PENN MUTUAL VARIABLE ANNUITY ACCOUNT III, 497, 1996-05-06

PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
497, 1996-05-06

Previous: KRUPP REALTY FUND LTD III, 10-Q, 1996-05-06

Next: PENN SERIES FUNDS INC, 497, 1996-05-06

<PAGE>

PROSPECTUS -- MAY 1, 1996
INDIVIDUAL ANNUITY CONTRACTS WITH VARIABLE BENEFIT PROVISIONS -- FLEXIBLE
PURCHASE PAYMENTS
- --------------------------------------------------------------------------------
DIVERSIFIER II

PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
THE PENN MUTUAL LIFE INSURANCE COMPANY
INDEPENDENCE SQUARE . PHILADELPHIA, PA 19172 . TELEPHONE (215) 956-8000
- --------------------------------------------------------------------------------
This prospectus describes two forms of annuity contracts--a combination
variable and fixed annuity contract and a variable annuity contract. The
contracts provide for accumulation of values and for the payment of annuities.
Through Penn Mutual Variable Annuity Account III (referred to herein as the
"Separate Account"), purchase payments and annuity payment reserves may be
invested under the contracts in one or more of the following Funds:
PENN SERIES FUNDS, INC. MANAGERS
Growth Equity Fund Independence Capital Management, Inc. (a
Value Equity Fund subsidiary of Penn Mutual)
Flexibly Managed Fund OppCap Advisors (a subsidiary of
Small Capitalization Fund Oppenheimer Capital)
International Equity Fund T. Rowe Price Associates, Inc.
Quality Bond Fund OppCap Advisors
High Yield Bond Fund Vontobel USA Inc. (a subsidiary of
Money Market Fund Vontobel Holding Ltd.)
Independence Capital Management, Inc.
T. Rowe Price Associates, Inc.
- --------------------------------------------------------------------------------
TCI PORTFOLIOS, INC. Independence Capital Management, Inc.
TCI Growth Portfolio Investors Research Corporation (a
Twentieth Century company)
- --------------------------------------------------------------------------------
NEUBERGER & BERMAN ADVISERS MANAGEMENT TRUST
Limited Maturity Bond Portfolio Neuberger & Berman Management Incorporated
Balanced Portfolio Neuberger & Berman Management Incorporated
- --------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND
Growth Portfolio Fidelity Management and Research Company
Equity Income Portfolio Fidelity Management and Research Company
- --------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND II
Asset Manager Portfolio Fidelity Management and Research Company
- --------------------------------------------------------------------------------
Contract values and annuity payments based upon investment in one or more of
these funds vary in accordance with the investment experience of the selected
Funds.

Under the combination variable and fixed annuity contract, purchasers may
allocate their contract value to fixed interest accounts funded through Penn
Mutual's general account, as well as to one or more of the Funds.

The variable annuity contract is offered only to owners of a companion fixed
annuity contract issued by Penn Mutual.

Under some circumstances, early withdrawals from the combination variable
and fixed annuity contract may be subject to a contingent deferred sales charge
ranging from 7% on withdrawals made in the first contract year to 1% on
withdrawals made in the tenth contract year and early withdrawals from the
variable annuity contract may be subject to a 5% contingent deferred sales
charge. In addition, early withdrawals from both contracts may be subject to a
10% additional income tax. See pages 17 and 20.

The combination variable and fixed annuity contract may be returned within
ten days of receipt for a full refund of the variable account value and a full
refund of purchase payments credited to the fixed interest accounts. The
variable annuity contract may be returned within ten days of receipt for a full
refund of the contract value. Longer free look periods and full refund of
purchase payments are required for contracts sold in some states.

This prospectus sets forth concisely the information a prospective investor
should know before investing. It should be retained for future reference.

A statement of additional information dated the same as this prospectus has
been filed with the Securities and Exchange Commission and is incorporated
herein by reference. It is available, at no charge, by writing The Penn Mutual
Life Insurance Company, Customer Service Group -- H3F, Independence Square,
Philadelphia, PA 19172. Or, you can call, toll free, 1-800-548-1119. The table
of contents of the statement of additional information is at the end of this
prospectus.

THIS PROSPECTUS IS VALID ONLY WHEN ACCOMPANIED BY OR PRECEDED BY A CURRENT
PROSPECTUS FOR EACH APPLICABLE FUND.

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>

- --------------------------------------------------------------------------------
PROSPECTUS CONTENTS
<TABLE>
- --------------------------------------------------------------------------------
<S> <C>
SPECIAL TERMS............................................................... 3
- --------------------------------------------------------------------------------
EXPENSES.................................................................... 4
- --------------------------------------------------------------------------------
CONDENSED FINANCIAL INFORMATION............................................. 8
Penn Series Growth Equity Fund Subaccount................................. 8
Penn Series Value Equity Fund Subaccount.................................. 9
Penn Series Flexibly Managed Fund Subaccount.............................. 9
Penn Series International Equity Fund Subaccount.......................... 9
Penn Series Quality Bond Fund Subaccount.................................. 10
Penn Series High Yield Bond Fund Subaccount............................... 10
Penn Series Small Capitalization Fund Subaccount.......................... 10
Penn Series Money Market Fund Subaccount.................................. 10
TCI Growth Portfolio Subaccount........................................... 11
Neuberger & Berman Limited Maturity Bond Portfolio Subaccount............. 11
Neuberger & Berman Balanced Portfolio Subaccount.......................... 11
Fidelity Equity Income Fund Subaccount.................................... 11
Fidelity Growth Fund Subaccount........................................... 11
Fidelity Asset Manager Fund Subaccount.................................... 12
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY...................................... 13
- --------------------------------------------------------------------------------
THE SEPARATE ACCOUNT........................................................ 13
Penn Series Funds, Inc. .................................................. 13
TCI Portfolios, Inc. ..................................................... 14
Neuberger & Berman Advisers Management Trust.............................. 14
Fidelity Investments' Variable Insurance Products Fund.................... 14
Fidelity Investments' Variable Insurance Products Fund II................. 15
- --------------------------------------------------------------------------------
THE CONTRACTS............................................................... 15
Purchases................................................................. 15
Accumulation Units........................................................ 16
Annuity Payments.......................................................... 16
Payment on Death.......................................................... 17
Transfers................................................................. 17
Withdrawals............................................................... 18
Deferment of Payments and Transfers....................................... 18
Deductions and Expenses................................................... 18
- --------------------------------------------------------------------------------
THE FIXED INTEREST OPTIONS.................................................. 20
- --------------------------------------------------------------------------------
FEDERAL INCOME TAX CONSIDERATIONS........................................... 21
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION CONTENTS................................ 23
- --------------------------------------------------------------------------------
</TABLE>

2
<PAGE>

- --------------------------------------------------------------------------------
SPECIAL TERMS

As used in this prospectus, the following terms have the indicated meaning:
ACCUMULATION UNIT: With respect to the Variable/Fixed Contract, a unit of
measure used to compute the Variable Account Value prior to the Annuity
Date; with respect to the Variable Contract, a unit of measure used to
compute the Contract Value prior to the Annuity Date.
ANNUITANT: The person during whose life annuity payments are made.
ANNUITY DATE: The date on which annuity payments start.
CONTRACT: The combination variable and fixed annuity contract or the
variable annuity contract described in this prospectus.
CONTRACT OWNER: The person specified in the Contract as the contract owner.
CONTRACT VALUE: With respect to the Variable/Fixed Contract, the sum of the
Variable Account Value and the Fixed Account Value; with respect to the
Variable Contract, the value of amounts held under the Contract in all
subaccounts of the Separate Account.
FIXED ACCOUNT VALUE: The value of amounts held under the Variable/Fixed
Contract in all fixed interest options.
SEPARATE ACCOUNT: Penn Mutual Variable Annuity Account III, a separate
account of The Penn Mutual Life Insurance Company that is registered as a
unit investment trust under The Investment Company Act of 1940.
VARIABLE ACCOUNT VALUE: The value of amounts held under the Variable/ Fixed
Contract in all subaccounts of the Separate Account.
VARIABLE CONTRACT: The variable annuity contract described in this
prospectus.
VARIABLE/FIXED CONTRACT: The combination variable and fixed annuity contract
described in this prospectus.
WE: A reference to "we" or "us" denotes The Penn Mutual Life Insurance
Company.

3
<PAGE>

- -------------------------------------------------------------------------------
EXPENSES

- -------------------------------------------------------------------------------
PENN SERIES FUNDS, INC.**
UNDERLYING FUND ANNUAL EXPENSES (AS A % OF PORTFOLIO AVG. NET ASSETS)
<TABLE>
<CAPTION>
MANAGEMENT ADMINISTRATIVE TOTAL
FEES (AFTER AND CORPORATE ACCOUNTING OTHER FUND
WAIVER) SERVICES FEES FEES EXPENSES EXPENSES
----------- -------------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Growth Equity........... 0.45% 0.15% 0.08% 0.09% 0.77%
Value Equity............ 0.50% 0.15% 0.07% 0.08% 0.80%
Flexibly Managed........ 0.50% 0.15% 0.06% 0.08% 0.79%
Small Capitalization.... 0.50% 0.15% 0.04% 0.31% 1.00%
International Equity.... 0.75% 0.15% 0.09% 0.24% 1.23%
Quality Bond............ 0.40% 0.15% 0.08% 0.10% 0.73%
High Yield Bond......... 0.50% 0.15% 0.08% 0.14% 0.87%
Money Market............ 0.35% 0.15% 0.08% 0.11% 0.69%
</TABLE>
- -----------------------
** The expenses presented are for the last fiscal year. In the absence of vol-
untary fee waivers by the investment adviser, the total expenses of the
Growth Equity and Quality Bond Funds would have been 0.82% and 0.78% re-
spectively. In the absence of expense waivers and voluntary fee waivers by
the investment adviser, the total expenses of the Money Market Fund would
have been 0.74%. In the absence of voluntary fee waivers by the investment
adviser and administrator of the Fund, the total expenses of the Small Cap-
italization Fund would have been 1.29% annualized for the period from March
1, 1995 to December 31, 1995.

4
<PAGE>

- -------------------------------------------------------------------------------
TCI PORTFOLIOS, INC.
UNDERLYING FUND ANNUAL EXPENSES (AS A % OF PORTFOLIO AVG. NET ASSETS)
<TABLE>
<CAPTION>
MANAGEMENT OTHER TOTAL FUND
FEES 12B-1 FEES EXPENSES EXPENSES
---------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Growth................................ 1.00% None None 1.00%
</TABLE>

- -------------------------------------------------------------------------------
NEUBERGER & BERMAN ADVISERS MANAGEMENT TRUST***
UNDERLYING FUND ANNUAL EXPENSES (AS A % OF PORTFOLIO AVG. NET ASSETS)
<TABLE>
<CAPTION>
MANAGEMENT,
ADVISORY AND
ADMINISTRATION OTHER TOTAL FUND
FEES EXPENSES EXPENSES
-------------- -------- ----------
<S> <C> <C> <C>
Limited Maturity Bond........................ 0.65% 0.10% 0.75%
Balanced..................................... 0.85% 0.19% 1.04%
</TABLE>
- -----------------------
*** Neuberger & Berman Advisers Management Trust (the "Trust") is divided into
portfolios ("Portfolios"), each of which invests all of its net investable
assets in a corresponding series ("Series") of Advisers Managers Trust.
Expenses in the table reflect expenses of the Portfolios and include each
Portfolio's pro rata portion of the operating expenses of each Portfolio's
corresponding Series. The Portfolios pay Neuberger & Berman Management
Inc. ("NBMI") an administration fee based on the Portfolio's net asset
value. Each Portfolio's corresponding Series pays NBMI a management fee
based on the Series' average daily net assets. Accordingly, this table
combines management fees at the Series level and administration fees at
the Portfolio level in a unified fee rate. Total Annual Expenses for each
portfolio have been restated based upon current administration fees for
the Portfolio and management fees for its corresponding Series. See "Ex-
penses" in the Trust's Prospectus.

- -------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND
UNDERLYING FUND ANNUAL EXPENSES (AS A % OF PORTFOLIO AVG. NET ASSETS)
<TABLE>
<CAPTION>
MANAGEMENT OTHER TOTAL FUND
FEES EXPENSES EXPENSES
---------- -------- ----------
<S> <C> <C> <C>
Equity-Income.................................... 0.51% 0.10% 0.61%
Growth........................................... 0.61% 0.09% 0.70%
</TABLE>

- -------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND II++
UNDERLYING FUND ANNUAL EXPENSES (AS A % OF PORTFOLIO AVG. NET ASSETS)
<TABLE>
<CAPTION>
MANAGEMENT OTHER TOTAL FUND
FEE EXPENSES EXPENSES
---------- -------- ----------
<S> <C> <C> <C>
Asset Manager.................................... 0.71% 0.08% 0.79%
</TABLE>
++ The expenses presented are for the last fiscal year. A portion of the
brokerage commissions the fund paid was used to reduce its expenses. Without
this reduction, total expenses would have been 0.81% for the Asset Manager
Portfolio.
- -------------------------------------------------------------------------------
The purpose of this foregoing table is to assist Contract Owners in
understanding the various costs and expenses that a Contract Owner will bear
directly and indirectly. The table shows Contract expenses and underlying Fund
expenses. See the accompanying prospectuses of Penn Series Funds, Inc., TCI
Portfolios, Inc., Neuberger & Berman Advisers Management Trust, Fidelity
Investments' Variable Insurance Products Fund, and Fidelity Investments'
Variable Insurance Products Fund II for information on expenses.
Premium taxes may be applicable. SEE DEDUCTIONS AND EXPENSES in this
prospectus.

5
<PAGE>

- --------------------------------------------------------------------------------
EXAMPLE

If you own a Variable/Fixed Contract, make purchase payments only during the
first year and surrender your contract at the end of the applicable period, you
would pay the following expenses on each $1,000 invested, assuming 5% annual
return on assets:
<TABLE>
<CAPTION>
ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
---- ----- ----- -----
<S> <C> <C> <C> <C>
Penn Series Growth Equity Fund........................... $86 $115 $145 $244
Penn Series Value Equity Fund............................ $87 $116 $146 $248
Penn Series Flexibly Managed Fund........................ $86 $116 $146 $247
Penn Series Small Capitalization Fund.................... $88 $122 $156 $268
Penn Series International Equity Fund.................... $91 $128 $167 $291
Penn Series Quality Bond Fund............................ $86 $114 $143 $241
Penn Series High Yield Bond Fund......................... $87 $118 $150 $255
Penn Series Money Market Fund............................ $86 $113 $141 $236
TCI Growth Portfolio..................................... $88 $122 $156 $268
Neuberger & Berman Limited Maturity Bond Portfolio....... $86 $115 $144 $242
Neuberger & Berman Balanced Portfolio.................... $89 $123 $158 $272
Fidelity's Growth Portfolio.............................. $86 $113 $141 $237
Fidelity's Equity Income Portfolio....................... $85 $111 $137 $228
Fidelity's Asset Manager Portfolio....................... $86 $116 $146 $247
</TABLE>

- --------------------------------------------------------------------------------
EXAMPLE

If you own a Variable/Fixed Contract, make purchase payments in any contract
year after the first and surrender your contract at the end of the applicable
period, you would pay the following expenses on each $1,000 invested on the
date the Contract was purchased, assuming 5% annual return on assets:
<TABLE>
<CAPTION>
ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
---- ----- ----- -----
<S> <C> <C> <C> <C>
Penn Series Growth Equity Fund........................... $86 $115 $150 $256
Penn Series Value Equity Fund............................ $87 $116 $151 $259
Penn Series Flexibly Managed Fund........................ $86 $116 $151 $259
Penn Series Small Capitalization Fund.................... $88 $122 $161 $280
Penn Series International Equity Fund.................... $91 $128 $172 $303
Penn Series Quality Bond Fund............................ $86 $114 $148 $253
Penn Series High Yield Bond Fund......................... $87 $118 $155 $267
Penn Series Money Market Fund............................ $86 $113 $146 $248
TCI Growth Portfolio..................................... $88 $122 $161 $280
Neuberger & Berman Limited Maturity Bond Portfolio....... $86 $115 $149 $254
Neuberger & Berman Balanced Portfolio.................... $89 $123 $163 $284
Fidelity's Growth Portfolio.............................. $86 $113 $146 $249
Fidelity's Equity Income Portfolio....................... $85 $111 $142 $240
Fidelity's Asset Manager Portfolio....................... $86 $116 $151 $259
</TABLE>

6
<PAGE>

- --------------------------------------------------------------------------------
EXAMPLE

If you own a Variable Contract and surrender your contract at the end of the
applicable period, you would pay the following expenses on each $1,000
invested, assuming 5% annual return on assets:
<TABLE>
<CAPTION>
ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
---- ----- ----- -----
<S> <C> <C> <C> <C>
Penn Series Growth Equity Fund........................... $68 $116 $163 $244
Penn Series Value Equity Fund............................ $68 $116 $165 $248
Penn Series Flexibly Managed Fund........................ $68 $116 $164 $247
Penn Series Small Capitalization Fund.................... $70 $122 $175 $268
Penn Series International Equity Fund.................... $72 $129 $187 $291
Penn Series Quality Bond Fund............................ $68 $115 $162 $241
Penn Series High Yield Bond Fund......................... $69 $119 $169 $255
Penn Series Money Market Fund............................ $67 $113 $159 $236
TCI Growth Portfolio..................................... $70 $122 $175 $268
Neuberger & Berman Limited Maturity Bond Portfolio....... $68 $115 $162 $242
Neuberger & Berman Balanced Portfolio.................... $70 $123 $177 $272
Fidelity's Growth Portfolio.............................. $67 $114 $160 $237
Fidelity's Equity Income Portfolio....................... $66 $111 $155 $228
Fidelity's Asset Manager Portfolio....................... $68 $116 $164 $247
</TABLE>

- --------------------------------------------------------------------------------
EXAMPLE

If you own either a Variable/Fixed Contract or a Variable Contract and do
not surrender your contract, or you elect an annuity option at the end of the
applicable time period, you would pay the following expenses on each $1,000
invested, assuming 5% annual return on assets:
<TABLE>
<CAPTION>
ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
---- ----- ----- -----
<S> <C> <C> <C> <C>
Penn Series Growth Equity Fund........................... $21 $66 $113 $244
Penn Series Value Equity Fund............................ $22 $67 $115 $248
Penn Series Flexibly Managed Fund........................ $22 $67 $114 $247
Penn Series Small Capitalization Fund.................... $24 $73 $125 $268
Penn Series International Equity Fund.................... $26 $80 $137 $291
Penn Series Quality Bond Fund............................ $21 $65 $112 $241
Penn Series High Yield Bond Fund......................... $22 $69 $119 $255
Penn Series Money Market Fund............................ $21 $64 $109 $236
TCI Growth Portfolio..................................... $24 $73 $125 $268
Neuberger & Berman Limited Maturity Bond Portfolio....... $21 $66 $112 $242
Neuberger & Berman Balanced Portfolio.................... $24 $74 $127 $272
Fidelity's Growth Portfolio.............................. $21 $64 $110 $237
Fidelity's Equity Income Portfolio....................... $20 $61 $105 $228
Fidelity's Asset Manager Portfolio....................... $22 $67 $114 $247
</TABLE>

The examples are based upon data for the fiscal year ended December 31, 1994
and assume an average Variable Account Value or Contract Value of approximately
$18,300. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE EXPENSES UNDER YOUR CONTRACT; ACTUAL EXPENSES MAY BE GREATER OR LESSER
THAN THOSE SHOWN.

