankers' acceptances of
U.S. branches of foreign banks having total assets in excess of $10
billion.
4. Commercial paper rated Prime-1 or Prime-2 by Moody's Investors Service,
Inc. ("Moody's") or A-1 or A-2 by Standard & Poor's Corporation ("S&P"), or
commercial paper or notes of comparable quality, such as are issued by
companies with an unsecured debt issue outstanding currently rated A or
higher by Moody's or S&P where the obligation is on the same or a higher
level of priority as the rated issue, and investments in other corporate
obligations such as publicly traded bonds, debentures and notes rated A or
higher by Moody's or S&P. See "Appendix--Ratings of Investments" in the
Statement of Additional Information for a description of the ratings.
5. Repurchase agreements of obligations which are suitable for investment
under the categories set forth above. Repurchase agreements are discussed
under "Investment Techniques--Repurchase Agreements."
In addition, the Money Market Portfolio limits its portfolio investments to
securities that meet the quality and diversification requirements of Rule 2a-7
of the 1940 Act. See "Net Asset Value."
To the extent the Money Market Portfolio purchases Eurodollar certificates of
deposit issued by London branches of U.S. banks, or commercial paper issued by
foreign entities, consideration will be given to their marketability, possible
restrictions on international currency transactions and to regulations imposed
by the domicile country of the foreign issuer. Eurodollar certificates of
deposit may not be subject to the same regulatory requirements as certificates
issued by U.S. banks and associated income may be subject to the imposition of
foreign taxes. The Money Market Portfolio will normally invest at least 25% of
its net assets in instruments issued by domestic or foreign banks.
The Money Market Portfolio seeks to maintain its net asset value at $1.00 per
share by valuing its portfolio of investments on the amortized cost method in
accordance with Rule 2a-7 of the 1940 Act. See "Net Asset Value." While the
Portfolio will make every effort to maintain a fixed net asset value at $1.00
per share, there can be no assurance that this objective will be achieved.
The Money Market Portfolio may invest in instruments that bear rates of interest
that are adjusted periodically or that "float" continuously according to
formulae intended to minimize fluctuations in values of the instruments
("Variable Rate Securities"). The Fund determines the maturity of Variable Rate
Securities in accordance with Securities and Exchange Commission ("SEC") rules
that allow the Fund to consider certain of such instruments as having maturities
earlier than the maturity date on the instrument.
TOTAL RETURN PORTFOLIO. The Total Return Portfolio seeks a high total return, a
combination of income and capital appreciation, by investing in a combination of
debt securities and common stocks. The Portfolio's investments will
7
<PAGE> 89
normally consist of domestic and foreign fixed income and equity securities.
Fixed income securities will include bonds, money market instruments (including
repurchase agreements) and other debt securities (such as U.S. and foreign
government securities and investment grade and high yield corporate obligations)
and preferred stocks, some of which may have a call on common stocks through
attached warrants or a conversion privilege. The Portfolio may invest in fixed
income securities that are in the lower rating categories and those that are
non-rated (sometimes called "junk bonds"). The characteristics of the rating
categories are described in "Appendix--Ratings of Investments" in the Statement
of Additional Information. For a discussion of lower rated and non-rated
securities and related risks, see "High Yield Portfolio" and "Special Risk
Factors--High Yield (High Risk) Bonds" below. Equity investments normally will
consist of common stocks and securities convertible into or exchangeable for
common stocks; however, the Portfolio may also make private placement
investments (which are normally restricted securities). For a further
description of equity securities, see "Equity Portfolio" below. The percentage
of assets invested in specific categories of fixed-income and equity securities
will vary from time to time depending upon the judgment of the investment
manager as to general market and economic conditions, trends in yields and
interest rates, and changes in fiscal or monetary policies.
The Portfolio does not make investments for short-term profits nor does it have
a separate portfolio turnover policy for equity and fixed income segments of its
portfolio. The Portfolio is not restricted in policy with regard to portfolio
turnover and will make changes in its investment portfolio from time to time as
business and economic conditions or market prices may dictate and as its
investment policy may require.
The Portfolio may write and purchase put and call options traded on national
securities exchanges or over-the-counter, including options on securities
indices. The Portfolio may also engage in financial futures transactions and may
purchase foreign securities and engage in related foreign currency transactions.
The Portfolio may purchase or sell portfolio securities on a when-issued or
delayed delivery basis. See "Special Risk Factors--Foreign Securities" and
"Investment Techniques."
HIGH YIELD PORTFOLIO. The High Yield Portfolio seeks to provide a high level of
current income by investing in fixed income securities. Fixed income obligations
include corporate debt securities, U.S. and Canadian Government securities,
obligations of U.S. and Canadian banking institutions, convertible securities,
assignments or participations in loans, preferred stock, and cash and cash
equivalents, including repurchase agreements.
The fixed income securities purchased by the Portfolio may include those in the
lower rating categories of the established rating services and those that are
non-rated (sometimes called "junk bonds"). Investments in such securities entail
relatively greater risk of loss of income or principal than investments in
higher rated securities; market prices may fluctuate more than market prices of
higher rated securities. See "Special Risk Factors--High Yield Bonds (High
Risk)" below for a discussion of such risks. These fixed income securities (debt
and preferred stock issues, including convertibles) normally offer a current
yield or yield to maturity that is significantly higher than the yield available
from securities rated in the four highest categories assigned by Moody's or S&P.
See "Appendix--Ratings of Investments" in the Statement of Additional
Information for a description of Moody's and S&P ratings.
The average maturity and the mix of investments of the Portfolio will vary as
the investment manager seeks to provide a high level of income considering the
available alternatives in the market. See "Appendix--Portfolio Composition of
High Yield Bonds" in this prospectus. Since interest rates vary with changes in
economic, market, political and other conditions, there can be no assurance that
historic interest rates are indicative of rates which may prevail in the future.
Since the value of securities in the Portfolio fluctuates depending upon market
factors and inversely with current interest rate levels, the net asset value of
its shares will fluctuate. The investment adviser will adjust the investments of
the Portfolio as considered advisable in view of prevailing or anticipated
market conditions. Accordingly, certain portfolio securities may be purchased or
sold in anticipation of a rise or a decline in interest rates.
The Portfolio does not make investments for short-term profits, but it is not
restricted in policy with regard to portfolio turnover and will make changes in
its investment portfolio from time to time as business and economic conditions
or market prices may dictate and as its investment policy may require.
The Portfolio may write and purchase put and call options traded on national
securities exchanges or over-the-counter, including options on securities
indices. The Portfolio may also engage in financial futures transactions and may
purchase foreign securities and engage in related foreign currency transactions.
The Portfolio may purchase or sell portfolio securities on a when-issued or
delayed delivery basis. See "Special Risk Factors--Foreign Securities" and
"Investment Techniques."
EQUITY PORTFOLIO. The Equity Portfolio seeks maximum appreciation of capital
through diversification of investment securities having potential for capital
appreciation. Current income will not be a significant factor. The Portfolio's
8
<PAGE> 90
investments normally will consist of equity securities and securities
convertible into or exchangeable for equity securities; however, it may also
make private placement investments (which are normally restricted securities).
As a non-fundamental investment policy, the Equity Portfolio will invest at
least 65% of its total assets in equity securities under normal circumstances.
Equity securities include common stocks, preferred stocks, securities
convertible into or exchangeable for common or preferred stocks, equity
investments in partnerships, joint ventures and other forms of non-corporate
investment and warrants, options and rights exercisable for equity securities.
The common stocks or the other securities selected will be those which, in the
investment manager's judgment, have significant appreciation possibilities.
Investment opportunities will often be sought among securities of small, less
well-known companies; but securities of large, well-known companies will also be
purchased, particularly when the investment manager considers such securities to
be priced favorably in comparison with securities of smaller companies.
For defensive purposes the Portfolio may temporarily hold a significant portion
of its assets in cash or defensive type securities, such as liquid high grade
debt securities, high quality money market instruments and repurchase
agreements.
The Portfolio does not intend to engage actively in trading for short-term
profits, but it is not restricted in policy with regard to portfolio turnover
and will make changes in its investment portfolio from time to time as business
and economic conditions or market prices may dictate and as its investment
policy may require.
The Portfolio may write and purchase put and call options traded on national
securities exchanges or over-the-counter, including options on securities
indices. The Portfolio may also engage in financial futures transactions and may
purchase foreign securities and engage in related foreign currency transactions.
The Portfolio may purchase or sell portfolio securities on a when-issued or
delayed delivery basis. See "Special Risk Factors--Foreign Securities" and
"Investment Techniques."
GOVERNMENT SECURITIES PORTFOLIO. The Government Securities Portfolio seeks high
current return consistent with preservation of capital from a portfolio composed
primarily of U.S. Government securities. The Portfolio will also invest in
fixed-income securities other than U.S. Government securities, and will engage
in options and financial futures transactions. The Portfolio may purchase or
sell portfolio securities on a when-issued or delayed delivery basis. See
"Investment Techniques." The Portfolio's current return is sought from interest
income and net short-term gains on securities and options and futures
transactions.
Under normal market conditions, the Portfolio will, as a fundamental policy,
invest at least 65% of its total assets in U.S. Government securities and
repurchase agreements of U.S. Government securities. There are two broad
categories of U.S. Government securities: (a) direct obligations of the U.S.
Treasury and (b) obligations issued or guaranteed by agencies and
instrumentalities of the United States. Some obligations issued or guaranteed by
agencies or instrumentalities are backed by the full faith and credit of the
United States (such as Government National Mortgage Association "GNMA"
Certificates) and others are backed exclusively by the agency or instrumentality
with limited rights of the issuer to borrow from the U.S. Treasury (such as
Federal National Mortgage Association Bonds). GNMA Certificates are debt
securities which represent an interest in one or a pool of mortgages which are
insured by the Federal Housing Administration or the Farmers Home
Administration, or guaranteed by the Veterans Administration. U.S. Government
securities may include "zero coupon" securities that have been stripped by the
U.S. Government of their unmatured interest coupons (see "Investment Policies
and Techniques" in the Statement of Additional Information for a discussion of
their features and risks) and collateralized obligations issued or guaranteed by
a U.S. Government agency or instrumentality (see "Investment Techniques").
U.S. Government securities of the type in which the Portfolio may invest have
historically involved little risk of loss of principal if held to maturity. The
government guarantee of the securities in the Portfolio, however, does not
guarantee the market value of the shares of the Portfolio. There are market
risks inherent in all investments in securities and the value of an investment
in the Portfolio will fluctuate over time. Normally, the value of the
Portfolio's investments varies inversely with changes in interest rates. For
example, as interest rates rise, the value of the Portfolio's investments will
tend to decline and, as interest rates fall, the value of the Portfolio's
investments will tend to increase. In addition, the potential for appreciation
in the event of a decline in interest rates may be limited or negated by
increased principal prepayments in respect to certain mortgage-backed
securities, such as GNMA certificates. Prepayment of high interest rate
mortgage-backed securities during times of declining interest rates will tend to
lower the return of the Portfolio and may even result in losses to the Portfolio
if some securities were acquired at a premium. With respect to securities
supported only by the credit of the issuing agency or by an additional line of
credit with the U.S. Treasury, there is no guarantee that the U.S. Government
will provide support to such agencies and such securities may involve risk of
loss of principal and interest.
9
<PAGE> 91
The Portfolio will seek to enhance income through limited investment (up to 35%
of total assets) in fixed income securities other than U.S. Government
securities. Such other fixed-income securities include: (a) corporate debt
securities that are rated at the time of purchase within the four highest grades
by either Moody's (Aaa, Aa, A, or Baa) or S&P (AAA, AA, A, or BBB); (b)
commercial paper that is rated at the time of purchase within the two highest
grades by either Moody's (Prime-1 or Prime-2) or S&P (A-1 or A-2); (c) bank
certificates of deposit (including term deposits) or bankers' acceptances issued
by domestic banks (including their foreign branches) and Canadian chartered
banks having total assets in excess of $1 billion; and (d) repurchase agreements
with respect to any of the foregoing; provided, however, the Portfolio may
invest up to 10% of its total assets in fixed income securities without regard
to the foregoing limitations, including securities that are rated below Baa by
Moody's and BBB by S&P or are non-rated (sometimes called "junk bonds"). The
characteristics of the rating categories are described in "Appendix--Ratings of
Investments" in the Statement of Additional Information. For a discussion of
lower rated and non-rated securities and related risks, see "High Yield
Portfolio" above and "Special Risk Factors--High Yield Bonds (High Risk)" below.
The Portfolio may also invest in collateralized obligations which, consistent
with the limitations reflected above, may be privately issued or may be issued
or guaranteed by U.S. Government agencies or instrumentalities. See "Investment
Techniques."
During temporary defensive periods when the Fund's investment manager deems it
appropriate, the Portfolio may invest all or a portion of its assets in cash or
short-term high quality money market instruments, including short-term U.S.
Government securities and repurchase agreements with respect to such securities.
The yields on these securities tend to be lower than the yields on other
securities to be purchased by the Portfolio.
INTERNATIONAL PORTFOLIO. The International Portfolio seeks a total return, a
combination of capital growth and income, principally through an internationally
diversified portfolio of equity securities. Investments may be made for capital
growth or for income or any combination thereof for the purpose of achieving a
high overall return. There is no limitation on the percentage or amount of the
Portfolio's assets that may be invested for growth or income, and therefore at
any particular time the investment emphasis may be placed solely or primarily on
growth of capital or on income. While the Portfolio invests principally in
equity securities of non-U.S. issuers, it may also invest in convertible and
debt securities and foreign currencies. The Portfolio invests primarily in
non-U.S. issuers, and under normal circumstances more than 80% of the
Portfolio's total assets will be invested in non-U.S. issuers. In determining
whether the Portfolio will be invested for capital growth or income, the
investment manager analyzes the international equity and fixed income markets
and seeks to assess the degree of risk and level of return that can be expected
from each market. Also see "Special Risk Factors--Foreign Securities."
In pursuing its objective, the Portfolio invests primarily in common stocks of
established non-U.S. companies believed to have potential for capital growth,
income or both. However, there is no requirement that the Portfolio invest
exclusively in common stocks or other equity securities. The Portfolio may
invest in any other type of security including, but not limited to, convertible
securities (including warrants), preferred stocks, bonds, notes and other debt
securities of companies (including Euro-currency instruments and securities) or
obligations of domestic or foreign governments and their political subdivisions.
When the investment manager believes that the total return potential in debt
securities equals or exceeds that of equity securities, the Portfolio may
substantially increase its holdings of such debt securities. The Portfolio may
establish and maintain reserves for defensive purposes or to enable it to take
advantage of future buying opportunities. The Portfolio's reserves may be
invested in domestic as well as foreign short-term money market instruments
including, but not limited to, government obligations, certificates of deposit,
bankers' acceptances, time deposits, commercial paper, short-term corporate debt
securities and repurchase agreements.
The Portfolio makes investments in various countries. Under normal
circumstances, business activities in not less than three different foreign
countries will be represented in the portfolio. The Portfolio may, from time to
time, have more than 25% of its assets invested in any major industrial or
developed country that in the view of KFS poses no unique investment risk. The
Portfolio may purchase securities of companies, wherever organized, that have
their principal activities and interests outside the United States. Under
exceptional economic or market conditions abroad, the Portfolio may, for
defensive purposes, invest all or a major portion of its assets in U.S.
Government obligations or securities of companies incorporated in and having
their principal activities in the United States. The Portfolio may also invest
its reserves in domestic short-term money market instruments as described above.
In determining the appropriate distribution of investments among various
countries and geographic regions, the investment manager ordinarily considers
such factors as: prospects for relative economic growth among foreign countries;
expected levels of inflation; relative price levels of the various capital
markets; government policies influencing business conditions; the outlook for
currency relationships and the range of individual investment
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opportunities available to the international investor. Currently, more than 60%
of the market capitalization of equity securities are represented by securities
in currencies other than the U.S. Dollar.
The Portfolio may purchase and sell options on securities, index options,
financial futures contracts and options on financial futures contracts. The
Portfolio may enter into forward foreign currency exchange contracts, foreign
currency options and foreign currency futures contracts and options thereon to
protect against uncertainty in the level of future foreign exchange rates. See
"Investment Techniques" below.
Generally, the Portfolio will not trade in securities for short-term profits
but, when circumstances warrant, securities may be sold without regard to the
length of time held.
Investors should understand that the expense ratio of the Portfolio can be
expected to be higher than that of portfolios investing in domestic securities
since the costs of operation are higher.
SMALL CAP PORTFOLIO. The Small Cap Portfolio seeks maximum appreciation of
investors' capital. Current income will not be a significant factor. The
Portfolio is designed primarily for investors with substantial resources and the
investment experience to consider their shares as a long-term investment
involving financial risk commensurate with potential substantial gains. Since
many of the securities in the Portfolio may be considered speculative in nature
by traditional investment standards, substantially greater than average market
volatility and investment risk may be involved. There is no assurance that the
Portfolio's objective will be achieved and its returns and net asset value will
fluctuate.
The Small Cap Portfolio seeks attractive areas for investment opportunity
arising from such factors as technological advances, new marketing methods, and
changes in the economy and population. Currently, the investment manager
believes that such investment opportunities may be found among the following:
(a) companies engaged in high technology fields such as electronics, medical
technology and computer software and specialty retailing; (b) companies having a
significantly improved earnings outlook as the result of a changed economic
environment, acquisitions, mergers, new management, changed corporate strategy
or product innovation; (c) companies supplying new or rapidly growing services
to consumers and businesses in such fields as automation, data processing,
communications, and marketing and finance; and (d) companies having innovative
concepts or ideas.
As a non-fundamental investment policy, at least 65% of the Small Cap
Portfolio's total assets normally will be invested in the equity securities of
smaller companies, i.e., those having a market capitalization of $1 billion or
less at the time of investment, many of which would be in the early stages of
their life cycle. The investment manager currently believes that investment in
such companies may offer greater opportunities for growth of capital than
larger, more established companies, but also involves certain special risks.
Smaller companies often have limited product lines, markets or financial
resources, and they may be dependent upon one or a few key people for
management. The securities of such companies generally are subject to more
abrupt or erratic market movements and may be less liquid than securities of
larger, more established companies or the market averages in general.
The Small Cap Portfolio's investment portfolio will normally consist primarily
of common stocks and securities convertible into or exchangeable for common
stocks, including warrants and rights. The Portfolio may also invest to a
limited degree in preferred stocks and debt securities when they are believed by
the investment manager to offer opportunities for capital growth. The Portfolio
may also write and purchase options, engage in financial futures transactions,
purchase foreign securities, engage in related foreign currency transactions and
lend its portfolio securities. See "Special Risk Factors--Foreign Securities"
and "Investment Techniques" below. When a defensive position is deemed
advisable, the Portfolio may, without limit, invest in high grade debt
securities and securities of the U.S. Government and its agencies or
instrumentalities or retain cash or cash equivalents, including repurchase
agreements.
In the selection of investments, long-term capital appreciation will take
precedence over short range market fluctuations. The Small Cap Portfolio does
not intend to engage actively in trading for short-term profits, although it may
occasionally make investments for short-term capital appreciation when such
action is believed to be desirable and consistent with sound investment
procedure. Generally, the Portfolio will make long-term rather than short-term
investments. Nevertheless, it may dispose of such investments at any time it may
be deemed advisable because of a subsequent change in the circumstances of a
particular company or industry or in general market or economic conditions. The
rate of portfolio turnover is not a limiting factor when changes in investment
are deemed appropriate. In addition, market conditions, cash requirements for
redemption and repurchase of Portfolio shares or other factors could affect the
portfolio turnover rate.
SPECIAL RISK FACTORS--HIGH YIELD (HIGH RISK) BONDS. As reflected above, the
High Yield Portfolio intends to invest a substantial portion of its assets in
fixed income securities offering high current income. Subject to their specific
investment objectives and policies as described above, the Total Return and
Government Securities
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Portfolios also may invest a portion of their assets in such securities. Such
high yield (high risk) fixed income securities will ordinarily be in the lower
rating categories (securities rated below the fourth category) of recognized
rating agencies or will be non-rated. Lower rated and non-rated securities,
which are sometimes referred to by the popular press as "junk bonds," have
widely varying characteristics and quality. These lower rated and non-rated
fixed income securities are considered, on balance, as predominantly speculative
with respect to capacity to pay interest and repay principal in accordance with
the terms of the obligation and generally involve more credit risk than
securities in the higher rating categories. Accordingly, an investment in the
High Yield Portfolio may not constitute a complete investment program and may
not be appropriate for all investors.
The market values of such securities tend to reflect individual corporate
developments to a greater extent than do those of higher rated securities, which
react primarily to fluctuations in the general level of interest rates. Such
lower rated securities also are more sensitive to economic conditions than are
higher rated securities. Adverse publicity and investor perceptions regarding
lower rated bonds, whether or not based on fundamental analysis, may depress the
prices for such securities. These and other factors adversely affecting the
market value of high yield securities will adversely affect a Portfolio's net
asset value. Although some risk is inherent in all securities ownership, holders
of fixed income securities have a claim on the assets of the issuer prior to the
holders of common stock. Therefore, an investment in fixed income securities
generally entails less risk than an investment in common stock of the same
issuer.
The investment philosophy of the High Yield Portfolio with respect to high yield
(high risk) bonds is based upon the premise that over the long term a broadly
diversified portfolio of high yield fixed-income securities should, even taking
into account possible losses, provide a higher net return than that achievable
on a portfolio of higher rated securities. The Portfolio seeks to achieve the
highest yields possible while reducing relative risk through (a) broad
diversification, (b) credit analysis by the investment manager of the issuers in
which the Portfolio invests, (c) purchase of high yield securities at discounts
from par or stated value when practicable and (d) monitoring and seeking to
anticipate changes and trends in the economy and financial markets that might
affect the prices of portfolio securities. The investment manager's judgment as
to the "reasonableness" of the risk involved in any particular investment will
be a function of its experience in managing fixed income investments and its
evaluation of general economic and financial conditions; of a specific issuer's
business and management, cash flow, earnings coverage of interest and dividends,
ability to operate under adverse economic conditions, and fair market value of
assets; and of such other considerations as the investment manager may deem
appropriate. The investment manager, while seeking maximum current yield, will
monitor current corporate developments with respect to portfolio securities and
potential investments and to broad trends in the economy. In some circumstances,
defensive strategies may be implemented to preserve or enhance capital even at
the sacrifice of current yield. Defensive strategies, which may be used singly
or in any combination, may include, but are not limited to, investments in
discount securities or investments in money market instruments as well as
futures and options strategies.
High yield (high risk) securities frequently are issued by corporations in the
growth stage of their development. They may also be issued in connection with a
corporate reorganization or issued as part of a corporate takeover. Companies
that issue such high yielding securities often are highly leveraged and may not
have available to them more traditional methods of financing. Therefore, the
risk associated with acquiring the securities of such issuers generally is
greater than is the case with higher rated securities. For example, during an
economic downturn or recession, highly leveraged issuers of high yield
securities may experience financial stress. During such periods, such issuers
may not have sufficient revenues to meet their interest payment obligations. The
issuer's ability to service its debt obligations may also be adversely affected
by specific corporate developments, or the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing. The
risk of loss from default by the issuer is significantly greater for the holders
of high yielding securities because such securities are generally unsecured and
are often subordinated to other creditors of the issuer.
A Portfolio may have difficulty disposing of certain high yield (high risk)
securities because they may have a thin trading market. Because not all dealers
maintain markets in all high yield securities, the Fund anticipates that such
securities could be sold only to a limited number of dealers or institutional
investors. The lack of a liquid secondary market may have an adverse effect on
market price and a Portfolio's ability to dispose of particular issues and may
also make it more difficult for the Fund to obtain accurate market quotations
for purposes of valuing a Portfolio's assets. Market quotations generally are
available on many high yield issues only from a limited number of dealers and
may not necessarily represent firm bids of such dealers or prices for actual
sales.
Zero coupon securities and pay-in-kind bonds involve additional special
considerations. Zero coupon securities are debt obligations that do not entitle
the holder to any periodic payments of interest prior to maturity or a specified
cash payment date when the securities begin paying current interest (the "cash
payment date") and therefore are
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issued and traded at a discount from their face amount or par value. The market
prices of zero coupon securities are generally more volatile than the market
prices of securities that pay interest periodically and are likely to respond to
changes in interest rates to a greater degree than do securities paying interest
currently having similar maturities and credit quality. Zero coupon, pay-in-kind
or deferred interest bonds carry additional risk in that, unlike bonds that pay
interest throughout the period to maturity, a Portfolio will realize no cash
until the cash payment date unless a portion of such securities is sold and, if
the issuer defaults, a Portfolio may obtain no return at all on its investment.
Additional information concerning high yield (high risk) securities appears
under "Appendix--Portfolio Composition of High Yield Bonds" in this prospectus
and under "Appendix--Ratings of Investments" in the Statement of Additional
Information.
SPECIAL RISK FACTORS--FOREIGN SECURITIES. The Total Return, High Yield, Equity
and Small Cap Portfolios invest primarily in securities that are publicly traded
in the United States; but, they have discretion to invest a portion of their
assets in foreign securities that are traded principally in securities markets
outside the United States. As a non-fundamental policy, these Portfolios
currently limit investment in foreign securities not publicly traded in the
United States to 25% of their total assets. These Portfolios may also invest
without limit in U.S. Dollar denominated American Depository Receipts ("ADRs")
which are bought and sold in the United States. The Money Market Portfolio,
within its quality standards, may also invest in securities of foreign issuers.
However, such investments will be in U.S. Dollar denominated instruments.