7
<PAGE>

- --------------------------------------------------------------------------------
CONDENSED FINANCIAL INFORMATION

The following tables show Accumulation Unit values and the number of
Accumulation Units outstanding for each of the subaccounts of the Separate
Account for the specified periods. The financial data included in the tables
should be read in conjunction with the financial statements and the related
notes included in the Statement of Additional Information.

- --------------------------------------------------------------------------------
PENN SERIES GROWTH EQUITY FUND SUBACCOUNT (a)

Values of an Accumulation Unit Outstanding Throughout Each Period for Qualified
and Nonqualified Retirement Plans

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
- -------------------------------------------------------------------------------------------------------------
NON- NON- NON- NON- NON-
QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit
Value, beginning
of period....... $ 26.102 $25.887 $ 28.766 $28.528 $ 25.906 $ 25.692 $ 24.756 $24.552 $ 18.605 $18.451
Accumulation Unit
Value, end of
period.......... $ 32.596 $32.327 $ 26.102 $25.887 $ 28.766 $ 28.528 $ 25.906 $25.692 $ 24.756 $24.552
Number of
Accumulation
Units
outstanding, end
of period....... 1,991,646 674,290 2,119,836 717,328 2,042,023 685,110 2,004,015 669,679 1,680,322 518,717
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------
1990 1989 1988 1987 1986
- -------------------------------------------------------------------------------------------------------------
NON- NON- NON- NON- NON-
QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit
Value, beginning
of period....... $ 21.204 $21.029 $ 16.356 $16.221 $ 14.702 $ 14.581 $ 14.145 $14.029 $ 12.472 $12.370
Accumulation Unit
Value, end of
period.......... $ 18.605 $18.451 $ 21.204 $21.029 $ 16.356 $ 16.221 $ 14.702 $14.581 $ 14.145 $14.029
Number of
Accumulation
Units
outstanding, end
of period....... 1,470,210 439,287 1,284,583 333,486 1,309,408 360,185 1,366,286 306,559 896,288 232,273
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Growth Stock Fund Subaccount prior to November 1, 1992.

8
<PAGE>

- --------------------------------------------------------------------------------
PENN SERIES VALUE EQUITY FUND SUBACCOUNT (a)

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987(b)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $18.361 $18.062 $17.080 $15.058 $11.939 $13.157 $11.802 $ 9.226 $10.000
Accumulation Unit Value,
end of period.......... $24.928 $18.361 $18.062 $17.080 $15.058 $11.939 $13.157 $11.802 $ 9.226
Number of Accumulation
Units outstanding, end
of period.............. 4,235,839 3,886,404 3,693,652 2,865,294 2,207,661 1,883,581 1,802,897 918,020 349,261
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Equity Income Fund Subaccount prior to November 1, 1992.
(b) For the period March 17, 1987 (date subaccount was established) through
December 31, 1987.

- --------------------------------------------------------------------------------
PENN SERIES FLEXIBLY MANAGED FUND SUBACCOUNT (a)

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit
Value, beginning
of period......... $35.496 $34.514 $30.179 $27.893 $23.215 $23.712 $19.832 $16.898 $13.851 $12.226
Accumulation Unit
Value, end of
period............ $42.865 $35.496 $34.514 $30.179 $27.893 $23.215 $23.712 $19.832 $16.898 $13.851
Number of
Accumulation Units
outstanding, end
of period......... 4,946,240 4,198,305 3,143,601 2,327,829 1,664,751 1,237,347 1,129,858 853,647 623,017 299,278
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Capital Appreciation Fund Subaccount prior to November 1, 1992.

- --------------------------------------------------------------------------------
PENN SERIES INTERNATIONAL EQUITY FUND SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
- --------------------------------------------------------------------------------
1995 1994 1993 1992(a)
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Accumulation Unit Value, beginning of
period.................................. $12.843 $13.880 $10.175 $10.000
Accumulation Unit Value, end of period... $14.434 $12.843 $13.880 $10.175
Number of Accumulation Units outstanding,
end of period........................... 3,388,479 3,556,098 1,847,892 92,386
- --------------------------------------------------------------------------------
</TABLE>
(a) For the period November 2, 1992 (date subaccount was established) through
December 31, 1992.

9
<PAGE>

- --------------------------------------------------------------------------------
PENN SERIES QUALITY BOND FUND SUBACCOUNT (a)

Values of an Accumulation Unit Outstanding Throughout Each Period

- --------------------------------------------------------------------------------
PENN SERIES HIGH YIELD BOND FUND SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $22.644 $24.742 $20.918 $18.291 $13.534 $15.035 $15.325 $13.193 $13.461 $12.266
Accumulation Unit Value,
end of period.......... $26.033 $22.644 $24.742 $20.918 $18.291 $13.534 $15.035 $15.325 $13.193 $13.461
Number of Accumulation
Units outstanding, end
of period.............. 1,194,944 1,264,890 1,257,271 705,414 594,530 613,408 817,147 708,838 469,236 393,704
- ---------------------------------------------------------------------------------------------------------------
</TABLE>

- --------------------------------------------------------------------------------
PENN SERIES SMALL CAPITALIZATION FUND SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
- --------------------------------------------------------------------------------
1995(a)
- --------------------------------------------------------------------------------
<S> <C>
Accumulation Unit Value, beginning of period....................... $10.000
Accumulation Unit Value, end of period............................. $11.171
Number of Accumulation Units outstanding,
end of period..................................................... 137,653
</TABLE>
- --------------------------------------------------------------------------------
(a) For the period May 1, 1995 (date subaccount was established) through Decem-
ber 31, 1995.

- --------------------------------------------------------------------------------
PENN SERIES MONEY MARKET FUND SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $17.416 $17.003 $16.791 $16.491 $15.732 $14.893 $13.844 $13.089 $12.482 $11.891
Accumulation Unit Value,
end of period.......... $18.148 $17.416 $17.003 $16.791 $16.491 $15.732 $14.893 $13.844 $13.089 $12.482
Number of Accumulation
Units outstanding,
end of period.......... 1,062,385 825,274 658,620 698,584 769,958 965,117 753,052 319,671 242,494 117,030
</TABLE>

10
<PAGE>

- --------------------------------------------------------------------------------
TCI GROWTH PORTFOLIO SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout the Period

<TABLE>
<CAPTION>
1995 1994 1993 (a)
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Accumulation Unit Value, beginning of period...... $ 10.857 $11.124 $10.000
Accumulation Unit Value, end of period............ $ 14.057 $10.857 $11.124
Number of Accumulation Units outstanding, end of
period........................................... 2,157,888 1,791,799 716,404
- -------------------------------------------------------------------------------
</TABLE>
(a) For the period May 1, 1993 (date subaccount was established) through Decem-
ber 31, 1993

- --------------------------------------------------------------------------------
NEUBERGER & BERMAN LIMITED MATURITY BOND PORTFOLIO SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout the Period

<TABLE>
<CAPTION>
1995 1994 1993 (a)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Accumulation Unit Value, beginning of period.......... $10.039 $10.181 $10.000
Accumulation Unit Value, end of period................ $10.999 $10.039 $10.181
Number of Accumulation Units outstanding, end of
period............................................... 444,986 448,825 311,665
- --------------------------------------------------------------------------------
</TABLE>
(a) For the period May 1, 1993 (date subaccount was established) through Decem-
ber 31, 1993

- --------------------------------------------------------------------------------
NEUBERGER & BERMAN BALANCED PORTFOLIO SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout the Period

<TABLE>
<CAPTION>
1995 1994 1993 (a)
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Accumulation Unit Value, beginning of period...... $ 10.218 $10.706 $10.000
Accumulation Unit Value, end of period............ $ 12.488 $10.218 $10.706
Number of Accumulation Units outstanding, end of
period........................................... 1,468,254 1,223,496 621,326
- -------------------------------------------------------------------------------
</TABLE>
(a) For the period May 1, 1993 (date subaccount was established) through Decem-
ber 31, 1993

- --------------------------------------------------------------------------------
FIDELITY EQUITY INCOME FUND SUBACCOUNT (SM)

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
- --------------------------------------------------------------------------------
1995(a)
- --------------------------------------------------------------------------------
<S> <C>
Accumulation Unit Value, beginning of period....................... $10.000
Accumulation Unit Value, end of period............................. $11.920
Number of Accumulation Units outstanding, end of period............ 581,691
- --------------------------------------------------------------------------------
</TABLE>
(a) For the period May 1, 1995 (date subaccount was established) through Decem-
ber 31, 1995.

- --------------------------------------------------------------------------------
FIDELITY GROWTH FUND SUBACCOUNT (SM)

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
- --------------------------------------------------------------------------------
1995(a)
- --------------------------------------------------------------------------------
<S> <C>
Accumulation Unit Value, beginning of period....................... $10.000
Accumulation Unit Value, end of period............................. $12.359
Number of Accumulation Units outstanding, end of period............ 690,602
- --------------------------------------------------------------------------------
</TABLE>
(a) For the period May 1, 1995 (date subaccount was established) through Decem-
ber 31, 1995.

11
<PAGE>

- --------------------------------------------------------------------------------
FIDELITY ASSET MANAGER FUND SUBACCOUNT (SM)

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
- --------------------------------------------------------------------------------
1995(a)
- --------------------------------------------------------------------------------
<S> <C>
Accumulation Unit Value, beginning of period....................... $10.000
Accumulation Unit Value, end of period............................. $11.153
Number of Accumulation Units outstanding, end of period............ 117,290
- --------------------------------------------------------------------------------
</TABLE>
(a) For the period May 1, 1995 (date subaccount was established) through Decem-
ber 31, 1995.
The financial statements of the Separate Account for the year ended December
31, 1995 are included in the statement of additional information referred to on
the cover page of this prospectus.

- --------------------------------------------------------------------------------

In advertisements of the Contracts, Penn Mutual may provide information on
total return performance and on annual changes in accumulation unit values. We
may also provide information on "yields" and "effective yields" on investments
in the Money Market Fund subaccount.
Information on total return performance will include average annual rates of
total return for one, five and ten year periods, or lesser periods depending on
how long the subaccount has been in existence. Average annual total return
figures will show the average annual rates of increase or decrease in
investments in the subaccounts, assuming a $1,000 investment at the beginning
of the period, withdrawal of the investment at the end of the period, and the
deduction of all applicable charges. We may also show average annual rates of
total return, assuming other amounts invested at the beginning of the period
and no withdrawal at the end of the period. Average annual total return figures
which assume no withdrawal at the end of the period will reflect all recurring
charges, but will not reflect the contingent deferred sales charge (if
applicable, the contingent deferred sales charge would reduce the amount that
may be withdrawn under the Contracts).
The "yield" on an investment in the Money Market Fund subaccount refers to
the income generated by the investment over a 7-day period. This income is then
annualized. That is, the amount of income generated by the investment during
that week is assumed to be generated each week over a 52-week period and is
shown as a percentage of the investment. The "effective yield" is calculated
similarly but, when annualized, the income earned by an investment in the
subaccount is assumed to be reinvested. The effective yield will be slightly
higher than the yield because of the compounding effect of this assumed
reinvestment.

12
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY

The Penn Mutual Life Insurance Company ("Penn Mutual") is a Pennsylvania mutual
life insurance company. We were chartered in 1847 and have been continuously
engaged in the life insurance business since that date. Our home office is
located at Independence Square, Philadelphia, PA 19172.

- --------------------------------------------------------------------------------
THE SEPARATE ACCOUNT

Penn Mutual Variable Annuity Account III was established as a separate account
of Penn Mutual on April 13, 1982. The Separate Account is registered with the
Securities and Exchange Commission as a unit investment trust under the
Investment Company Act of 1940 and qualifies as a "separate account" within the
meaning of the federal securities laws.
The Separate Account is divided into subaccounts for investment in shares of
different Funds of Penn Series Funds, Inc., TCI Portfolios, Inc., Neuberger &
Berman Advisers Management Trust, Fidelity Investments' Variable Insurance
Products Fund and Variable Insurance Products Fund II. In addition, there are
two subaccounts for investment in shares of the Growth Equity Fund of Penn
Series Funds, Inc. -- one for Contracts which were issued in connection with
tax qualified retirement plans and one for Contracts which were not issued in
connection with such plans. Income, gains and losses, realized or unrealized,
of a subaccount are credited to or charged against the subaccount without
regard to any other income, gains or losses of Penn Mutual. Assets equal to the
reserves and other contract liabilities with respect to each subaccount are not
chargeable with liabilities arising out of any other business of Penn Mutual.
Penn Mutual is obligated to pay all benefits and make all payments provided
under the Contracts.
Assets held in the Separate Account under the Contracts described in this
prospectus are invested, at the direction of the Contract Owner, in one or more
Funds of Penn Series Funds, Inc., Neuberger & Berman Advisers Management Trust,
TCI Portfolios, Inc., Fidelity Investments' Variable Insurance Products Fund
and Variable Insurance Products Fund II.
Under the Investment Company Act of 1940, as currently interpreted, Contract
Owners and persons receiving annuity payments have the right to instruct Penn
Mutual as to the voting of the various Fund shares held in the Separate Account
pursuant to the Contracts. The number of shares of a Fund for which voting
instructions may be given by a Contract Owner is determined by dividing the
Contract Owner's interest in the applicable subaccount of the Separate Account
by the net asset value per share of the Fund. The number of shares of a Fund
for which voting instructions may be given by a person receiving annuity
payments is determined by dividing the reserve allocated to the applicable
subaccount by the net asset value per share of the Fund. Should the applicable
law, or interpretations thereof, change so as to permit us to vote shares of
the mutual funds in our own right, we may elect to do so. Further, we reserve
the right to modify the manner in which we calculate the weight to be given to
pass through voting instructions where such a change is necessary to comply
with federal law or interpretations thereof.
Shares of Penn Series are sold not only to the Separate Account, but also to
other separate accounts of Penn Mutual and its subsidiary, The Penn Insurance
and Annuity Company, that fund benefits under variable annuity and variable
life insurance contracts. Shares of TCI Portfolios, Inc., Neuberger & Berman
Advisers Management Trust, Fidelity Investments' Variable Insurance Products
Fund and Variable Insurance Products Fund II are offered not only to variable
annuity and variable life separate accounts of Penn Mutual, but also to such
accounts of other insurance companies unaffiliated with Penn Mutual and, in the
case of Neuberger & Berman Advisers Management Trust, directly to qualified
pension and retirement plans. For a discussion of possible conflicts involved
in the Separate Account investing in Funds that are so offered, see the
accompanying Fund prospectuses.

- --------------------------------------------------------------------------------
PENN SERIES FUNDS, INC.:

GROWTH EQUITY FUND - seeks long term growth of capital and increase of
future income by investing primarily in common stocks of well established
growth companies;
VALUE EQUITY FUND - seeks to maximize total return (capital appreciation and
income) primarily by investing in equity securities of companies believed to be
undervalued considering such factors as assets, earnings, growth potential and
cash flows;
FLEXIBLY MANAGED FUND - seeks to maximize total return (capital appreciation
and income) by investing in common stocks, other equity securities, corporate
debt securities, and/or short term reserves, in proportions considered
appropriate in light of the availability of attractively valued individual
securities and current and expected economic and market conditions;

13
<PAGE>

SMALL CAPITALIZATION FUND - seeks capital appreciation through investment in
a diversified Portfolio which under normal conditions will have at least 65% of
its assets invested in equity securities of companies with market
capitalization under $1 billion.
INTERNATIONAL EQUITY FUND - seeks to maximize capital appreciation by
investing in a carefully selected diversified portfolio consisting primarily of
equity securities. The investments will consist principally of equity
securities of European and Pacific Basin countries;
QUALITY BOND FUND - seeks the highest income over the long term consistent
with the preservation of principal through investment primarily in marketable
investment grade debt securities;
HIGH YIELD BOND FUND - seeks high current income by investing primarily in a
diversified portfolio of long term high-yield/high-risk fixed income securities
in the medium to lower quality ranges; capital appreciation is a secondary
objective; such securities, which are commonly referred to as "junk" bonds,
generally involve greater risks of loss of income and principal than higher
rated securities (see accompanying Penn Series prospectus);
MONEY MARKET FUND - seeks to preserve capital, maintain liquidity and
achieve the highest possible level of current income consistent therewith, by
investing in high quality money market instruments; an investment in the Fund
is neither insured nor guaranteed by the U.S. Government and there can be no
assurance that the Fund will be able to maintain a stable net asset value of
$1.00 per share;
Independence Capital Management, Inc., Horsham, Pennsylvania, is investment
adviser to the Growth Equity, Quality Bond and Money Market Funds. OpCap
Advisors (formerly Quest for Value Advisors), New York, New York, is investment
adviser to the Value Equity and Small Capitalization Funds. T. Rowe Price
Associates, Baltimore, Maryland, is investment adviser to the Flexibly Managed
and High Yield Bond Funds. Vontobel USA Inc., New York, New York, is investment
adviser to the International Equity Fund.

- --------------------------------------------------------------------------------
TCI PORTFOLIOS, INC.:

TCI GROWTH PORTFOLIO - seeks capital growth by investing primarily in common
stocks believed to have better-than-average prospects for appreciation.
Investors Research Corporation, Kansas City, Missouri, is investment adviser to
the TCI Growth Portfolio.

- --------------------------------------------------------------------------------
NEUBERGER & BERMAN ADVISERS MANAGEMENT TRUST:

LIMITED MATURITY BOND PORTFOLIO - seeks highest current income consistent
with low risk to principal and liquidity, primarily by investing in a
diversified portfolio of limited maturity debt securities. A secondary
objective is capital appreciation. The portfolio invests all of its assets in a
series of Advisers Managers Trust (a diversified open-end management investment
company) with identical investment objectives, policies and limitations.
BALANCED PORTFOLIO - seeks long-term capital growth and reasonable current
income without undue risk to principal through investment in common stock and
debt securities. The portfolio invests all of its assets in a series of
Advisers Managers Trust (a diversified open-end management investment company)
with identical investment objectives, policies and limitations.
Neuberger & Berman Management Incorporated, New York, New York, is
investment adviser to each series of Advisers Managers Trust underlying the
Limited Maturity Bond Portfolio and the Balanced Portfolio.

- --------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND:

EQUITY-INCOME PORTFOLIO - seeks reasonable income by investing primarily in
income-producing equity securities. In choosing these securities, the fund will
also consider the potential for capital appreciation. The fund's goal is to
achieve a yield which exceeds the composite yield on the securities comprising
the Standard & Poor's 500 Composite Stock Price Index.
GROWTH PORTFOLIO - seeks to achieve capital appreciation. The fund normally
purchases common stocks, although its investments are not restricted to any one
type of security. Capital appreciation may also be found in other types of
securities, including bonds and preferred stocks.
Fidelity Management & Research Company, Boston, Massachusetts, is investment
adviser to the Equity-Income Portfolio and the Growth Portfolio.

14
<PAGE>

- --------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND II:

ASSET MANAGER PORTFOLIO - seeks high total return with reduced risk over the
long-term by allocating its assets among domestic and foreign stocks, bonds and
short-term fixed income investments.
Fidelity Management & Research Company, Boston, Massachusetts, is investment
adviser to the Asset Manager Portfolio.

- --------------------------------------------------------------------------------
FOR MORE INFORMATION ON THE FUNDS IN WHICH THE SUBACCOUNTS INVEST, SEE THE
ACCOMPANYING PROSPECTUSES FOR PENN SERIES FUNDS, INC., TCI PORTFOLIOS, INC.,
NEUBERGER & BERMAN ADVISERS MANAGEMENT TRUST, AND FIDELITY INVESTMENTS'
VARIABLE INSURANCE PRODUCTS FUND AND VARIABLE INSURANCE PRODUCTS FUND II.
INVESTORS SHOULD READ THE PROSPECTUSES FOR THE FUNDS IN WHICH THEY ARE
INTERESTED BEFORE INVESTING.

- --------------------------------------------------------------------------------
THE CONTRACTS

The Contracts offered in this prospectus are a combination variable and fixed
annuity contract ("Variable/Fixed Contract") and a variable annuity contract
("Variable Contract").
The Variable/Fixed Contract provides for investment, through the Separate
Account, in one or more of the available Funds of Penn Series Funds, Inc., TCI
Portfolios, Inc., Neuberger & Berman Advisers Management Trust, and Fidelity
Investments' Variable Insurance Products Fund and Variable Insurance Products
Fund II. It also provides for investment in one or more fixed interest
accounts. The fixed interest accounts are guaranteed and funded by Penn Mutual
through its general account. See FIXED INTEREST OPTIONS in this prospectus.
Currently, over the life of the Variable/Fixed Contract, you may invest in one
or more of 19 Funds and fixed interest accounts.
The Variable Contract provides exclusively for investment, through the
Separate Account, in one or more of the available Funds of Penn Series Funds,
Inc., TCI Portfolios, Inc., Neuberger & Berman Advisers Management Trust, and
Fidelity Investments' Variable Insurance Products Fund and Variable Insurance
Products Fund II. Owners of Variable Contracts who wish to invest in a fixed
annuity contract may transfer amounts or allocate purchase payment to a
companion fixed annuity contract offered by Penn Mutual. The Variable Contract
is currently offered only to owners of a companion fixed annuity contract
issued by Penn Mutual. Unless otherwise indicated, the term "Contracts," as
used in this prospectus, refers to both the Variable/Fixed Contract and the
Variable Contract.
The Contract Owner determines (1) the amount and frequency of the purchase
payments to be made to Penn Mutual, (2) the accounts to which the purchase
payments are to be allocated, (3) transfers among investment accounts, (4) the
form of annuity to be paid after the accumulation period, (5) the beneficiary
to whom death benefits are to be paid, and (6) the amount and frequency of
withdrawals from the Contract Value.
During the annuity period, the person entitled to the annuity may transfer
Annuity Unit values among subaccounts of the Separate Account. Further, if the
annuity is for a specified number of years (under Option 1 in the Contract),
the person entitled to the annuity may withdraw the present value of annuity
payments remaining to be paid.
Upon death of the Annuitant prior to the Annuity Date, the beneficiary may
elect to receive a death benefit in a lump sum or in the form of an annuity.
The Contracts may be amended at any time to conform to applicable laws or
governmental regulations. If, in our judgment, investment in any of the
underlying funds becomes inappropriate to the purposes of the Contracts, we
may, with approval of the Securities and Exchange Commission and the governing
state insurance department, substitute another fund for existing and future
investments.
Contract Owner inquiries may be made by writing The Penn Mutual Life
Insurance Company, Customer Service Group --H3F, Independence Square,
Philadelphia, PA 19172. Or, you can call, toll free, 1-800-548-1119.

- --------------------------------------------------------------------------------
PURCHASES

A completed application, together with a check for the first purchase
payment, is forwarded to our service office. Normally, a completed application
form received at our service office will be accepted within two business days.
If an incomplete application is not completed and acted upon within five
business days, the purchase payment will be returned unless the Contract Owner
requests that we retain it while he or she completes the application. All
subsequent purchase payments are sent directly to our service office.

15
<PAGE>

For Variable/Fixed Contracts issued in connection with qualified retirement
plans, the minimum first purchase payment is $250 and the minimum for each
subsequent purchase payment is $50. The minimum first purchase payment for
Variable/Fixed Contracts which are not issued in connection with qualified
retirement plans is $2,500 and the minimum for each subsequent purchase payment
is $300. Total purchase payments credited to a Variable/Fixed Contract may not
exceed $1,000,000 in any calendar year without the consent of Penn Mutual.
For Variable Contracts issued in connection with retirement plans qualifying
for special tax treatment under the Internal Revenue Code, the minimum first
purchase payment is $250 and the minimum for each subsequent purchase payment
is $40. The minimum first purchase payment for Variable Contracts which are not
issued in connection with qualified retirement plans is $1,500 and the minimum
for each subsequent purchase payment is $300.
We may, at our discretion, reduce the minimum requirements for initial and
subsequent purchase payments under the Contracts.
Purchase payments allocated to the Separate Account are credited in the form
of Accumulation Units of the subaccount selected. The number of Accumulation
Units credited is determined by dividing the purchase payment allocated to the
Separate Account by the value of the Accumulation Unit at the end of the
valuation period in which the purchase payment is received at our service
office or, in a case of the first purchase payment, is accepted by us.
The principal underwriter of the Contracts (under federal securities laws)
is Hornor, Townsend & Kent, Inc., 600 Dresher Road, Horsham, PA 19044 (formerly
Penn Mutual Equity Services, Inc.), a wholly owned subsidiary of Penn Mutual.

- --------------------------------------------------------------------------------
ACCUMULATION UNITS

For each subaccount of the Separate Account, the value of an Accumulation
Unit was set at $10 when the subaccount was established. The value of an
Accumulation Unit may increase or decrease from one valuation period to the
next.
A valuation period is the period from one valuation to the next. Valuation
is performed on each day the New York Stock Exchange is open for trading.
The value of an Accumulation Unit for a valuation period is determined by
multiplying the value of an Accumulation Unit for the prior valuation period by
the net investment factor for the subaccount for the current valuation period.
The net investment factor is a measure of (1) investment performance of Fund
shares held in the subaccount, (2) any taxes on income or gains from
investments held in the subaccount and (3) the mortality and expense risk
charges assessed against the subaccount. Under current law, no taxes are levied
against income or gain from investments held in a subaccount.

- --------------------------------------------------------------------------------
ANNUITY PAYMENTS

Contract Owners may choose (1) an annuity for a specified number of years
(not less than 5 or more than 25 for a Variable/Fixed Contract and not less
than 5 or more than 30 for the Variable Contract), (2) a life annuity, (3) a
life annuity with payments guaranteed for 10 or 20 years, (4) a joint and
survivor life annuity or (5) such other form of annuity as we may agree upon.
Annuity payments do not start until an annuity option is chosen by the Contract
Owner.
The level of the variable annuity payments is determined by various factors,
including the form of annuity chosen, the expected duration of the annuity
period, the performance of the applicable investment accounts, and the annuity
purchase rates and charges specified in the Contract.
The mortality and expense risk charges specified in the Contracts are
assessed during both the accumulation and annuity pay-out phases of the
Contract. We continue to assess the charges during payment of a variable
annuity not involving a life contingency although we no longer bear any
mortality risk on such payment obligation.
The variable annuity purchase rates assume an annual net investment return
of 4%. If the annual net investment return is greater than 4%, the level of the
annuity payments increases. If the annual net investment return is less than
4%, the level of the annuity payments decreases.
The level of fixed annuity payments under a Variable/Fixed Contract is
determined by various factors, including the form of annuity chosen, the
expected duration of the annuity period and the amount accumulated and applied
under the contract to the fixed annuity.
Unless the Contract Owner specifies otherwise, the Annuity Date will be the
first day of the next month after the Annuitant's 85th birthday for Contracts
which are not issued under qualified retirement plans and the first day of
April in the calendar year following the year in which the Annuitant attains
the age of 70 1/2 for Contracts which are issued under qualified retirement
plans. The Contract Owner or the Contract Owner's surviving beneficiary may
change the Annuity Date or annuity

16
<PAGE>

option by giving written notice at our service office at least 30 days prior to
the current Annuity Date. The Annuity Date under the Variable/ Fixed Contract
may not be earlier than the first contract anniversary.
If the Contract Value of a Variable/Fixed Contract is less than $5,000, or
if the Contract Value of a Variable Contract is less than $2,000, we may elect
to pay such amount in lump sum in place of an annuity. Annuity payments
generally are made on the first day of each month starting with the Annuity
Date. However, if any payment would be less than $50, we may change the
frequency of annuity payments so that payments are at least $50 each.

- --------------------------------------------------------------------------------
PAYMENT ON DEATH

Variable/Fixed Contracts sold in most states provide that if the Annuitant
(or Contract Owner in some cases, if different) dies prior to the Annuity Date,
we will pay the beneficiary the greatest of (1) the sum of all purchase
payments, adjusted for withdrawals and contract transfers, (2) the Contract
Value for the valuation period in which proof of death and any other required
information needed to make payment is received at our service office or (3) the
sum of the Fixed Account Value (if any) on the date of death and the Variable
Account Value as of the contract date or, if later, the most recent seven-year
contract anniversary occurring prior to the Contract Owner's 81st birthday,
adjusted for subsequent purchase payments and adjusted for withdrawals and
contract transfers. Similarly, Variable Contracts sold in most states provide
that if the Annuitant (or Contract Owner in some cases, if different) dies
prior to the Annuity Date, we will pay the beneficiary the greatest of (1) the
sum of all purchase payments, adjusted for withdrawals and contract transfers,
(2) the Contract Value for the valuation period in which proof of death and any
other required information needed to make payment is received at our service
office or (3) the Contract Value as of the contract date or, if later, the most
recent seven year contract anniversary occurring prior to the Contract Owner's
81st birthday, adjusted for subsequent purchase payments and adjusted for
withdrawals and contract transfers. With respect to Contracts sold in North
Carolina and Texas, if the Annuitant (or the Contract Owner in some cases, if
different) dies prior to the Annuity Date, Penn Mutual will pay the greater of
(1) the sum of all purchase payments, adjusted for withdrawals and contract
transfers or (2) the Contract Value for the valuation period in which proof of
death and any other required information needed to make payment is received at
Penn Mutual's service office. "Proof of death" in the foregoing means a death
certificate or other official document establishing death.
Payment generally will be in a lump sum and must be paid within five years
of the date of death. If the beneficiary is not the decedent's spouse, the
beneficiary may elect an annuity option for death payments in lieu of receiving
a lump sum payment. If an annuity option is selected, payments must commence
within one year of the decedent's death and must be made over a period not
longer than the beneficiary's life or over a period not longer than the
beneficiary's life expectancy. If the beneficiary is the spouse of the
decedent, the beneficiary may elect an annuity option that was available to the
decedent. Further, a spousal beneficiary may apply to become the owner of the
Contract.
If the Annuitant dies on or after the Annuity Date and the annuity is for a
specified number of years or for life with payments guaranteed for 10 or 20
years, the beneficiary may elect to have the payments continue for the
specified or guaranteed period or to receive in lump sum the present value of
the remaining payments.
Contract Owners may designate a beneficiary in their purchase applications.
Owners of Variable/Fixed Contracts may change the beneficiary at any time
before the death of the Contract Owner or Annuitant, whichever occurs first.
Owners of Variable Contracts may change the beneficiary while the Annuitant is
alive.

- --------------------------------------------------------------------------------
TRANSFERS

Owners of Variable/Fixed Contracts may transfer Accumulation and Annuity
Unit Values from one subaccount of the Separate Account to another subaccount
of the Separate Account. The minimum amount that may be transferred is $250 or,
if less, the amount held in the account. Contract Owners may make no more than
two transfers in any calendar month and no more than twelve transfers in any
calendar year. We reserve the right to charge a fee for transfers in excess of
six per calendar year. Within certain additional limitations stated in the
Contract, owners of Variable/Fixed Contracts also may transfer Accumulation
Unit Values to the Fixed Account and transfer amounts from the Fixed Account to
the Variable Account or to another fixed interest option within the Fixed
Account.
Owners of Variable/Fixed Contracts may transfer all or part of the Contract
Value to another annuity contract issued by Penn Mutual if both contracts are
owned under the same qualified plan by the trustee under the plan.
Owners of Variable Contracts may transfer Accumulation and Annuity Unit
values from one subaccount of the Separate Account to another, subject to a
limit of six transfers during a calendar year.
Owners of a Variable Contract may transfer all or part of the Contract Value
to another contract issued by us containing a reciprocal transfer provision,
subject to the following conditions. The owner, annuitant and beneficiary must
be the same under

17
<PAGE>

both contracts. No more than six such transfers may be made in a calendar year
and no transfer may be made after the thirtieth day before the Annuity Date.
Subject to such lesser amounts we may establish, the minimum for transfers to
contracts which are not issued in connection with qualified retirement plans is
$1,000 and the minimum for all other transfers is $250. For partial transfers,
the remaining Contract Value must be at least $250.
Transfers may be made to a Contract from other contracts we have issued to
the extent provided in such contracts. Withdrawals from the Contract,
attributable to amounts transferred from other contracts with front end sales
charges, will not be subject to a deferred sales charge.
A written request for transfer (or, if authorized in writing, a telephone
request for transfer) must be received at our service office and all other
administrative requirements for transfer must be met to make the transfer. The
Account and Penn Mutual will not be liable for following instructions
communicated by telephone that we reasonably believe to be genuine. We require
certain personal identifying information to process a telephone transfer.
DOLLAR COST AVERAGING: If you have a Contract Value of at least $10,000, you
may elect to have flat dollar amounts ($100 minimum) transferred monthly or
quarterly from one source account to other accounts ($50 minimum per account).
These transfers may be made only from one of the following accounts: Money
Market Subaccount, Limited Maturity Bond Subaccount, Quality Bond Subaccount,
or Fixed Holding Account. The dollar cost averaging term may run from 12 to 60
months, or until you give notice of a change in allocation or cancellation of
the feature.
AUTOMATIC REBALANCING: You may elect to have your investments in subaccounts
of the Separate Account automatically rebalanced. We will transfer funds under
your Contract on a quarterly (calendar) basis among the subaccounts to maintain
a specified percentage allocation among your selected variable investment
options. Dollar cost averaging and automatic rebalancing may not be in effect
at the same time.