Foreign securities in which a Portfolio may invest include any type of security
consistent with that Portfolio's investment objective and policies. In
connection with their foreign securities investments, such Portfolios may, to a
limited extent, engage in foreign currency exchange transactions and purchase
and sell foreign currency options and foreign currency futures contracts as a
hedge and not for speculation. The International Portfolio may invest without
limit in foreign securities and may engage in foreign currency exchange
transactions and may purchase and sell foreign currency options and foreign
currency futures contracts. See "Investment Techniques--Options and Financial
Futures Transactions--Foreign Currency Transactions." The International
Portfolio may invest without limitation in securities of foreign issuers.
Foreign securities involve currency risks. The U.S. Dollar value of a foreign
security tends to decrease when the value of the U.S. Dollar rises against the
foreign currency in which the security is denominated and tends to increase when
the value of the U.S. Dollar falls against such currency. Fluctuations in
exchange rates may also affect the earning power and asset value of the foreign
entity issuing the security. Dividend and interest payments may be repatriated
based on the exchange rate at the time of disbursement or payment, and
restrictions on capital flows may be imposed. Losses and other expenses may be
incurred in converting between various currencies.
Foreign securities may be subject to foreign government taxes that reduce their
attractiveness. Other risks of investing in such securities include political or
economic instability in the country involved, the difficulty of predicting
international trade patterns and the possibility of imposition of exchange
controls. The prices of such securities may be more volatile than those of
domestic securities. In addition, there may be less publicly available
information about foreign issuers than about domestic issuers. Many foreign
issuers are not subject to uniform accounting, auditing and financial reporting
standards comparable to those applicable to domestic issuers. There is generally
less regulation of stock exchanges, brokers, banks, and listed companies abroad
than in the United States. With respect to certain foreign countries, there is a
possibility of expropriation, excessive taxation or diplomatic developments
which could affect investment in these countries.
Emerging Markets. While a Portfolio's investments in foreign securities will
principally be in developed countries, a Portfolio may make investments in
developing or "emerging" countries, which involve exposure to economic
structures that are generally less diverse and mature than in the United States,
and to political systems that may be less stable. A developing or emerging
market country can be considered to be a country that is in the initial stages
of its industrialization cycle. Currently, emerging markets generally include
every country in the world other than the United States, Canada, Japan,
Australia, New Zealand, Hong Kong, Singapore and most Western European
countries. Currently, investing in many emerging markets may not be desirable or
feasible because of the lack of adequate custody arrangements for a Portfolio's
assets, overly burdensome repatriation and similar restrictions, the lack of
organized and liquid securities markets, unacceptable political risks or other
reasons. As opportunities to invest in securities in emerging markets develop, a
Portfolio may expand and further broaden the group of emerging markets in which
it invests. In the past, markets of developing or emerging market countries have
been more volatile than the markets of developed countries; however, such
markets often have provided higher rates of return to investors. The investment
manager believes that these characteristics can be expected to continue in the
future.
Many of the risks described above relating to foreign securities generally will
be greater for emerging markets than for developed countries. For instance,
economies in individual developing markets may differ favorably or unfavorably
from the U.S. economy in such respects as growth of domestic product, rates of
inflation, currency
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depreciation, capital reinvestment, resource self-sufficiency and balance of
payments positions. Many emerging markets have experienced substantial rates of
inflation for many years. Inflation and rapid fluctuations in inflation rates
have had and may continue to have very negative effects on the economies and
securities markets of certain developing markets. Economies in emerging markets
generally are dependent heavily upon international trade and, accordingly, have
been and may continue to be affected adversely by trade barriers, exchange
controls, managed adjustments in relative currency values and other
protectionist measures imposed or negotiated by the countries with which they
trade. These economies also have been and may continue to be affected adversely
by economic conditions in the countries with which they trade.
Also, the securities markets of developing countries are substantially smaller,
less developed, less liquid and more volatile than the securities markets of the
United States and other more developed countries. Disclosure, regulatory and
accounting standards in many respects are less stringent than in the United
States and other developed markets. There also may be a lower level of
monitoring and regulation of developing markets and the activities of investors
in such markets, and enforcement of existing regulations has been extremely
limited.
In addition, brokerage commissions, custodial services and other needs relating
to investment in foreign markets generally are more expensive than in the United
States; and this is particularly true with respect to emerging markets. Such
markets have different settlement and clearance procedures. In certain markets
there have been times when settlements could not keep pace with the volume of
securities transactions, making it difficult to conduct such transactions. Such
settlement problems may cause emerging market securities to be illiquid. The
inability of a Portfolio to make intended securities purchases because of
settlement problems could cause the Portfolio to miss attractive investment
opportunities. Inability to dispose of a portfolio security because of
settlement problems could result in losses to a Portfolio from subsequent
declines in value of the portfolio security or, if a Portfolio has entered into
a contract to sell the security, it could result in possible liability to the
purchaser. Certain emerging markets may lack clearing facilities equivalent to
those in developed countries. Accordingly, settlements can pose additional risks
in such markets and ultimately can expose the Portfolio to the risk of losses
resulting from a Portfolio's inability to recover from a counterparty.
The risk also exists that an emergency situation may arise in one or more
emerging markets as a result of which trading in securities may cease or may be
substantially curtailed and prices for a Portfolio's securities in such markets
may not be readily available. A Portfolio's securities in the affected markets
will be valued at fair value determined in good faith by or under the direction
of the Board of Trustees of the Fund.
Investment in certain emerging market securities is restricted or controlled to
varying degrees. These restrictions or controls may at times limit or preclude
foreign investment in certain emerging market securities and increase the costs
and expenses of a Portfolio. Emerging markets may require governmental approval
for the repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. In addition, if a deterioration occurs in an
emerging market country's balance of payments, the market could impose temporary
restrictions on foreign capital remittances.
Fixed Income. Since most foreign fixed income securities are not rated, a
Portfolio will invest in foreign fixed income securities based on KFS's analysis
without relying on published ratings. Since such investments will be based upon
KFS's analysis rather than upon published ratings, achievement of a Portfolio's
goals may depend more upon the abilities of KFS than would otherwise be the
case.
The value of the foreign fixed income securities held by a Portfolio, and thus
the net asset value of the Portfolio's shares, generally will fluctuate with (a)
changes in the perceived creditworthiness of the issuers of those securities,
(b) movements in interest rates, and (c) changes in the relative values of the
currencies in which a Portfolio's investments in fixed income securities are
denominated with respect to the U.S. Dollar. The extent of the fluctuation will
depend on various factors, such as the average maturity of a Portfolio's
investments in foreign fixed income securities, and the extent to which a
Portfolio hedges its interest rate, credit and currency exchange rate risks.
Many of the foreign fixed income obligations in which a Portfolio will invest
will have long maturities. A longer average maturity generally is associated
with a higher level of volatility in the market value of such securities in
response to changes in market conditions.
Investments in sovereign debt, including Brady Bonds, involve special risks.
Brady Bonds are debt securities issued under a plan implemented to allow debtor
nations to restructure their outstanding commercial bank indebtedness. Foreign
governmental issuers of debt or the governmental authorities that control the
repayment of the debt may be unable or unwilling to repay principal or pay
interest when due. In the event of default, there may be limited or no legal
recourse in that, generally, remedies for defaults must be pursued in the courts
of the defaulting party. Political conditions, especially a sovereign entity's
willingness to meet the terms of its fixed income securities, are of
considerable significance. Also, there can be no assurance that the holders of
commercial bank loans to the same
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sovereign entity may not contest payments to the holders of sovereign debt in
the event of default under commercial bank loan agreements. In addition, there
is no bankruptcy proceeding with respect to sovereign debt on which a sovereign
has defaulted, and a Portfolio may be unable to collect all or any part of its
investment in a particular issue.
Foreign investment in certain sovereign debt is restricted or controlled to
varying degrees, including requiring governmental approval for the repatriation
of income, capital or proceeds of sales by foreign investors. These restrictions
or controls may at times limit or preclude foreign investment in certain
sovereign debt or increase the costs and expenses of a Portfolio. A significant
portion of the sovereign debt in which a Portfolio may invest is issued as part
of debt restructuring and such debt is to be considered speculative. There is a
history of defaults with respect to commercial bank loans by public and private
entities issuing Brady Bonds. All or a portion of the interest payments and/or
principal repayment with respect to Brady Bonds may be uncollateralized.
Privatized Enterprises. Investments in foreign securities may include securities
issued by enterprises that have undergone or are currently undergoing
privatization. The governments of certain foreign countries have, to varying
degrees, embarked on privatization programs contemplating the sale of all or
part of their interests in state enterprises. A Portfolio's investments in the
securities of privatized enterprises include privately negotiated investments in
a government or state-owned or controlled company or enterprise that has not yet
conducted an initial equity offering, investments in the initial offering of
equity securities of a state enterprise or former state enterprise and
investments in the securities of a state enterprise following its initial equity
offering.
In certain jurisdictions, the ability of a foreign entity to participate in
privatizations may be limited by local law, or the price or terms on which the
entity may be able to participate may be less advantageous than for local
investors. Moreover, there can be no assurance that governments that have
embarked on privatization programs will continue to divest their ownership of
state enterprises, that proposed privatizations will be successful or that
governments will not re-nationalize enterprises that have been privatized.
In the case of the enterprises in which a Portfolio may invest, large blocks of
the stock of those enterprises may be held by a small group of stockholders,
even after the initial equity offerings by those enterprises. The sale of some
portion or all of those blocks could have an adverse effect on the price of the
stock of any such enterprise.
Prior to making an initial equity offering, most state enterprises or former
state enterprises go through an internal reorganization or management. Such
reorganizations are made in an attempt to better enable these enterprises to
compete in the private sector. However, certain reorganizations could result in
a management team that does not function as well as the enterprises's prior
management and may have a negative effect on such enterprise. In addition, the
privatization of an enterprise by its government may occur over a number of
years, with the government continuing to hold a controlling position in the
enterprise even after the initial equity offering for the enterprise.
Prior to privatization, most of the state enterprises in which a Portfolio may
invest enjoy the protection of and receive preferential treatment from the
respective sovereigns that own or control them. After making an initial equity
offering these enterprises may no longer have such protection or receive such
preferential treatment and may become subject to market competition from which
they were previously protected. Some of these enterprises may not be able to
effectively operate in a competitive market and may suffer losses or experience
bankruptcy due to such competition.
Depositary Certificates. For many foreign securities, there are U.S.
Dollar-denominated ADRs, which are bought and sold in the United States and are
issued by domestic banks. ADRs represent the right to receive securities of
foreign issuers deposited in the domestic bank or a correspondent bank. ADRs do
not eliminate all the risk inherent in investing in the securities of foreign
issuers. However, by investing in ADRs rather than directly in foreign issuers'
stock, the Portfolios avoid currency risks during the settlement period. In
general, there is a large, liquid market in the United States for most ADRs. The
Portfolios may also invest in European Depository Receipts ("EDRs"), which are
receipts evidencing an arrangement with a European bank similar to that for ADRs
and are designed for use in the European securities markets. EDRs are not
necessarily denominated in the currency of the underlying security.
THE FUND. The portfolio turnover rates for the Portfolios are listed under
"Financial Highlights." Since securities with maturities of less than one year
are excluded from portfolio turnover rate calculations, the portfolio turnover
rate for the Money Market Portfolio is zero. Frequency of portfolio turnover
will not be a limiting factor should the investment manager deem it desirable to
purchase or sell securities. Higher portfolio turnover (over 100%) involves
correspondingly greater brokerage commissions or other transaction costs. Higher
portfolio turnover may result in the realization of greater net short-term
capital gains. In order to continue to qualify as a regulated investment company
for federal income tax purposes, less than 30% of the annual gross income of a
Portfolio must be derived
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from the sale or disposition of securities and certain other investments held by
a Portfolio for less than three months. See "Dividends and Taxes" in the
Statement of Additional Information.
A Portfolio will not, as a non-fundamental policy, purchase illiquid securities
including repurchase agreements maturing in more than seven days, if, as a
result thereof, more than 15% (10% for the Money Market Portfolio) of the
Portfolio's net assets, valued at the time of the transactions, would be
invested in such securities.
INVESTMENT TECHNIQUES
LENDING OF PORTFOLIO SECURITIES. Consistent with applicable regulatory
requirements, any of the Portfolios may lend securities (principally to
broker-dealers) where such loans are callable at any time and are continuously
secured by segregated collateral (cash or U.S. Government securities) equal to
no less than the market value, determined daily, of the securities loaned. The
Portfolio will receive amounts equal to dividends or interest on the securities
loaned. It will also earn income for having made the loan. Any cash collateral
pursuant to these loans will be invested in short-term money market instruments.
As with other extensions of credit there are risks of delay in recovery or even
loss of rights in the collateral should the borrower of the securities fail
financially. However, the loans would be made only to firms deemed by the Fund's
investment manager to be of good standing, and when the Fund's investment
manager believes the potential earnings justify the attendant risk. The Fund
will limit such lending to not more than one-third of the value of a Portfolio's
total assets.
OPTIONS AND FINANCIAL FUTURES TRANSACTIONS. The Total Return, High Yield,
Equity, Government Securities, International and Small Cap Portfolios may each
deal in options on securities and securities indices, which options may be
listed for trading on a national securities exchange or traded over-the-counter.
The Money Market Portfolio does not engage in options transactions. The ability
to engage in options transactions enables a Portfolio to pursue its investment
objective and also to hedge against currency and market risks but is not
intended for speculation. In connection with their foreign securities
investments, the Total Return, High Yield, Equity, International and Small Cap
Portfolios may also purchase and sell foreign currency options.
The Government Securities Portfolio individually may write (sell) covered call
options on up to 100% of net assets, may write (sell) secured put options on up
to 50% of net assets and may purchase put and call options provided that no more
than 5% of net assets may be invested in premiums on such options. The Total
Return, High Yield, Equity, International and Small Cap Portfolios may write
(sell) covered call and secured put options on up to 25% of net assets and may
purchase put and call options provided that no more than 5% of its net assets
may be invested in premiums on such options.
The Total Return, High Yield, Equity, Government Securities, International and
Small Cap Portfolios may write (sell) covered call options so long as they own
securities or other assets that are acceptable for escrow purposes. Also, such
Portfolios may write (sell) secured put options, which means that so long as the
Portfolio is obligated as a writer of a put option, it will invest an amount not
less than the exercise price of the put option in money market instruments.
A call option gives the purchaser the right to buy, and the writer the
obligation to sell, the underlying security or other asset at the exercise price
during the option period. A put option gives the purchaser the right to sell,
and the writer the obligation to buy, the underlying security or other asset at
the exercise price during the option period. The writer of a covered call owns
securities or other assets that are acceptable for escrow and the writer of a
secured put invests an amount not less than the exercise price in eligible
securities or other assets to the extent that it is obligated as a writer. If a
call written by a Portfolio is exercised, the Portfolio foregoes any possible
profit from an increase in the market price of the underlying security or other
asset over the exercise price plus the premium received. In writing puts, there
is a risk that a Portfolio may be required to take delivery of the underlying
security or other asset at a disadvantageous price.
Over-the-counter traded options ("OTC options") differ from exchange traded
options in several respects. Such options are transacted with dealers directly
and not with a clearing corporation and there is a risk of non-performance by
the dealer as a result of the insolvency of such dealer or otherwise, in which
event a Portfolio may experience material losses. However, in writing options
the premium is paid in advance by the dealer. OTC options are available for a
greater variety of securities or other assets, and a wider range of expiration
dates and exercise prices, than for exchange traded options.
A Portfolio, as part of its option transactions, also may use index options.
Through the writing or purchase of index options a Portfolio can achieve many of
the same objectives as through the use of options on individual securities.
Options on securities indices are similar to options on a security except that,
rather than the right to take or make delivery of a security at a specified
price, an option on a securities index gives the holder the right to receive,
upon
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exercise of the option, an amount of cash if the closing level of the securities
index upon which the option is based is greater than, in the case of a call, or
less than, in the case of a put, the exercise price of the option.
Price movements in securities which a Portfolio owns or intends to purchase
probably will not correlate perfectly with movements in the level of an index
and, therefore, a Portfolio bears the risk of a loss on an index option which is
not completely offset by movements in the price of such securities. Because
index options are settled in cash, a call writer cannot determine the amount of
its settlement obligations in advance and, unlike call writing on specific
securities, cannot provide in advance for, or cover, its potential settlement
obligations by acquiring and holding the underlying securities.
The Total Return, High Yield, Equity, Government Securities, International and
Small Cap Portfolios may each engage in financial futures transactions. The
Money Market Portfolio does not engage in financial futures transactions.
Financial futures contracts are commodity contracts that obligate the long or
short holder to take or make delivery of a specified quantity of a financial
instrument, such as a security, or the cash value of a securities index during a
specified future period at a specified price. A Portfolio will "cover" futures
contracts sold by the Portfolio and maintain in a segregated account certain
liquid assets in connection with futures contracts purchased by the Portfolio as
described under "Investment Policies and Techniques" in the Statement of
Additional Information. In connection with their foreign securities investments,
the Total Return, High Yield, Equity, International and Small Cap Portfolios may
also engage in foreign currency financial futures transactions. A Portfolio will
not enter into any futures contracts or options on futures contracts if the
aggregate of the contract value of the outstanding futures contracts of the
Portfolio and futures contracts subject to outstanding options written by the
Portfolio would exceed 50% of the total assets of the Portfolio.
The Portfolios may engage in financial futures transactions and may use index
options as an attempt to hedge against currency and market risks. For example,
when the near-term market view is bearish but the portfolio composition is
judged satisfactory for the longer term, exposure to temporary declines in the
market may be reduced by entering into futures contracts to sell securities or
the cash value of an index. Conversely, where the near-term view is bullish, but
a Portfolio is believed to be well positioned for the longer term with a high
cash position, the Portfolio can hedge against market increases by entering into
futures contracts to buy securities or the cash value of an index. In either
case, the use of futures contracts would tend to reduce portfolio turnover and
facilitate a Portfolio's pursuit of its investment objective. Also, if a
Portfolio owned long-term bonds and interest rates were expected to rise, it
could sell financial futures contracts. If interest rates did increase, the
value of the bonds in the Portfolio would decline, but this decline would be
offset in whole or in part by an increase in the value of the Portfolio's
futures contracts. If, on the other hand, long-term interest rates were expected
to decline, the Portfolio could hold short-term debt securities and benefit from
the income earned by holding such securities, while at the same time the
Portfolio could purchase futures contracts on long-term bonds or the cash value
of a securities index. Thus, the Portfolio could take advantage of the
anticipated rise in the value of long-term bonds without actually buying them.
The futures contracts and short-term debt securities could then be liquidated
and the cash proceeds used to buy long-term bonds.
Futures contracts entail risks. If the investment manager's judgment about the
general direction of interest rates, markets or exchange rates is wrong, the
overall performance may be poorer than if no such contracts had been entered
into. There may be an imperfect correlation between movements in prices of
futures contracts and portfolio assets being hedged. In addition, the market
prices of futures contracts may be affected by certain factors. If participants
in the futures market elect to close out their contracts through offsetting
transactions rather than meet margin requirements, distortions in the normal
relationship between the assets and futures market could result. Price
distortions also could result if investors in futures contracts decide to make
or take delivery of underlying securities or other assets rather than engage in
closing transactions because of the resultant reduction in the liquidity of the
futures market. In addition, because, from the point of view of speculators,
margin requirements in the futures market are less onerous than margin
requirements in the cash market, increased participation by speculators in the
futures market could cause temporary price distortions. Due to the possibility
of price distortions in the futures market and because of the imperfect
correlation between movements in the prices of securities or other assets and
movements in the prices of futures contracts, a correct forecast of market
trends by the investment manager still may not result in a successful hedging
transaction. A Portfolio could also experience losses if it could not close out
its futures position because of an illiquid secondary market. If any of these
events should occur, a Portfolio could lose money on the financial futures
contracts and also on the value of its portfolio assets. The costs incurred in
connection with futures transactions could reduce a Portfolio's return.
Index options involve risks similar to those risks relating to transactions in
financial futures contracts described above. Also, an option purchased by a
Portfolio may expire worthless, in which case a Portfolio would lose the premium
paid therefor.
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A Portfolio may engage in futures transactions only on commodities exchanges or
boards of trade. A Portfolio will not engage in transactions in index options,
financial futures contracts or related options for speculation, but only as an
attempt to hedge against changes in interest rates or market conditions
affecting the values of securities which the Portfolio owns or intends to
purchase.
FOREIGN CURRENCY TRANSACTIONS. As indicated under "Investment Objectives,
Policies and Risk Factors--Special Risk Factors--Foreign Securities," the Total
Return, High Yield, Equity and Small Cap Portfolios may invest a limited portion
of their assets, and the International Portfolio may invest without limit, in
securities denominated in foreign currencies. These Portfolios may engage in
foreign currency transactions in connection with their investments in foreign
securities but will not speculate in foreign currency exchange.
The value of the foreign securities investments of a Portfolio measured in U.S.
Dollars may be affected favorably or unfavorably by changes in foreign currency
exchange rates and exchange control regulations, and the Portfolio may incur
costs in connection with conversions between various currencies. A Portfolio
will conduct its foreign currency exchange transactions either on a spot (i.e.,
cash) basis at the spot rate prevailing in the foreign currency exchange market,
or through forward contracts to purchase or sell foreign currencies. A forward
foreign currency exchange contract involves an obligation to purchase or sell a
specific currency at a future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are traded directly between currency traders
(usually large commercial banks) and their customers.
When a Portfolio enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may want to establish the U.S. Dollar cost
or proceeds, as the case may be. By entering into a forward contract in U.S.
Dollars for the purchase or sale of the amount of foreign currency involved in
an underlying security transaction, the Portfolio is able to protect itself
against a possible loss between trade and settlement date resulting from an
adverse change in the relationship between the U.S. Dollar and such foreign
currency. However, this tends to limit potential gains that might result from a
positive change in such currency relationships. A Portfolio may also hedge its
foreign currency exchange rate risk by engaging in currency financial futures
and options transactions.
When the investment manager believes that the currency of a particular foreign
country may suffer a substantial decline against the U.S. Dollar, it may enter
into a forward contract to sell an amount of foreign currency approximating the
value of some or all of the Portfolio's securities denominated in such foreign
currency. In this situation the International Portfolio may, instead, enter into
a forward contract to sell a different foreign currency for a fixed U.S. Dollar
amount when the investment manager believes that the U.S. Dollar value of the
currency to be sold pursuant to the forward contract will fall whenever there is
a decline in the U.S. Dollar value of the currency in which portfolio securities
of the International Portfolio are denominated ("cross-hedge"). The forecasting
of short-term currency market movement is extremely difficult and whether such a
short-term hedging strategy will be successful is highly uncertain.
It is impossible to forecast with precision the market value of portfolio
securities at the expiration of a contract. Accordingly, it may be necessary for
a Portfolio to purchase additional currency on the spot market (and bear the
expense of such purchase) if the market value of the security is less than the
amount of foreign currency the Portfolio is obligated to deliver when a decision
is made to sell the security and make delivery of the foreign currency in
settlement of a forward contract. Conversely, it may be necessary to sell on the
spot market some of the foreign currency received upon the sale of the portfolio
security if its market value exceeds the amount of foreign currency the
Portfolio is obligated to deliver.
The Portfolios will not speculate in foreign currency exchange. A Portfolio will
not enter into such forward contracts or maintain a net exposure in such
contracts where the Fund would be obligated to deliver an amount of foreign
currency in excess of the value of the Portfolio's securities or other assets
(a) denominated in that currency or (b), in the case of a "cross-hedge" for the
International Portfolio, denominated in a currency or currencies that the Fund's
investment manager believes will have price movements that closely correlate
with that currency. The Fund's custodian bank segregates cash or liquid
high-grade debt securities in an amount not less than the value of each
Portfolio's total assets committed to forward foreign currency exchange
contracts entered into for the purchase of a foreign currency. If the value of
the securities segregated declines, additional cash or securities are added so
that the segregated amount is not less than the amount of the Portfolio's
commitments with respect to such contracts. The Portfolios do not intend to
enter into such forward contracts if they would have more than 15% of the value
of their total assets committed to such contracts. A Portfolio generally does
not enter into a forward contract with a term longer than one year.
RISK CONSIDERATIONS. The Statement of Additional Information contains further
information about the characteristics, risks and possible benefits of options,
futures and foreign currency transactions. See "Investment Policies and
Techniques" in the Statement of Additional Information. The principal risks are:
(a) possible imperfect correlation
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between movements in the prices of options, currencies or futures contracts and
movements in the prices of the securities or currencies hedged or used for
cover; (b) lack of assurance that a liquid secondary market will exist for any
particular option, futures or foreign currency contract at any particular time;
(c) the need for additional skills and techniques beyond those required for
normal portfolio management; (d) losses on futures contracts resulting from
market movements not anticipated by the investment manager; and (e) the possible
need to defer closing out certain options or futures contracts in order to
continue to qualify for beneficial tax treatment afforded regulated investment
companies under the Internal Revenue Code.
DELAYED DELIVERY TRANSACTIONS. The Total Return, High Yield, Equity and
Government Securities Portfolios may purchase or sell portfolio securities on a
when-issued or delayed delivery basis. When-issued or delayed delivery
transactions arise when securities are purchased by a Portfolio with payment and
delivery to take place in the future in order to secure what is considered to be
an advantageous price and yield to the Portfolio at the time of entering into
the transactions. The value of fixed yield securities to be delivered in the
future will fluctuate as interest rates vary. Because a Portfolio must set aside
cash or liquid high grade securities to satisfy its commitments to purchase
when-issued or delayed delivery securities, flexibility to manage the
Portfolio's investments may be limited if commitments to purchase when-issued or
delayed delivery securities were to exceed 25% of the value of its assets.
To the extent a Portfolio engages in when-issued or delayed delivery
transactions, it will do so for the purpose of acquiring portfolio securities
consistent with the Portfolio's investment objective and policies and not for
the purpose of investment leverage or to speculate in interest rate changes. A
Portfolio will make commitments to purchase securities on a when-issued or
delayed delivery basis only with the intention of actually acquiring the
securities, but a Portfolio reserves the right to sell these securities before
the settlement date if deemed advisable.