- --------------------------------------------------------------------------------
WITHDRAWALS

Prior to the earlier of the death of the Annuitant (or the Contract Owner)
or the Annuity Date, the Contract Owner may withdraw all or part of the
Contract Value. After the Annuity Date, a Contract Owner who has chosen an
annuity for a specified number of years under Option 1 of the Contract (or
other person receiving such annuity), may withdraw the present value of the
annuity. Withdrawals will be based on values at the end of the valuation period
in which the written request for withdrawal (and the Contract, in case of full
withdrawal) are received at our service office. Payment will normally be made
within seven days of receipt of the written request and the Contract, if
required. A partial withdrawal must be at least $250 and the remaining Contract
Value must be at least $250.
With respect to Contracts qualifying under Section 403(b) of the Internal
Revenue Code, there are certain restrictions on withdrawals. Withdrawals
attributable to purchase payments made after December 31, 1988 pursuant to a
salary reduction agreement may be made only if the Contract Owner is over the
age of 59 1/2, leaves the employment of the employer, dies or becomes disabled
as defined in the Code. Withdrawals (other than withdrawals attributable to
income earned on purchase payments) may also be possible in the case of
hardship as defined in the Code. The restrictions do not apply to transfers
among subaccounts and may also not apply to transfers to other investments
qualifying under Section 403(b). The restrictions on withdrawals under Section
403(b) Contracts are imposed in reliance upon a no-action letter issued by the
Chief of the Office of Insurance Products and Legal Compliance of the
Securities and Exchange Commission to the American Council of Life Insurance
dated November 28, 1988. Penn Mutual will comply with the conditions set forth
in that letter.

- --------------------------------------------------------------------------------
DEFERMENT OF PAYMENTS AND TRANSFERS

We reserve the right to defer a withdrawal, a transfer of values or annuity
payments funded by the Separate Account if (a) the New York Stock Exchange is
closed (other than customary weekend and holiday closings); (b) trading on the
Exchange is restricted; (c) an emergency exists such that it is not reasonably
practical to dispose of securities held in the Separate Account or to determine
the value of its assets; or (d) the Securities and Exchange Commission by order
so permits for the protection of investors. Conditions described in (b) and (c)
will be decided by, or in accordance with rules of, the Commission.

- --------------------------------------------------------------------------------
DEDUCTIONS AND EXPENSES

Each year on the date specified in the Contract (and on the date the
Variable Account Value or Contract Value is withdrawn in full if other than the
date specified), we deduct a contract administration charge of $30, or a lesser
amount as

18
<PAGE>

required under state insurance laws, from the amount held under the Contract in
the Separate Account. This charge is made solely to reimburse us for expenses
we incur in administering the Contracts and the Separate Account. The charge is
made by cancelling Accumulation Units credited to the Contract.
We deduct a daily expense risk charge equal to an annual rate of 0.5% of the
daily net asset value of the Separate Account. This charge is made to
compensate us for the risk of guaranteeing not to increase the annual contract
administration charge to more than $30 regardless of actual administrative
costs.
We deduct a daily mortality risk charge equal to an annual rate of 0.75% of
the daily net asset value of the Separate Account (prior to September 1, 1990
the charge was 0.8%). This charge is to compensate us for the mortality-related
guarantees (e.g. guarantees that the annuity factors will never be decreased
even if mortality experience is substantially different than originally
assumed) we make under the Contract.
A contingent deferred sales charge may be deducted in the event of full or
partial withdrawal of the Contract Value or withdrawal of the present value of
remaining annuity payments. This charge is made to cover sales expenses that we
have incurred. Sales expenses which are not covered by the deferred sales
charge are paid from the surplus of Penn Mutual, which may include proceeds
from the expense and mortality risk charges.
With respect to the Variable/Fixed Contract, if the contingent deferred
sales charge applies, it will be calculated in accordance with the following
schedules. First, if no purchase payments have been made after the first
contract year, the deferred sales charge will equal:
<TABLE>
<CAPTION>
WITHDRAWAL DURING DEFERRED SALES CHARGE AS A
CONTRACT YEAR PERCENTAGE OF AMOUNT WITHDRAWN
----------------------------------------------------------
<S> <C>
1 7.0%
----------------------------------------------------------
2 6.0%
----------------------------------------------------------
3 5.0%
----------------------------------------------------------
4 4.0%
----------------------------------------------------------
5 3.0%
----------------------------------------------------------
6 2.0%
----------------------------------------------------------
7 1.0%
----------------------------------------------------------
8 and later No Charge
----------------------------------------------------------
</TABLE>
Second, if purchase payments have been made in any contract year after the
first, the deferred sales charge will equal:
<TABLE>
<CAPTION>
WITHDRAWAL DURING DEFERRED SALES CHARGE AS A
CONTRACT YEAR PERCENTAGE OF AMOUNT WITHDRAWN
----------------------------------------------------------
<S> <C>
1 7.0%
----------------------------------------------------------
2 6.0%
----------------------------------------------------------
3 5.0%
----------------------------------------------------------
4 4.0%
----------------------------------------------------------
5 3.5%
----------------------------------------------------------
6 3.0%
----------------------------------------------------------
7 2.5%
----------------------------------------------------------
8 2.0%
----------------------------------------------------------
9 1.5%
----------------------------------------------------------
10 1.0%
----------------------------------------------------------
11 and later No Charge
----------------------------------------------------------
</TABLE>
Once in each contract year on or after the last day of the first contract
year the Owner of a Variable/Fixed Contract may withdraw 10% of the Contract
Value (determined as of the date of withdrawal) free of the contingent deferred
sales charge. The Contract Owner may also elect to receive scheduled partial
withdrawals free of the contingent deferred sales charge, provided that the sum
of the scheduled payments and any single unscheduled withdrawals do not exceed
10% of the contract value (determined as of the date of withdrawal). The total
sum of the contingent deferred sales charges deducted from amounts withdrawn
from the Separate Account will never exceed 8 1/2% of the total of all purchase
payments credited to the Separate Account.
With respect to the Variable Contract, if the contingent deferred sales
charge applies, it will equal the lesser of (a) 5% of the sum of purchase
payments made within seven years prior to the date of withdrawal or (b) 5% of
the amount withdrawn.

19
<PAGE>

Under no circumstances will the charge ever exceed 5% of total purchase
payments. No charge will be made on that portion of the first withdrawal in a
contract year that does not exceed 10% of total purchase payments made one year
or more prior to the withdrawal. Further, no charge will be made under the
Variable Contract on that portion of the first withdrawal in the eighth, ninth
and tenth contract years that does not exceed the following percentages of the
Contract Value:
<TABLE>
<CAPTION>
CONTRACT YEAR PERCENTAGE
----------------------------------
<S> <C>
Eighth 25%
----------------------------------
Ninth 50%
----------------------------------
Tenth 75%
----------------------------------
</TABLE>
No charge will be made on the first withdrawal in any contract year after
the tenth contract year.
The Contract Owner may elect to receive scheduled partial withdrawals free
of the contingent deferred sales charge, provided that the sum of the scheduled
payments and any single unscheduled withdrawal do not exceed 10% of total
purchase payments made one year or more prior to the first withdrawal.
The Contract Owner may at any time withdraw all or any part of the Contract
Value free from the contingent deferred sales charge if (i) the Contract Owner
(or Annuitant under a qualified retirement plan) is disabled as defined in
Section 72 (m) (7) of the Internal Revenue Code and as applied under the Social
Security Act, (ii) the disability began after the Contract Date and (iii) the
disability has continued without interruption for four months.
The contingent deferred sales charge may be reduced on Contracts sold to a
trustee, employer or similar party pursuant to a retirement plan or to a group
of individuals, if such sales are expected to involve reduced sales expenses.
The amount of reduction will depend upon such factors as the size of the group,
any prior or existing relationship with the purchaser or group, the total
amount of purchase payments and other relevant factors that might tend to
reduce expenses incurred in connection with such sales. The reduction will not
be unfairly discriminatory to any Contract Owners.
Some states and municipalities impose premium taxes on purchase payments
received by insurance companies. Any premium taxes payable will be deducted
upon annuitization. Currently, they range from 0% to 3.5%.

- --------------------------------------------------------------------------------
THE FIXED INTEREST OPTIONS

BECAUSE OF EXEMPTIVE AND EXCLUSIONARY PROVISIONS, INTERESTS IN PENN MUTUAL'S
GENERAL ACCOUNT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND
THE GENERAL ACCOUNT HAS NOT BEEN REGISTERED AS AN INVESTMENT COMPANY UNDER THE
INVESTMENT COMPANY ACT OF 1940. THE GENERAL ACCOUNT AND ANY INTERESTS HELD IN
THE GENERAL ACCOUNT ARE THEREFORE NOT SUBJECT TO THE PROVISIONS OF THESE ACTS.
PENN MUTUAL HAS BEEN ADVISED THAT THE STAFF OF THE SECURITIES AND EXCHANGE
COMMISSION HAS NOT REVIEWED THE DISCLOSURE IN THIS PROSPECTUS RELATING TO THE
FIXED ACCOUNT. DISCLOSURE REGARDING THE FIXED ACCOUNT, HOWEVER, MAY BE SUBJECT
TO GENERALLY APPLICABLE PROVISIONS OF THE FEDERAL SECURITIES LAWS RELATING TO
THE ACCURACY AND COMPLETENESS OF STATEMENTS MADE IN THIS PROSPECTUS.
Owners of Variable/Fixed Contracts may allocate or transfer all or part of
the amount credited to their Contracts to one or more of the following fixed
interest options in the Fixed Account: (1) the Fixed Holding Account; (2) the
One Year Guaranteed Account; (3) the Three Year Guaranteed Account; (4) the
Five Year Guaranteed Account; and (5) the Seven Year Guaranteed Account. The
minimum amount for an allocation to the Fixed Holding Account is $50; the
minimum amount for an allocation to the One Year Guaranteed Account or the
Three Year Guaranteed Account is $250; and the minimum amount for an allocation
to the Five Year Guaranteed Account or the Seven Year Guaranteed Account is
$5,000. We periodically declare an effective annual interest rate applicable to
allocations to the various fixed interest options. For each amount allocated to
the Fixed Holding Account, interest will be credited at an effective annual
interest rate declared by us on the first day of each calendar year. The
declared rate of interest will apply through the end of the calendar year in
which an allocation is made to the Fixed Holding Account at which time a new
rate will be declared by Penn Mutual. For each amount allocated to the One Year
Guaranteed Account, the Three Year Guaranteed Account, the Five Year Guaranteed
Account or the Seven Year Guaranteed Account, interest will be credited at an
annual effective interest rate declared by us each month. The declared rate of
interest will apply through the end of the twelve month, thirty-six month,
sixty month or eighty-four month period, as applicable, which begins on the
first day of the calendar month in which the allocation is made. We guarantee
an effective annual rate of interest on allocations to all fixed interest
options of not less than 4%. In addition, rates declared during the first seven
contract years for the One Year Guaranteed Account will not be less than the 52
week Treasury Bill discount rate obtained from the most recent regularly
scheduled auction.
Owners of Variable/Fixed Contracts may transfer Fixed Account funds to the
Separate Account or to another fixed interest option within the Fixed Account,
subject to the conditions and limitations in the fixed account provisions of
the Contract. A

20
<PAGE>

premature withdrawal charge may be deducted from the interest earned on any
amount that is withdrawn from the Three Year Guaranteed Account, the Five Year
Guaranteed Account or the Seven Year Guaranteed Account during the period for
which an interest rate is guaranteed. In no event will the premature withdrawal
charge invade the Contract Owner's principal investment in the applicable fixed
interest option. In accordance with state law, we may defer a withdrawal or
transfer from the Fixed Account for up to six months if we reasonably determine
that investment conditions are such that an orderly sale of assets in Penn
Mutual's general account is not feasible.
Owners of Variable/Fixed Contracts qualifying under Section 403(b) of the
Code may be able to borrow against a portion of the amount credited under their
Contract, provided the loan privilege has been approved in the applicable
state. The loan will be made from the general account of Penn Mutual. Because
this prospectus generally is limited to describing the variable portion of the
Contract, you should review the Contract loan endorsement or consult your Penn
Mutual representative for a complete description of the terms of the loan
privilege, including minimum and maximum loan amounts, repayment terms, and
restrictions on prepayments. The following paragraphs describe how exercise of
the loan privilege may relate to the Variable Account Value.
First, at the time a contract loan is made and in accordance with the
Contract Owner's direction, an amount equal to the initial loan amount will be
transferred from the Contract's investment options to an account in Penn
Mutual's general account called the "Restricted Account." Amounts transferred
from investment options to the Restricted Account will not participate in the
investment experience of those investment options. Amounts transferred to the
Restricted Account will generally earn interest at a rate 2 1/2 percentage
points less than the rate of interest charged on the loan.
Second, on a Contract anniversary, the accrued interest in the Restricted
Account will be transferred to the Contract Owner's investment options in
accordance with the Contract Owner's current payment allocation instructions.
Third, loan repayments, which are due quarterly, will result in the transfer
of an amount equal to the principal portion of the repayment from the
Restricted Account to the Fixed Holding Account. Contract Owners may then
transfer amounts from the Fixed Holding Account to the other investment options
offered under the Contract.
Fourth, if a payment or the entire loan is in default as defined in the
Contract, Penn Mutual will report the amount of the default to the Internal
Revenue Service as a taxable distribution and, if the Owner is under age 59
1/2, as a premature distribution. Subject to restrictions in Section 403(b) of
the Code, the amount of any missed payment, plus interest, or the entire loan
balance, plus interest, if the entire loan is in default, plus any applicable
contingent deferred sales charge, will be withdrawn by Penn Mutual from the
Contract's investment options in accordance with the Contract Owner's direction
in the Loan Request and Agreement. The net proceeds from the withdrawal will be
used to repay the loan. If a withdrawal is restricted under the Code, the
outstanding loan balance will continue to accrue interest and the amount due
will be withdrawn when a withdrawal becomes permissible. Thus, when an event
takes place which makes withdrawal from the Contract permissible under the
Code, such as attainment of age 59 1/2, disability or death, the Contract will
be checked to determine if there is an outstanding loan balance for which one
or more payments have been missed. If so, funds necessary to pay the overdue
amount, plus any applicable contingent deferred sales charge, will be withdrawn
from the Contract's investment options in the order set forth in the preceding
paragraph. While a loan balance is outstanding, any withdrawal or death benefit
proceeds must first be used to pay the loan.
Loans are subject to the terms of the Contract, the Code and the Employee
Retirement Income Security Act of 1974, all of which may impose restrictions.
Penn Mutual reserves the right to suspend, modify or terminate the availability
of loans. Where there is a plan fiduciary, it is the responsibility of the
fiduciary to ensure that any Contract loans comply with plan qualification
requirements, including ERISA.

- --------------------------------------------------------------------------------
FEDERAL INCOME TAX CONSIDERATIONS

The following brief discussion of federal income tax considerations is based on
the law as in effect on the date of this prospectus. The Government Accounting
Office and the Treasury Department have submitted congressionally mandated
studies of the tax treatment of life insurance and annuities. Whether these
studies will result in any subsequent legislative changes in the tax treatment
of annuity contracts is uncertain. It is anticipated, however, that any
legislative changes will be prospective in nature.
Under current law, no federal income taxes are imposed on increases in the
value of a Contract until distribution occurs, either in the form of a
withdrawal or death benefit or as annuity payments under an annuity option.
For a withdrawal or death benefit, the taxable portion is generally the
amount in excess of the cost basis of the Contract. Amounts withdrawn by the
Contract Owner or received as a death benefit by the designated beneficiary are
treated first as taxable income to the extent of the excess of the Contract
Value over the purchase payments made under the Contract. Such

21
<PAGE>

taxable portion is taxed at ordinary income tax rates. Designation of a
beneficiary who is either 37 1/2 years younger than the Contract Owner or a
grandchild of the Contract Owner may have Generation Skipping Transfer Tax
consequences under Section 2601 of the Internal Revenue Code.
For annuity payments, the taxable portion is generally determined by a
formula that establishes the ratio of the cost basis of the Contract (as
adjusted for any refund feature) to the expected return under the Contract. The
taxable portion, which is the amount of the annuity payment in excess of the
cost basis, is taxed at ordinary income tax rates.
An additional income tax of 10% may be imposed on the taxable portion of an
early withdrawal or distribution unless one of several exceptions apply. There
will be no additional income tax on early withdrawals which are part of a
series of substantially equal periodic payments (not less frequently than
annually) made for life (or life expectancy) of the taxpayer or the joint lives
(or joint life expectancies) of the taxpayer and a beneficiary, or on
withdrawals made on or after age 59 1/2. There also will be no additional tax
on distributions made after death or on withdrawals attributable to disability
(as defined in the Code). Further, there will be no additional tax on
distributions within certain other exceptions to the general rule.
The transfer of a Contract for less than adequate consideration may result
in the transferor incurring tax. The taxable portion would be the Contract
Value at the time of transfer over the investment in the Contract at such time.
This rule does not apply to transfers between spouses or to transfers incident
to a divorce.
Subject to certain exceptions, a Contract must be held by or on behalf of a
natural person in order to be treated as an annuity contract under federal
income tax law and to be accorded the tax treatment described in the preceding
paragraphs. If a Contract is not treated as an annuity contract for federal
income tax purposes, the income on the Contract is treated as ordinary income
received or accrued by the Contract Owner during the taxable year.
Section 817(h) of the Code provides that the investments of a separate
account underlying a variable annuity contract which is not purchased under a
qualified retirement plan (or the investments of a mutual fund, the shares of
which are owned by the variable annuity separate account) must be "adequately
diversified" in order for the contract to be treated as an annuity contract for
tax purposes. The Treasury Department has issued regulations prescribing such
diversification requirements. The Separate Account, through each of the
available Funds of Penn Series, TCI Portfolios, Inc., Neuberger & Berman
Advisers Management Trust and Fidelity Investments' Variable Insurance Products
Fund and Variable Insurance Products Fund II, intends to comply with those
requirements. The requirements are briefly discussed in the accompanying
prospectuses for the underlying Funds. See page 14 of the attached Neuberger &
Berman Adviser Management Trust Limited Maturity Bond Portfolio prospectus and
page 16 of the attached Neuberger & Berman Adviser Management Trust Balanced
Portfolio prospectus for a discussion of federal income tax considerations
associated with the Trust's reorganization.
The Treasury Department has indicated that in regulations or revenue rulings
under Section 817(d) (relating to the definition of a variable contract), it
will provide guidance on the extent to which contract owners may direct their
investments to particular subaccounts without being treated as owners of the
underlying shares. It is possible that when such regulations or rulings are
issued, certain of the Contracts may need to be modified to comply with them.
The Contracts may be used in connection with retirement plans that qualify
for special tax treatment under the Code. The plans include individual
retirement annuities qualified under Section 408(b) of the Code (referred to as
IRAs), simplified employee pension plans qualified under Section 408(k) of the
Code, tax deferred annuities qualified under Section 403(b) of the Code, state
and local government deferred compensation plans qualified under Section 457 of
the Code, pension or profit sharing plans for self-employed individuals
qualified under Section 401 of the Code (referred to as H.R. 10 or Keogh plans)
and corporate pension or profit sharing plans qualified under Section 401 of
the Code or annuity plans qualified under Section 403(a) of the Code. Special
provisions are required in some Contracts for qualification under the Code.
For some types of qualified retirement plans, there may be no cost basis in
the Contract. In this case, the total payments received may be taxable. Before
purchasing a Contract under a qualified retirement plan, the tax law provisions
applicable to the particular plan should be considered.
Generally, under a nonqualified annuity or individual retirement annuity
qualified under Section 408(b), unless the Contract Owner elects to the
contrary, any amounts that are received under the Contract that Penn Mutual
believes are includable in gross income for tax purposes will be subject to
withholding to meet federal income tax obligations. The same treatment will
apply to distributions from a qualified plan or Section 403(b) annuity that are
payable as an annuity for the life or life expectancy of one or more
individuals, or for a period of at least 10 years, or are required minimum
distributions. Other distributions from a qualified plan or a Section 403(b)
annuity are subject to mandatory 20% federal income tax withholding, unless an
election is made to make a direct transfer to another eligible retirement plan.
Distributions from a Section 457 deferred compensation plan are wages subject
to general income tax withholding requirements.
It should be understood that the foregoing description of federal income
taxes is not exhaustive and that special rules and considerations may be
applicable. For further information, a prospective purchaser should consult
qualified tax counsel.

22
<PAGE>

- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION CONTENTS
<TABLE>
- --------------------------------------------------------------------------------
<S> <C>
VARIABLE ANNUITY PAYMENTS.................................................. B-2
First Variable Annuity Payments.......................................... B-2
Subsequent Variable Annuity Payments..................................... B-2
Annuity Units............................................................ B-2
Value of Annuity Units................................................... B-2
Net Investment Factor.................................................... B-2
Assumed Interest Rate.................................................... B-3
Valuation Period......................................................... B-3
- --------------------------------------------------------------------------------
PERFORMANCE DATA........................................................... B-4
Average Annual Total Return.............................................. B-4
Annual Changes in Accumulation Unit Values............................... B-10
Yields (Money Market Fund)............................................... B-10
- --------------------------------------------------------------------------------
DISTRIBUTION OF CONTRACTS AND CERTIFICATES................................. B-11
- --------------------------------------------------------------------------------
CUSTODIAN.................................................................. B-11
- --------------------------------------------------------------------------------
INDEPENDENT ACCOUNTANTS.................................................... B-11
- --------------------------------------------------------------------------------
LEGAL MATTERS.............................................................. B-11
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS....................................................... B-12
- --------------------------------------------------------------------------------
</TABLE>

23
<PAGE>

PROSPECTUS -- MAY 1, 1996
CERTIFICATES ISSUED UNDER GROUP VARIABLE AND FIXED ANNUITY CONTRACTS --
FLEXIBLE PURCHASE PAYMENTS
- --------------------------------------------------------------------------------
OPTIMIZER

PENN SERIES FUNDS, INC. MANAGERS
Growth Equity Fund Independence Capital Management, Inc. (a
subsidiary of The Penn Mutual Life
Insurance Company)

Value Equity Fund
Flexibly Managed Fund OpCap Advisors (a subsidiary of
International Equity Fund Oppenheimer Capital)
Quality Bond Fund T. Rowe Price Associates, Inc.
High Yield Bond Fund Vontobel USA Inc. (a subsidiary of
Money Market Fund Vontobel Holding Ltd.)
Independence Capital Management, Inc.
T. Rowe Price Associates, Inc.
Independence Capital Management, Inc.

The accumulation value and annuity payments vary in accordance with the
investment experience of the Funds.

Under some circumstances, early withdrawals from a Contract may be subject to
a 5% contingent deferred sales charge and/or a 10% additional income tax. See
pages 12 and 14.

A certificate issued under a contract may be returned within ten days of
receipt for a full refund of the account value. Longer free look periods and
full refund of purchase payments are required in some states.

This prospectus sets forth concisely the information a prospective investor
should know before investing. It should be retained for future reference.

A statement of additional information dated the same as this prospectus has
been filed with the Securities and Exchange Commission and is incorporated
herein by reference. It is available, at no charge, by writing The Penn Mutual
Life Insurance Company, Customer Service Group--H3F, Independence Square,
Philadelphia, PA 19172. Or, you can call, toll free, 1-800-548-1119. The table
of contents of the statement of additional information is at the end of this
prospectus.

THIS PROSPECTUS IS VALID ONLY WHEN ACCOMPANIED BY THE CURRENT PROSPECTUS OF
PENN SERIES FUNDS, INC.

- --------------------------------------------------------------------------------
PROSPECTUS CONTENTS
<TABLE>
- --------------------------------------------------------------------------------
<S> <C>
SPECIAL TERMS............................................................... 3
- --------------------------------------------------------------------------------
EXPENSES.................................................................... 4
- --------------------------------------------------------------------------------
CONDENSED FINANCIAL INFORMATION............................................. 6
Penn Series Growth Equity Fund............................................ 6
Penn Series Value Equity Fund............................................. 7
Penn Series Flexibly Managed Fund......................................... 7
Penn Series International Equity Fund..................................... 7
Penn Series Quality Bond Fund............................................. 7
Penn Series High Yield Bond Fund.......................................... 8
Penn Series Money Market Fund............................................. 8
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY...................................... 9
- --------------------------------------------------------------------------------
THE SEPARATE ACCOUNT........................................................ 9
- --------------------------------------------------------------------------------
THE CONTRACT................................................................ 10
Purchases................................................................. 10
Accumulation Units........................................................ 10
Annuity Payments.......................................................... 11
Payment on Death.......................................................... 11
Transfers................................................................. 11
Withdrawals............................................................... 12
Deferment of Payments and Transfers....................................... 12
Deductions and Expenses................................................... 12
- --------------------------------------------------------------------------------
THE FIXED INTEREST OPTIONS.................................................. 13
- --------------------------------------------------------------------------------
FEDERAL INCOME TAX CONSIDERATIONS........................................... 14
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION CONTENTS................................ 16
- --------------------------------------------------------------------------------
</TABLE>

2
<PAGE>

- --------------------------------------------------------------------------------
SPECIAL TERMS

As used in this prospectus, the following terms have the indicated meaning:
CERTIFICATE: A certificate issued under the Contract which sets forth
provisions of the Contract.
CONTRACT: The group variable and fixed annuity contract described in this
prospectus.
ACCUMULATION UNIT: A unit of measure used to compute a Participant's
Variable Account Value prior to the Annuity Date.
ANNUITY DATE: The date on which annuity payments start.
OWNER: The Participant or other person specified in the Certificate.
PARTICIPANT: A person on whose behalf purchase payments are made under the
Contract.
PARTICIPANT'S VARIABLE ACCOUNT: An account established and maintained for a
Participant.
PARTICIPANT'S VARIABLE ACCOUNT VALUE: The value of all Accumulation Units
credited to the Participant's Variable Account.

3
<PAGE>

- -------------------------------------------------------------------------------
EXPENSES

<TABLE>
- ------------------------------------------------------------------------------
<S> <C>
CONTRACT OWNER TRANSACTION EXPENSES
Sales Load Imposed on Purchase Payments................................. None
Deferred Sales Load, as percentage of the amount withdrawn.............. 5%*
Exchange Fee............................................................ None
- -----------------------
* The deferred sales charge will not be made on that portion of the first
withdrawal in an enrollment year that does not exceed specified percentages
of the sum of the Participant's Variable Account Value and the Partici-
pant's fixed account value. See "Deductions and Expenses" in this prospec-
tus.
ANNUAL CONTRACT ADMINISTRATION CHARGE................................... $30
SEPARATE ACCOUNT ANNUAL EXPENSES (AS A PERCENTAGE OF AVERAGE VARIABLE
ACCOUNT VALUE)
Mortality and Expense Risk Charge....................................... 1.25%
Account Fees and Expenses............................................... None
-----
Total Separate Account Annual Expenses.................................. 1.25%
</TABLE>
- -------------------------------------------------------------------------------
PENN SERIES FUNDS, INC.**
UNDERLYING FUND ANNUAL EXPENSES (AS A % OF PORTFOLIO AVG. NET ASSETS)
<TABLE>
<CAPTION>
ADMINISTRATIVE
MANAGEMENT AND CORPORATE TOTAL
FEES (AFTER SERVICES FEES ACCOUNTING OTHER FUND
WAIVER) (AFTER WAIVER) FEES EXPENSES EXPENSES
----------- -------------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Growth Equity........... 0.45% 0.15% 0.08% 0.09% 0.77%
Value Equity............ 0.50% 0.15% 0.07% 0.08% 0.80%
Flexibly Managed........ 0.50% 0.15% 0.06% 0.08% 0.79%
International Equity.... 0.75% 0.15% 0.09% 0.24% 1.23%
Quality Bond............ 0.40% 0.15% 0.08% 0.10% 0.73%
High Yield Bond......... 0.50% 0.15% 0.08% 0.14% 0.87%
Money Market............ 0.35% 0.15% 0.08% 0.11% 0.69%
</TABLE>
- -----------------------
** The expenses presented are for the last fiscal year, except accounting fees
have been restated to reflect current fees based on a revised accounting
fee agreement. In the absence of voluntary fee waivers by the investment
adviser, the Total Fund Expenses of the Growth Equity and Quality Bond
Funds would have been 0.82% and 0.78% respectively. In the absence of ex-
pense waivers and voluntary fee waivers by the investment adviser, the to-
tal expenses of the Money Market Fund would have been 0.74%.
- -------------------------------------------------------------------------------
The purpose of this foregoing table is to assist Contract Owners in
understanding the various costs and expenses that a Contract Owner will bear
directly and indirectly. The table shows Contract expenses and underlying Fund
expenses. See the accompanying prospectus of Penn Series Funds, Inc. for
information on expenses.
Premium taxes may be applicable. SEE DEDUCTIONS AND EXPENSES in this
prospectus.

4
<PAGE>

- --------------------------------------------------------------------------------
EXAMPLE

If you own a Certificate and surrender your Certificate at the end of the
applicable period, you would pay the following expenses on each $1,000
invested, assuming 5% annual return on assets:
<TABLE>
<CAPTION>
ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
---- ----- ----- -----
<S> <C> <C> <C> <C>
Penn Series Money Market Fund............................ $67 $113 $162 $253
Penn Series Quality Bond Fund............................ $67 $114 $164 $257
Penn Series High Yield Bond Fund......................... $69 $118 $170 $271
Penn Series Growth Equity Fund........................... $68 $115 $165 $261
Penn Series Value Equity Fund............................ $68 $116 $167 $264
Penn Series Flexibly Managed Fund........................ $68 $116 $166 $263
Penn Series International Equity Fund.................... $72 $128 $187 $307
</TABLE>

- --------------------------------------------------------------------------------
EXAMPLE

If you own a Certificate and do not surrender your Certificate, or you elect
an annuity option at the end of the applicable time period, you would pay the
following expense on each $1,000 invested, assuming 5% annual return on assets:
<TABLE>
<CAPTION>
ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
---- ----- ----- -----
<S> <C> <C> <C> <C>
Penn Series Money Market Fund............................ $21 $64 $109 $236
Penn Series Quality Bond Fund............................ $21 $65 $112 $241
Penn Series High Yield Bond Fund......................... $22 $69 $119 $255
Penn Series Growth Equity Fund........................... $21 $66 $113 $244
Penn Series Value Equity Fund............................ $22 $67 $115 $248
Penn Series Flexibly Managed Fund........................ $22 $67 $114 $247
Penn Series International Equity Fund.................... $26 $60 $137 $291
</TABLE>

The example is based upon data for the fiscal year ended December 31, 1995
and assumes an average Participant's Variable Account Value of approximately
$18,300. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE EXPENSES UNDER THE CONTRACT; ACTUAL EXPENSES MAY BE GREATER OR LESSER
THAN THOSE SHOWN.

5
<PAGE>

- --------------------------------------------------------------------------------
CONDENSED FINANCIAL INFORMATION

The following tables show Accumulation Unit values and the number of
Accumulation Units outstanding for each of the subaccounts of the Separate
Account for the specified periods. The financial data included in these tables
should be read in conjunction with the financial statements and the related
notes included in the Statement of Additional Information.

- --------------------------------------------------------------------------------
PENN SERIES GROWTH EQUITY FUND SUBACCOUNT (A)

Values of an Accumulation Unit Outstanding Throughout Each Period for Qualified
and Nonqualified Retirement Plans

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991
- -------------------------------------------------------------------------------------------------------------------
NON- NON- NON- NON- NON-
QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $26.102 $25.887 $28.766 $28.528 $25.906 $25.692 $24.756 $24.552 $18.605 $18.451
Accumulation Unit Value,
end of period.......... $32.596 $32.327 $26.102 $25.887 $28.766 $28.528 $25.906 $25.692 $24.756 $24.552
Number of Accumulation
Units outstanding, end
of period.............. 1,991,646 674,290 2,119,836 717,328 2,042,023 685,110 2,004,015 669,679 1,680,322 518,717
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------
1990 1989 1988 1987
- -------------------------------------------------------------------------------------------------
NON- NON- NON- NON-
QUAL QUAL QUAL QUAL QUAL QUAL QUAL QUAL
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $21.204 $21.029 $16.356 $16.221 $14.702 $14.581 $14.145 $14.029
Accumulation Unit Value,
end of period.......... $18.605 $18.451 $21.204 $21.029 $16.356 $16.221 $14.702 $14.581
Number of Accumulation
Units outstanding, end
of period.............. 1,470,210 439,287 1,284,583 333,486 1,309,408 360,185 1,366,286 306,559
- -------------------------------------------------------------------------------------------------
</TABLE>
(a) Growth Stock Fund Subaccount prior to November 1, 1992.

6
<PAGE>

- --------------------------------------------------------------------------------
PENN SERIES VALUE EQUITY FUND SUBACCOUNT (A)

Values of an Accumulation Unit Outstanding Throughout The Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987(B)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $18.361 $18.062 $17.080 $15.058 $11.939 $13.157 $11.802 $ 9.226 $10.000
Accumulation Unit Value,
end of period.......... $24.928 $18.361 $18.062 $17.080 $15.058 $11.939 $13.157 $11,802 $ 9.226
Number of Accumulation
Units outstanding, end
of period.............. 4,235,839 3,886,404 3,693,652 2,865,294 2,207,661 1,883,581 1,802,897 918,020 349,261
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Equity Income Fund Subaccount prior to November 1, 1992.
(b) For the period March 17, 1987 (date subaccount was established) through De-
cember 31, 1987.

- --------------------------------------------------------------------------------
PENN SERIES FLEXIBLY MANAGED FUND SUBACCOUNT (A)

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $35.496 $34.514 $30.179 $27.893 $23.215 $23.712 $19.832 $16.898 $13.851 $12.226
Accumulation Unit Value,
end of period.......... $42.865 $35.496 $34.514 $30,179 $27.893 $23.215 $23.712 $19.832 $16.898 $13.851
Number of Accumulation
Units outstanding, end
of period.............. 4,946,240 4,198,305 3,143,601 2,327,829 1,664,751 1,237,347 1,129,858 853,647 623,017 299,278
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Capital Appreciation Fund Subaccount prior to November 1, 1992.
(b) For the period July 31, 1984 (date subaccount was established) through De-
cember 31, 1984.

- --------------------------------------------------------------------------------
PENN SERIES INTERNATIONAL EQUITY FUND SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- --------------------------------------------------------------------------------
1995 1994 1993 1992(A)
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Accumulation Unit Value, beginning of
period.................................. $12.843 $13.880 $10.175 $10.000
Accumulation Unit Value, end of period... $14.434 $12.843 $13.880 $10.175
Number of Accumulation Units outstanding,
end of period........................... 3,388,479 3,556,098 1,847,892 92,386
- --------------------------------------------------------------------------------
</TABLE>
(a) For the period November 2, 1992 (date subaccount was established) through
December 31, 1992.