In some instances, the third-party seller of when-issued or delayed delivery
securities may determine prior to the settlement date that it will be unable to
meet its existing transaction commitments without borrowing securities. If
advantageous from a yield perspective, a Portfolio may, in that event, agree to
resell its purchase commitment to the third-party seller at the current market
price on the date of sale and concurrently enter into another purchase
commitment for such securities at a later date. As an inducement for a Portfolio
to "roll over" its purchase commitment, the Portfolio may receive a negotiated
fee.
REPURCHASE AGREEMENTS. Each Portfolio may invest in repurchase agreements,
under which it acquires ownership of a security and the broker-dealer or bank
agrees to repurchase the security at a mutually agreed upon time and price,
thereby determining the yield during the Portfolio's holding period. The
investment manager will evaluate the creditworthiness of all entities with which
the Fund intends to engage in repurchase agreements pursuant to procedures
adopted by the Board of Trustees of the Fund. Maturity of the securities subject
to repurchase may exceed one year. In the event of a bankruptcy or other default
of a seller of a repurchase agreement, the Portfolio might have expenses in
enforcing its rights, and could experience losses, including a decline in the
value of the underlying securities and loss of income. Repurchase agreements
maturing in more than seven days will be considered illiquid for purposes of the
Portfolios' limitations on illiquid securities.
SECTION 4(2) PAPER. Subject to its investment objectives and policies, a
Portfolio may invest in commercial paper issued by major corporations under the
Securities Act of 1933 in reliance on the exemption from registration afforded
by Section 3(a)(3) thereof. Such commercial paper may be issued only to finance
current transactions and must mature in nine months or less. Trading of such
commercial paper is conducted primarily by institutional investors through
investment dealers, and individual investor participation in the commercial
paper market is very limited. A Portfolio also may invest in commercial paper
issued in reliance on the so-called "private placement" exemption from
registration afforded by Section 4(2) of the Securities Act of 1933 ("Section
4(2) paper"). Section 4(2) paper is restricted as to disposition under the
federal securities laws, and generally is sold to institutional investors such
as a Portfolio who agree that they are purchasing the paper for investment and
not with a view to public distribution. Any resale by the purchaser must be in
an exempt transaction. Section 4(2) paper normally is resold to other
institutional investors like the Portfolio through or with the assistance of the
issuer or investment dealers who make a market in the Section 4(2) paper, thus
providing liquidity. The Fund's investment adviser considers the legally
restricted but readily saleable Section 4(2) paper to be liquid; however,
pursuant to procedures approved by the Board of Trustees of the Fund, if a
particular investment in Section 4(2) paper is not determined to be liquid, that
investment will be included within the 10% limitation on illiquid securities.
The Fund's investment manager monitors the liquidity of the Fund's investments
in Section 4(2) paper on a continuing basis.
COLLATERALIZED OBLIGATIONS. Subject to its investment objectives and policies, a
Portfolio may purchase collateralized obligations, including interest only
("IO") and principal only ("PO") securities. A collateralized obligation is a
debt security issued by a corporation, trust or custodian, or by a U.S.
Government agency or instrumentality, that is
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collateralized by a portfolio or pool of mortgages, mortgage-backed securities,
U.S. Government securities or other assets. The issuer's obligation to make
interest and principal payments is secured by the underlying pool or portfolio
of securities. Collateralized obligations issued or guaranteed by a U.S.
Government agency or instrumentality, such as the Federal Home Loan Mortgage
Corporation, are considered U.S. Government securities for purposes of this
prospectus. Privately-issued collateralized obligations collateralized by a
portfolio of U.S. Government securities are not direct obligations of the U.S.
Government or any of its agencies or instrumentalities and are not considered
U.S. Government securities for purposes of this prospectus. A variety of types
of collateralized obligations are available currently and others may become
available in the future.
Since the collateralized obligations may be issued in classes with varying
maturities and interest rates, the investor may obtain greater predictability of
maturity than with direct investments in mortgage-backed securities. Classes
with shorter maturities may have lower volatility and lower yield while those
with longer maturities may have higher volatility and higher yield. This
provides the investor with greater control over the characteristics of the
investment in a changing interest rate environment. With respect to interest
only and principal only securities, an investor has the option to select from a
pool of underlying collateral the portion of the cash flows that most closely
corresponds to the investor's forecast of interest rate movements. These
instruments tend to be highly sensitive to prepayment rates on the underlying
collateral and thus place a premium on accurate prepayment projections by the
investor.
A Portfolio, other than the Money Market Portfolio, may invest in collateralized
obligations whose yield floats inversely against a specified index rate. These
"inverse floaters" are more volatile than conventional fixed or floating rate
collateralized obligations and the yield thereon, as well as the value thereof,
will fluctuate in inverse proportion to changes in the index upon which rate
adjustments are based. As a result, the yield on an inverse floater will
generally increase when market yields (as reflected by the index) decrease and
decrease when market yields increase. The extent of the volatility of inverse
floaters depends on the extent of anticipated changes in market rates of
interest. Generally, inverse floaters provide for interest rate adjustments
based upon a multiple of the specified interest index, which further increases
their volatility. The degree of additional volatility will be directly
proportional to the size of the multiple used in determining interest rate
adjustments.
Additional information concerning collateralized obligations is contained in the
Statement of Additional Information under "Investment Policies and
Techniques--Collateralized Obligations."
NET ASSET VALUE
TOTAL RETURN, HIGH YIELD, EQUITY, GOVERNMENT SECURITIES, INTERNATIONAL AND SMALL
CAP PORTFOLIOS. The net asset value per share is determined by calculating the
total value of a Portfolio's assets, deducting total liabilities, and dividing
the result by the number of shares outstanding of such Portfolio. Portfolio
securities traded on a domestic securities exchange or securities listed on the
NASDAQ National Market are valued at the last sale price on the exchange or
market where primarily traded or listed or, if there is no recent sale price
available, at the last current bid quotation. Portfolio securities that are
primarily traded on foreign securities exchanges are generally valued at the
preceding closing values of such securities on their respective exchanges where
primarily traded. A security that is listed or traded on more than one exchange
is valued at the quotation on the exchange determined to be the primary market
for that security by the Board of Trustees or its delegates. Securities not so
traded or listed are valued at the last current bid quotation if market
quotations are available. Fixed income securities are valued by using market
quotations, or independent pricing services that use prices provided by market
makers or estimates of market values obtained from yield data relating to
instruments or securities with similar characteristics. Equity options are
valued at the last sale price unless the bid price is higher or the asked price
is lower, in which event such bid or asked price is used. Exchange traded fixed
income options are valued at the last sale price unless there is no sale price,
in which event current prices provided by market makers are used.
Over-the-counter traded fixed income options are valued based upon current
prices provided by market makers. Financial futures and options thereon are
valued at the settlement price established each day by the board of trade or
exchange on which they are traded. Other securities and assets are valued at
fair value as determined in good faith by the Board of Trustees. Because of the
need to obtain prices as of the close of trading on various exchanges throughout
the world; the calculation of net asset value does not necessarily take place
contemporaneously with the determination of the prices of a Portfolio's foreign
securities. For purposes of determining a Portfolio's net asset value, any
assets and liabilities initially expressed in foreign currency values will be
converted into U.S. Dollar values at the mean between the bid and offered
quotations of such currencies against U.S. Dollars as last quoted by a
recognized dealer. If an event were to occur, after the value of a security was
so established but before the net asset value per share was determined, which
was likely to materially change the net asset value, then that security would be
valued using fair value considerations by the Board of Trustees or its
delegates. On each day the New York Stock Exchange ("Exchange") is open for
trading, the net asset value is determined as of the earlier of 3:00 p.m.
Central time or the
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close of the Exchange, except that the net asset value will not be computed on a
day in which no order to purchase shares was received or no shares were tendered
for redemption.
MONEY MARKET PORTFOLIO. The net asset value per share of the Money Market
Portfolio is determined at 11:00 a.m. and as of the earlier of 3:00 p.m. Central
time or the close of the Exchange on each day the Exchange is open for trading,
except that the net asset value will not be computed on a day in which no orders
to purchase shares were received or no shares were tendered for redemption. The
net asset value per share is determined by dividing the total assets of the
Portfolio minus its liabilities by the total number of its shares outstanding.
The net asset value per share of the Money Market Portfolio is ordinarily $1.00
calculated at amortized cost in accordance with Rule 2a-7 under the 1940 Act.
While this rule provides certainty in valuation, it may result in periods during
which value, as determined by amortized cost, is higher or lower than the price
the Portfolio would have received if all its investments were sold. Under the
direction of the Board of Trustees, certain procedures have been adopted to
monitor and stabilize the price per share for the Portfolio. Calculations are
made to compare the value of its investments valued at amortized cost with
market-based values. Market-based values will be obtained by using actual
quotations provided by market makers, estimates of market value, or values
obtained from yield data relating to classes of money market instruments or
government securities published by reputable sources at the mean between the bid
and asked prices for the instruments. In the event that a deviation of 1/2 of 1%
or more exists between the Portfolio's $1.00 per share net asset value,
calculated at amortized cost, and the net asset value calculated by reference to
market-based quotations, or if there is any other deviation that the Board of
Trustees believes would result in a material dilution to shareholders or
purchasers, the Board of Trustees will promptly consider what action, if any,
should be initiated. In order to value its investments at amortized cost, the
Money Market Portfolio purchases only securities with a maturity of one year or
less and maintains a dollar-weighted average portfolio maturity of 90 days or
less. In addition, the Money Market Portfolio limits its portfolio investments
to securities that meet the quality and diversification requirements of Rule
2a-7. Under the quality requirements of Rule 2a-7, the Money Market Portfolio
may only purchase U.S. Dollar-denominated instruments that are determined to
present minimal credit risks and that are at the time of acquisition "Eligible
Securities" as defined in Rule 2a-7. "Eligible Securities" under Rule 2a-7
include only securities that are rated in the top two rating categories by the
required number of nationally recognized statistical rating organizations (at
least two or, if only one such organization has rated the security that one
organization) or, if unrated, are deemed comparable in quality. The
diversification requirements of Rule 2a-7 provide generally that the Fund may
not at the time of acquisition invest more than 5% of its assets in securities
of any one issuer or invest more than 5% of its assets in securities that are
Eligible Securities that have not been rated in the highest category by the
required number of rating organizations or, if unrated, have not been deemed
comparable in quality, except U.S. Government securities and repurchase
agreements of such securities.
PURCHASE AND REDEMPTION
The separate accounts of the Participating Insurance Companies place orders to
purchase and redeem shares of each Portfolio based on, among other things, the
amount of premium payments to be invested and surrender and transfer requests to
be effected on that day pursuant to VLI and VA contracts. The shares of Total
Return, High Yield, Equity, Government Securities, International and Small Cap
Portfolios are each purchased and redeemed at the net asset value of each
Portfolio's shares determined that same day or, in the case of an order not
resulting automatically from VLI and VA contract transactions, next determined
after an order in proper form is received. An order is considered to be in
proper form if it is communicated by telephone or wire by an authorized employee
of the Participating Life Insurance Company.
From time to time, the Fund may temporarily suspend the offering of shares of
one or more of its Portfolios. During the period of such suspension,
shareholders of such Portfolio are normally permitted to continue to purchase
additional shares and to have dividends reinvested.
The Fund seeks to have its Money Market Portfolio as fully invested as possible
at all times in order to achieve maximum income. Since the Money Market
Portfolio will be investing in instruments which normally require immediate
payment in Federal funds (monies credited to a bank's account with its regional
Federal Reserve Bank), the Fund has adopted certain procedures for the
convenience of its shareholders and to ensure that the Money Market Portfolio
receives investable funds.
No fee is charged the shareholders when they purchase or redeem Portfolio
shares.
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DIVIDENDS AND TAXES
DIVIDENDS FOR MONEY MARKET PORTFOLIO. The Money Market Portfolio's net
investment income is declared as a dividend daily. Shareholders will receive
dividends monthly in additional shares. If a shareholder withdraws its entire
account, all dividends accrued to the time of withdrawal will be paid at that
time.
DIVIDENDS FOR ALL PORTFOLIOS EXCEPT MONEY MARKET PORTFOLIO. The Fund normally
follows the practice of declaring and distributing substantially all the net
investment income and any net short-term and long-term capital gains of these
Portfolios at least annually.
TAXES. Under the current Internal Revenue Code ("Code"), Participating
Insurance Companies are taxed as life insurance companies and the operations of
their separate accounts are taxed as part of their total operations. Under
current interpretations of existing federal income tax law, investment income
and capital gains of separate accounts are not subject to federal income tax to
the extent applied to increase the values of VLI or VA contracts. Tax
consequences to VLI or VA contract holders are described in the separate
prospectuses issued by the Participating Insurance Companies.
Each Portfolio intends to continue to qualify as a regulated investment company
under subchapter M of the Code. As a result, with respect to any fiscal year in
which a Portfolio distributes all its net investment income and net realized
capital gains, that Portfolio will not be subject to federal income tax.
Subchapter M includes other requirements relating to the diversification of
investments. Subchapter M's diversification requirements are in addition to
diversification requirements under Section 817(h) of the Code and the 1940 Act.
Each applicable law's diversification requirement could require the sale of
assets of a Portfolio, which could have an adverse impact on the net asset value
of such Portfolio.
The preceding is a brief summary of certain of the relevant tax considerations.
The Statement of Additional Information includes a more detailed discussion.
This discussion is not intended, even as supplemented by the Statement of
Additional Information, as a complete explanation or a substitute for careful
tax planning and consultation with individual tax advisers.
CAPITAL STRUCTURE AND GENERAL INFORMATION
The Fund was organized as a business trust under the laws of Massachusetts on
March 24, 1987. The Fund may issue an unlimited number of shares of beneficial
interest all having no par value. Since the Fund offers multiple Portfolios, it
is known as a "series company." Shares of a Portfolio have equal noncumulative
voting rights and equal rights with respect to dividends, assets and liquidation
of such Portfolio. Shares are fully paid and nonassessable when issued, and have
no preemptive or conversion rights. The Fund is not required to hold annual
shareholders' meetings and does not intend to do so. However, it will hold
special meetings as required or deemed desirable for such purposes as electing
trustees, changing fundamental policies or approving an investment advisory
contract. If shares of more than one Portfolio are outstanding, shareholders
will vote by Portfolio and not in the aggregate except when voting in the
aggregate is required under the 1940 Act, such as for the election of trustees.
The Board of Trustees may authorize the issuance of additional Portfolios if
deemed desirable, each with its own investment objective, policies and
restrictions.
On November 3, 1989, KILICO Money Market Separate Account, KILICO Total Return
Separate Account, KILICO Income Separate Account and KILICO Equity Separate
Account (collectively, the Accounts), which were separate accounts organized as
open-end management investment companies, were restructured into one continuing
separate account (KILICO Variable Annuity Separate Account) in unit investment
trust form with subaccounts investing in corresponding Portfolios of the Fund.
An additional subaccount also was created to invest in the Fund's Government
Securities Portfolio. The restructuring and combining of the Accounts is
referred to as the Reorganization. In connection with the Reorganization,
approximately $550,000,000 in assets was added to the Fund (which at that time
consisted of approximately $6,000,000 in assets). Because the assets added to
the Fund as a result of the Reorganization were significantly greater than the
existing assets of the Fund, the per share financial highlights of the Money
Market, Total Return, High Yield and Equity Portfolios in this Prospectus
reflect the Accounts as the continuing entities.
Information about the Portfolios' investment performance is contained in the
Fund's 1994 Annual Report to Shareholders, which may be obtained without charge
from the Fund.
Shareholder inquiries should be made by writing the Fund at the address shown on
the front cover of this Prospectus.
22
<PAGE> 104
INVESTMENT MANAGER
INVESTMENT MANAGER. Kemper Financial Services, Inc. ("KFS"), 120 South LaSalle
Street, Chicago, Illinois 60603, is the investment manager of the Fund and
provides the Fund with continuous professional investment supervision. KFS is
one of the largest investment managers in the country and has been engaged in
the management of investment funds for more than forty-five years. KFS and its
affiliates provide investment advice and manage investment portfolios for the
Kemper Funds, the Kemper insurance companies, Kemper Corporation and other
corporate, pension, profit-sharing and individual accounts representing
approximately $60 billion under management. KFS acts as investment adviser for
24 open-end and seven closed-end investment companies, with 60 separate
investment portfolios representing more than 3 million shareholder accounts. KFS
is a wholly-owned subsidiary of Kemper Financial Companies, Inc., which is a
financial services holding company that is more than 96% owned by Kemper
Corporation, a diversified insurance and financial services holding company.
Kemper Corporation has entered into an agreement in principle with an investor
group led by Zurich Insurance Company ("Zurich") pursuant to which Kemper
Corporation would be acquired by the investor group in a merger transaction. As
part of the transaction, Zurich or an affiliate would purchase KFS.
A definitive agreement is expected in early May, 1995, subject to the completion
of the investor group's due diligence. Consummation of the transaction is
subject to a number of contingencies, including approval by the board and
stockholders of Kemper Corporation and the Zurich board and regulatory
approvals. Because the transaction would constitute an assignment of the Fund's
investment management agreement with KFS under the Investment Company Act of
1940, and therefore a termination of such agreement, the transaction is subject
also to approval of new agreements by Kemper Fund boards and shareholders. If
the contingencies are timely met, the transaction is expected to close early in
the fourth quarter of 1995.
After consummation of the transaction, it is anticipated that the KFS management
team and the Kemper Fund portfolio managers would remain in place and that the
Kemper Funds would be operated in the same manner as they are currently.
Responsibility for overall management of the Fund rests with the Board of
Trustees and officers of the Fund. Professional investment supervision is
provided by KFS. The investment management agreement provides that KFS shall act
as the Fund's investment adviser, manage its investments and provide it with
various services and facilities. For its services, KFS is paid a management fee
at an effective annual rate, payable monthly, of .50%, .55%, .60%, .60%, .55%,
.75% and .65% of average daily net assets of the Money Market, Total Return,
High Yield, Equity, Government Securities, International and Small
Capitalization Equity Portfolios, respectively. KFS may from time to time use
the services of Kemper Investment Management Company Limited ("KIMCO"), 1 Fleet
Place, London EC4M 7RQ, a wholly owned subsidiary of KFS, with respect to
foreign securities investments of the Portfolios including analysis, research,
execution and trading services.
Frank J. Rachwalski, Jr. is the portfolio manager of the Money Market Portfolio.
He has served in this capacity since the Portfolio commenced operations in 1982.
Mr. Rachwalski joined KFS in January 1973 and is currently a Senior Vice
President of KFS and a Vice President of the Fund. He received a B.B.A. and an
M.B.A. from Loyola University, Chicago, Illinois.
Karen A. Hussey has been the portfolio manager of the Small Cap Portfolio since
September 1994 when she joined KFS. She is a Vice President of the Fund. Prior
to joining KFS, she was a portfolio manager for a national bank. She received a
B.S. from Southwest Missouri State, Springfield, Missouri and did graduate work
towards an M.B.A. at St. Louis University. Ms. Hussey is a Chartered Financial
Analyst.
Dennis H. Ferro has been the portfolio manager for the International Portfolio
since March 1994 when he joined KFS. He is an Executive Vice President and the
Director of International Equity Investments of KFS and a Vice President of the
Fund. Mr. Ferro was President, Managing Director and Chief Investment Officer of
an international investment advisory firm prior to joining KFS. He received a
B.A. in Political Science from Villanova University, Villanova, Pennsylvania and
an MBA in Finance from St. Johns University, Jamaica, New York. Mr. Ferro is a
Chartered Financial Analyst.
Michael A. McNamara (since 1990) and Harry E. Resis, Jr. (since 1993) are the
co-portfolios managers of the High Yield Portfolio. Mr. McNamara joined KFS in
February 1972 and is currently a Senior Vice President of KFS and a Vice
President of the Fund. He received a B.S. in Business Administration from the
University of Missouri, St. Louis, Missouri, and an M.B.A. in Finance from
Loyola University, Chicago, Illinois. Mr. Resis joined KFS in 1988 and is
currently a First Vice President of KFS and a Vice President of the Fund. He
received a B.A. in Finance from Michigan State University, Lansing, Michigan.
Mr. Resis holds a number of NYSE and NASD licenses.
23
<PAGE> 105
C. Beth Cotner has been the portfolio manager of the Equity Portfolio since
1986. Ms. Cotner joined KFS in January 1985 and is currently an Executive Vice
President and the Director of Domestic Equity Portfolio Management of KFS and a
Vice President of the Fund. She received a B.A. from Ohio State University,
Columbus, Ohio, and an M.B.A. from George Washington University, Washington,
D.C.
Paul F. Sloan has been the portfolio manager of the Government Securities
Portfolio since April 1995 when he joined KFS. Prior to joining KFS, Mr. Sloan
was the Director of Institutional Portfolio Management at an investment
management company and prior thereto he was a Vice President and Investment
Officer for a regional bank. He received a B.A. in English Literature from the
University of Detroit, Detroit, Michigan, and an M.B.A. in Finance and Business
Economics from Wayne State University, Detroit, Michigan.
Gary A. Langbaum has been the portfolio manager for the Total Return Portfolio
since February 1995. He is assisted by investment personnel who specialize in
certain areas. Mr. Langbaum joined KFS in 1988 and is currently an Executive
Vice President of KFS. He received a B.A. in Finance from the University of
Maryland, College Park, Maryland.
KFS has an Equity Investment Committee that determines overall investment
strategy for equity portfolios managed by KFS. The Equity Investment Committee
is currently comprised of the following members: Daniel J. Bukowski, Tracy
McCormick Chester, C. Beth Cotner, James H. Coxon, Richard A. Goers, Karen A.
Hussey, Frank D. Korth, Gary A. Langbaum, James R. Neel, Thomas M. Regner and
Stephen B. Timbers. The portfolio managers work together as a team with the
Equity Investment Committee and various equity analysts and equity traders to
manage the Fund's equity Portfolios. Equity analysts--through research, analysis
and evaluation--work to develop investment ideas appropriate for these
Portfolios. These ideas are studied and debated by the Equity Investment
Committee and, if approved, are added to a list of eligible investments. The
portfolio managers use the list of eligible securities to help them structure
the Portfolios in a manner consistent with each Portfolio's objective. The KFS
international investments area, directed by Dennis H. Ferro, provides research
and analysis regarding foreign investments to the portfolio managers. After
investment decisions are made, equity traders execute the portfolio manager's
instructions through various broker-dealer firms.
KFS also has a Fixed Income Investment Committee that determines overall
investment strategy for fixed income portfolios managed by KFS. The Fixed
Income Committee is currently comprised of the following members: J. Patrick
Beimford, Jr., Frank E. Collecchia, George Klein, Michael A. McNamara,
Christopher J. Mier, Frank J. Rachwalski, Jr., Harry E. Resis, Jr., Robert H.
Schumacher, John E. Silvia, Paul F. Sloan and Christopher T. Vincent. The
portfolio managers work together as a team with the Fixed Income Committee and
various fixed income analysts and traders to manage the Fund's fixed income
Portfolios. Analysts provide market, economic and financial research and
analysis that is used by the Fixed Income Committee to establish broad
parameters for these Portfolios, including duration and cash levels. In
addition, credit research by analysts is used by portfolio managers in selecting
securities appropriate for the Portfolios' policies. The KFS international
investments area provides research and analysis regarding foreign investments to
the fixed income portfolio managers, as it does for the equity portfolio
managers. After investment decisions are made, fixed income traders execute the
portfolio manager's instructions through various broker-dealer firms.
CUSTODIAN. Investors Fiduciary Trust Company ("IFTC"), 127 West 10th Street,
Kansas City, Missouri 64105, as custodian, and the United Missouri Bank, n.a.,
Tenth and Grand Streets, Kansas City, Missouri 64106 and State Street Bank and
Trust Company, 225 Franklin Street, Boston, Massachusetts 02110, as
sub-custodians, have custody of all securities and cash of the Fund maintained
in the United States. The Chase Manhattan Bank, N.A., Chase MetroTech Center,
Brooklyn, New York 11245, as custodian, has custody of all securities and cash
held outside the United States. They attend to the collection of principal and
income, and payment for and collection of proceeds of securities bought and sold
by the Fund. IFTC is also the Fund's transfer agent and dividend-paying agent.
IFTC receives an annual custodian fee from the Portfolios of $.085 for each
$1,000 of average monthly net assets plus certain transaction charges and
out-of-pocket expense reimbursements subject to the custody agreement. For its
services as custodian and transfer agent for the fiscal year ended December 31,
1994, IFTC received fees of $514,000. Prior to February 1, 1995, IFTC was 50%
owned by KFS.
PORTFOLIO TRANSACTIONS. KFS places all orders for purchases and sales of a
Portfolio's securities. Subject to seeking best execution of orders, KFS may
consider sales of shares of the Fund and other funds managed by KFS or variable
life insurance and variable annuity contracts funded by the Fund as a factor in
selecting broker-dealers. See "Portfolio Transactions" in the Statement of
Additional Information.
Each Portfolio pays its respective fees and expenses of independent auditors,
counsel, custodian, the cost of reports and notices to owners of VLI and VA
contracts, brokerage commissions or transaction costs, taxes and registration
fees.
24
<PAGE> 106
DISTRIBUTOR
Kemper Distributors, Inc. ("KDI"), an affiliate of KFS, serves as distributor
and principal underwriter for the Fund pursuant to an underwriting agreement.
KDI bears all its expenses of providing services pursuant to the agreement. KDI
provides for the preparation of advertising or sales literature, and bears the
cost of printing and mailing prospectuses to persons other than shareholders.