- --------------------------------------------------------------------------------
PENN SERIES QUALITY BOND FUND SUBACCOUNT (A)

Values of an Accumulation Unit Outstanding Throughout Each Period

7
<PAGE>

- --------------------------------------------------------------------------------
PENN SERIES HIGH YIELD BOND FUND SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $22.644 $24.742 $20.918 $18.291 $13.534 $15.035 $15.325 $13.193 $13.461 $12.266
Accumulation Unit Value,
end of period.......... $26.033 $22.644 $24.742 $20.918 $18.291 $13.534 $15.035 $15.325 $13.193 $13.461
Number of Accumulation
Units outstanding, end
of period.............. 1,194,944 1,264,890 1,257,271 705,414 594,530 613,408 817,147 708,838 469,236 393,704
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(a) For the period August 6, 1984 (date subaccount was established) through De-
cember 31, 1984.

- --------------------------------------------------------------------------------
PENN SERIES MONEY MARKET FUND SUBACCOUNT

Values of an Accumulation Unit Outstanding Throughout Each Period

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $17.416 $17.003 $16.791 $16.491 $15.732 $14.893 $13.844 $13.089 $12.482 $11.891
Accumulation Unit Value,
end of period.......... $18.148 $17.416 $17.003 $16.791 $16.491 $15.732 $14.893 $13.844 $13.089 $12.482
Number of Accumulation
Units outstanding, end
of period.............. 1,062,385 825,274 658,620 698,584 769,958 965,117 753,052 319,671 242,494 117,030
- -----------------------------------------------------------------------------------------------------------
</TABLE>
The financial statements of the Separate Account for the year ended December
31, 1994 are included in the statement of additional information referred to on
the cover page of this prospectus.

- --------------------------------------------------------------------------------

In advertisements of the Contracts and Certificates thereunder, Penn Mutual
may provide information on total return performance and on annual changes in
accumulation unit values. We may also provide information on "yields" and
"effective yields" on investments in the Money Market Fund subaccount.
Information on total return performance will include average annual rates of
total return for one, five and ten year periods, or lesser periods depending on
how long the subaccount has been in existence. Average annual total return
figures will show the average annual rates of increase or decrease in
investments in the subaccounts, assuming a $1,000 investment at the beginning
of the period, withdrawal of the investment at the end of the period, and the
deduction of all applicable charges. We may also show average annual rates of
total return, assuming other amounts invested at the beginning of the period
and no withdrawal at the end of the period. Average annual total return figures
which assume no withdrawal at the end of the period will reflect all recurring
charges, but will not reflect the contingent deferred sales charge (if
applicable, the contingent deferred sales charge would reduce the amount that
may be withdrawn under the Contracts.)
The "yield" on an investment in the Money Market Fund subaccount refers to
the income generated by the investment over a 7-day period. This income is then
annualized. That is, the amount of income generated by the investment during
that week is assumed to be generated each week over a 52-week period and is
shown as a percentage of the investment. The "effective yield" is calculated
similarly but, when annualized, the income earned by an investment in the
subaccount is assumed to be reinvested. The effective yield will be slightly
higher than the yield because of the compounding effect of this assumed
reinvestment.

8
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY

- --------------------------------------------------------------------------------
THE SEPARATE ACCOUNT

Penn Mutual Variable Annuity Account III was established as a separate account
of Penn Mutual on April 13, 1982. The Separate Account is registered with the
Securities and Exchange Commission as a unit investment trust under the
Investment Company Act of 1940 and qualifies as a "separate account" within the
meaning of the federal securities laws.
The Separate Account is divided into subaccounts for investment in shares of
different Funds of Penn Series Funds, Inc. In addition, there are two
subaccounts for investment in shares of the Growth Equity Fund of Penn Series
Funds, Inc.--one for Contracts which were issued in connection with tax
qualified retirement plans and one for Contracts which were not issued in
connection with such plans. Income, gains and losses, realized or unrealized,
of a subaccount are credited to or charged against the subaccount without
regard to any other income, gains or losses of Penn Mutual. Assets equal to the
reserves and other contract liabilities with respect to each subaccount are not
chargeable with liabilities arising out of any other business of Penn Mutual.
Penn Mutual is obligated to pay all benefits and make all payments provided
under the Contracts.
Assets held in the Separate Account under a Contract are invested, at the
direction of the Owner, in one or more of the following Funds of Penn Series
Funds, Inc.:
GROWTH EQUITY FUND - seeks long-term growth of capital and increase of future
income by investing primarily in common stocks of well established growth
companies;
VALUE EQUITY FUND - seeks to maximize total return (capital appreciation and
income) primarily by investing in equity securities of companies believed to be
undervalued considering such factors as assets, earnings, growth potential and
cash flows;
FLEXIBLY MANAGED FUND - seeks to maximize total return (capital appreciation
and income) by investing in common stocks, other equity securities, corporate
debt securities, and/or short term reserves, in proportions considered
appropriate in light of the availability of attractively valued individual
securities and current and expected economic and market conditions;
INTERNATIONAL EQUITY FUND - seeks to maximize capital appreciation by investing
in a carefully selected diversified portfolio consisting primarily of equity
securities. The investments will consist principally of equity securities of
European and Pacific Basin Countries;
QUALITY BOND FUND - seeks the highest income over the long term consistent with
the preservation of principal by investing primarily in marketable investment
grade debt securities;
HIGH YIELD BOND FUND - seeks high current income by investing primarily in a
diversified portfolio of long term high-yield fixed income securities in the
medium to lower quality ranges; capital appreciation is a secondary objective;
such securities, which are commonly referred to as "junk" bonds, generally
involve greater risks of loss of income and principal than higher rated
securities (see accompanying Penn Series prospectus);
MONEY MARKET FUND - seeks to preserve capital, maintain liquidity and achieve
the highest possible level of current income consistent therewith, by investing
in high quality money market instruments; an investment in the Fund is neither
insured nor guaranteed by the U.S. Government and there can be no assurance
that the Fund will be able to maintain a stable net asset value of $1.00 per
share.
Independence Capital Management, Inc., Horsham, Pennsylvania, is investment
adviser to the Growth Equity, Quality Bond and Money Market Funds. OpCap
Advisors (formerly Quest for Value Advisors), New York, New York, is investment
adviser to the Value Equity Fund. T. Rowe Price Associates, Inc., Baltimore,
Maryland, is investment adviser to the Flexibly Managed and High Yield Bond
Funds. Vontobel USA Inc., New York, New York, is investment adviser to the
International Equity Fund.

- --------------------------------------------------------------------------------
FOR MORE INFORMATION ON PENN SERIES FUNDS, INC., SEE THE ATTACHED PENN SERIES
PROSPECTUS. INVESTORS SHOULD READ THE PENN SERIES PROSPECTUS CAREFULLY BEFORE
INVESTING.

9
<PAGE>

Under the Investment Company Act of 1940, as currently interpreted, Owners
and persons receiving annuity payments have the right to instruct Penn Mutual
as to the voting of shares of Penn Series Funds, Inc. held in the Separate
Account pursuant to the Contracts. The number of shares of a Fund for which
voting instructions may be given by an Owner is determined by dividing the
Owner's interest in the applicable subaccount of the Separate Account by the
net asset value per share of the Fund. The number of shares of a Fund for which
voting instructions may be given by a person receiving annuity payments is
determined by dividing the reserve allocated to the applicable subaccount by
the net asset value per share of the Fund. Should the applicable law, or
interpretations thereof, change so as to permit us to vote shares of the mutual
funds in our own right, we may elect to do so. Further, we reserve the right to
modify the manner in which we calculate the weight to be given to pass-through
voting instructions where such a change is necessary to comply with federal law
or interpretations thereof.
Shares of Penn Series are sold not only to the Separate Account, but also to
other separate accounts of Penn Mutual that fund benefits under variable
annuity and variable life insurance contracts. See "General Information" in the
Penn Series prospectus for a discussion of possible risks associated with the
sale of shares to other separate accounts.

- --------------------------------------------------------------------------------
THE CONTRACT

The Owner determines (1) the amount and frequency of the purchase payments to
be made to Penn Mutual, (2) the Funds of Penn Series Funds, Inc. in which the
purchase payments are invested, (3) transfers among subaccounts of the Separate
Account and to the fixed account provided under the Contract, (4) the form of
annuity to be paid after the accumulation period, (5) the beneficiary to whom
death benefits are to be paid, and (6) the amount and frequency of withdrawals
from the Participant's Variable Account Value.
During the annuity period, the person entitled to the annuity may transfer
annuity values among subaccounts of the Separate Account. Further, if the
annuity is for a specified number of years (under Option 1 in the Contract),
the person entitled to the annuity may withdraw the present value of annuity
payments remaining to be paid.
Upon death of the Participant prior to the Annuity Date, the beneficiary
will receive the death benefit in a lump sum (or in the form of an annuity
under some circumstances).
The Contracts may be amended at any time to conform to applicable laws or
governmental regulations. If, in our judgment, investment in any of the Penn
Series Funds becomes inappropriate to the purposes of the Contracts, we may,
with approval of the Securities and Exchange Commission and the governing state
insurance department, substitute another fund for existing and future
investments.
Owner inquiries may be made by writing The Penn Mutual Life Insurance
Company, Customer Service Group--H3F, Independence Square, Philadelphia, PA
19172. Or, you can call, toll free, 1-800-548-1119.

- --------------------------------------------------------------------------------
PURCHASES

A completed application for participation in a Contract, together with a
check for the first purchase payment, is forwarded to our service office.
Normally, a completed application form received at our service office will be
accepted within two business days. If an incomplete application is not
completed and acted upon within five business days, the purchase payment will
be returned unless the Owner requests that we retain it while he or she
completes the application. All subsequent purchase payments are sent directly
to our service office.
The minimum purchase for a Participant is $25 (or such lesser amounts we may
establish). Total purchase payments in a calendar year for a Participant may
not exceed $1,000,000 without our consent.
Purchase payments are credited to a Participant's Variable Account in the
form of Accumulation Units of the subaccount selected. The number of
Accumulation Units credited is determined by dividing the purchase payment by
the value of the Accumulation Unit at the end of the valuation period in which
the purchase payment is received at our service office or, in a case of the
first purchase payment, is accepted by us.
The principal underwriter of the Contracts and Certificates (under federal
securities laws) is Hornor, Townsend & Kent, Inc., 600 Dresher Road, Horsham,
PA 19044 and CBL Equities, Inc., Twenty-Sixth Century Boulevard, Nashville, TN
37214. Hornor, Townsend & Kent, Inc. is a wholly owned subsidiary of Penn
Mutual. CBL Equities, Inc. is a wholly owned subsidiary of Willis Corroon
Corporation.

- --------------------------------------------------------------------------------
ACCUMULATION UNITS

For each subaccount of the Separate Account the value of an Accumulation
Unit was set at $10 when the subaccount was established. The value of an
Accumulation Unit may increase or decrease from one valuation period to the
next.

10
<PAGE>

A valuation period is the period from one valuation to the next. Valuation
is performed each day the New York Stock Exchange is open for trading.
The value of an Accumulation Unit for a valuation period is determined by
multiplying the value of an Accumulation Unit for the prior valuation period by
the net investment factor for the subaccount for the valuation period.
The net investment factor is a measure of (1) investment performance of Fund
shares held in the subaccount, (2) any taxes on income or gains from
investments held in the subaccount and (3) the mortality and expense risk
charges assessed against the subaccount. Under current law, no taxes are levied
against income or gain from investments held in a subaccount.

- --------------------------------------------------------------------------------
ANNUITY PAYMENTS

The Owner may choose (1) an annuity for a specified number of years (not
less than 5 or more than 30), (2) a life annuity, (3) a life annuity with
payments guaranteed for 10 or 20 years, (4) a joint and survivor annuity or (5)
such other form of annuity as we may agree upon. Annuity Payments do not start
until an annuity option is chosen by the Owner.
The level of the annuity payments are determined by various factors,
including the form of annuity chosen, the age and expected duration of the
annuity period, the performance of the applicable investment accounts, and the
annuity purchase rates and charges specified in the Contract.
The mortality and expense risk charges specified in the Contracts are
assessed during both the accumulation and annuity pay-out phases of the
Contract. We continue to assess the charges during payment of a variable
annuity not involving a life contingency although we no longer bear any
mortality risk on such payment obligation.
The annuity purchase rates assume an investment return of 4%. If the
investment return on a share of the applicable Penn Series Fund is greater than
4%, the level of the annuity payments increases. If the investment return is
less than 4%, the level of the annuity payments decreases.
The Annuity Date selected by the Owner may not be later than the first day
of the next month after the Annuitant's 85th birthday. Annuity payments will be
made on the first day of each month starting with the Annuity Date. The Owner
may change the annuity option or Annuity Date by giving written notice at our
service office at least 30 days prior to the Annuity Date.
If the Participant's Variable Account Value is less than $2,000, we may
elect to pay such amount in lump sum in place of an annuity. Annuity payments
generally are made monthly; however, if any payment would be less than $50, we
may change the frequency so that payments are at least $50 each.

- --------------------------------------------------------------------------------
PAYMENT ON DEATH

If the Participant dies prior to the Annuity Date, we will pay the
beneficiary the greater of the sum of all purchase payments, adjusted for
withdrawals and Contract transfers, or the Participant's Variable Account Value
for the valuation period in which proof of death and any other required
information needed to make payment is received at our service office. Payment
will be in a lump sum. In lieu of receiving a lump sum payment, the beneficiary
may elect an annuity option, provided that payment is made within five years or
payment commences within one year of death and is made over the beneficiary's
life or over a period not longer than the beneficiary's life expectancy. If the
beneficiary is the Participant's spouse, the beneficiary may elect an annuity
option that was available to the deceased Participant. "Proof of death" in the
foregoing means a death certificate or other official document establishing
death.
If the Participant dies on or after the Annuity Date and the annuity is for
a specified number of years or for life with payments guaranteed for 10 or 20
years, the beneficiary may elect to have the payments continue for the
specified or guaranteed period or to receive in lump sum the present value of
the remaining payments.

- --------------------------------------------------------------------------------
TRANSFERS

The Owner or person entitled to the annuity may transfer Accumulation and
Annuity Unit values from one subaccount of the Separate Account to another,
subject to a limit of four transfers during a calendar year.
The Owner may transfer all or part of the Participant's Variable Account
Value to the fixed account provided under the Contract, subject to the
following conditions. No more than four such transfers may be made in a
calendar year. A written request (or, if authorized, a telephone request) must
be received at our service office, and all applicable requirements for

11
<PAGE>

transfer must be met, prior to death of the Participant. No transfer may be
made after the thirtieth day before the Annuity Date. The minimum transfer
amount is $250 and for a partial transfer the remaining balance in the
Participant's Variable Account must be $250. The Separate Account and Penn
Mutual will not be liable for following instructions communicated by telephone
that we reasonably believe to be genuine. We require certain personal
identifying information to process a telephone transfer.
The Owner may transfer amounts from the fixed account to the Participant's
Variable Account to the extent provided in the fixed account provisions of the
Contract.

- --------------------------------------------------------------------------------
WITHDRAWALS

Prior to the earlier of the death of the Participant or the Annuity Date,
the Owner may withdraw all or part of the Participant's Variable Account Value.
After the Annuity Date, an Owner who has chosen an annuity for a specified
number of years under Option 1 of the Contract (or other person receiving such
annuity), may withdraw the present value of the annuity. Withdrawals will be
based on values at the end of the valuation period in which the written request
for withdrawal (and the Certificate, in case of full withdrawal) are received
at our service office. Payment will normally be made within seven days of
receipt of the written request and the Certificate, if required. A partial
withdrawal must be at least $250 and the remaining Participant's Variable
Account Value must be at least $250.
With respect to Contracts qualifying under Section 403(b) of the Internal
Revenue Code, there are certain restrictions on withdrawals. Withdrawals
attributable to purchase payments made after December 31, 1988 pursuant to a
salary reduction agreement may be made only if the Owner is over the age of 59
1/2, leaves the employment of the employer, dies or becomes disabled as defined
in the Code. Withdrawals (other than withdrawals attributable to income earned
on purchase payments) may also be possible in the case of hardship as defined
in the Code. The restrictions do not apply to transfers among subaccounts and
may also not apply to transfers to other investments qualifying under Section
403(b). The restrictions on withdrawals under Section 403(b) Contracts are
imposed in reliance upon a no-action letter issued by the Chief of the Office
of Insurance Products and Legal Compliance of the Securities and Exchange
Commission to the American Council of Life Insurance dated November 28, 1988.
Penn Mutual will comply with the conditions set forth in that letter.

- --------------------------------------------------------------------------------
DEFERMENT OF PAYMENTS AND TRANSFERS

We reserve the right to defer a withdrawal, a transfer of values or annuity
payments if (a) the New York Stock Exchange is closed (other than customary
weekend and holiday closings); (b) trading on the Exchange is restricted; (c)
an emergency exists such that it is not reasonably practical to dispose of
securities held in the Separate Account or to determine the value of its
assets; or (d) the Securities and Exchange Commission by order so permits for
the protection of investors. Conditions described in (b) and (c) will be
decided by, or in accordance with rules of, the Commission.

- --------------------------------------------------------------------------------
DEDUCTIONS AND EXPENSES

Each year on the date specified in the Certificate (and on the date the
Participant's Variable Account Value is withdrawn in full if other than the
date specified), we deduct a variable account administration charge of $30 from
the Participant's Variable Account Value. This charge is made to reimburse us
for expenses relating to administration of the Contracts and is made by
cancelling Accumulation Units credited to the Participant's Variable Account.
We deduct a daily expense risk charge equal to an annual rate of 0.5% of the
daily net asset value of the Separate Account. This charge is made to
compensate us for the risk of guaranteeing not to increase the contract
administration charge regardless of actual administrative costs.
We deduct a daily mortality risk charge equal to an annual rate of 0.75% of
the daily net asset value of the Separate Account (prior to September 10, 1990
the charge was 0.8%). This charge is to compensate us for the mortality
guarantees (e.g. guarantees that the annuity factors will never be decreased
even if mortality experience is substantially different than originally
assumed) we make under the Contract.
A contingent deferred sales charge may be deducted in the event of full or
partial withdrawal of the Participant's Variable Account Value or withdrawal of
the present value of remaining annuity payments. This charge is made to cover
sales expenses that we have incurred. Sales expenses which are not covered by
the deferred sales charge are paid from the surplus of Penn Mutual, which may
include proceeds from the expense and mortality risk charges.

12
<PAGE>

If the contingent deferred sales charge applies, it will be 5% of the amount
withdrawn and will be made by cancelling Accumulation Units credited to the
Participant's Variable Account. No charge will be made on a withdrawal if the
Participant has provided due proof of disability. Further, no charge will be
made on that portion of the first withdrawal made during an enrollment year
that does not exceed the following percentages of the sum of the Participant's
Variable Account Value and the Participant's fixed account value under the
Contract:
<TABLE>
<CAPTION>
PARTICIPANT'S
ENROLLMENT YEAR PERCENTAGE
-------------------------------------------
<S> <C>
Second through Seventh 10%
-------------------------------------------
Eighth 25%
-------------------------------------------
Ninth 50%
-------------------------------------------
Tenth 75%
-------------------------------------------
</TABLE>
No charge will be made on any withdrawal after the Participant has been
enrolled for ten years.
Some states and municipalities impose premium taxes on purchase payments
received by insurance companies. Any premium taxes payable will be deducted at
the Annuity Date. Currently, they range from 0% to 3.5%.

- --------------------------------------------------------------------------------
THE FIXED INTEREST OPTIONS

BECAUSE OF EXEMPTIVE AND EXCLUSIONARY PROVISIONS, INTERESTS IN PENN MUTUAL'S
GENERAL ACCOUNT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND
THE GENERAL ACCOUNT HAS NOT BEEN REGISTERED AS AN INVESTMENT COMPANY UNDER THE
INVESTMENT COMPANY ACT OF 1940. THE GENERAL ACCOUNT AND ANY INTERESTS HELD IN
THE GENERAL ACCOUNT ARE THEREFORE NOT SUBJECT TO THE PROVISIONS OF THESE ACTS.
PENN MUTUAL HAS BEEN ADVISED THAT THE STAFF OF THE SECURITIES AND EXCHANGE
COMMISSION HAS NOT REVIEWED THE DISCLOSURE IN THIS PROSPECTUS RELATING TO THE
FIXED ACCOUNT. DISCLOSURE REGARDING THE FIXED ACCOUNT, HOWEVER, MAY BE SUBJECT
TO GENERALLY APPLICABLE PROVISIONS OF THE FEDERAL SECURITIES LAWS RELATING TO
THE ACCURACY AND COMPLETENESS OF STATEMENTS MADE IN THIS PROSPECTUS.
Owners of Contracts may allocate or transfer all or part of the
Participants' Variable Account to one or more of the following fixed interest
options in the Fixed Account: (1) the Fixed Holding Account; (2) the One Year
Guaranteed Account; and (3) the Three Year Guaranteed Account. The minimum
amount for an allocation to the Fixed Holding Account is $50; the minimum
amount for an allocation to the One Year Guaranteed Account or the Three Year
Guaranteed Account is $250. We periodically declare an effective annual
interest rate applicable to allocations to the various fixed interest options.
For each amount allocated to the Fixed Holding Account, interest will be
credited at an effective annual interest rate declared by us on the first day
of each calendar year. The declared rate of interest will apply through the end
of the calendar year in which an allocation is made to the Fixed Holding
Account at which time a new rate will be declared by Penn Mutual. For each
amount allocated to the One Year Guaranteed Account and the Three Year
Guaranteed Account, interest will be credited at an annual effective interest
rate declared by us each month. The declared rate of interest will apply
through the end of the twelve month and thirty-six month period, as applicable,
which begins on the first day of the calendar month in which the allocation is
made. We guarantee an effective annual rate of interest on allocations to all
fixed interest options of not less than 4%. In addition, rates declared during
the first seven contract years for the One Year Guaranteed Account will not be
less than the 52 week Treasury Bill discount rate obtained from the most recent
regularly scheduled auction.
Owners may transfer Fixed Account funds to the Separate Account or to
another fixed interest option within the Fixed Account, subject to the
conditions and limitations in the fixed account provisions of the Contract. A
premature withdrawal charge may be deducted from the interest earned on any
amount that is withdrawn from the Three Year Guaranteed Account during the
period for which an interest rate is guaranteed. In no event will the premature
withdrawal charge invade the Participant's principal investment in the
applicable fixed interest option. In accordance with state law, we may defer a
withdrawal or transfer from the Fixed Account for up to six months if we
reasonably determine that investment conditions are such that an orderly sale
of assets in Penn Mutual's general account is not feasible.
Participants under Contracts qualifying under Section 403(b) of the Internal
Revenue Code may be able to borrow against a portion of the amount credited to
them under the Contract, provided the loan privilege has been approved in the
applicable state. The loan will be made from the general account of Penn
Mutual. Because the prospectus generally is limited to describing the variable
portion of the Contract, you should review the Contract loan endorsement or
consult your Penn Mutual representative for a complete description of the terms
of the loan privilege, including minimum and maximum loan amounts, repayment
terms, and restrictions on prepayments. The following paragraphs describe how
exercise of the loan privilege may relate to the Participant's Variable Account
Value.

13
<PAGE>

First, at the time a contract loan is made and in accordance with the
Participant's direction, an amount equal to the initial loan amount will be
transferred from the Contract's investment options to an account in Penn
Mutual's general account called the "Restricted Account." Amounts transferred
from investment options to the Restricted Account will not participate in the
investment experience of those investment options. Amounts transferred to the
Restricted Account will generally earn interest at a rate 3 percentage points
less than the rate of interest charged on the loan.
Second, on the anniversary of the Participant's participation in the
Contract, the accrued interest in the Restricted Account will be transferred to
the Participant's investment options in accordance with the Participant's
current payment allocation instructions.
Third, loan repayments, which are due quarterly, will result in the transfer
of an amount equal to the principal portion of the repayment from the
Restricted Account to the Fixed Holding Account. Participant may then transfer
amounts from the Fixed Holding Account to the other investment options offered
under the Contract.
Fourth, if a payment or the entire loan is in default as defined in the
Contract, Penn Mutual will report the amount of the default to the Internal
Revenue Service as a taxable distribution and, if the Participant is under age
59 1/2, as a premature distribution. Subject to restrictions in Section 403(b)
of the Code, the amount of any missed payment, plus interest, or the entire
loan balance, plus interest, if the entire loan is in default, plus any
applicable contingent deferred sales charge, will be withdrawn by Penn Mutual
from the Contract's investment options in the following order: (a) Fixed
Holding Account; (b) One Year Guaranteed Account; (c) pro rata from the
Subaccounts of the Variable Account; and (d) Three Year Guaranteed Account. The
net proceeds from the withdrawal will be used to repay the loan. If a
withdrawal is restricted under the Code, the outstanding loan balance will
continue to accrue interest and the amount due will be withdrawn when a
withdrawal becomes permissible. Thus, when an event takes place which makes
withdrawal from the Contract permissible under the Code, such as attainment of
age 59 1/2, disability or death, the Contract will be checked to determine if
there is an outstanding loan balance for which one or more payments have been
missed. If so, funds necessary to pay the overdue amount, plus any applicable
contingent deferred sales charge, will be withdrawn from the Contract's
investment options in the order set forth in the preceding paragraph. While a
loan balance is outstanding, any withdrawal or death benefit proceeds must
first be used to pay the loan.
Loans are subject to the terms of the Contract, the Code and the Employee
Retirement Income Security Act of 1974, all of which may impose restrictions.
Penn Mutual reserves the right to suspend, modify or terminate the availability
of loans. Where there is a plan fiduciary, it is the responsibility of the
fiduciary to ensure that any Contract loans comply with plan qualification
requirements, including ERISA.

- --------------------------------------------------------------------------------
FEDERAL INCOME TAX CONSIDERATIONS

The following brief discussion of federal income tax considerations is based on
the law in effect on the date of this prospectus. The Government Accounting
Office and the Treasury Department have submitted congressionally mandated
studies of the tax treatment of life insurance and annuities. Whether these
studies will result in any subsequent legislative changes in the tax treatment
of annuity contracts is uncertain. It is anticipated, however, that any
legislative changes will be prospective in nature.
Under current law, no federal income taxes are imposed on increases in the
value of a Participant's Variable Account until distribution occurs, either in
the form of a withdrawal or death benefit or as annuity payments under an
annuity option.
For a withdrawal or death benefit, the taxable portion is generally the
amount in excess of the cost basis of the Participant's Variable Account.
Amounts withdrawn by the Owner or received as a death benefit by the designated
beneficiary are treated first as taxable income to the extent of the excess of
the Participant's Variable Account Value over the purchase payments made by or
on behalf of the Participant. Such taxable portion is taxed at ordinary income
tax rates. Designation of a beneficiary who is either 37 1/2 years younger than
the Owner or a grandchild of the Owner may have Generation Skipping Transfer
Tax consequences under Section 2601 of the Internal Revenue Code.
For annuity payments, the taxable portion is generally determined by a
formula that establishes the ratio of the cost basis of the Participant's
Variable Account (as adjusted for any refund feature) to the expected return
under the Contract. The taxable portion, which is the amount of the annuity
payment in excess of the cost basis, is taxed at ordinary income tax rates.
An additional income tax of 10% may be imposed on the taxable portion of an
early withdrawal or distribution unless one of several exceptions apply. There
will be no additional income tax on early withdrawals which are part of a
series of substantially equal periodic payments (not less frequently than
annually) made for life (or life expectancy) of the taxpayer or the joint lives
(or joint life expectancies) of the taxpayer and a beneficiary, or on
withdrawals made on or after age 59 1/2. There also will be no additional tax
on distributions made after death or on withdrawals attributable to disability.
Further, there will be no additional tax on distributions within certain other
exceptions to the general rule.

14
<PAGE>

The transfer of a Participant's Variable Account for less than adequate
consideration may result in the transferor incurring tax. The taxable portion
would be the Participant's Variable Account Value at the time of transfer over
the investment in the Account at such time. This rule does not apply to
transfers between spouses or to transfers incident to a divorce.
Subject to certain exceptions, a Contract must be held by or on behalf of a
natural person in order to be treated as an annuity contract under federal
income tax law and to be accorded the tax treatment described in the preceding
paragraphs. If a Contract is not treated as an annuity contract for federal
income tax purposes, the income on the Contract is treated as ordinary income
received or accrued by the Contract Owner during the taxable year.
Section 817(h) of the Internal Revenue Code provides that the investments of
a separate account underlying a variable annuity contract which is not
purchased under a qualified retirement plan (or the investments of a mutual
fund, the shares of which are owned by the variable annuity separate account)
must be "adequately diversified" in order for the contract to be treated as an
annuity contract for tax purposes. The Treasury Department has issued
regulations prescribing such diversification requirements. The Separate
Account, through each of the Funds of Penn Series, intends to comply with those
requirements. The requirements are briefly discussed in the accompanying
prospectus for Penn Series.
The Treasury Department has indicated that in regulations or revenue rulings
under Section 817(d) (relating to the definition of a variable contract), it
will provide guidance on the extent to which contract owners may direct their
investments to particular subaccounts without being treated as owners of the
underlying shares. It is possible that when such regulations or rulings are
issued certain of the Contracts may need to be modified to comply with them.
The Contracts may be used in connection with retirement plans that qualify
for special tax treatment under the Code. The plans include individual
retirement annuities qualified under Section 408(b) of the Code (referred to as
IRAs), simplified employee pension plans qualified under Section 408(k) of the
Code, tax deferred annuities qualified under Section 403(b) of the Code, state
and local government deferred compensation plans qualified under Section 457 of
the Code, pension or profit sharing plans for self-employed individuals
qualified under Section 401 of the Code (referred to as H.R. 10 or Keogh plans)
and corporate pension or profit sharing plans qualified under Section 401 of
the Code, or annuity plans qualified under Section 403(a) of the Code. Special
provisions are required in some Contracts for qualification under the Code.
For some types of qualified retirement plans, there may be no cost basis in
the Contract. In this case, the total payments received may be taxable. Before
participating in a Contract under a qualified retirement plan, the tax law
provisions applicable to the particular plan should be considered.
Generally, under a nonqualified annuity or individual retirement annuity
qualified under Section 408(b), unless the Participant elects to the contrary,
any amounts that are received under the Contract that Penn Mutual believes are
includable in gross income for tax purposes will be subject to withholding to
meet federal income tax obligations. The same treatment will apply to
distributions from a qualified plan or Section 403(b) annuity that are payable
as an annuity for the life or life expectancy of one or more individuals, or
for a period of at least 10 years, or are required minimum distributions. Other
distributions from a qualified plan or a Section 403(b) annuity are subject to
mandatory 20% federal income tax withholding, unless an election is made to
make a direct transfer to another eligible retirement plan. (Depending upon
applicable State law, however, mandatory withholding may not apply to
distributions from a Section 403(b) annuity plan maintained by a State or local
government until 1994.) Distributions from a Section 457 deferred compensation
plan are wages subject to general income tax withholding requirements.
It should be understood that the foregoing description of federal income
taxes is not exhaustive and that special rules and considerations may be
applicable. For further information, a prospective purchaser should consult
qualified tax counsel.

15
<PAGE>

- -------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION CONTENTS

The following is the table of contents of the statement of additional
information referred to on the cover page of this prospectus.
<TABLE>
- --------------------------------------------------------------------------------
<S> <C>
VARIABLE ANNUITY PAYMENTS.................................................. B-2
First Variable Annuity Payments.......................................... B-2
Subsequent Variable Annuity Payments..................................... B-2
Annuity Units............................................................ B-2
Value of Annuity Units................................................... B-2
Net Investment Factor.................................................... B-2
Assumed Interest Rate.................................................... B-2
Valuation Period......................................................... B-3
- --------------------------------------------------------------------------------
PERFORMANCE DATA........................................................... B-4
Average Annual Total Return.............................................. B-4
Annual Changes in Accumulation Unit Values............................... B-10
Yields (Money Market Fund)............................................... B-10
- --------------------------------------------------------------------------------
DISTRIBUTION OF CONTRACTS AND CERTIFICATES................................. B-11
- --------------------------------------------------------------------------------
CUSTODIAN.................................................................. B-11
- --------------------------------------------------------------------------------
INDEPENDENT ACCOUNTANTS.................................................... B-11
- --------------------------------------------------------------------------------
LEGAL MATTERS.............................................................. B-11
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS....................................................... B-12
- --------------------------------------------------------------------------------
</TABLE>

16
<PAGE>

STATEMENT OF ADDITIONAL INFORMATION -- MAY 1, 1996
- --------------------------------------------------------------------------------

PENN MUTUAL VARIABLE ANNUITY ACCOUNT III

THE PENN MUTUAL LIFE INSURANCE COMPANY

INDEPENDENCE SQUARE . PHILADELPHIA, PA 19172 . TELEPHONE (215) 956-8000
- --------------------------------------------------------------------------------
This statement of additional information is not a prospectus. It should be read
in conjunction with the current prospectus for Penn Mutual Diversifier II
Variable/Fixed Contracts and Penn Mutual Diversifier II Variable Contracts or
the current prospectus for Penn Mutual Optimizer Group Variable and Fixed
Annuity Contracts, both dated May 1, 1996. The Contracts are funded through
Penn Mutual Variable Annuity Account III (referred to herein as the "Separate
Account"). To obtain a prospectus you may write to The Penn Mutual Life
Insurance Company, Customer Service Group H3F, Independence Square,
Philadelphia, PA 19172. Or, you may call, toll free, 1-800-548-1119.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
- --------------------------------------------------------------------------------
<S> <C>
VARIABLE ANNUITY PAYMENTS.................................................. B-2
First Variable Annuity Payment........................................... B-2
Subsequent Variable Annuity Payments..................................... B-2
Annuity Units............................................................ B-2
Value of Annuity Units................................................... B-2
Net Investment Factor.................................................... B-2
Assumed Interest Rate.................................................... B-3
Valuation Period......................................................... B-3
- --------------------------------------------------------------------------------
PERFORMANCE DATA........................................................... B-4
Average Annual Total Return.............................................. B-4
Annual Changes in Accumulation Unit Values............................... B-10
Yields (Money Market Fund)............................................... B-10
- --------------------------------------------------------------------------------
DISTRIBUTION OF CONTRACTS AND CERTIFICATES................................. B-11
- --------------------------------------------------------------------------------
CUSTODIAN.................................................................. B-11
- --------------------------------------------------------------------------------
INDEPENDENT ACCOUNTANTS.................................................... B-11
- --------------------------------------------------------------------------------
LEGAL MATTERS.............................................................. B-11
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS....................................................... B-12
- --------------------------------------------------------------------------------
</TABLE>

B-1
<PAGE>

- --------------------------------------------------------------------------------
VARIABLE ANNUITY PAYMENTS

- --------------------------------------------------------------------------------
FIRST VARIABLE ANNUITY PAYMENT

The dollar amount of the first monthly annuity payment will be determined by
applying the net contract or variable account value to the annuity table set
forth in the contract for the annuity option chosen. The annuity tables show
the amount of the first monthly income payment under each annuity option for
each $1,000 of value applied. The annuity tables for the Diversifier II
Variable/Fixed Contracts are based on the 1983 Individual Annuity Mortality
Tables and the annuity tables for the Diversifier II Variable Contracts and the
Penn Mutual Optimizer Group Variable and Fixed Annuity Contracts are based on
the 1971 Individual Annuity Mortality Tables. The tables assume a rate of
interest of 4%. The amount of the first monthly income for each $1,000 of value
is shown at various ages.
The United States Supreme Court has ruled that life annuity payments under an
employer's retirement plan may not be based upon sex-distinct mortality tables.
Where this decision applies or where otherwise required by law, Penn Mutual
will provide annuity payments based upon unisex tables.