KDI bears the cost of qualifying and maintaining the qualification of Fund
shares for sale under the securities laws of Massachusetts and the Fund bears
the expense of registering its shares with the Securities and Exchange
Commission. KDI will pay all fees and expenses in connection with its
qualification and registration as a broker or dealer under Federal and state
laws, a portion of the toll free telephone service and of computer terminals,
and of any activity which is primarily intended to result in the sale of shares
issued by the Fund, unless a plan pursuant to Rule 12b-1 under the 1940 Act
("12b-1 Plan") is in effect that provides that the Fund shall bear some or all
of such expenses.
KDI currently offers shares of each Portfolio of the Fund continuously to the
separate accounts of Participating Insurance Companies where permitted by
applicable law. The underwriting agreement provides that KDI accepts orders for
shares at net asset value, as no sales commission or load is charged. KDI has
made no firm commitment to acquire shares of the Fund.
NOTE: Although the Fund does not currently have a 12b-1 Plan and shareholder
approval would be required in order to adopt one, the underwriting agreement
provides that the Fund will also pay those fees and expenses permitted to be
paid or assumed by the Fund pursuant to a 12b-1 Plan, if any, adopted by the
Fund, notwithstanding any other provision to the contrary in the underwriting
agreement, and the Fund or a third party will pay those fees and expenses not
specifically allocated to KDI in the underwriting agreement.
25
<PAGE> 107
APPENDIX--PORTFOLIO COMPOSITION OF HIGH YIELD BONDS
The table below reflects the composition by quality rating of the investment
portfolio of the High Yield Portfolio. Percentages for the Portfolio reflect the
net asset weighted average of the percentage for each category on the last day
of each month in the 12 month period ended December 31, 1994. The table reflects
the percentage of net assets represented by fixed income securities rated by
Moody's or S&P, by non-rated fixed income securities and by other assets. The
percentage shown reflects the higher of the Moody's or S&P rating. U.S.
Government securities, whether or not rated, are reflected as Aaa and AAA
(highest quality). Cash equivalents include money market instruments, repurchase
agreements, net payables and receivables and cash. Other assets include options,
financial futures contracts and equity securities. As noted under "Investment
Objectives, Policies and Risk Factors," the High Yield Portfolio invests in high
yielding, fixed income securities without relying upon published ratings. The
allocations in the table are not necessarily representative of the composition
of the Portfolio at other times. Portfolio composition will change over time.
END OF THE MONTH COMPOSITION OF PORTFOLIO BY QUALITY AS A PERCENTAGE OF
NET ASSETS (JANUARY 1994--DECEMBER 1994)
<TABLE>
<CAPTION>
HIGH
MOODY'S/S&P RATING YIELD GENERAL DESCRIPTION
OR OTHER CATEGORY PORTFOLIO OF BOND QUALITY
------------------------------------- ---- -------------------------------------------------
<S> <C> <C>
Cash Equivalents..................... 6%
Aaa/AAA.............................. 2 Highest quality
Aa/AA................................ 0 High quality
A/A.................................. 0 Upper medium grade
Baa/BBB.............................. 0 Medium grade
Ba/BB................................ 18 Some speculative elements
B/B.................................. 61 Speculative
Caa/CCC.............................. 6 More speculative
Ca/CC, C/C........................... 1 Very speculative
D.................................... 1 In default
Non-rated, Not in Default............ 2
Non-rated, In Default................ 0
Other Assets......................... 3
----
Net Assets........................... 100%
</TABLE>
The description of each bond quality category set forth in the table above is
intended to be a general guide and not a definitive statement as to how Moody's
and S&P define such rating category. A more complete description of the rating
categories is set forth under "Appendix--Ratings of Investments" in the
Statement of Additional Information. The ratings of Moody's and S&P represent
their opinions as to the quality of the securities that they undertake to rate.
It should be emphasized, however, that ratings are relative and subjective and
are not absolute standards of quality.
26
<PAGE> 108
[KEMPER LOGO]
KEMPER ADVANTAGE III
A Flexible Payment Fixed and Variable Annuity from
Kemper Investors Life Insurance Company
1 Kemper Drive, Long Grove, IL 60049
Issued by Kemper Investors Life Insurance Company
Securities distributed by Investors Brokerage Services, Inc.
[RECYCLED LOGO]
ADV 01 (5/95) PRINTED ON RECYCLED PAPER Policy Form Series L-1000
<PAGE> 109
SUPPLEMENT DATED SEPTEMBER 15, 1995
TO STATEMENT OF ADDITIONAL INFORMATION
DATED MAY 1, 1995 FOR
--------------------------------------------------------------------------------
PERIODIC PAYMENT
VARIABLE ANNUITY CONTRACTS
--------------------------------------------------------------------------------
KEMPER ADVANTAGE III
ISSUED BY
KEMPER INVESTORS LIFE INSURANCE COMPANY
The Statement of Additional Information is modified effective September 15, 1995
as follows.
1. The fourth sentence of the first paragraph appearing under Services to
the Separate Account on page B-1 of the Statement of Additional
Information is revised to read as follows:
"KILICO maintains records of all purchases and redemptions of shares
of each Fund by each of the Subaccounts."
2. The first paragraph appearing under Performance Information of
Subaccounts on page B-1 of the Statement of Additional Information is
revised by adding the following to the end thereof:
"In addition, yield information may be provided in the case of the
Janus Short-Term Bond Subaccount."
3. The first sentence of the fourth paragraph appearing under Performance
Information of Subaccounts on page B-1 of the Statement of Additional
Information is revised to read as follows:
"The yield for the KINF High Yield Subaccount, the KINF Government
Securities Subaccount, and the Janus Short-Term Bond Subaccount is
computed in accordance with a standard method prescribed by rules of
the Securities and Exchange Commission."
4. The first paragraph appearing under Performance Information of
Subaccounts on page B-3 of the Statement of Additional Information is
revised by adding the following after the eighth sentence but before the
ninth sentence:
"The Janus Growth, Janus Aggressive Growth, Janus Worldwide Growth,
Janus Balanced, Janus Short-Term Bond, Lexington Natural Resources
and Lexington Emerging Markets Subaccounts may also be compared to
the Standard & Poor's Midcap Index, the Lehman Brothers
Government/Corporate 1-3 Year Bond Index, the Lehman Brothers Long
Government/Corporate Bond Index, the Russell 2000 Index, and the
NASDAQ composite. In addition, the Janus Worldwide Growth
Subaccount's performance may also be compared to the Morgan Stanley
International World Index.
<PAGE> 110
STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 1995
--------------------------------------------------------------------------------
PERIODIC PAYMENT
VARIABLE ANNUITY CONTRACTS
--------------------------------------------------------------------------------
ISSUED BY
KEMPER INVESTORS LIFE INSURANCE COMPANY
IN CONNECTION WITH
KILICO VARIABLE ANNUITY SEPARATE ACCOUNT
HOME OFFICE: 1 KEMPER DRIVE, LONG GROVE, ILLINOIS 60049 (708) 320-4500
This Statement of Additional Information is not a prospectus. This Statement of
Additional Information should be read in conjunction with the Prospectus of the
Separate Account dated May 1, 1995. The Prospectus may be obtained from Kemper
Investors Life Insurance Company by writing or calling the address or telephone
number listed above.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Services to the Separate Account....................................... B-1
Performance Information of Subaccounts................................. B-1
State Regulation....................................................... B-8
Experts................................................................ B-8
Financial Statements................................................... B-8
</TABLE>
<PAGE> 111
SERVICES TO THE SEPARATE ACCOUNT
Kemper Investors Life Insurance Company ("KILICO") maintains the books and
records of the KILICO Variable Annuity Separate Account (the "Separate
Account"). KILICO holds the assets of the Separate Account. The assets are kept
segregated and held separate and apart from the general funds of KILICO. KILICO
maintains records of all purchases and redemptions of shares of each Portfolio
of the Kemper Investors Fund (the "Fund") by each of the Subaccounts. All
expenses incurred in the operations of the Separate Account, except the charge
for mortality and expense risk and administrative expenses, and records
maintenance charge (as described in the Prospectus) are borne by KILICO.
The independent auditors for the Separate Account are KPMG Peat Marwick LLP,
Chicago, Illinois. The firm performs an annual audit of the financial statements
of the Separate Account and KILICO.
The Contracts are sold by licensed insurance agents, where the Contracts may be
lawfully sold, who are registered representatives of broker-dealers which are
registered under the Securities Exchange Act of 1934 and are members of the
National Association of Securities Dealers, Inc. The Contracts are distributed
through the principal underwriter for the Separate Account, Investors Brokerage
Services, Inc. ("IBS"), a wholly owned subsidiary of KILICO, which enters into
selling group agreements with affiliated and unaffiliated broker-dealers.
Subject to the provisions of the Contracts, units of the Subaccounts under the
Contract are offered on a continuous basis.
KILICO pays commissions to the seller which may vary but are not anticipated to
exceed in the aggregate an amount equal to six percent (6%) of Purchase
Payments. During 1994, 1993 and 1992, KILICO incurred gross commissions payable
of approximately $13,085,000, $15,143,000 and $18,600,000 to licensed insurance
agents.
PERFORMANCE INFORMATION OF SUBACCOUNTS
As described in the prospectus, a Subaccount's historical performance may be
shown in the form of "average annual total return" and "total return"
calculations in the case of all Subaccounts, except "average annual total
return" is not shown for the Money Market Subaccount; "yield" information may be
provided in the case of the High Yield Subaccount and the Government Securities
Subaccount; and "yield" and "effective yield" information may be provided in the
case of the Money Market Subaccount. These various measures of performance are
described below.
A Subaccount's average annual total return quotation is computed in accordance
with a standard method prescribed by rules of the Securities and Exchange
Commission. The average annual total return for a Subaccount for a specific
period is found by first taking a hypothetical $1,000 investment in each of the
Subaccount's units on the first day of the period at the maximum offering price,
which is the Accumulation Unit value per unit ("initial investment") and
computing the ending redeemable value ("redeemable value") of that investment at
the end of the period. The redeemable value reflects the effect of the
applicable Withdrawal Charge that may be imposed at the end of the period as
well as all other recurring charges and fees applicable under the Contract to
all Contract Owner accounts. Premium taxes are not included in the term charges.
The redeemable value is then divided by the initial investment and this quotient
is taken to the Nth root (N represents the number of years in the period) and 1
is subtracted from the result, which is then expressed as a percentage. Average
annual total return quotations for various periods are set forth in the table
below.
No standard formula has been prescribed for calculating total return
performance. Total return performance for a specific period is calculated by
first taking an investment (assumed to be $10,000 below) in each Subaccount's
units on the first day of the period at the maximum offering price, which is the
Accumulation Unit Value per unit ("initial investment") and computing the ending
value ("ending value") of that investment at the end of the period. The ending
value does not include the effect of the applicable Withdrawal Charge that may
be imposed at the end of the period, and thus may be higher than if such charge
were deducted. The total return percentage is then determined by subtracting the
initial investment from the ending value and dividing the remainder by the
initial investment and expressing the result as a percentage. An assumed
investment of $10,000 was chosen because that approximates the size of a typical
account. The account size used affects the performance figure because the
Records Maintenance Charge is a fixed per account charge. Total return
quotations for various periods are set forth in the table below.
The yield for the High Yield Subaccount and the Government Securities Subaccount
is computed in accordance with a standard method prescribed by rules of the
Securities and Exchange Commission. The yields for the High Yield Subaccount and
Government Securities Subaccount, based upon the one month period ended March
31, 1995 were 9.20% and 4.97%, respectively. The yield quotation is computed by
dividing the net investment income per
B-1
<PAGE> 112
unit earned during the specified one month or 30-day period by the accumulation
unit values on the last day of the period, according to the following formula
that assumes a semi-annual reinvestment of income:
a - b 6
YIELD = 2 [( ------- +1) -1]
cd
a = net dividends and interest earned during the period by the Fund attributable
to the Subaccount
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of Accumulation Units outstanding during the period
d = the Accumulation Unit value per unit on the last day of the period
The yield of each Subaccount reflects the deduction of all recurring fees and
charges applicable to each Subaccount, but does not reflect the deduction of
withdrawal charges or premium taxes.
The Money Market Subaccount's yield is computed in accordance with a standard
method prescribed by rules of the Securities and Exchange Commission. Under that
method, the current yield quotation is based on a seven-day period and computed
as follows: the net change in the Accumulation Unit Value during the period is
divided by the Accumulation Unit Value at the beginning of the period ("base
period return") and the result is divided by 7 and multiplied by 365 and the
current yield figure carried to the nearest one-hundredth of one percent.
Realized capital gains or losses and unrealized appreciation or depreciation of
the Account's portfolio are not included in the calculation. The Money Market
Subaccount's yield for the seven-day period ended March 31, 1995 was 4.26% and
average portfolio maturity was 27 days.
The Money Market Subaccount's effective yield is determined by taking the base
period return (computed as described above) and calculating the effect of
assumed compounding. The formula for the effective yield is: (base period return
+1) (3)65 L 7 - 1. The Money Market Subaccount's effective yield for the seven
day period ended March 31, 1995 was 4.35%.
In computing yield, the Separate Account follows certain standard accounting
practices specified by Securities and Exchange Commission rules. These practices
are not necessarily consistent with the accounting practices that the Separate
Account uses in the preparation of its annual and semi-annual financial
statements.
A Subaccount's performance quotations are based upon historical earnings and are
not necessarily representative of future performance. The Subaccount's units are
sold at Accumulation Unit value. Performance figures and Accumulation Unit value
will fluctuate. Factors affecting a Subaccount's performance include general
market conditions, operating expenses and investment management. Units of a
Subaccount are redeemable at Accumulation Unit value, which may be more or less
than original cost. The performance figures include the deduction of all
expenses and fees, including a prorated portion of the Records Maintenance
Charge. Redemptions within the first six years after purchase may be subject to
a Withdrawal Charge that ranges from 6% the first year to 0% after six years;
however, the aggregate Withdrawal Charge will not exceed 7.25% of aggregate
Purchase Payments under the Contract. Yield, effective yield and total return do
not reflect the effect of the Withdrawal Charge or premium taxes that may be
imposed upon the redemption of units. Average annual total return reflects the
effect of the applicable Withdrawal Charge (but not premium tax) that may be
imposed at the end of the period in question.
The figures below show performance information for periods from March 5, 1982
(inception) for the Money Market Subaccount, Total Return Subaccount and High
Yield Subaccount and for periods from December 9, 1983 (inception) for the
Equity Subaccount to December 31, 1994. This performance information is stated
to reflect that the Separate Account was reorganized on November 3, 1989 as a
unit investment trust with Subaccounts investing in corresponding Portfolios of
the Fund. In addition, on that date the Government Securities Subaccount was
added to the Separate Account to invest in the Fund's Government Securities
Portfolio. For the Government Securities Subaccount, performance figures will
reflect investment experience as if the Government Securities Subaccount had
been available under the Contracts since September 3, 1987, the inception date
of the Government Securities Portfolio. Performance of the Subaccounts will vary
from time to time, and these results are not necessarily representative of
future results. Performance information is also shown for the year ended
December 31, 1994. The total return performance of each Subaccount is calculated
for a specified period of time by assuming an initial Purchase Payment of
$10,000 fully allocated to each Separate Account and the deduction of all
expenses and fees, including a prorated portion of the $36 annual Records
Maintenance Charge. No withdrawals are assumed. The percentage increases are
determined by subtracting the initial Purchase Payment from the ending value and
dividing the remainder by the beginning value.
B-2
<PAGE> 113
Comparative information for certain Subaccounts with respect to the Dow Jones
Industrial Average, the Standard & Poor's 500 Stock Index, the Consumer Price
Index, the CDA Certificate of Deposit Index, the Lehman Brothers Government and
Corporate Bond Index, the Salomon Brothers High Grade Corporate Bond Index and
the Merrill Lynch Government/Corporate Master Index is also included.
Comparative information may be shown for the International Subaccount with
respect to the CDA Mutual Fund International Index and the Morgan Stanley
Capital International Europe Australia Far East Index. The Total Return and
Equity Subaccounts are compared to, and the International Subaccount may be
compared to, the Dow Jones Industrial Average and the Standard & Poor's 500
Stock Index because these indices are generally considered representative of the
U. S. stock market in general. The Consumer Price Index is generally considered
to be a measure of inflation and thus the performance of the Money Market, Total
Return, High Yield, Equity and Government Securities Subaccounts is compared to,
and the International Subaccount may be compared to, that index. The High Yield
and Government Securities Subaccounts are compared to the Lehman Brothers
Government and Corporate Bond Index, the Salomon Brothers High Grade Corporate
Bond Index and the Merrill Lynch Government/Corporate Master Index because such
indices are generally considered to represent the performance of intermediate
and long term bonds during various market cycles. The Money Market Subaccount is
also compared to the CDA Certificate of Deposit Index because certificates of
deposit represent an alternative current income producing product. The
International Subaccount may be compared to the CDA Mutual Fund--International
Index because the index is a weighted performance average of other mutual funds
that invest primarily in securities of foreign issuers. The International
Subaccount also may be compared to the Morgan Stanley Capital International
Europe Australia Far East Index because the index is an unmanaged index that is
considered to be generally representative of major non-United States stock
markets. Please note the differences and similarities between the investments
which a Subaccount may purchase and the investments measured by the indexes
which are described below. In particular, it should be noted that certificates
of deposit may offer fixed or variable yields and principal is guaranteed and
may be insured. The units of the Subaccounts are not insured. Also, the value of
the Subaccounts will fluctuate.
B-3
<PAGE> 114
<TABLE>
<CAPTION>
VALUES OF INITIAL $10,000 INVESTMENT IN
SUBACCOUNTS--AS OF DECEMBER 31, 1994
-------------------------------------------------- COMPARED TO
Non- Non- ---------------------------------------
Qualified Qualified Qualified Qualified Dow Jones Standard Consumer
Ending Percentage Ending Percentage Industrial & Poor's Price EAFE
TOTAL RETURN TABLE Value Increase Value Increase Average(1) 500(2) Index(3) (13)
---------------------------------- --------- ---------- --------- ---------- --------- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
EQUITY SUBACCOUNT
Life of Subaccount(4)........... $32,261 222.61% $32,215 222.15% 351.28% 304.56% 47.95%
Ten years....................... 28,648 186.48 28,649 186.49 349.67 282.68 42.14
Five years...................... 17,056 70.56 17,056 70.56 63.05 51.60 18.72
One year........................ 9,450 (5.50) 9,450 (5.50) 5.02 1.31 2.67
TOTAL RETURN SUBACCOUNT
Life of Subaccount(5)........... $36,253 262.53% $33,758 237.58% 664.33% 553.57% 58.41%
Ten years....................... 26,912 169.12 26,912 169.12 349.67 282.68 42.14
Five years...................... 13,893 38.93 13,893 38.93 63.05 51.60 18.72
One year........................ 8,903 (10.97) 8,903 (10.97) 5.02 1.31 2.67
INTERNATIONAL SUBACCOUNT
Life of Subaccount (14)......... $12,187 21.87% $12,187 21.87% 31.94% 19.99% 8.56% 26.64%
One year........................ 9,499 (5.01) 9,499 (5.01) 5.02 1.31 2.67 8.06
SMALL CAP SUBACCOUNT
Life of Subaccount(15).......... $10,296 2.96% $10,296 2.96%
</TABLE>
<TABLE>
<CAPTION>
COMPARED TO
VALUES OF INITIAL $10,000 INVESTMENT IN --------------------------------------------------------------
SUBACCOUNTS--AS OF DECEMBER 31, 1994 Salomon
-------------------------------------------------- Bros. Lehman Merrill
Non- Non- High Grade Bros. Lynch
TOTAL Qualified Qualified Qualified Qualified Consumer CDA Cert. Corp. Govt./Corp. Govt./Corp.
RETURN Ending Percentage Ending Percentage Price of Deposit Bond Bond Master
TABLE Value Increase Value Increase Index(3) Index(6) Index(7) Index(8) Index(9)
----------- --------- ---------- --------- ---------- -------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
MONEY
MARKET
SUBACCOUNT
Life of
Subaccount
(10).... $20,157 101.57% $20,157 101.57% 58.41% 153.99% 404.53% 301.86% 302.39%
Ten
years..... 15,924 59.24 15,924 59.24 42.14 90.66 198.97 155.53 157.17
Five
years..... 11,785 17.85 11,785 17.85 18.72 29.69 49.43 44.93 45.45
One
year..... 10,230 2.30 10,230 2.30 2.67 5.05 (5.74) (3.51) (3.27)
HIGH YIELD
SUBACCOUNT
Life of
Subaccount
(11)... $41,931 319.31% $40,843 308.43% 58.41% 153.99% 404.53% 301.86% 302.39%
Ten
years..... 26,895 168.95 26,895 168.95 42.14 90.66 198.97 155.53 157.17
Five
years..... 16,523 65.23 16,523 65.23 18.72 29.69 49.43 44.93 45.45
One
year..... 9,625 (3.75) 9,625 (3.75) 2.67 5.05 (5.74) (3.51) (3.27)
GOVERNMENT
SECURITIES
SUBACCOUNT
Life of
Subaccount
(12)... $14,925 49.25% $14,925 49.25% 30.86% 57.55% 100.07% 84.45% 85.30%
Five
years..... 12,941 29.41 12,941 29.41 18.72 29.69 49.43 44.93 45.45
One
year..... 9,578 (4.22) 9,578 (4.22) 2.67 5.05 (5.74) (3.51) (3.27)
</TABLE>
<TABLE>
<CAPTION>
Average Annual
Total Return COMPARED TO
(based on $1,000 ----------------------------------------
investment) Standard
--------------------- Dow Jones & Poor's Consumer
AVERAGE ANNUAL TOTAL Non- Industrial 500 Stock Price EAFE
RETURN TABLE Qualified Qualified Average(1) Index(2) Index(3) (13)
------------------------------------------------------------- --------- --------- ---------- --------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
EQUITY SUBACCOUNT
Life of Subaccount(4)...................................... 10.85% 10.83% 14.56% 13.44% 3.60%
Ten years.................................................. 10.69 10.69 16.22 14.36 3.58
Five years................................................. 9.89 9.89 10.27 8.68 3.49
One year................................................... (12.73) (12.73) 5.02 1.31 2.67
TOTAL RETURN SUBACCOUNT
Life of Subaccount(5)...................................... 9.97% 9.31% 17.29% 15.86% 3.67%
Ten years.................................................. 9.45 9.45 16.22 14.36 3.58
Five years................................................. 4.70 4.70 10.27 8.68 3.49
One year................................................... (18.45) (18.45) 5.02 1.31 2.67
INTERNATIONAL SUBACCOUNT
Life of Subaccount (14).................................... 4.31% 4.31% 9.68% 6.26% 2.77% 8.19%
One year................................................... (11.76) (11.76) 5.02 1.31 2.67 8.06
</TABLE>
B-4
<PAGE> 115
<TABLE>
<CAPTION>
COMPARED TO
AVERAGE ANNUAL ------------------------------------------------------------
TOTAL RETURN LEHMAN
(BASED ON $1,000 SALOMON BROS. BROS. MERRILL LYNCH
INVESTMENT) CONSUMER HIGH GRADE GOVT./CORP. GOVT./CORP.
AVERAGE ANNUAL TOTAL ----------------------------- PRICE CORP. BOND BOND MASTER
RETURN TABLE QUALIFIED NON-QUALIFIED INDEX(3) INDEX(7) INDEX(8) INDEX(9)
--------------------------------- --------- ------------- -------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
HIGH YIELD SUBACCOUNT
Life of Subaccount(11)......... 11.60% 11.36% 3.67 13.53 11.53 11.54
Ten years...................... 9.84 9.84 3.58 11.57 9.84 9.91
Five years..................... 8.94 8.94 3.49 8.36 7.70 7.78
One year....................... (11.04) (11.04) 2.67 (5.74) (3.51) (3.27)
GOVERNMENT SECURITIES SUBACCOUNT
Life of Subaccount(12)......... 5.02% 5.02% 3.74 9.92 8.71 8.77
Five years..................... 3.91 3.91 3.49 8.36 7.70 7.78
One year....................... (11.34) (11.34) 2.67 (5.74) (3.51) (3.27)
SMALL CAP SUBACCOUNT
Life of Subaccount(15)......... (5.09) (5.09)
<CAPTION>
YIELD INFORMATION QUALIFIED AND NON-QUALIFIED
--------------------------- -----------------------------
<S> <C>
HIGH YIELD SUBACCOUNT
30 day period ended 3/31/95.... 9.20%
GOVERNMENT SECURITIES SUBACCOUNT
30 day period ended 3/31/95.... 4.97%
MONEY MARKET SUBACCOUNT
7 day period ended 3/31/95..... 4.26%
</TABLE>
(1) The Dow Jones Industrial Average is an unmanaged unweighted average of
thirty blue chip industrial corporations listed on the New York Stock Exchange.
Assumes reinvestment of dividends.
(2) The Standard & Poor's 500 Stock Index is an unmanaged weighted average of
500 stocks, over 95% of which are listed on the New York Stock Exchange. Assumes
reinvestment of dividends.
(3) The Consumer Price Index, published by the U.S. Bureau of Labor Statistics,
is a statistical measure of change, over time, in the prices of goods and
services in major expenditure groups.
(4) From December 9, 1983 to December 31, 1994.
(5) From March 5, 1982 to December 31, 1994.
(6) The CDA Certificate of Deposit Index is provided by CDA Investment
Technologies, Inc., Silver Spring, Maryland, and is based upon a statistical
sampling of the yield of 30-day certificates of deposit of major commercial
banks. Yield is based upon a monthly compounding of interest.
(7) The Salomon Brothers High Grade Corporate Bond Index is on a total return
basis with all dividends reinvested and is comprised of high grade long-term
industrial and utility bonds rated in the top two rating categories.
(8) The Lehman Brothers Government/Corporate Bond Index is on a total return
basis and is comprised of all publicly issued, non-convertible, domestic debt of
the U.S. Government or any agency thereof, quasi-Federal corporation, or
corporate debt guaranteed by the U.S. Government and all publicly issued,
fixed-rate, non-convertible, domestic debt of the three major corporate
classifications: industrial, utility, and financial. Only notes and bonds with a
minimum outstanding principal amount of $1,000,000 and a minimum of one year are
included. Bonds included must have a rating of at least Baa by Moody's Investors
Service, BBB by Standard & Poor's Corporation or in the case of bank bonds not
rated by either Moody's or Standard & Poor's, BBB by Fitch Investors Service.
(9) The Merrill Lynch Government/Corporate Master Index is based upon the total
return with all dividends reinvested of 4,000 corporate and 300 government bonds
issued with an intermediate average maturity and an average quality rating of Aa
(Moody's Investors Service, Inc.) /AA (Standard & Poor's Corporation).
(10) From March 5, 1982 to December 31, 1994.
(11) From March 5, 1982 to December 31, 1994.
(12) From September 3, 1987 to December 31, 1994.
(13) EAFE is the Morgan Stanley Capital International Europe, Australia, Far
East index. This index is an unmanaged index that is considered to be generally
representative of major non-United States stock markets.
(14) From January 6, 1992 to December 31, 1994.
(15) From May 2, 1994 to December 31, 1994.
B-5
<PAGE> 116
The following tables illustrate an assumed $10,000 investment in shares of
certain Subaccounts. The ending value does not include the effect of the
applicable Withdrawal Charge that may be imposed at the end of the period, and
thus may be higher than if such charge were deducted. Each table covers the
period from commencement of operations of the Subaccount to December 31, 1994.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURN SUBACCOUNT
NON-
YEAR QUALIFIED QUALIFIED
ENDED TOTAL TOTAL
12/31 VALUE VALUE
----- -------- --------
<S> <C> <C>
1982 .................... $ 12,336 $ 11,769
1983 .................... 14,313 13,211
1984 .................... 13,427 12,508
1985 .................... 17,019 15,853
1986 .................... 19,328 18,003
1987 .................... 19,188 17,872
1988 .................... 21,207 19,752
1989 .................... 25,945 24,164
1990 .................... 26,889 25,043
1991 .................... 36,583 34,069
1992 .................... 36,703 34,179
1993 .................... 40,598 37,805
1994 .................... 36,253 33,758
<CAPTION>
HIGH YIELD SUBACCOUNT
NON-
YEAR QUALIFIED QUALIFIED
ENDED TOTAL TOTAL
12/31 VALUE VALUE
----- -------- --------
<S> <C> <C>
1982 .................... $ 12,363 $ 11,920
1983 .................... 14,000 13,427
1984 .................... 15,557 15,155
1985 .................... 18,686 18,203
1986 .................... 21,710 21,149
1987 .................... 22,693 22,105
1988 .................... 25,944 25,273
1989 .................... 25,278 24,624
1990 .................... 21,092 20,546
1991 .................... 31,597 30,778
1992 .................... 36,712 35,760
1993 .................... 43,466 42,338
1994 .................... 41,931 40,843
<CAPTION>
INTERNATIONAL SUBACCOUNT
QUALIFIED
AND NON-
YEAR QUALIFIED
ENDED TOTAL
12/31 VALUE
----- --------
<S> <C>
1992 .................... $ 9,803
1993 .................... 12,836
1994 .................... 12,187
<CAPTION>
SMALL CAP SUBACCOUNT
QUALIFIED
AND NON-
YEAR QUALIFIED
ENDED TOTAL
12/31 VALUE
----- --------
<S> <C>
1994 .................... $ 10,296
<CAPTION>
EQUITY SUBACCOUNT
NON-
YEAR QUALIFIED QUALIFIED
ENDED TOTAL TOTAL
12/31 VALUE VALUE
----- -------- --------
<S> <C> <C>
1983 .................... $ 10,290 $ 10,271
1984 .................... 11,254 11,237
1985 .................... 13,898 13,877
1986 .................... 14,986 14,965
1987 .................... 15,043 15,022
1988 .................... 14,908 14,887
1989 .................... 18,871 18,844
1990 .................... 18,736 18,709
1991 .................... 29,479 29,437
1992 .................... 30,123 30,080
1993 .................... 34,063 34,011
1994 .................... 32,261 32,215
<CAPTION>
MONEY MARKET SUBACCOUNT
QUALIFIED
AND NON-
YEAR QUALIFIED
ENDED TOTAL
12/31 VALUE
----- --------
<S> <C>
1982 .................... $ 10,747
1983 .................... 11,575
1984 .................... 12,630
1985 .................... 13,479
1986 .................... 14,185
1987 .................... 14,922
1988 .................... 15,827
1989 .................... 17,045
1990 .................... 18,195
1991 .................... 19,003
1992 .................... 19,385
1993 .................... 19,661
1994 .................... 20,157
<CAPTION>
GOVERNMENT SECURITIES SUBACCOUNT
QUALIFIED
AND NON-
YEAR QUALIFIED
ENDED TOTAL
12/31 VALUE
----- --------
<S> <C>
1987 .................... $ 10,030
1988 .................... 10,232
1989 .................... 11,437
1990 .................... 12,396
1991 .................... 14,084
1992 .................... 14,708
1993 .................... 15,559
1994 .................... 14,925
</TABLE>
The following table compares the performance of the Subaccounts over various
periods with that of other variable annuity funds within the categories
described below according to data reported by Lipper Analytical Services, Inc.
("Lipper"), New York, New York, mutual fund reporting service. Lipper rankings
are based on changes in net asset value, with all income and capital gain
dividends reinvested. Such calculations do not include the effect of any sales
B-6
<PAGE> 117
charges and include the deduction of mortality and expense risk charges and
other asset based charges. Future performance cannot be guaranteed. Lipper
publishes performance analyses on a regular basis from which the following
rankings were derived.
<TABLE>
<CAPTION>
LIPPER VARIABLE ANNUITY
PERFORMANCE ANALYSIS
-------------------------------------
2/28/94 2/28/89
TO TO
SUBACCOUNT 2/28/95 2/28/95
---------- --------------- --------------
<S> <C> <C>
Total Return (Q).............................................. 113 out of 117 17 out of 52
Total Return (NQ)............................................. 112 out of 117 18 out of 52
High Yield (Q)................................................ 20 out of 60 21 out of 39
High Yield (NQ)............................................... 21 out of 60 20 out of 39
Equity (Q).................................................... 43 out of 84 7 out of 36
Equity (NQ)................................................... 43 out of 84 8 out of 36
Money Market (Q).............................................. 80 out of 169 59 out of 106
Money Market (NQ)............................................. 80 out of 169 59 out of 106
Government Securities (Q & NQ)................................ 8 out of 12 N/A
International (Q & NQ)........................................ 42 out of 48 N/A
</TABLE>
The Total Return Subaccount, High Yield Subaccount, Equity Subaccount, Money
Market Subaccount, International Subaccount and Government Securities Subaccount
are ranked by Lipper in the Flexible Portfolio, High Current Yield, Capital
Appreciation, Money Market, International and U.S. Mortgage and GNMA Government
Securities categories, respectively. Variable annuity funds in these categories
have a variety of objectives, policies and market and credit risks that should
be considered in reviewing the rankings. The performance of the Subaccount may
also be compared to other variable annuity funds ranked by Morningstar, Inc. or
VARDS Inc.
TAX-DEFERRED ACCUMULATION
<TABLE>
<CAPTION>
TAX-DEFERRED NON-QUALIFIED CONVENTIONAL
RETIREMENT ANNUITY ANNUITY SAVINGS PLAN
BEFORE-TAX CONTRIBUTIONS AFTER-TAX CONTRIBUTIONS
AND TAX-DEFERRED EARNINGS. AND TAX-DEFERRED EARNINGS.
-------------------------- -------------------------- AFTER-TAX
TAXABLE TAXABLE CONTRIBUTIONS
LUMP LUMP AND
NO SUM NO SUM TAXABLE
WITHDRAWALS WITHDRAWAL WITHDRAWALS WITHDRAWAL EARNINGS.
--------- --------- --------- --------- -----------
<S> <C> <C> <C> <C> <C>
10 Years................ $ 33,898 $ 22,732 $ 23,283 $ 20,746 $ 22,137
20 Years................ 100,018 66,967 68,698 56,258 60,535
30 Years................ 228,992 151,140 157,284 119,479 127,136
</TABLE>
This chart compares the accumulation of monthly contributions into a
Tax-Deferred Retirement Annuity through a payroll reduction program, a
Non-qualified Annuity and a Conventional Savings Plan. Before-tax contributions
to the Tax-Deferred Retirement Annuity are $200 per month and the entire amount
of a taxable lump sum withdrawal will be subject to income tax. After-tax
contributions to the Non-qualified Annuity and the Conventional Savings Plan are
$138 per month. Only the gain in the Non-qualified Annuity will be subject to
income tax in a taxable lump sum withdrawal. The chart assumes a 31% tax bracket
and an 8% annual return. Tax rates are subject to change as is the tax-deferred
treatment of the Contracts. Tax-deferred retirement accumulations, as well as
the income on non-qualified annuities, are taxed as ordinary income upon
withdrawal. A 10% tax penalty may apply to early withdrawals. See "Federal
Income Taxes" in the prospectus. For the Tax-Deferred Retirement Annuity and the
Non-Qualified Annuity the figures include a deduction for all applicable
Contract charges. No implication is intended by the use of these assumptions
that the return shown is guaranteed in any way or that the return shown
represents an average or expected rate of return over the period of the
Contracts. [IMPORTANT--THIS IS NOT AN ILLUSTRATION OF YIELD OR RETURN]
Unlike savings plans, contributions to tax-deferred retirement annuities and
non-qualified annuities provide tax-deferred treatment on earnings. In addition,
contributions to tax-deferred retirement annuities are not subject to current
tax in the year of contribution. When monies are received from a tax-deferred
retirement annuity or non-qualified annuity (and you have many different options
on how you receive your funds), they are subject to income
B-7
<PAGE> 118
tax. At the time of receipt, if the person receiving the monies is retired, not
working or has additional tax exemptions, these monies may be taxed at a lesser
rate.
STATE REGULATION
KILICO is subject to the laws of Illinois governing insurance companies and to
regulation by the Illinois Department of Insurance. An annual statement in a
prescribed form is filed with the Illinois Department of Insurance each year.
KILICO's books and accounts are subject to review by the Department of Insurance
at all times, and a full examination of its operations is conducted
periodically. Such regulation does not, however, involve any supervision of
management or investment practices or policies. In addition, KILICO is subject
to regulation under the insurance laws of other jurisdictions in which it may
operate.
EXPERTS
The financial statements of KILICO and the Separate Account have been included
in the Statement of Additional Information in reliance upon the reports of KPMG
Peat Marwick LLP, independent certified public accountants, appearing elsewhere
herein, and upon the authority of said firm as experts in accounting and
auditing. As discussed in the notes to KILICO's consolidated financial
statements effective January 1, 1994, KILICO changed its method of accounting
for investment securities to adopt the provisions of the Financial Accounting
Standards Board's Statement of Financial Accounting Standards ("SFAS") 115,
ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBTS AND EQUITY SECURITIES. Also, as
discussed in the notes, effective January 1, 1993, KILICO changed its method of
accounting for impairment of loans receivable to adopt the provisions of SFAS
114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, and changed its method of
accounting for income taxes to adopt the provisions of SFAS 109, ACCOUNTING FOR
INCOME TAXES. Further, as discussed in the notes, KILICO adopted the provisions
of SFAS 106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN
PENSIONS in 1992.
FINANCIAL STATEMENTS
This Statement of Additional Information contains financial statements for the
Separate Account which reflect assets attributable to the Contracts and also
reflect assets attributable to other variable annuity contracts offered by
KILICO through the Separate Account.
B-8
<PAGE> 119
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS
KEMPER INVESTORS LIFE INSURANCE COMPANY:
We have audited the accompanying combined statement of assets and liabilities
and contract owners' equity of the KILICO Variable Annuity Separate Account as
of December 31, 1994, and the related combined statement of operations for the
year then ended, and the combined statements of changes in contract owners'
equity for the years ended December 31, 1994 and 1993. 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 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the combined financial position of the KILICO
Variable Annuity Separate Account as of December 31, 1994, and the combined
results of its operations for the year then ended, and the combined changes in
its contract owners' equity for the years ended December 31, 1994 and 1993, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Chicago, Illinois
February 13, 1995
B-9
<PAGE> 120
KILICO VARIABLE ANNUITY SEPARATE ACCOUNT
COMBINED STATEMENT OF ASSETS AND LIABILITIES AND CONTRACT OWNERS' EQUITY
DECEMBER 31, 1994 (IN THOUSANDS)
<TABLE>
<CAPTION>
MONEY
MONEY MARKET TOTAL HIGH GOVERNMENT
MARKET SUB- RETURN YIELD EQUITY SECURITIES
SUB- ACCOUNT SUB- SUB- SUB- SUB-
COMBINED ACCOUNT #2 ACCOUNT ACCOUNT ACCOUNT ACCOUNT
-------- -------- ------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Investments,
at current value.......... $1,432,488 78,837 3,676 584,469 217,698 320,586 91,604
Dividends and other
receivables............... 301 216 9 23 10 21 4
---------- ------ ----- ------- ------- ------- ------
Total assets............. 1,432,789 79,053 3,685 584,492 217,708 320,607 91,608
---------- ------ ----- ------- ------- ------- ------
LIABILITIES AND CONTRACT
OWNERS' EQUITY
Liabilities:
Mortality and expense risk
and administrative
charges................... 1,525 99 -- 627 220 337 99
Other..................... 110 4 -- -- -- -- --
---------- ------ ----- ------- ------- ------- ------
Total liabilities...... 1,635 103 -- 627 220 337 99
---------- ------ ----- ------- ------- ------- ------
Contract owners' equity..... $1,431,154 78,950 3,685 583,865 217,488 320,270 91,509
========== ====== ===== ======= ======= ======= ======
ANALYSIS OF CONTRACT
OWNERS' EQUITY
Excess of proceeds
from units sold over
payments for units
redeemed.................. $ 971,895 17,494 3,265 394,080 103,120 243,967 79,529
Accumulated
net investment
income (loss)............. 378,073 61,456 420 159,772 122,056 19,327 16,110
Accumulated
net realized
gain (loss) on sales of
investments............... 72,532 -- -- 44,173 (4,720) 29,760 1,041
Unrealized
appreciation
(depreciation)
of investments............ 8,654 -- -- (14,160) (2,968) 27,216 (5,171)
---------- ------ ----- ------- ------- ------- ------
Contract owners'
equity.................... $1,431,154 78,950 3,685 583,865 217,488 320,270 91,509
========== ====== ===== ======= ======= ======= ======
<CAPTION>
SMALL
INTER- CAPITALIZATION
NATIONAL EQUITY
SUB- SUB-
ACCOUNT ACCOUNT
------- -------------
<S> <C> <C>
ASSETS
Investments, at current
value..................... 122,709 12,909
Dividends and other
receivables............... 6 12
------- ------
Total assets............. 122,715 12,921
------- ------
LIABILITIES AND CONTRACT
OWNERS' EQUITY
Liabilities:
Mortality and expense
risk and administrative
charges................. 131 12
Other....................... -- 106
------- ------
Total liabilities........ 131 118
------- ------
Contract owners' equity..... 122,584 12,803
======= ======
ANALYSIS OF CONTRACT
OWNERS' EQUITY
Excess of proceeds
from units sold over
payments for units
redeemed.................. 117,687 12,753
Accumulated net investment
income (loss)............. (907) (161)
Accumulated
net realized gain (loss)
on sales of investments... 2,355 (77)
Unrealized appreciation
(depreciation) of
investments............... 3,449 288
------- ------
Contract owners' equity...... 122,584 12,803
======= ======
</TABLE>
See accompanying notes to combined financial statements.
B-10
<PAGE> 121
KILICO VARIABLE ANNUITY SEPARATE ACCOUNT
COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1994 (IN THOUSANDS)
<TABLE>
<CAPTION>
MONEY MONEY TOTAL
MARKET MARKET RETURN HIGH YIELD
COMBINED SUBACCOUNT SUBACCOUNT #2 SUBACCOUNT SUBACCOUNT
--------- ---------- -------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Dividends and
capital gains
distributions................ $ 105,315 3,840 153 58,451 19,146
Expenses:
Mortality and expense
risk and administrative
charges.................... 20,153 1,266 1 8,636 2,988
--------- ----- --- -------- --------
Net investment income (loss)... 85,162 2,574 152 49,815 16,158
--------- ----- --- -------- --------
Net realized and unrealized gain
(loss) on investments:
Net realized gain (loss) on
sales of investments....... 11,105 -- -- 878 3,164
Change in unrealized
appreciation (depreciation)
of investments............. (199,366) -- -- (121,752) (27,264)
--------- ----- --- -------- --------
Net realized and unrealized gain
(loss) on investments........ (188,261) -- -- (120,874) (24,100)
--------- ----- --- -------- --------
Net increase (decrease) in
contract owners' equity
resulting from
operations................... $(103,099) 2,574 152 (71,059) (7,942)
========= ===== === ======== ========
</TABLE>
(a) For the period from May 2, 1994 (commencement of operations) to December 31,
1994.
See accompanying notes to combined financial statements.
<TABLE>
<CAPTION>
SMALL
GOVERNMENT CAPITALIZATION
EQUITY SECURITIES INTERNATIONAL EQUITY
SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT(a)
---------- ---------- ------------- --------------
<S> <C> <C> <C> <C>
Dividends and
capital gains
distributions................ 14,860 7,695 1,170 --
Expenses:
Mortality and expense
risk and administrative
charges.................... 4,137 1,379 1,585 161
------- ------- ------ -----
Net investment income (loss)... 10,723 6,316 (415) (161)
------- ------- ------ -----
Net realized and unrealized gain
(loss) on investments:
Net realized gain (loss) on
sales of investments....... 5,853 (726) 2,013 (77)
Change in unrealized
appreciation (depreciation)
of investments............. (32,435) (10,070) (8,133) 288
------- ------- ------ -----
Net realized and unrealized gain
(loss) on investments........ (26,582) (10,796) (6,120) 211
------- ------- ------ -----
Net increase (decrease) in
contract owners' equity
resulting from
operations................... (15,859) (4,480) (6,535) 50
======= ======= ====== =====
</TABLE>
(a) For the period from May 2, 1994 (commencement of operations) to December 31,
1994.
See accompanying notes to combined financial statements.
B-11
<PAGE> 122
KILICO VARIABLE ANNUITY SEPARATE ACCOUNT
COMBINED STATEMENTS OF CHANGES IN CONTRACT OWNERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993
(IN THOUSANDS)
<TABLE>
<CAPTION>
MONEY MARKET MONEY MARKET
COMBINED SUBACCOUNT SUBACCOUNT #2
---------------------------- ----------------------- ---------------------
1994 1993 1994 1993 1994 1993
---------- --------- ------- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Operations:
Net investment income (loss)....... $ 85,162 49,841 2,574 997 152 127
Net realized gain (loss) on sales
of investments................... 11,105 19,074 -- -- -- --
Change in unrealized appreciation
(depreciation) of investments.... (199,366) 72,722 -- -- -- --
---------- --------- ------- ------- ------ ------
Net increase (decrease) in
contract owners' equity
resulting from operations...... (103,099) 141,637 2,574 997 152 127
---------- --------- ------- ------- ------ ------
Account unit transactions:
Proceeds from units sold........... 254,411 266,721 19,971 12,800 6,673 4,794
Net transfers (to) from affiliate
and subaccounts.................. 3,471 48,524 16,310 (2,660) (6,297) (8,394)
Payments for units redeemed........ (152,336) (104,210) (24,064) (13,103) (68) (84)
---------- --------- ------- ------- ------ ------
Net increase (decrease) in
contract owners' equity from
account unit transactions...... 105,546 211,035 12,217 (2,963) 308 (3,684)
---------- --------- ------- ------- ------ ------
Total increase (decrease) in contract
owners' equity..................... 2,447 352,672 14,791 (1,966) 460 (3,557)
Contract owners' equity:
Beginning of period................ 1,428,707 1,076,035 64,159 66,125 3,225 6,782
---------- --------- ------- ------- ------ ------
End of period...................... $1,431,154 1,428,707 78,950 64,159 3,685 3,225
========== ========= ======= ======= ====== ======
</TABLE>
(a) For the period from May 2, 1994 (commencement of operations) to December 31,
1994.
See accompanying notes to combined financial statements.
B-12
<PAGE> 123
<TABLE>
<CAPTION>
SMALL
GOVERNMENT CAPITALIZATION
TOTAL RETURN HIGH YIELD EQUITY SECURITIES INTERNATIONAL EQUITY
SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT
-------------------- ------------------- ------------------- ------------------- ------------------ ---------------
1994 1993 1994 1993 1994 1993 1994 1993 1994 1993 1994(a) 1993
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
49,815 28,972 16,158 11,854 10,723 2,502 6,316 5,694 (415) (305) (161) --
878 6,051 3,164 2,654 5,853 9,420 (726) 632 2,013 317 (77) --
(121,752) 23,970 (27,264) 19,150 (32,435) 18,912 (10,070) (1,182) (8,133) 11,872 288 --
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------- ------
(71,059) 58,993 (7,942) 33,658 (15,859) 30,834 (4,480) 5,144 (6,535) 11,884 50 --
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------- ------
89,169 104,977 34,261 39,600 52,913 56,537 15,214 32,889 32,734 15,124 3,476 --
(16,297) (5,727) (15,720) 15,978 25,150 9,542 (24,188) (4,289) 15,006 44,074 9,507 --
(58,032) (43,640) (24,877) (18,723) (24,735) (16,241 (12,918) (10,666) (7,412) (1,753) (230) --
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------- ------
14,840 55,610 (6,336) 36,855 53,328 49,838 (21,892) 17,934 40,328 57,445 12,753 --
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------- ------
(56,219) 114,603 (14,278) 70,513 37,469 80,672 (26,372) 23,078 33,793 69,329 12,803 --
640,084 525,481 231,766 161,253 282,801 202,129 117,881 94,803 88,791 19,462 -- --
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------- ------
583,865 640,084 217,488 231,766 320,270 282,801 91,509 117,881 122,584 88,791 12,803 --
======== ======= ======= ======= ======= ======= ======= ======= ======= ====== ======== ======
</TABLE>
B-13
<PAGE> 124
KILICO VARIABLE ANNUITY SEPARATE ACCOUNT
NOTES TO COMBINED FINANCIAL STATEMENTS
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION.
KILICO Variable Annuity Separate Account (the "Separate Account") is a unit
investment trust registered under the Investment Company Act of 1940, as
amended, established by Kemper Investors Life Insurance Company ("KILICO"). The
Separate Account is used to fund contracts or certificates (collectively
referred to as "contracts") for ADVANTAGE III periodic and flexible payment
variable annuity contracts and PASSPORT individual and group variable and market
value adjusted deferred annuity contracts. The Separate Account is divided into
eight Subaccounts and each Subaccount invests exclusively in a corresponding
Portfolio of the Kemper Investors Fund (the "Fund"), an open-end diversified
management investment company.
SECURITY VALUATION.
The investments are stated at current value which is based on the closing bid
price, net asset value, at December 31, 1994.
SECURITY TRANSACTIONS AND INVESTMENT INCOME.
Security transactions are accounted for on the trade date (date the order to buy
or sell is executed). Dividends and capital gains distributions are recorded as
income on the ex-dividend date. Realized gains and losses from security
transactions are reported on an identified cost basis.
ACCUMULATION UNIT VALUATION.
On each day the New York Stock Exchange (the "Exchange") is open for trading,
the accumulation unit value is determined as of the earlier of 3:00 p.m.
(Chicago time) or the close of the Exchange by dividing the total value of each
Subaccount's investments and other assets, less liabilities, by the number of
accumulation units outstanding in the respective Subaccount.
FEDERAL INCOME TAXES.
The operations of the Separate Account are included in the Federal income tax
return of KILICO. Under existing Federal income tax law, investment income and
realized capital gains and losses of the Separate Account increase liabilities
under the contract and are, therefore, not taxed. Thus the Separate Account may
realize net investment income and capital gains and losses without Federal
income tax consequences.
(2) SUMMARY OF INVESTMENTS
Investments, at cost, at December 31, 1994, are as follows (in thousands):
<TABLE>
<CAPTION>
Shares
Owned Cost
-------- ----------
<S> <C> <C>
INVESTMENTS
Kemper Investors Fund Money Market Portfolio (Money Market and
Money Market #2 Subaccounts)................................................................ 82,513 $ 82,513
Kemper Investors Fund Total Return Portfolio.................................................. 276,685 598,629
Kemper Investors Fund High Yield Portfolio.................................................... 183,754 220,666
Kemper Investors Fund Equity Portfolio........................................................ 120,300 293,370
Kemper Investors Fund Government Securities Portfolio......................................... 80,232 96,775
Kemper Investors Fund International Portfolio................................................. 98,620 119,260
Kemper Investors Fund Small Capitalization Equity Portfolio................................... 12,420 12,621
----------
TOTAL INVESTMENTS....................................................................... $1,423,834
==========
</TABLE>
B-14
<PAGE> 125
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The underlying investments and significant industry concentrations of the Fund's
portfolios are summarized below.
MONEY MARKET PORTFOLIO: This Portfolio invests primarily in short-term
obligations of major banks and corporations. The Money Market Subaccount
represents the ADVANTAGE III Money Market Subaccount and the PASSPORT Money
Market Subaccount #1. Money Market Subaccount #2 represents funds allocated by
the owner of a contract to the dollar cost averaging program. Under the dollar
cost averaging program, an owner may predesignate a portion of the Subaccount
value to be automatically transferred on a monthly basis to one or more of the
other Subaccounts. This option is only available to PASSPORT individual and
group variable and market value adjusted deferred annuity contracts. At December
31, 1994, no industry exceeded 20% of the Portfolio's assets.
TOTAL RETURN PORTFOLIO: This Portfolio's investments will normally consist of
fixed-income and equity securities. Fixed-income securities will include bonds
and other debt securities and preferred stocks. Equity investments normally will
consist of common stocks and securities convertible into or exchangeable for
common stocks, however, the Portfolio may also make private placement
investments (which are normally restricted securities). At December 31, 1994, no
industry exceeded 20% of the Portfolio's assets.
HIGH YIELD PORTFOLIO: This Portfolio invests in fixed-income securities, a
substantial portion of which are high yielding fixed-income securities. These
securities ordinarily will be in the lower rating categories of recognized
rating agencies or will be non-rated, and generally will involve more risk than
securities in the higher rating categories. At December 31, 1994, 21.3% of the
Portfolio's assets were invested in the manufacturing, metals and mining
industry. No other industry exceeded 20% of the Portfolio's assets.
EQUITY PORTFOLIO: This Portfolio's investments normally will consist of common
stocks and securities convertible into or exchangeable for common stocks,
however, it may also make private placement investments (which are normally
restricted securities). At December 31, 1994, no industry exceeded 20% of the
Portfolio's assets.
GOVERNMENT SECURITIES PORTFOLIO: This Portfolio invests primarily in U.S.
Government securities. The Portfolio will also invest in fixed-income securities
other than U.S. Government securities and will engage in options and financial
futures transactions. At December 31, 1994, the Portfolio had 89.6% of its
assets invested in U.S. Government obligations.
INTERNATIONAL PORTFOLIO: This Portfolio's investments will normally consist of
equity securities of non-United States issuers, however, it may also invest in
convertible and debt securities of non-United States issuers and foreign
currencies. At December 31, 1994, 32% of the Portfolio's assets were invested in
Japan. No other industry or country exceeded 20% of the Portfolio's assets.
SMALL CAPITALIZATION EQUITY PORTFOLIO: This Portfolio's investments will consist
primarily of common stocks and securities convertible into or exchangeable for
common stocks and to a limited degree in preferred stocks and debt securities.
At least 65% of the Portfolio's total assets will be invested in equity
securities of companies having a market capitalization of $1 billion or less at
the time of initial investment. At December 31, 1994 no industry exceeded 20% of
the Portfolio's assets.
(3) TRANSACTIONS WITH AFFILIATES
KILICO assumes mortality risks associated with the annuity contracts and incurs
all expenses involved in administering the contracts. In return, KILICO assesses
that portion of each Subaccount representing assets under the ADVANTAGE III
flexible payment contracts with a daily charge for mortality and expense risk
and administrative costs which amounts to an aggregate of one percent (1.00%)
per annum. KILICO also assesses that portion of each Subaccount representing
assets under the ADVANTAGE III periodic payment contracts with a daily asset
charge for mortality and expense risk and administrative costs which amounts to
an aggregate of one and three-tenths percent (1.30%) per annum. KILICO assesses
that portion of each Subaccount representing assets under PASSPORT individual
and group variable and market value adjusted deferred annuity contracts with a
daily asset charge for mortality and expense risk and administrative costs which
amounts to an aggregate of one and one-quarter percent (1.25%) per annum. The
PASSPORT DCA Money Market Subaccount #2, available for participation in the
dollar cost averaging program, has no daily asset charge deduction.
B-15
<PAGE> 126
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
KILICO also assesses against each ADVANTAGE III contract participating in one or
more of the Subaccounts at any time during the year a records maintenance
charge. For contracts purchased prior to June 1, 1993, the charge is $25 and is
assessed on December 31st of each calendar year. For contracts purchased June 1,
1993 and subsequent, the charge is $36 and is assessed ratably every quarter of
each calendar year, except in those states which have yet to approve these
contract changes. The charge is assessed whether or not any purchase payments
have been made during the year. KILICO also assesses against each PASSPORT
contract participating in one or more of the Subaccounts a records maintenance
charge of $30 at the end of each contract year.
For contracts issued prior to May 1, 1994, KILICO has undertaken to reimburse
each of the ADVANTAGE III Money Market, Total Return, High Yield, and Equity
Subaccounts whose direct and indirect operating expenses exceed eighty
hundredths of one percent (.80%) of average daily net assets. In determining
reimbursement of direct and indirect operating expenses, for each Subaccount,
charges for mortality and expense risks and administrative expenses, and records
maintenance charges are excluded and, for each Portfolio, charges for taxes,
extraordinary expenses, and brokerage and transaction costs are excluded. During
the year ended December 31, 1994, no such payment was made.
Proceeds payable on the redemption of units are reduced by the amount of any
applicable contingent deferred sales charge due to KILICO. During the year ended
December 31, 1994, KILICO received contingent deferred sales charges of
$1,568,200.
Kemper Financial Services, Inc., an affiliated company, is the investment
manager and principal underwriter of the Portfolios of the Fund which serve as
the underlying investments of the Separate Accounts.
(4) NET TRANSFERS (TO) FROM AFFILIATED DIVISIONS AND SUBACCOUNTS
Net transfers (to) from affiliated divisions or accounts include transfers of
all or part of the contract owner's interest to or from another Subaccount or to
the general account of KILICO.
(5) CONTRACT OWNERS' EQUITY
The contract owners' equity is affected by the investment results of each
Portfolio and contract charges. The accompanying financial statements include
only contract owners' payments pertaining to the variable portions of their
contracts and exclude any payments for the market value adjusted or fixed
portions, the latter being included in the general account of KILICO. Contract
owners may elect to annuitize the contract under one of several annuity options,
as specified in the prospectus.
B-16
<PAGE> 127
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
Contract owners' equity at December 31, 1994, is as follows (in thousands,
except unit value; differences are due to rounding):
<TABLE>
<CAPTION>
NUMBER CONTRACT
OF UNIT OWNERS'
UNITS VALUE EQUITY
-------- ------ ----------
<S> <C> <C> <C>
ADVANTAGE III SUBACCOUNT
MONEY MARKET
Flexible Payment, Qualified................................................... 733 $2.111 $ 1,547
Flexible Payment, Nonqualified................................................ 6,914 2.111 14,596
Periodic Payment, Qualified................................................... 15,997 2.033 32,519
Periodic Payment, Nonqualified................................................ 7,343 2.033 14,926
----------
Total....................................................................... 63,588
----------
TOTAL RETURN
Flexible Payment, Qualified................................................... 1,299 3.796 4,932
Flexible Payment, Nonqualified................................................ 6,613 3.515 23,244
Periodic Payment, Qualified................................................... 110,428 3.656 403,681
Periodic Payment, Nonqualified................................................ 24,773 3.406 84,376
----------
Total....................................................................... 516,233
----------
HIGH YIELD
Flexible Payment, Qualified................................................... 532 4.372 2,324
Flexible Payment, Nonqualified................................................ 3,621 4.186 15,157
Periodic Payment, Qualified................................................... 26,546 4.210 111,758
Periodic Payment, Nonqualified................................................ 12,416 4.101 50,918
----------
Total....................................................................... 180,157
----------
EQUITY
Flexible Payment, Qualified................................................... 238 3.345 795
Flexible Payment, Nonqualified................................................ 1,370 3.334 4,568
Periodic Payment, Qualified................................................... 58,845 3.238 190,522
Periodic Payment, Nonqualified................................................ 19,776 3.233 63,935
----------
Total....................................................................... 259,820
----------
GOVERNMENT SECURITIES
Flexible Payment, Qualified................................................... 237 1.337 317
Flexible Payment, Nonqualified................................................ 1,465 1.337 1,958
Periodic Payment, Qualified................................................... 24,332 1.317 32,039
Periodic Payment, Nonqualified................................................ 23,487 1.317 30,926
----------
Total....................................................................... 65,240
----------
INTERNATIONAL
Flexible Payment, Qualified................................................... 625 1.234 771
Flexible Payment, Nonqualified................................................ 2,450 1.234 3,024
Periodic Payment, Qualified................................................... 61,490 1.223 75,223
Periodic Payment, Nonqualified................................................ 14,546 1.223 17,795
----------
Total....................................................................... 96,813
----------
SMALL CAPITALIZATION EQUITY
Flexible Payment, Qualified................................................... 14 1.033 14
Flexible Payment, Nonqualified................................................ 227 1.033 234
Periodic Payment, Qualified................................................... 8,304 1.031 8,558
Periodic Payment, Nonqualified................................................ 1,242 1.031 1,280
----------
Total....................................................................... 10,086
----------
TOTAL ADVANTAGE III CONTRACT OWNERS' EQUITY.............................................................. $1,191,937
----------
</TABLE>
B-17
<PAGE> 128
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
NUMBER CONTRACT
OF UNIT OWNERS'
UNITS VALUE EQUITY
-------- ------ ----------
<S> <C> <C> <C>
PASSPORT SUBACCOUNT
MONEY MARKET #1
Qualified.................................................................... 4,014 $1.065 $ 4,275
Nonqualified................................................................. 10,409 1.065 11,087
----------
Total...................................................................... 15,362
----------
MONEY MARKET #2
Qualified.................................................................... 858 1.105 949
Nonqualified................................................................. 2,475 1.105 2,736
----------
Total...................................................................... 3,685
----------
TOTAL RETURN
Qualified.................................................................... 17,755 0.991 17,606
Nonqualified................................................................. 50,452 0.991 50,026
----------
Total...................................................................... 67,632
----------
HIGH YIELD
Qualified.................................................................... 7,119 1.308 9,311
Nonqualified................................................................. 21,426 1.308 28,020
----------
Total...................................................................... 37,331
----------
EQUITY
Qualified.................................................................... 16,003 1.093 17,491
Nonqualified................................................................. 39,305 1.093 42,959
----------
Total...................................................................... 60,450
----------
GOVERNMENT SECURITIES
Qualified.................................................................... 5,654 1.061 5,999
Nonqualified................................................................. 19,106 1.061 20,270
----------
Total...................................................................... 26,269
----------
INTERNATIONAL
Qualified.................................................................... 5,886 1.225 7,211
Nonqualified................................................................. 15,149 1.225 18,560
----------
Total...................................................................... 25,771
----------
SMALL CAPITALIZATION EQUITY
Qualified.................................................................... 881 1.031 907
Nonqualified................................................................. 1,756 1.031 1,810
----------
Total...................................................................... 2,717
----------
TOTAL PASSPORT CONTRACT OWNERS' EQUITY................................................................... 239,217
----------
TOTAL CONTRACT OWNERS' EQUITY............................................................................ $1,431,154
==========
</TABLE>
B-18
<PAGE> 129
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors
Kemper Investors Life Insurance Company:
We have audited the consolidated balance sheet of Kemper Investors Life
Insurance Company and subsidiaries as of December 31, 1994 and 1993, and the
related consolidated statements of operations, stockholder's equity and cash
flows for each of the years in the three-year period ended December 31, 1994.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Kemper Investors
Life Insurance Company and subsidiaries at December 31, 1994 and 1993, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1994, in conformity with generally accepted
accounting principles.
As discussed in the notes to the consolidated financial statements, effective
January 1, 1994, the Company changed its method of accounting for investment
securities to adopt the provisions of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards ("SFAS") 115, ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES. Also, as discussed in the notes,
effective January 1, 1993, the Company changed its method of accounting for
impairment of loans receivable to adopt the provisions of SFAS 114, ACCOUNTING
BY CREDITORS FOR IMPAIRMENT OF A LOAN, and changed its method of accounting for
income taxes to adopt the provisions of SFAS 109, ACCOUNTING FOR INCOME TAXES.
Further, as discussed in the notes, the Company adopted the provisions of SFAS
106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS in
1992.
KPMG PEAT MARWICK LLP
Chicago, Illinois
March 3, 1995
B-19
<PAGE> 130
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1994 1993
---------- ----------
<S> <C> <C>
ASSETS
Fixed maturities, available for sale, at market (cost: 1994,
$3,707,356; 1993, $3,333,202)..................................... $3,463,732 $3,441,224
Equity securities, at market (cost: 1994, $14,947; 1993, $35,170)... 14,767 67,700
Short-term investments.............................................. 204,164 402,463
Joint venture mortgage loans........................................ 351,359 730,753
Third-party mortgage loans.......................................... 318,682 132,162
Other real estate-related investments............................... 237,242 291,489
Policy loans........................................................ 277,743 264,112
Other invested assets............................................... 25,760 43,267
---------- ----------
Total investments......................................... 4,893,449 5,373,170
Cash................................................................ 23,189 7,487
Accrued investment income........................................... 125,543 132,834
Deferred insurance acquisition costs................................ 310,465 288,097
Fixed assets, at cost less accumulated depreciation................. 3,735 6,413
Receivable for securities sold...................................... -- 26,631
Reinsurance recoverable............................................. 642,801 745,554
Other assets and receivables........................................ 29,914 34,058
Assets held in separate accounts.................................... 1,507,984 1,499,471
---------- ----------
Total assets.............................................. $7,537,080 $8,113,715
========== ==========
LIABILITIES
Future policy benefits.............................................. $4,843,690 $5,040,002
Ceded future policy benefits........................................ 642,801 745,554
Payable for securities purchased.................................... 574 43,758
Other accounts payable and liabilities.............................. 66,687 66,298
Deferred income taxes............................................... 41,364 64,045
Liabilities related to separate accounts............................ 1,507,984 1,499,471
---------- ----------
Total liabilities......................................... 7,103,100 7,459,128
---------- ----------
Commitments and contingent liabilities
STOCKHOLDER'S EQUITY
Capital stock--$10 par value,
authorized 300,000 shares; outstanding 250,000 shares............. 2,500 2,500
Additional paid-in capital.......................................... 491,994 409,423
Unrealized gain (loss) on investments............................... (236,443) 93,096
Retained earnings................................................... 175,929 149,568
---------- ----------
Total stockholder's equity................................ 433,980 654,587
---------- ----------
Total liabilities and stockholder's equity................ $7,537,080 $8,113,715
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
B-20
<PAGE> 131
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------------
1994 1993 1992
--------- --------- ---------
<S> <C> <C> <C>
REVENUE
Net investment income...................................... $353,084 $339,274 $404,758
Realized investment losses................................. (54,557) (27,584) (83,502)
Fees and other income...................................... 31,950 25,687 32,360
-------- -------- --------
Total revenue.................................... 330,477 337,377 353,616
-------- -------- --------
BENEFITS AND EXPENSES
Benefits and interest credited to policyholders............ 248,494 275,689 348,555
Commissions, taxes, licenses and fees...................... 26,910 33,875 49,309
Operating expenses......................................... 25,324 24,383 38,617
Deferral of insurance acquisition costs.................... (31,852) (31,781) (46,649)
Amortization of insurance acquisition costs................ 20,809 12,376 29,119
-------- -------- --------
Total benefits and expenses...................... 289,685 314,542 418,951
-------- -------- --------
Income (loss) before income tax expense (benefit) and
cumulative effect of changes in accounting principles.... 40,792 22,835 (65,335)
Income tax expense (benefit)............................... 14,431 11,142 (13,730)
-------- -------- --------
Income (loss) before cumulative effect of changes
in accounting principles....................... 26,361 11,693 (51,605)
Cumulative effect of changes in accounting principles, net
of tax................................................... -- 2,350 (281)
-------- -------- --------
Net income (loss)................................ $ 26,361 $ 14,043 $(51,886)
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
B-21
<PAGE> 132
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
(in thousands)
<TABLE>
<CAPTION>
1994 1993 1992
--------- --------- ---------
<S> <C> <C> <C>
CAPITAL STOCK, beginning and end of year................. $ 2,500 $ 2,500 $ 2,500
-------- -------- --------
ADDITIONAL PAID-IN CAPITAL, beginning of year............ 409,423 310,237 280,237
Capital contributions from Parent........................ 82,500 90,000 30,000
Transfer of limited partnership interest to Parent....... 71 9,186 --
-------- -------- --------
End of year.................................... 491,994 409,423 310,237
-------- -------- --------
UNREALIZED GAIN (LOSS) ON INVESTMENTS, beginning of
year................................................... 93,096 39,872 (830)
Unrealized gain (loss) on revaluation of investments,
net.................................................... (329,539) 53,224 40,702
-------- -------- --------
End of year.................................... (236,443) 93,096 39,872
-------- -------- --------
RETAINED EARNINGS, beginning of year..................... 149,568 136,055 187,941
Net income (loss)........................................ 26,361 14,043 (51,886)
Dividend of limited partnership interest to Parent....... -- (530) --
-------- -------- --------
End of year.................................... 175,929 149,568 136,055
-------- -------- --------
Total stockholder's equity..................... $433,980 $654,587 $488,664
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
B-22
<PAGE> 133
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------------------
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)................................. $ 26,361 $ 14,043 $ (51,886)
Reconcilement of net income (loss) to net cash
provided:
Realized investment losses..................... 54,557 27,584 83,502
Interest credited and other charges............ 242,591 269,766 343,788
Deferred insurance acquisition costs........... (11,043) (19,405) (17,529)
Amortization of discount and premium on
investments.................................. (1,383) (203) (4,699)
Deferred income taxes.......................... 20,809 14,596 16,599
Other, net..................................... (13,352) 30,148 (33,740)
----------- ----------- -----------
Net cash provided from operating
activities.............................. 318,540 336,529 336,035
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash from investments sold or matured:
Fixed maturities held to maturity.............. 144,717 187,949 96,588
Fixed maturities sold prior to maturity........ 910,913 1,652,119 2,939,784
Mortgage loans, policy loans and other invested
assets....................................... 536,668 881,505 557,237
Cost of investments purchased or loans originated:
Fixed maturities............................... (1,447,393) (2,322,085) (3,456,016)
Mortgage loans, policy loans and other invested
assets....................................... (281,059) (443,445) (326,899)
Short-term investments, net....................... 198,299 (214,999) 474,280
Net change in receivable and payable for
securities transactions........................ (16,553) 39,078 (70,088)
Net reductions in fixed assets.................... 2,678 8,062 2,667
----------- ----------- -----------
Net cash provided by (used in) investing
activities.............................. 48,270 (211,816) 217,553
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Policyholder account balances:
Deposits....................................... 215,034 246,219 440,576
Withdrawals.................................... (652,513) (516,340) (498,287)
Capital contributions from Parent................. 82,500 90,000 30,000
Reinsured life reserves........................... -- -- (515,684)
Other............................................. 3,871 16,776 7,934
----------- ----------- -----------
Net cash used in financing activities..... (351,108) (163,345) (535,461)
----------- ----------- -----------
Net increase (decrease) in cash...... 15,702 (38,632) 18,127
CASH, beginning of period........................... 7,487 46,119 27,992
----------- ----------- -----------
CASH, end of period................................. $ 23,189 $ 7,487 $ 46,119
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
B-23
<PAGE> 134
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Kemper Investors Life Insurance Company and subsidiaries (the "Company") issues
fixed and variable annuity products and interest-sensitive life insurance
products marketed primarily through a network of financial institutions,
nonaffiliated and affiliated securities brokerage firms, insurance agents and
financial planners. The Company is a wholly-owned subsidiary of Kemper Financial
Companies, Inc. ("KFC"), which in turn is a holding company formed by Kemper
Corporation ("Kemper"), the Company's ultimate parent.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles. The statements include the accounts of
the Company on a consolidated basis. All significant intercompany balances and
transactions have been eliminated.
LIFE INSURANCE REVENUE AND EXPENSES
Revenue for annuities and interest-sensitive life products consists of
investment income, and policy charges such as mortality, expense and surrender
charges. Expenses consist of benefits and interest credited to contracts, policy
maintenance costs and amortization of deferred insurance acquisition costs. Also
reflected in fees and other income are ceding commissions received as a result
of certain reinsurance transactions entered into by the Company during 1992.
(See the note captioned "Reinsurance" on page B-38.)
DEFERRED INSURANCE ACQUISITION COSTS
The costs of acquiring new business, principally commission expense and certain
policy issuance and underwriting expenses, have been deferred to the extent they
are recoverable from estimated future gross profits on the related contracts and
policies. The deferred insurance acquisition costs for annuities, separate
account business and interest-sensitive life products are being amortized over
the estimated contract life in relation to the present value of estimated gross
profits. Beginning in 1994, deferred insurance acquisition costs reflect the
estimated impact of unrealized gains or losses on fixed maturities held as
available for sale in the investment portfolio, through a credit or charge to
stockholder's equity, net of income tax.
FUTURE POLICY BENEFITS
Liabilities for future policy benefits related to annuities and
interest-sensitive life contracts reflect net premiums received plus interest
credited during the contract accumulation period and the present value of future
payments for contracts that have annuitized. Current interest rates credited
during the contract accumulation period range from 4 percent to 8.75 percent.
Future minimum guaranteed interest rates vary from 4 percent to 8.75 percent for
periods ranging from a portion of 1995 up to a portion of 1999 and are generally
3 percent to 4.5 percent thereafter. For contracts that have annuitized,
interest rates that are used in determining the present value of future payments
range principally from 3 percent to 11.25 percent.
INVESTED ASSETS AND RELATED INCOME
Investments in fixed maturities (bonds and redeemable preferred stocks) are
carried at market value at December 31, 1994 and 1993, as they are currently
considered available for sale. Short-term investments are carried at cost, which
approximates market value. Equity securities of nonrelated companies are
generally carried at market value using the closing prices as of the balance
sheet date derived from either a major securities exchange or the National
Association of Securities Dealers Automated Quotations system.
Mortgage loans are carried at their unpaid balance net of unamortized discount
and any applicable reserve. Other real estate-related investments net of any
applicable reserve and write-downs include certain bonds issued by real
B-24
<PAGE> 135
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
estate finance or development companies; notes receivable from real estate
ventures; investments in real estate ventures carried at cost, adjusted for the
equity in the operating income or loss of such ventures; and real estate owned
carried primarily at fair value.
The Company evaluates its real estate-related assets (including accrued
interest) by estimating the probabilities of loss utilizing various projections
that include several factors relating to the borrower, property, term of the
loan, tenant composition, rental rates, other supply and demand factors and
overall economic conditions. Real estate reserves are established when declines
in collateral values, estimated in light of current economic conditions and
calculated in conformity with Statement of Financial Accounting Standards
("SFAS") 114, indicate a likelihood of loss. Generally, the reserve is based
upon the excess of the loan amount over the estimated future cash flows from the
loan discounted at the loan's contractual rate of interest taking into
consideration the effects of recourse to, and subordination of loans held by,
affiliated non-life realty companies. Changes in the Company's real estate
reserves and write-downs are included in revenue as realized investment gain or
loss.
The Company adopted SFAS 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN,
in the fourth quarter of 1993. SFAS 114 defines "impaired loans" as loans in
which it is probable that a creditor will be unable to collect all amounts due
according to the contractual terms of the loan agreement. In the fourth quarter
of 1994, the Company adopted SFAS 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF
A LOAN--INCOME RECOGNITION AND DISCLOSURES. SFAS 118 amends SFAS 114, providing
clarification of income recognition issues and requiring additional disclosures
relating to impaired loans. The adoption of SFAS 118 had no effect on the
Company's financial position or results of operations at or for the year ended
December 31, 1994.
At December 31, 1994 and 1993, total impaired loans amounted to $75.9 million
and $179.4 million, respectively. Impaired loans with reserves were $67.6
million and $91.9 million with corresponding reserves of $18.8 million and $38.5
million at December 31, 1994 and 1993, respectively. In determining reserves
relative to impaired loans, the Company also considered the deficit in equity
investments in real estate of $2.0 million and $35.0 million at December 31,
1994 and 1993, respectively.
The Company had an average balance of $93.9 million and $158.0 million in
impaired loans for 1994 and 1993, respectively. Cash payments received on
impaired loans are generally applied to reduce the outstanding loan balance. At
December 31, 1994 and 1993, loans on nonaccrual status amounted to $274.6
million and $563.6 million, respectively. Impaired loans are generally included
in the Company's nonaccrual loans. The additional amount of nonaccrual loans in
excess of impaired loans represents the Company's consideration of market risks
associated with the real estate loan portfolio.
Upon adoption of SFAS 114, the Company determined that its previous disclosures
relating to impaired loans and recorded real estate reserves were adequate. As
such, restating prior quarters' operating results for the impact of SFAS 114 was
not considered necessary.
Policy loans are carried at their unpaid balance. Other invested assets consist
primarily of venture capital and a leveraged lease and are carried at cost.
Realized gains or losses on sales of investments, determined on the basis of
identifiable cost on the disposition of the respective investment, recognition
of other-than-temporary declines in value and changes in real estate-related
reserves and write-downs are included in revenue. Unrealized gains or losses on
revaluation of investments are credited or charged to stockholder's equity net
of deferred income tax.
The amortized cost of fixed maturities is adjusted for amortization of premiums
and accretion of discounts to maturity, or in the case of mortgage-backed
securities, over the estimated life of the security. Such amortization is
included in net interest income. Amortization of the discount or premium from
mortgage-backed securities is recognized using a level effective yield method
which considers the estimated timing and amount of prepayments of the underlying
mortgage loans and is adjusted to reflect differences which arise between the
prepayments originally anticipated and the actual prepayments received and
currently anticipated. To the extent that the estimated lives of mortgage-backed
securities change as a result of changes in prepayment rates, the adjustment is
also included in net investment income. The Company does not accrue interest
income on fixed maturities deemed to be impaired on
B-25
<PAGE> 136
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
an other-than-temporary basis, or on mortgage loans, real estate-related bonds
and other real estate loans where the likelihood of collection of interest is
doubtful.
SEPARATE ACCOUNT BUSINESS
The assets and liabilities of the separate accounts represent segregated funds
administered and invested by the Company for purposes of funding variable
annuity and variable life insurance contracts for the exclusive benefit of
variable annuity and variable life insurance contract holders. The Company
receives administrative fees from the separate account and retains varying
amounts of withdrawal charges to cover expenses in the event of early
withdrawals by contract holders. The assets and liabilities of the separate
accounts are carried at market value.
INCOME TAX
The operations of the Company are included in the consolidated federal income
tax return of Kemper. Income taxes receivable or payable are determined on a
separate return basis, and payments are received from or remitted to Kemper
pursuant to a tax allocation arrangement between Kemper and its subsidiaries,
including the Company. The Company generally receives a tax benefit for losses
to the extent such losses can be utilized in Kemper's consolidated tax return.
Upon adoption of SFAS 109, ACCOUNTING FOR INCOME TAXES, effective January 1,
1993, deferred taxes are provided on the temporary differences between the tax
and financial statement basis of assets and liabilities. Deferred income tax
previously was provided on the tax effects of timing differences between
financial statement and taxable income.
FIXED ASSETS
Fixed assets, consisting primarily of electronic data processing equipment, are
recorded at cost and are depreciated over the useful lives of the assets on a
straight-line method. At December 31, 1994 and 1993, the accumulated
depreciation on fixed assets was $20.8 million and $21.6 million, respectively.
OTHER
Certain reclassifications have been made in the consolidated financial
statements for the years 1993 and 1992 to conform to 1994 reporting.
(2) CASH FLOW INFORMATION
The Company defines cash as cash in banks and money market accounts. Federal
income tax paid to (refunded by) Kemper under the tax allocation arrangement for
the years ended December 31, 1994, 1993 and 1992 amounted to $(10.7) million,
$4.2 million and $7.8 million, respectively.
Not reflected in the statement of cash flows are rollovers of mortgage loans,
other loans and investments totaling $57 million, $146 million and $229 million
in 1994, 1993 and 1992, respectively.
Reflected in the statement of cash flows is the 1992 sale of $515.7 million of
reinsured life reserves for which the Company delivered an investment portfolio
that included $151.4 million of mortgage loans, $294.8 million of fixed
maturities and $69.5 million of other investments.
The Company also transferred its equity ownership interests in two limited
partnerships during 1994 and 1993. (See the note captioned "Related-Party
Transactions" on page B-38.)
B-26
<PAGE> 137
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME
Fixed maturities are considered available for sale, depending upon certain
economic and business conditions. The Company is carrying its fixed maturity
investment portfolio at estimated market value, with the aggregate unrealized
appreciation or depreciation being recorded as a separate component of
stockholder's equity net of any applicable income tax effect. The carrying value
(estimated market value) of fixed maturities compared with amortized cost,
adjusted for other-than-temporary declines in value, at December 31, 1994 and
1993, was as follows:
<TABLE>
<CAPTION>
ESTIMATED UNREALIZED
CARRYING AMORTIZED ---------------------
(in thousands) VALUE COST GAINS LOSSES
---------- ---------- -------- ---------
<S> <C> <C> <C> <C>
1994
U.S. treasury securities and obligations of U.S.
government agencies and authorities.............. $ 10,682 $ 10,998 $ 24 $ (340)
Obligations of states and political subdivisions,
special revenue and nonguaranteed................ 25,021 25,691 -- (670)
Debt securities issued by foreign governments...... 109,624 120,950 50 (11,376)
Corporate securities............................... 1,679,428 1,805,933 7,027 (133,532)
Mortgage-backed securities......................... 1,638,977 1,743,784 -- (104,807)
---------- ---------- -------- ---------
Total fixed maturities...................... $3,463,732 $3,707,356 $ 7,101 $(250,725)
========== ========== ======== =========
1993
U.S. treasury securities and obligations of U.S.
government agencies and authorities.............. $ 11,686 $ 11,464 $ 240 $ (18)
Obligations of states and political subdivisions,
special revenue and nonguaranteed................ 16,434 15,232 1,202 --
Debt securities issued by foreign governments...... 114,275 112,825 2,782 (1,332)
Corporate securities............................... 2,025,888 1,948,268 89,445 (11,825)
Mortgage-backed securities......................... 1,272,941 1,245,413 34,268 (6,740)
---------- ---------- -------- ---------
Total fixed maturities...................... $3,441,224 $3,333,202 $127,937 $ (19,915)
========== ========== ======== =========
</TABLE>
Upon default or indication of potential default by an issuer of fixed maturity
securities, the Company-owned issue(s) of such issuer would be placed on
nonaccrual status and, since declines in market value would no longer be
considered by the Company to be temporary, would be analyzed for possible
write-down. Any such issue would be written down to its net realizable value,
determined in the manner described in the following paragraph, during the fiscal
quarter in which the impairment was determined to have become other than
temporary, unless such net realizable value exceeded the Company's carrying
value for such issue. Thereafter, each issue on nonaccrual status is regularly
reviewed, and additional write-downs may be taken in light of later
developments.
The Company's computation of net realizable value involves judgments and
estimates, so such value should be used with care. Such value determination
considers such factors as the existence and value of any collateral security;
the capital structure of the issuer; the level of actual and expected market
interest rates; where the issue ranks in comparison with other debt of the
issuer; the economic and competitive environment of the issuer and its business;
the Company's view on the likelihood of success of any proposed issuer
restructuring plan; and the timing, type and amount of any restructured
securities that the Company anticipates it will receive.
B-27
<PAGE> 138
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
The Company's $907 million real estate portfolio consists of the following:
SUMMARY OF GROSS AND NET REAL ESTATE INVESTMENTS
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31
-----------------
1994 1993
------ ------
<S> <C> <C>
Investments before reserves, write-downs and net joint venture operating
losses:
Joint venture mortgage loans................................................. $ 358 $ 766
Third-party mortgage loans................................................... 353 200
Other real estate-related investments........................................ 350 354
------ ------
Subtotal................................................................ 1,061 1,320
Reserves..................................................................... (43) (61)
Write-downs.................................................................. (97) (88)
Cumulative net operating losses of joint ventures owned...................... (14) (17)
------ ------
Net real estate investments.................................................... $ 907 $1,154
====== ======
</TABLE>
At December 31, 1994, the Company had $216.2 million of mortgage loans and other
real estate-related investments (net of reserves and write-downs) that were
non-income producing for the preceding 12 months.
The Company evaluates its real estate-related assets (including accrued
interest) by estimating the probabilities of loss utilizing various projections
that include several factors relating to the borrower, property, term of the
loan, tenant composition, rental rates, other supply and demand factors and
overall economic conditions. Because the Company's real estate review process
includes estimates, there can be no assurance that current estimates will prove
accurate over time due to changing economic conditions and other factors.
The Company's real estate reserve was allocated as follows:
REAL ESTATE RESERVE
(in millions)
<TABLE>
<CAPTION>
JOINT VENTURE THIRD-PARTY OTHER REAL
MORTGAGE MORTGAGE ESTATE-RELATED
LOANS LOANS INVESTMENTS TOTAL
------------- ----------- -------------- ------
<S> <C> <C> <C> <C>
Balance at 12/31/92................................... $ 64.4 $ 5.0 $23.4 $ 92.8
1993 change in reserve................................ (29.3) (5.0) 2.6 (31.7)
------ ----- ----- ------
Balance at 12/31/93................................... 35.1 -- 26.0 61.1
1994 change in reserve................................ (28.0) 10.4 (.5) (18.1)
------ ----- ----- ------
Balance at 12/31/94................................... $ 7.1 $10.4 $25.5 $ 43.0
====== ===== ===== ======
</TABLE>
In addition to the reserve, the Company's provision for real estate-related
losses (on assets held at the respective period end) included cumulative
write-downs (both by the Company and including the Company's share of write-
downs by joint ventures) totaling $96.6 million at December 31, 1994 and $88.3
million at December 31, 1993. The 1994 decrease in reserves was primarily due to
write-downs which increased in 1994 as reserves for general real estate risks
were allocated to certain specific loans and equity investments in real estate,
particularly with respect to investments in land. In 1993, the Company's real
estate reserve and write-downs reflected declining valuations in the Company's
real estate portfolio, offset in part by the positive effects of recourse to,
and subordination of loans held by, affiliated non-life realty companies. The
declining valuations in 1993 reflected the Company's view, based on economic
data then available, that there will be slower than previously anticipated
economic growth in the future and therefore slower absorption of real estate,
particularly undeveloped land. Due to the Company's assessment for slower
economic growth, its plans with respect to certain projects were changed to
reflect deferrals of their commencement or completion.
B-28
<PAGE> 139
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
The Company's real estate experience could continue to be adversely affected by
overbuilding and weak economic conditions in certain real estate markets and by
fairly restrictive lending practices by banks and other lenders. Stagnant or
worsening economic conditions in the areas in which the Company has made loans,
or additional adverse information becoming known to the Company through its
regular reviews or otherwise, could result in higher levels of problem loans or
potential problem loans, reductions in the value of real estate collateral and
adjustments to the real estate reserve. The Company's net income and
stockholder's equity could be materially reduced in future periods if real
estate market conditions remain stagnant or worsen in areas where the Company's
portfolio is located.
Current conditions in the real estate markets have been adversely affecting the
financial resources of certain of the Company's joint venture partners. Every
partner, however, remains active in the control of its respective joint
ventures. In evaluating a partner's ability to meet its financial commitments,
the Company considers the amount of all applicable debt and the value of all
properties within that portion of the Company's portfolio consisting of loans to
and investments in joint ventures with such partner.
The following table is a summary of the Company's troubled real estate-related
investments:
TROUBLED REAL ESTATE-RELATED INVESTMENTS
(BEFORE RESERVES AND WRITE-DOWNS, EXCEPT FOR REAL ESTATE OWNED)
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1994 1993
------ ------
<S> <C> <C>
Potential problem loans(1)................................................. $ 57.9 $ 20.2
Past due loans(2).......................................................... -- 2.8
Nonaccrual loans(3)........................................................ 274.6 563.6
Restructured loans (currently performing)(4)............................... 50.5 56.7
Real estate owned(5)....................................................... 57.3 55.1
------ ------
Total(6)(7)......................................................... $440.3 $698.4
====== ======
</TABLE>
---------------
(1) These are real estate-related investments where the Company, based on known
information, has serious doubts about the borrowers' abilities to comply
with present repayment terms and which the Company anticipates may go into
nonaccrual, past due or restructured status.
(2) Interest more than 90 days past due but not on nonaccrual status.
(3) The Company does not accrue interest on real estate-related investments when
it judges that the likelihood of collection of interest is doubtful. The
1994 decrease in nonaccrual loans primarily reflected sales and foreclosures
as well as write-offs of certain fully reserved loans.
(4) The Company defines a "restructuring" of debt as an event whereby the
Company, for economic or legal reasons related to the debtor's financial
difficulties, grants a concession to the debtor it would not otherwise
consider. Such concessions either stem from an agreement between the Company
and the debtor or are imposed by law or a court. By this definition,
restructured loans do not include any loan that, upon the expiration of its
term, both repays its principal and pays interest then due from the proceeds
of a new loan that the Company, at its option, may extend (roll over).
(5) Real estate owned is carried at fair value and includes deeds in lieu of
foreclosure and certain purchased property. Cumulative write-downs to fair
value were $67.5 million and $20.6 million at December 31, 1994 and 1993,
respectively.
(6) Total reserves and cumulative write-downs on properties owned at December
31, 1994 (excluding fair value adjustments to real estate owned) were 16.4
percent of total troubled real estate-related investments and 7.4 percent of
the Company's total real estate portfolio before reserves and write-downs.
(7) Equity investments in real estate are not defined as part of, and therefore
are not taken into account in calculating, total troubled real estate. The
Company's equity investments also involve real estate risks.
Based on the level of troubled real estate-related investments the Company
experienced in 1994 and 1993, the Company anticipates additional foreclosures
and deeds in lieu of foreclosure in 1995 and beyond. Any consolidation
B-29
<PAGE> 140
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
accounting resulting from foreclosures would add the related ventures' assets
and senior third-party liabilities to the Company's balance sheet and eliminate
the Company's loans to such ventures.
Due to the adverse real estate environment affecting the Company's portfolio in
recent years, the Company has continued to devote significant attention to its
real estate portfolio, enhancing monitoring of the portfolio and formulating
specific action plans addressing nonperforming and potential problem credits.
Since 1991, the Company has intensified its attention to evaluating the asset
quality, cash flow and prospects associated with each of its projects. The
Company continues to analyze various potential transactions designed to reduce
both its joint venture operating losses and the amount of its real
estate-related investments. Specific types of transactions under consideration
(and previously utilized) include loan sales, property sales, mortgage
refinancings and real estate investment trusts. However, there can be no
assurance that such efforts will result in continued improvements in the
performance of the Company's real estate portfolio.
At December 31, 1994, securities carried at approximately $5.3 million were on
deposit with governmental agencies as required by law.
Proceeds from sales of investments in fixed maturities prior to maturity were
$910.9 million, $1.7 billion and $2.9 billion during 1994, 1993 and 1992,
respectively. Gross gains of $6.0 million, $80.4 million and $69.5 million and
gross losses of $55.9 million, $37.8 million and $101.7 million were realized on
sales of fixed maturities in 1994, 1993 and 1992, respectively. Gross unrealized
gains and losses on equity securities at December 31, 1994 amounted to $469
thousand and $649 thousand, respectively.
The following table sets forth the maturity aging schedule of fixed maturity
investments at December 31, 1994:
<TABLE>
<CAPTION>
CARRYING AMORTIZED
(in thousands) VALUE COST VALUE
---------- ----------
<S> <C> <C>
One year or less........................................................ $ 1,135 $ 1,135
Over one year through five.............................................. 346,841 357,697
Over five years through ten............................................. 1,011,526 1,088,547
Over ten years.......................................................... 465,253 516,193
Securities not due at a single maturity date(1)......................... 1,638,977 1,743,784
---------- ----------
Total fixed maturities........................................... $3,463,732 $3,707,356
========== ==========
</TABLE>
---------------
(1) Weighted average maturity of 7 years.
The sources of net investment income were as follows:
<TABLE>
<CAPTION>
(in thousands) 1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Interest and dividends on fixed maturities.................. $274,231 $221,144 $210,047
Dividends on equity securities.............................. 1,751 3,084 2,061
Income from short-term investments.......................... 10,668 12,155 18,249
Income from mortgage loans.................................. 41,713 82,028 149,816
Income from policy loans.................................... 18,517 16,826 17,052
Income from other real estate-related investments........... 21,239 11,755 17,915
Income from other loans and investments..................... 3,533 8,008 2,580
-------- -------- --------
Total investment income.............................. 371,652 355,000 417,720
Investment expense.......................................... (18,568) (15,726) (12,962)
-------- -------- --------
Net investment income................................ $353,084 $339,274 $404,758
======== ======== ========
</TABLE>
B-30
<PAGE> 141
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
Unrealized gains (losses) are computed below as follows: fixed maturities--the
difference between market and amortized cost, adjusted for other-than-temporary
declines in value; equity securities and other--the difference between market
value and cost. The realized and change in unrealized investment gains (losses)
by class of investment for the years ended December 31, 1994, 1993 and 1992 were
as follows:
<TABLE>
<CAPTION>
REALIZED GAINS (LOSSES)
------------------------------------------
(in thousands) 1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Real estate-related.................................... $(41,720) $(79,652) $(94,995)
Fixed maturities....................................... (49,857) 36,234 11,150
Equity securities...................................... 28,243 17,086 109
Other.................................................. 8,777 (1,252) 234
-------- -------- --------
Realized investment losses before income tax
benefit........................................... (54,557) (27,584) (83,502)
Income tax benefit..................................... (19,095) (7,917) (21,256)
-------- -------- --------
Net realized investment losses....................... $(35,462) $(19,667) $(62,246)
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
CHANGE IN UNREALIZED GAINS (LOSSES)
------------------------------------------
(in thousands) 1994 1993 1992
--------- ------- --------
<S> <C> <C> <C>
Fixed maturities...................................... $(351,646) $60,258 $ 88,820
Equity securities..................................... (32,710) 19,882 14,882
Adjustment to deferred insurance acquisition costs.... 11,325 -- --
--------- ------- --------
Unrealized gain (loss) before income tax............ (373,031) 80,140 103,702
Income tax expense (benefit).......................... (43,492) 26,916 20,968
--------- ------- --------
Net unrealized gain (loss) on investments...... $(329,539) $53,224 $ 82,734
========= ======= ========
</TABLE>
(4) UNCONSOLIDATED INVESTEES
At December 31, 1994, the Company, along with other Kemper subsidiaries,
directly held partnership interests in a number of real estate joint ventures.
Also, the Company and Lumbermens Mutual Casualty Company ("Lumbermens") and
certain subsidiaries of Kemper and Lumbermens are partners in a master limited
partnership (the "MLP") formed, effective January 1, 1993, to hold the equity
interests each partner's organization separately held previously in joint
ventures with Peter B. Bedford or his affiliates ("Bedford"), and in January
1994, the MLP acquired substantially all of Bedford's interests in such joint
ventures. Kemper and Lumbermens each own 50 percent of the MLP.
The Company's direct and indirect real estate joint venture investments are
accounted for utilizing the equity method, with the Company recording its share
of the operating results of the respective partnerships. The Company, as an
equity owner, has the ability to fund, and historically has elected to fund,
operating requirements of certain of the joint ventures. Consolidation
accounting methods are not utilized as the Company, in most instances, does not
own more than 50 percent in the aggregate, and in any event, major decisions of
the partnership must be made jointly by all partners.
B-31
<PAGE> 142
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) UNCONSOLIDATED INVESTEES (CONTINUED)
Selected financial information, as of December 31, 1994 and 1993, is presented
below separately for the MLP, ventures with the Prime Group, Inc. or its
affiliates ("Prime"), and other real estate-related partnerships. (See the note
captioned "Concentration of Credit Risk" on page B-34.) Such real estate-related
information for 1994 and 1993 was based on unaudited financial information
received by the Company from the respective entities.
SELECTED FINANCIAL INFORMATION
(in thousands)
<TABLE>
<CAPTION>
REAL ESTATE-RELATED
-------------------------------------------------------
PRIME-RELATED
-------------------------
MLP DOMESTIC SPANISH OTHER
VENTURES PARTNERSHIPS PROJECTS PARTNERSHIPS
---------- ------------ --------- ------------
<S> <C> <C> <C> <C>
1994
Revenue............................................ $ 104,827 $ 14,966 $ 22,095 $ 52,295
Expenses........................................... 192,492 18,881 45,256 49,011
---------- -------- --------- --------
Operating income (loss)............................ (87,665) (3,915) (23,161) 3,284
Asset writedowns(1)................................ (23,536) (621) (102,031) (17,037)
---------- -------- --------- --------
Net loss........................................... $ (111,201) $ (4,536) $(125,192) $(13,753)
========== ======== ========= ========
The Company's share of operating loss(1)........... $ (121) $ (1,140) $ -- $ (145)
========== ======== ========= ========
The Company's share of net loss(1)................. $ (156) $ (1,244) $ -- $ (4,915)
========== ======== ========= ========
Properties at cost, net of depreciation............ $ 879,352 $ 55,804 $ 338,923 $ 38,075
========== ======== ========= ========
Total assets....................................... $1,049,019 $ 77,751 $ 373,637 $153,785
========== ======== ========= ========
Mortgages, notes payable and related accrued
interest payable to:
The Company...................................... $ 207,909 $ 31,767 $ 36,606 $ 7,436
Kemper subsidiaries other than the Company....... 417,967 2,713 394,764 2,411
Lumbermens....................................... 181,325 -- 92,592 26,734
Fidelity Life Association........................ 46,036 -- -- --
Other third parties.............................. 411,795 42,048 98,076 51,303
Total liabilities.................................. $1,354,624 $ 82,770 $ 660,557 $110,334
========== ======== ========= ========
The Company's net equity investment(1)............. $ 1,953 $ (585) $ 36,624 $ 7,415
========== ======== ========= ========
</TABLE>
---------------
(1) Excluded from the Company's share of operating and net losses and related
net equity investment in real estate-related entities is interest expense
related to loans by the Company which are on nonaccrual status and write-
downs taken directly by the Company. Included in the Company's share of
current year results are immaterial prior year audit adjustments by the
respective entities.
Included in the immediately preceding and immediately following tables are real
estate loans to partnerships or corporations in which the Company and other
Kemper subsidiaries hold equity interests. At December 31, 1994, the Company had
other joint venture-related loans totaling $16.0 million before reserves, not
included in the table above, to partnerships in which the Company has options to
acquire equity interests or has made loans with
B-32
<PAGE> 143
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) UNCONSOLIDATED INVESTEES (CONTINUED)
additional interest features. These joint venture-related loans totaled $38.5
million at December 31, 1993. Also at December 31, 1994, the Company had joint
venture-related loans totaling $37.5 million before reserves, not included in
the table above, to partnerships in which Lumbermens and Fidelity Life
Association, an affiliated mutual insurance company ("FLA"), had equity
interests. These joint venture-related loans totaled $68.1 million before
reserves at December 31, 1993. (See the note captioned "Financial
Instruments--Off-Balance-Sheet Risk" on page B-40.)
SELECTED FINANCIAL INFORMATION
(in thousands)
<TABLE>
<CAPTION>
REAL ESTATE-RELATED
------------------------------------------------------
PRIME-RELATED
------------------------
MLP DOMESTIC SPANISH OTHER
VENTURES PARTNERSHIPS PROJECTS PARTNERSHIPS
---------- ------------ -------- ------------
<S> <C> <C> <C> <C>
1993
Revenue............................................. $ 101,694 $ 50,636 $ 36,607 $ 60,701
Expenses............................................ 226,282 65,824 76,449 66,978
---------- -------- -------- --------
Operating loss...................................... (124,588) (15,188) (39,842) (6,277)
Asset writedowns(1)................................. (107,135) -- (39,274) --
---------- -------- -------- --------
Net loss............................................ $ (231,723) $(15,188) $(79,116) $ (6,277)
========== ======== ======== ========
The Company's share of operating loss(1)............ $ (172) $ (7,548) $ -- $ (852)
========== ======== ======== ========
The Company's share of net loss(1).................. $ (409) $ (7,548) $ -- $ (852)
========== ======== ======== ========
Properties at cost, net of depreciation............. $1,161,025 $278,635 $253,321 $ 46,184
========== ======== ======== ========
Total assets........................................ $1,426,638 $375,738 $292,825 $225,019
========== ======== ======== ========
Mortgages, notes payable and related accrued
interest payable to:
The Company....................................... $ 298,447 $ 48,303 $ 31,871 $ 5,287
Kemper subsidiaries other than the Company........ 490,031 56,602 305,335 5,430
Lumbermens........................................ 245,890 17,262 51,423 30,226
Fidelity Life Association......................... 65,691 -- -- --
Other third parties............................... 752,239 199,765 88,558 56,622
Total liabilities................................... $1,895,260 $390,888 $539,728 $153,334
========== ======== ======== ========
The Company's net equity investment(1).............. $ 18,548 $ 7,626 $ 31,871 $ 15,524
========== ======== ======== ========
</TABLE>
---------------
(1) Excluded from the Company's share of operating and net losses and related
net equity investment in real estate-related entities is interest expense
related to loans by the Company which are on nonaccrual status and write-
downs taken directly by the Company. Included in the Company's share of
current year results are immaterial prior year audit adjustments by the
respective entities.
B-33
<PAGE> 144
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) CONCENTRATION OF CREDIT RISK
The Company generally strives to maintain a diversified invested asset
portfolio; however, certain concentrations of credit risk exist, including
mortgage-backed securities and real estate.
Approximately 49.2 percent of the Company's investment-grade fixed maturities at
December 31, 1994 were mortgage-backed securities. These investments consist
primarily of marketable mortgage pass-through securities issued by the
Government National Mortgage Association, the Federal National Mortgage
Association or the Federal Home Loan Mortgage Corporation and other
investment-grade securities collateralized by mortgage pass-through securities
issued by these entities. The Company has not made any material investments in
interest-only or other similarly volatile tranches of mortgage-backed
securities. The Company's mortgage-backed investments are generally of AAA
credit quality, and the markets for the Company's investments in mortgage-backed
securities have been and are expected to remain liquid.
Future investment income from mortgage-backed securities may be affected by the
timing of principal payments and the yields on reinvestment alternatives
available at the time of such payments. Due to the fact that the Company's
investments in mortgage-backed securities predominately date from recent years,
the current rise in interest rates is not expected to cause any material
unanticipated extension of the average maturities of these investments.
Prepayment activity on securities purchased at a discount is not expected to
result in any material losses to the Company because such prepayment would
generally accelerate the reporting of the discounts as investment income.
Prepayments resulting from a decline in interest rates related to securities
purchased at a premium would accelerate the amortization of premiums on such
purchases which would result in reductions of investment income related to such
securities. At December 31, 1994, the Company had unamortized discounts and
premiums of $20.4 million and $14.8 million, respectively, related to
mortgage-backed securities. Given the credit quality, liquidity and anticipated
payment characteristics of the Company's investments in mortgage-backed
securities, the Company believes that the associated risk can be managed without
material adverse consequences on its consolidated financial statements.
The Company's real estate portfolio is distributed by geographic location and
property type, as shown in the following two tables:
<TABLE>
<S> <C>
GEOGRAPHIC DISTRIBUTION AS OF DECEMBER 31, 1994
California........................ 26.9%
Illinois.......................... 26.2
Texas............................. 11.2
Ohio.............................. 6.3
Spain............................. 4.0
Colorado.......................... 3.8
Oregon............................ 3.0
Indiana........................... 2.7
Washington........................ 2.7
Hawaii............................ 2.5
Virginia.......................... 2.5
Florida........................... 2.1
Other(1).......................... 6.1
-----
Total........................ 100.0%
=====
DISTRIBUTION BY PROPERTY TYPE AS OF DECEMBER 31, 1994
Office............................ 21.5%
Land.............................. 20.4
Industrial........................ 14.7
Retail............................ 13.9
Hotel............................. 11.7
Apartment......................... 5.0
Residential....................... 4.7
Mixed use......................... 2.1
Other............................. 6.0
-----
Total........................ 100.0%
=====
</TABLE>
---------------
(1) No other single location exceeded 2.0 percent.
The Company had $246.3 million (5.0 percent of invested assets and cash), $240.5
million (4.9 percent of invested assets and cash) and $102.8 million (2.1
percent of invested assets and cash) of mortgage loans and other real estate
investments in California, Illinois and Texas, respectively, at December 31,
1994. The majority of the Illinois and Texas loans and other investments are
Prime-related. The majority of the California loans and other investments are
MLP-related. (See the note captioned "Unconsolidated Investees.") Real estate
markets have been depressed in recent periods in areas where most of the
Company's real estate portfolio is located. Southern California shows
B-34
<PAGE> 145
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) CONCENTRATION OF CREDIT RISK (CONTINUED)
signs of improvement, although real estate market conditions there have
continued to be worse than in many other areas of the country. Northern
California and Illinois currently reflect some stabilization and improvement.
The Company had $184.9 million (3.8 percent of invested assets and cash) of
below investment-grade securities (including real estate-related bonds) totaling
$49.9 million, or 1.0 percent of invested assets and cash) at December 31, 1994.
At December 31, 1994, the Company held only one investment which exceeded 10
percent of stockholder's equity. This investment, amounting to $47.6 million, is
a joint venture mortgage loan to Lisle Park Plaza.
The following table shows the amounts of the Company's real estate portfolio at
December 31, 1994 which consisted of loans to or investments in joint ventures
with the MLP and Prime:
<TABLE>
<CAPTION>
(in millions) MLP PRIME
------ ------
<S> <C> <C>
Mortgage loans................................................................. $161.6 $150.3
Real estate-related bonds...................................................... 2.9 36.2
Other real estate loans........................................................ 54.5 29.7
Real estate owned.............................................................. 98.3 --
Equity investments............................................................. 7.4 42.9
Reserves....................................................................... (8.9) (21.0)
Write-downs.................................................................... (61.5) (.1)
------ ------
Total........................................................................ $254.3 $238.0
====== ======
</TABLE>
At December 31, 1994, the Company's real estate portfolio also included $36.6
million of loans carried as equity investments in real estate related to land
for office and retail development and residential projects located in Barcelona,
Spain. Such equity investments in Spain totaled $31.9 million at December 31,
1993, after accounting for fundings of $151.3 million during 1993. The Spanish
projects accounted for $29.4 million of net fundings during 1994 and represented
approximately 4.0 percent of the Company's real estate portfolio at December 31,
1994. These investments, which began in the late 1980s, accounted for $14.1
million of the December 31, 1994 off-balance-sheet commitments, of which the
Company expects to fund $7.1 million. Also during 1994, loans to the Spanish
projects totaling $24.7 million were sold at book value to an affiliated real
estate subsidiary of KFC.
Undeveloped land, including the Spanish projects, represented approximately 20.4
percent of the Company's real estate portfolio at December 31, 1994. To maximize
the value of certain land and other projects, additional development is
proceeding or is planned. Such development of existing projects may continue to
require substantial funding, either from the Company or third parties. In the
present real estate markets, third-party financing can require credit enhancing
arrangements (e.g., standby financing arrangements and loan commitments) from
the Company. The values of development projects are dependent on a number of
factors, including Kemper's and the Company's plans with respect thereto,
obtaining necessary permits and market demand for the permitted use of the
property. There can be no assurance that such permits will be obtained as
planned or at all, nor that such expenditures will occur as scheduled, nor that
Kemper's and the Company's plans with respect to such projects may not change
substantially.
(6) INCOME TAXES
Income tax expense (benefit) was as follows for the years ended December 31,
1994, 1993 and 1992:
<TABLE>
<CAPTION>
(in thousands) 1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Current..................................................... $(6,898) $(5,773) $ (9,457)
Deferred.................................................... 21,329 16,915 (4,273)
------- ------- --------
Total............................................. $14,431 $11,142 $(13,730)
======= ======= ========
</TABLE>
B-35
<PAGE> 146
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) INCOME TAXES (CONTINUED)
The actual income tax expense (benefit) for 1994, 1993 and 1992 differed from
the "expected" tax expense (benefit) for those years as displayed below.
"Expected" tax expense (benefit) was computed by applying the U.S. federal
corporate tax rate of 35 percent in 1994 and 1993 and 34 percent for 1992 to
income (loss) before income tax expense (benefit) and cumulative effect of
changes in accounting principles.
<TABLE>
<CAPTION>
(in thousands) 1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Computed expected tax expense (benefit)..................... $14,277 $ 7,992 $(22,214)
Difference between "expected" and actual tax expense
(benefit):
State taxes............................................... 645 332 777
Foreign tax credit........................................ (155) 358 (611)
Change in tax rate........................................ -- 1,441 --
Change in valuation allowance............................. -- 701 --
Unutilized capital losses................................. -- -- 8,286
Other, net................................................ (336) 318 32
------- ------- --------
Total actual tax expense (benefit)................ $14,431 $11,142 $(13,730)
======= ======= ========
</TABLE>
The Company adopted SFAS 109, Accounting for Income Taxes, as of January 1,
1993. SFAS 109 established new principles for calculating and reporting the
effects of income taxes in financial statements. SFAS 109 replaced the income
statement orientation inherent in APB Opinion 11 with a balance sheet approach.
Under the new approach, deferred tax assets and liabilities are generally
determined based on the difference between the financial statement and tax bases
of assets and liabilities using enacted tax rates in effect for the year in
which the differences are expected to reverse. Under SFAS 109, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. SFAS 109 allows
recognition of deferred tax assets if future realization of the tax benefit is
more likely than not, with a valuation allowance for the portion that is not
likely to be realized.
The implementation of SFAS 109 resulted in a one-time increase to earnings of
$2.4 million in the first quarter of 1993. Prior years' financial statements
have not been restated to apply the provisions of SFAS 109.
Upon adoption of SFAS 109, a valuation allowance was established to reduce the
deferred federal tax asset related to real estate and other investments to the
amount that, based upon available evidence, is, in management's judgment, more
likely than not to be realized. Any reversals of the valuation allowance are
contingent upon the recognition of future capital gains in Kemper's federal
income tax return or a change in circumstances which causes the recognition of
the benefits to become more likely than not. During 1994, the valuation
allowance was increased by $85.3 million. This increase in the valuation
allowance is solely attributable to the decrease in the net deferred federal tax
liability from unrealized losses on investments.
B-36
<PAGE> 147
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of the Company's net deferred federal tax liability were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
(in thousands) 1994 1993
--------- --------
<S> <C> <C>
Deferred federal tax assets:
Unrealized losses on investments...................................... $ 85,331 $ --
Life policy reserves.................................................. 51,519 60,446
Real estate-related................................................... 39,360 45,851
Other investment-related.............................................. 7,435 12,498
Other................................................................. 6,415 5,804
--------- --------
Total deferred federal tax assets.................................. 190,060 124,599
Valuation allowance................................................... (100,532) (15,201)
--------- --------
Total deferred federal tax assets after valuation allowance........ 89,528 109,398
--------- --------
Deferred federal tax liabilities:
Deferred insurance acquisition costs.................................. 108,663 100,834
Unrealized gains on investments....................................... -- 49,193
Depreciation and amortization......................................... 18,878 21,367
Other................................................................. 3,351 2,049
--------- --------
Total deferred federal tax liabilities............................. 130,892 173,443
--------- --------
Net deferred federal tax liabilities.................................... $ (41,364) $(64,045)
========= ========
</TABLE>
The valuation allowance of $100.5 million is subject to future adjustments based
on, among other items, Kemper's estimates of future operating earnings and
capital gains.
Pursuant to the deferred method under APB Opinion 11, deferred income taxes were
recognized for income and expense items that were reported in different years
for financial reporting purposes and income tax purposes using the tax rate
applicable for the year of the calculation. Under the deferred method, deferred
taxes were not adjusted for subsequent changes in tax rates.
The sources of deferred tax expense (benefit) and their tax effect were as
follows:
<TABLE>
<CAPTION>
(in thousands) 1992
--------
<S> <C>
Deferred insurance acquisition costs.................................................. $ 6,172
Future policy benefit reserves tax adjustment......................................... 5,692
Timing differences in recognition of accrued liabilities for GAAP and tax purposes.... (397)
Tax versus GAAP separate account gain................................................. (3,277)
Tax versus GAAP capital losses........................................................ 4,350
GAAP versus tax investment income on bonds............................................ (4,380)
Joint venture partnership income adjustments.......................................... 1,491
Leasing transactions.................................................................. 2,567
Change in real estate reserve......................................................... (21,305)
Tax capitalization of policy acquisition costs........................................ 555
Tax versus GAAP depreciation.......................................................... 490
Unutilized capital losses............................................................. 8,286
Other, net............................................................................ (4,517)
--------
Total....................................................................... $ (4,273)
========
</TABLE>
B-37
<PAGE> 148
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) INCOME TAXES (CONTINUED)
The tax returns through the year 1986 have been examined by the Internal Revenue
Service ("IRS"). Changes proposed are not material to the Company's financial
position. The tax returns for the years 1987 through 1990 are currently under
examination by the IRS.
(7) RELATED-PARTY TRANSACTIONS
The Company received cash capital contributions from KFC of $82.5 million, $90.0
million and $30.0 million during 1994, 1993 and 1992, respectively.
In 1994 and 1993, the Company transferred the majority of its deficit equity
ownership interest in two limited partnerships to KFC resulting in an increase
of the Company's additional paid-in capital of $71 thousand and $9.2 million,
respectively. The Company also paid a non-cash dividend of $530 thousand to KFC
in December 1993, which represented the positive equity ownership interests of
the majority of one of its limited partnerships. Net losses associated with the
Company's ownership interests in these limited partnerships amounted to $1.4
million, $5.4 million and $3.9 million in 1994, 1993 and 1992, respectively, and
are included in the Company's consolidated statement of operations.
The Company has loans to joint ventures, consisting primarily of mortgage loans
on real estate, in which the Company and/or one of its affiliates has an
ownership interest. At December 31, 1994 and 1993, joint venture mortgage loans
totaled $351 million and $731 million, respectively, and during 1994, 1993 and
1992, the Company earned interest income on these joint venture loans of $22.0
million, $63.1 million and $116.3 million, respectively.
As of January 1, 1993, all of the Company's personnel are employees of Federal
Kemper Life Assurance Company ("FKLA"), an affiliated company. Prior to January
1, 1993, the majority of the Company's personnel were employees of another
affiliated company, Kemper Financial Services, Inc. ("KFS"). The Company is
allocated expenses for the utilization of KFS and FKLA employees and facilities
and the information systems of Kemper Service Company ("KSvC") based on the
Company's share of administrative, legal, marketing, investment management,
information systems and operation and support services. During 1994, 1993 and
1992, expenses allocated to the Company from KFS and KSvC amounted to $6.5
million, $3.1 million and $28.2 million, respectively. The Company also paid to
KFS investment management fees of $6.0 million, $6.7 million and $5.9 million
during 1994, 1993 and 1992, respectively. The Company paid Kemper Sales Company
$7.1 million in 1992 for services relating to the distribution of the Company's
products. In addition, expenses allocated to the Company from FKLA during 1994,
1993 and 1992 amounted to $11.1 million, $13.1 million and $1.1 million,
respectively.
During 1994, 1993 and 1992, the Company sold certain mortgages and real
estate-related investments, net of reserves, amounting to approximately $154.0
million, $343.7 million and $144.8 million respectively, to KFC Portfolio Corp.,
an affiliated non-life realty company, in exchange for cash. No gain or loss was
recognized on the sales.
(8) REINSURANCE
In the ordinary course of business, the Company enters into reinsurance
agreements to diversify risk and limit its overall financial exposure to certain
blocks of fixed-rate annuities. The Company generally cedes 100 percent of the
related annuity liabilities under the terms of the reinsurance agreements.
Although these reinsurance agreements contractually obligate the reinsurers to
reimburse the Company, they do not discharge the Company from its primary
liabilities and obligations to policyholders. As such, these amounts paid or
deemed to have been paid are recorded on the Company's consolidated balance
sheet as reinsurance recoverables and ceded future policy benefits.
In 1992 and 1991, the Company entered into 100 percent indemnity reinsurance
agreements ceding $515.7 million and $416.3 million, respectively, of its
fixed-rate annuity liabilities to FLA. FLA is a mutual insurance company that
shares common management with the Company and FKLA and certain common board
members with the Company and Kemper. The 1992 reinsurance agreement resulted in
the sale to FLA of approximately $500 million of certain assets, including $151
million of mortgage loans, while the 1992 agreement was all cash. As of
B-38
<PAGE> 149
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) REINSURANCE (CONTINUED)
December 31, 1994, the reinsurance recoverable related to the fixed-rate annuity
liabilities ceded to FLA amounted to approximately $643 million.
(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company and FKLA sponsor a welfare plan that provides medical and life
insurance benefits to their retired and active employees and the Company is
allocated a portion of the costs of providing such benefits. The Company is self
insured with respect to medical benefits, and the plan is not funded except with
respect to certain disability-related medical claims. The medical plan provides
for medical insurance benefits at retirement, with eligibility based upon age
and the participant's number of years of participation attained at retirement.
The plan is contributory for pre-Medicare retirees, and will be contributory for
all retiree coverage for most current employees, with contributions generally
adjusted annually. Postretirement life insurance benefits are noncontributory
and are limited to $10,000 per participant.
The discount rate used in determining the allocated postretirement benefit
obligation was 8 percent and 7 percent for 1994 and 1993, respectively. The
assumed health care trend rate used was based on projected experience for 1994
and 1995, 10 percent in 1996, gradually declining to 6 percent by the year 1999
and remaining at that level thereafter.
The status of the plan as of December 31, 1994 and 1993, was as follows:
Accumulated postretirement benefit obligation:
<TABLE>
<CAPTION>
(in thousands) 1994 1993
---- ----
<S> <C> <C>
Retirees.......................................................................... $206 $171
Fully eligible active plan participants........................................... 58 90
Other active plan participants.................................................... 101 159
Unrecognized gain from actuarial experience....................................... 314 223
---- ----
Accrued liability....................................................... $679 $643
==== ====
</TABLE>
Components of the net periodic postretirement benefit cost:
<TABLE>
<CAPTION>
(in thousands) 1994 1993
---- ----
<S> <C> <C>
Service cost-benefits attributed to service during the period..................... $ 31 $ 84
Interest cost on accumulated postretirement benefit obligations................... 43 41
Amortization of unrecognized actuarial gain....................................... (35) --
---- ----
Total................................................................... $ 39 $125
==== ====
</TABLE>
A one percentage point increase in the assumed health care cost trend rate for
each year would increase the accumulated postretirement benefit obligation as of
December 31, 1994 and 1993 by $48 thousand and $69 thousand, respectively, and
the net postretirement health care interest and service costs for the years
ended December 31, 1994 and 1993 by $14 thousand and $19 thousand, respectively.
During 1994, the Company adopted certain severance-related policies to provide
benefits, generally limited in time, to former or inactive employees after
employment but before retirement. The effect of adopting these policies was
immaterial.
(10) COMMITMENTS AND CONTINGENT LIABILITIES
The Company is involved in various legal actions for which it establishes
liabilities where appropriate. In the opinion of the Company's management, based
upon the advice of legal counsel, the resolution of such litigation is not
expected to have a material adverse effect on the consolidated financial
statements.
Although none of the Company or its joint venture projects have been identified
as a "potentially responsible party" under federal environmental guidelines,
inherent in the ownership of or lending to real estate projects is the
possibility that environmental pollution conditions may exist on or near or
relate to properties owned or previously owned on properties securing loans.
Where the Company has presently identified remediation costs, they have been
B-39
<PAGE> 150
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
taken into account in determining the cash flows and resulting valuations of the
related real estate assets. Based on the Company's receipt and review of
environmental reports on most of the projects in which it is involved, the
Company believes its environmental exposure would be immaterial to its
consolidated results of operations. However, the Company may be required in the
future to take actions to remedy environmental exposures, and there can be no
assurance that material environmental exposures will not develop or be
identified in the future. The amount of future environmental costs is impossible
to estimate due to, among other factors, the unknown magnitude of possible
exposures, the unknown timing and extent of corrective actions that may be
required, the determination of the Company's liability in proportion to others
and the extent such costs may be covered by insurance or various environmental
indemnification agreements.
See the note captioned "Financial Instruments--Off-Balance-Sheet Risk" below for
the discussion regarding the Company's loan commitments and standby financing
agreements.
The Company is liable for guaranty fund assessments related to certain
unaffiliated insurance companies that have become insolvent during the years
1994 and prior. The Company's financial statements include provisions for all
known assessments that will be levied against the Company as well as an estimate
of amounts (net of estimated future premium tax recoveries) that the Company
believes it will be assessed in the future for which the life insurance industry
has estimated the cost to cover losses to policyholders. The Company is also
contingently liable for any future guaranty fund assessments related to
insolvencies of unaffiliated insurance companies, for which the life insurance
industry has been unable to estimate the cost to cover losses to policyholders.
No specific amount can be reasonably estimated for such insolvencies as of
December 31, 1994.
(11) FINANCIAL INSTRUMENTS--OFF BALANCE-SHEET RISK
The Company has continued to fund both existing projects and legal commitments.
At December 31, 1994, the Company had future legal loan commitments and stand-by
financing agreements totaling $376.1 million to support the financing needs of
various real estate investments. To the extent these arrangements are called
upon, amounts loaned would be secured by assets of the joint ventures, including
first mortgage liens on the real estate. The Company's criteria in making these
arrangements are the same as for its mortgage loans and other real estate
investments. The Company presently expects to fund approximately $96.5 million
of these arrangements, along with providing capital to existing projects. The
total legal commitments, along with estimated working capital requirements are
considered in the Company's analysis of real estate-related reserves and
write-downs. The disparity between total legal commitments and the amount
expected to be funded relates principally to standby financing arrangements that
provide credit enhancements to certain tax-exempt bonds, which the Company does
not presently expect to fund. The fair values of loan commitments and standby
financing agreements are estimated in conjunction with and using the same
methodology as the fair value estimates of mortgage loans and other real
estate-related investments.
(12) DERIVATIVE FINANCIAL INSTRUMENTS
The Company is party to derivative financial instruments in the normal course of
business for other than trading purposes to hedge exposures in foreign currency
fluctuations related to certain foreign fixed maturity securities held by the
Company. The following table summarizes various information regarding these
derivative financial instruments as of December 31, 1994 and 1993:
<TABLE>
<CAPTION>
WEIGHTED
WEIGHTED AVERAGE
(in thousands) AVERAGE REPRICING
NOTIONAL CARRYING ESTIMATED YEARS TO FREQUENCY
1994 AMOUNT VALUE FAIR VALUE EXPIRATION (DAYS)
---- -------- -------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Non-trading foreign exchange forward options..................... $ 34,541 $ 18 $ 18 .25 30
1993
----
Non-trading foreign exchange forward options..................... 69,241 2,194 2,194 .22 30
</TABLE>
The Company's hedges relating to foreign currency exposure are implemented using
forward contracts on foreign currencies. These are generally short duration
contracts with U.S. money-center banks. The Company records realized and
unrealized gains and losses on such investments in net income on a current
basis. The amounts of gain
B-40
<PAGE> 151
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
(loss) included in net income during 1994, 1993 and 1992 totaled $6.4 million,
$(2.8) million and $(2.4) million, respectively.
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value disclosures are required under SFAS 107. Such fair value estimates
are made at specific points in time, based on relevant market information and
information about the financial instrument. These estimates do not reflect any
premium or discount that could result from offering for sale at one time the
Company's entire holdings of a particular financial instrument. A significant
portion of the Company's financial instruments are carried at fair value. (See
the note captioned "Invested Assets and Related Income" on page B-27.) Fair
value estimates for financial instruments not carried at fair value are
generally determined using discounted cash flow models and assumptions that are
based on judgments regarding current and future economic conditions and the risk
characteristics of the investments. Although fair value estimates are calculated
using assumptions that management believes are appropriate, changes in
assumptions could significantly affect the estimates and such estimates should
be used with care.
Fair value estimates are determined for existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and certain liabilities that are not
considered financial instruments. Accordingly, the aggregate fair value
estimates presented do not represent the underlying value of the Company. For
example, the Company's subsidiaries are not considered financial instruments,
and their value has not been incorporated into the fair value estimates. In
addition, tax ramifications related to the realization of unrealized gains and
losses can have a significant effect on fair value estimates and have not been
considered in any of the estimates.
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:
Fixed maturities: Fair values for fixed maturity securities carried at market
value were determined by using market quotations, or independent pricing
services that use prices provided by market makers or estimates of market values
obtained from yield data relating to instruments or securities with similar
characteristics, or fair value as determined in good faith by the Company's
portfolio manager, Kemper Financial Services, Inc.
Equity securities: Fair values for equity securities were based upon quoted
market prices.
Cash and short-term investments: The carrying amounts reported in the
consolidated balance sheet for these instruments approximate fair values.
Mortgage loans and other real estate-related investments: Fair values for
mortgage loans and other real estate-related investments were estimated on a
project-by-project basis. Generally, the projected cash flows of the collateral
are discounted using a discount rate of 10 to 12 percent. The resulting
collateral estimates were then used to determine the value of the Company's real
estate-related investments. The estimate of fair value should be used with care
given the inherent difficulty of estimating the fair value of real estate due to
the lack of a liquid quotable market.
Other loans and investments: The carrying amounts reported in the consolidated
balance sheet for these instruments approximate fair values. The fair values of
policy loans were estimated by discounting the expected future cash flows using
an interest rate charged on policy loans for similar policies currently being
issued.
Life policy benefits: Fair values of the life policy benefits regarding
investment contracts (primarily deferred annuities) and universal life contracts
were estimated by discounting gross benefit payments, net of contractual
premiums, using the average crediting rate currently being offered in the
marketplace for similar contracts with maturities consistent with those
remaining for the contracts being valued. The Company had projected its future
average crediting rate in 1994 and 1993 to be 5.5 percent and 5.0 percent,
respectively, while the assumed average market crediting rate was 6.5 percent in
1994 and 5.25 percent in 1993.
B-41
<PAGE> 152
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying values and estimated fair values of the Company's financial
instruments at December 31, 1994 and 1993 were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------------------------------------
1994 1993
------------------------ ------------------------
CARRYING FAIR CARRYING FAIR
(in thousands) VALUE VALUE VALUE VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial instruments recorded as assets:
Fixed maturities(1).......................... $3,463,732 $3,463,732 $3,441,224 $3,441,224
Equity securities............................ 14,767 14,767 67,700 67,700
Cash and short-term investments.............. 227,353 227,353 409,950 409,950
Mortgage loans and other real estate-related
assets.................................... 907,283 804,867 1,154,404 1,010,038
Policy loans................................. 277,743 277,743 264,112 264,112
Other invested assets........................ 25,760 25,760 43,267 43,267
Financial instruments recorded as liabilities:
Life policy benefits......................... 4,843,690 4,709,561 5,040,002 5,120,000
</TABLE>
---------------
(1) Includes $18 and $2,200 carrying value and fair value for 1994 and 1993,
respectively, of derivative securities used to hedge the foreign currency
exposure on certain specific foreign fixed maturity investments.
(14) STOCKHOLDER'S EQUITY--RETAINED EARNINGS
The maximum amount of dividends which can be paid by insurance companies
domiciled in the State of Illinois to shareholders without prior approval of
regulatory authorities is restricted if such dividend, together with other
distributions during the twelve preceding months would exceed the greater of ten
percent of statutory surplus as regards policyholders as of the preceding
December 31, or statutory net income for the preceding calendar year, then such
proposed dividend must be reported to the Director of Insurance at least 30 days
prior to the proposed payment date and may be paid only if not disapproved.
Illinois insurance laws also permit payment of dividends only out of earned
surplus, exclusive of most unrealized capital gains. The maximum amount of
dividends which can be paid by the Company in 1995 is currently $0. The Company
paid no cash dividends in 1994, 1993 or 1992.
The Company's net income (loss) and stockholder's equity as determined in
accordance with statutory accounting principles are as follows:
<TABLE>
<CAPTION>
(in thousands) 1994 1993 1992
-------- -------- ---------
<S> <C> <C> <C>
Net income (loss)............................................. $ 44,491 $(36,178) $(141,975)
======== ======== =========
Statutory surplus............................................. $416,243 $329,430 $ 251,283
======== ======== =========
</TABLE>
B-42
<PAGE> 153
APPENDIX B
STATE PREMIUM TAX CHART
<TABLE>
<CAPTION>
Rate of Tax
--------------------------------
Qualified Non-Qualified
State Plans Plans
----- ----- -----
<S> <C> <C>
California...................................................... .50% 2.35%*
District of Columbia............................................ 2.25% 2.25%*
Kansas.......................................................... -- 2.00%*
Kentucky........................................................ 2.00%* 2.00%*
Maine........................................................... -- 2.00%
Mississippi..................................................... -- 1.00%
Nevada.......................................................... -- 3.50%*
Pennsylvania.................................................... -- 2.00%
South Dakota.................................................... -- 1.25%
West Virginia................................................... 1.00% 1.00%
Wyoming......................................................... -- 1.00%
</TABLE>
* Taxes become due when annuity benefits commence, rather than when the
premiums are collected. At the time of annuitization, the premium tax
payable will be charged against the Contract Value.
B-43