- --------------------------------------------------------------------------------
SUBSEQUENT VARIABLE ANNUITY PAYMENTS

The dollar amount of subsequent variable annuity payments will vary in
accordance with the investment experience of the subaccount(s) of the Separate
Account applicable to the annuity. Each subsequent variable annuity payment
will equal the number of annuity units credited, multiplied by the value of the
annuity unit for the valuation period. Penn Mutual guarantees that the amount
of each subsequent annuity payment will not be affected by variations in
expense or mortality experience.

- --------------------------------------------------------------------------------
ANNUITY UNITS

For each subaccount selected, the number of annuity units is the amount of
the first annuity payment allocated to the subaccount divided by the value of
an annuity unit for the subaccount on the annuity date. The number will not
change as a result of investment experience.

- --------------------------------------------------------------------------------
VALUE OF ANNUITY UNITS

For each subaccount selected, the value of an annuity unit was arbitrarily
set at $10 when the subaccount was established. The value may increase or
decrease from one valuation period to the next. For a valuation period, the
value of an annuity unit for a subaccount is the value of an annuity unit for
the subaccount for the last prior valuation period multiplied by the net
investment factor for the subaccount for the valuation period. The result is
then multiplied by a factor to neutralize the assumed interest rate of 4%
included in the annuity tables.

- --------------------------------------------------------------------------------
NET INVESTMENT FACTOR

For any subaccount the net investment factor for a valuation period is
determined by dividing (a) by (b) and subtracting (c):

Where (a) is:
The net asset value per share of the Fund held in the subaccount, as of the
end of the valuation period
plus
----
The per share amount of any dividend or capital gain distributions by the
Fund if the "ex-dividend" date occurs in the valuation period
plus or minus
-------------
A per share charge or credit, as we may determine as of the end of the
valuation period, for provision for taxes (if applicable).

B-2
<PAGE>

Where (b) is:
The net asset value per share of the Fund held in the subaccount as of the
end of the last prior valuation period
plus or minus
-------------
The per share charge or credit for provision for taxes as of the end of the
last prior valuation period (if applicable).
Where (c) is:
The sum of the daily expense risk charge and the daily mortality risk
charge. On an annual basis, the sum of such charges equals 1.25% of the
daily net asset value of the Separate Account.

- -------------------------------------------------------------------------------
ASSUMED INTEREST RATE

A 4% assumed annual interest rate is included in the annuity tables in the
contracts. A higher assumption would mean a higher first annuity payment but
more slowly rising and more rapidly falling subsequent payments. A lower
assumption would have the opposite effect. If the actual net investment rate
is 4% on an annual basis, annuity payments will be level.

- -------------------------------------------------------------------------------
VALUATION PERIOD

Valuation period is the period from one valuation to the next. Valuation is
performed each day the New York Stock Exchange is open for trading.

B-3
<PAGE>

- --------------------------------------------------------------------------------
PERFORMANCE DATA

- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURN

The returns calculated below reflect a hypothetical return as if the Separate
Account had invested in the underlying funds for the indicated periods.
However, certain of the funds were not offered to the Separate Account until
the effective date of this registration statement.
Tables 1A, 1B, 1C and 1D show the average annual rates of total return on
hypothetical investments of $1,000, through the Separate Account, in Funds of
Penn Series Funds, Inc., TCI Portfolios, Inc., Neuberger and Berman Advisers
Management Trust, and Fidelity Investments' Variable Insurance Products Fund
and Variable Insurance Products Fund II, for periods ended December 31, 1995,
and assume withdrawal of the investments at the end of the period.

TABLE 1A -- DIVERSIFIER II VARIABLE/FIXED ANNUITY CONTRACTS
(ASSUMING NO PURCHASE PAYMENTS MADE AFTER FIRST CONTRACT YEAR)

<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
---------------------------------------------------------------------
FROM INCEPTION
INCEPTION ONE YEAR FIVE YEARS TEN YEARS DATE THROUGH
FUND (MANAGER) DATE* ENDED 12/31/95 ENDED 12/31/95 ENDED 12/31/95 12/31/95
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 16.52% 10.87% 9.74% 9.68%
Nonqualified Plans (a). 06/01/83 16.52% 10.87% 9.74% 9.45%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 26.84% 14.89% N/A 10.44%
(OpCap)
Flexibly Managed (a).... 07/31/84 12.45% 11.86% 12.94% 13.20%
(T. Rowe Price Associ-
ates, Inc.)
Small Capitalization
(a).................... 03/01/95 N/A N/A N/A 4.55%
(OpCap)
International Equity
(a).................... 11/01/92 4.94% N/A N/A 10.62%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 10.99% 7.26% N/A 7.04%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 7.50% 13.19% 7.63% 8.59%
(T. Rowe Price Associ-
ates, Inc.)
Growth Portfolio (b).... 11/20/87 21.12% 12.48% N/A 11.15%
(Investors Research --
Twentieth Century)
Balanced Portfolio (c).. 02/28/89 14.43% 8.97% N/A 9.10%
(Neuberger & Berman)
Limited Maturity Bond
Portfolio (c).......... 09/10/84 2.63% 4.77% 6.25% 7.29%
(Neuberger & Berman)
Equity Income Portfolio
(d).................... 10/09/86 24.20% 18.98% N/A 11.83%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 25.24% 18.59% N/A 13.38%
(Fidelity Investments)
Fidelity Asset Manager
(e).................... 09/06/89 8.23% 10.74% N/A 9.70%
(Fidelity Investments)
</TABLE>
- -----------------------
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
(b) TCI Portfolios, Inc.
(c) Neuberger and Berman Advisers Management Trust
(d) Fidelity Investments' Variable Insurance Products Fund
(e) Fidelity Investments' Variable Insurance Products Fund II

B-4
<PAGE>

- --------------------------------------------------------------------------------
TABLE 1B -- DIVERSIFIER II VARIABLE/FIXED ANNUITY CONTRACTS
(ASSUMING PURCHASE PAYMENTS MADE AFTER FIRST CONTRACT YEAR)

<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
---------------------------------------------------------------------
FROM INCEPTION
INCEPTION ONE YEAR FIVE YEARS TEN YEARS DATE THROUGH
FUND (MANAGER) DATE* ENDED 12/31/95 ENDED 12/31/95 ENDED 12/31/95 12/31/95
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 16.52% 10.77% 9.74% 9.68%
Nonqualified Plans (a). 06/01/83 16.52% 10.77% 9.74% 9.45%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 26.84% 14.78% N/A 10.27%
(OpCap)
Flexibly Managed (a).... 07/31/84 12.45% 11.75% 12.94% 13.20%
(T. Rowe Price Associ-
ates, Inc.)
Small Capitalization
(a).................... 03/01/95 N/A N/A N/A 4.55%
(OpCap)
International Equity
(a).................... 11/01/92 4.94% N/A N/A 10.62%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 10.99% 7.16% N/A 6.88%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 7.50% 13.09% 7.63% 8.59%
(T. Rowe Price Associ-
ates, Inc.)
Growth Portfolio (b).... 11/20/87 21.12% 12.38% N/A 10.97%
(Investors Research --
Twentieth Century)
Balanced Portfolio (c).. 02/28/89 14.43% 8.87% N/A 8.87%
(Neuberger & Berman)
Limited Maturity Bond
Portfolio (c).......... 09/10/84 2.63% 4.67% 6.25% 7.30%
(Neuberger & Berman)
Equity Income Portfolio
(d).................... 10/09/86 24.20% 18.87% N/A 11.72%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 25.24% 18.48% N/A 13.27%
(Fidelity Investments)
Fidelity Asset Manager
(e).................... 09/06/89 8.23% 10.64% N/A 9.47%
(Fidelity Investments)
</TABLE>
- -----------------------
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
(b) TCI Portfolios, Inc.
(c) Neuberger and Berman Advisers Management Trust
(d) Fidelity Investments' Variable Insurance Products Fund
(e) Fidelity Investments' Variable Insurance Products Fund II

B-5
<PAGE>

- --------------------------------------------------------------------------------
TABLE 1C -- DIVERSIFIED II VARIABLE CONTRACT

<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
---------------------------------------------------------------------
FROM INCEPTION
INCEPTION ONE YEAR FIVE YEARS TEN YEARS DATE THROUGH
FUND (MANAGER) DATE* ENDED 12/31/95 ENDED 12/31/95 ENDED 12/31/95 12/31/95
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 19.39% 10.82% 9.74% 9.68%
Nonqualified Plans (a). 06/01/83 19.39% 10.82% 9.74% 9.45%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 30.34% 14.95% N/A 10.17%
(OpCap)
Flexibly Managed (a).... 07/31/84 15.05% 11.84% 12.94% 13.20%
(T. Rowe Price Associ-
ates, Inc.)
Small Capitalization
(a).................... 03/01/95 N/A N/A N/A 11.58%
(OpCap)
International Equity
(a).................... 11/01/92 7.02% N/A N/A 10.66%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 13.47% 7.10% N/A 6.71%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 9.74% 13.21% 7.63% 8.60%
(T. Rowe Price Associ-
ates, Inc.)
Growth Portfolio (b).... 11/20/87 24.28% 12.48% N/A 10.86%
(Investors Research --
Twentieth Century)
Balanced Portfolio (c).. 02/28/89 17.13% 8.86% N/A 8.79%
(Neuberger & Berman)
Limited Maturity Bond
Portfolio (c).......... 09/10/84 4.56% 4.52% 6.25% 7.29%
(Neuberger & Berman)
Equity Income Portfolio
(d).................... 10/09/86 27.55% 19.14% N/A 11.61%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 28.66% 18.74% N/A 13.18%
(Fidelity Investments)
Fidelity Asset Manager
(e).................... 09/06/89 10.51% 10.69% N/A 9.37%
(Fidelity Investments)
</TABLE>
- -----------------------
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
(b) TCI Portfolios, Inc.
(c) Neuberger and Berman Advisers Management Trust
(d) Fidelity Investments' Variable Insurance Products Fund
(e) Fidelity Investments' Variable Insurance Products Fund II

B-6
<PAGE>

- --------------------------------------------------------------------------------
TABLE 1D -- PENN MUTUAL OPTIMIZER GROUP VARIABLE ANNUITY CONTRACT

The average annual rates of total return shown in Tables lA, 1B, 1C and 1D
are computed by finding the average annual compounded rates of return over the
periods shown that would equate the initial amount invested to the withdrawal
value, in accordance with the following formula: P(1 + T)n = ERV. In the
formula, P is a hypothetical investment payment of $1,000; T is the average
annual total return; n is the number of years; and ERV is the withdrawal value
at the end of the periods shown. The contract or account administration charge
is prorated among the investment options available under the contract according
to the average number of contracts and accounts that have money allocated to
the investment option and the sum of the average number of contracts and
accounts that have money allocated to each of the investment options, except in
the case of the new Fidelity Investments' investment options offered under the
Diversifier II contracts. Since the Fidelity Investments' investment options
were not made available until May 1, 1995, the contract administrative charge
was pro-rated to those investment options by assuming that money and contracts
were allocated equally among all of the investment options.

B-7
<PAGE>

- -------------------------------------------------------------------------------
Table 2 shows the average annual rates of total return on hypothetical
investments of $1,000, through the Separate Account, in Funds of the Penn
Series Funds, Inc., TCI Portfolios, Inc., Neuberger and Berman Advisers
Management Trust and Fidelity Investments' Variable Insurance Products Fund
and Variable Insurance Products Fund II, for periods endedDecember 31, 1995,
and assumes the investments are not withdrawn at the end of the period.

TABLE 2 -- DIVERSIFIER II VARIABLE/FIXED CONTRACTS
DIVERSIFIER II VARIABLE CONTRACTS
PENN MUTUAL OPTIMIZER GROUP VARIABLE AND FIXED ANNUITY CONTRACTS

<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
---------------------------------------------------------------------
FROM INCEPTION
INCEPTION ONE YEAR FIVE YEARS TEN YEARS DATE THROUGH
FUND (MANAGER) DATE* ENDED 12/31/95 ENDED 12/31/95 ENDED 12/31/95 12/31/95
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 24.39% 11.48% 9.74% 9.68%
Nonqualified Plans (a). 06/01/83 24.39% 11.48% 9.74% 9.45%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 35.34% 15.52% N/A 10.44%
(OpCap)
Flexibly Managed (a).... 07/31/84 20.05% 12.47% 12.94% 13.20%
(T. Rowe Price Associ-
ates, Inc.)
Small Capitalization
(a).................... 03/01/95 N/A N/A N/A 11.58%
(OpCap)
International Equity
(a).................... 11/01/92 12.02% N/A N/A 11.91%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 18.47% 7.85% N/A 7.04%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 14.74% 13.81% 7.63% 8.59%
(T. Rowe Price Associ-
ates, Inc.)
Growth Portfolio (b).... 11/20/87 29.28% 13.10% N/A 11.15%
(Investors Research --
Twentieth Century)
Balanced Portfolio (c).. 02/28/89 22.13% 9.57% N/A 9.23%
(Neuberger & Berman)
Limited Maturity Bond
Portfolio (c).......... 09/10/84 9.53% 5.35% 6.25% 7.29%
(Neuberger & Berman)
Equity Income Portfolio
(d).................... 10/09/86 32.55% 19.63% N/A 11.83%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 33.66% 19.24% N/A 13.38%
(Fidelity Investments)
Fidelity Asset Manager
(e).................... 09/06/89 15.51% 11.35% N/A 9.86%
(Fidelity Investments)
</TABLE>
- -----------------------
* Represents the date the underlying Fund was established.
(a) Penn Series Funds, Inc.
(b) TCI Portfolios, Inc. (not currently available to Penn Mutual Optimizer
Group Variable and Fixed Annuity Contracts).
(c) Neuberger and Berman Advisers Management Trust (not currently available to
Penn Mutual Optimizer Group Variable and Fixed Annuity Contracts).
(d) Fidelity Investments' Variable Insurance Products Fund (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity Con-
tracts).
(e) Fidelity Investments' Variable Insurance Products Fund II (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity Con-
tracts).

B-8
<PAGE>

- -------------------------------------------------------------------------------
Table 3 shows the average annual rates of total return on hypothetical
investments of $10,000, through the Separate Account, in Funds of the Penn
Series Funds, Inc., TCI Portfolios, Inc., Neuberger and Berman Advisers
Management Trust and Fidelity Investments' Variable Insurance Products Fund
and Variable Insurance Products Fund II, for period endedDecember 31, 1995,
and assumes the investments are not withdrawn at the end of the period.

TABLE 3 -- DIVERSIFIER II VARIABLE/FIXED CONTRACTS
DIVERSIFIER II VARIABLE CONTRACTS
PENN MUTUAL OPTIMIZER GROUP VARIABLE AND FIXED ANNUITY CONTRACTS

<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
---------------------------------------------------------------------
FROM INCEPTION
INCEPTION ONE YEAR FIVE YEARS TEN YEARS DATE THROUGH
FUND (MANAGER) DATE* ENDED 12/31/95 ENDED 12/31/95 ENDED 12/31/95 12/31/95
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 24.84% 11.83% 10.05% 9.97%
Nonqualified Plans (a). 06/01/83 24.84% 11.83% 10.05% 9.74%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 35.73% 15.82% N/A 10.74%
(OpCap)
Flexibly Managed (a).... 07/31/84 20.70% 12.99% 13.32% 13.55%
(T. Rowe Price Associ-
ates, Inc.)
Small Capitalization
(a).................... 03/01/95 N/A N/A N/A 11.59%
(OpCap)
International Equity
(a).................... 11/01/92 12.36% N/A N/A 12.26%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 18.64% 8.00% N/A 7.19%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 14.95% 13.96% 7.79% 8.73%
(T. Rowe Price Associ-
ates, Inc.)
Growth Portfolio (b).... 11/20/87 29.46% 13.24% N/A 11.30%
(Investors Research --
Twentieth Century)
Balanced Portfolio (c).. 02/28/89 22.22% 9.64% N/A 9.30%
(Neuberger & Berman)
Limited Maturity Bond
Portfolio (c).......... 09/10/84 9.56% 5.37% 6.27% 7.31%
(Neuberger & Berman)
Equity Income Portfolio
(d).................... 10/09/86 32.58% 19.65% N/A 11.85%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 33.70% 19.27% N/A 13.40%
(Fidelity Investments)
Fidelity Asset Manager
(e).................... 09/06/89 15.51% 11.35% N/A 9.87%
(Fidelity Investments)
</TABLE>
- -----------------------
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
(b) TCI Portfolios, Inc. (not currently available to Penn Mutual Optimizer
Group Variable and Fixed Contracts)
(c) Neuberger and Berman Advisers Management Trust (not currently available to
Penn Mutual Optimizer Group Variable and Fixed Contracts).
(d) Fidelity Investments' Variable Insurance Products Fund (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity Con-
tracts).
(e) Fidelity Investments' Variable Insurance Products Fund II (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity Con-
tracts).

The average annual rates of total return shown in Tables 2 and 3 are
computed by finding the average annual compounded rates of return over the
periods shown that would equate the initial amount invested to the Contract
account value at the end of the periods shown, in accordance with the
following formula: P(1 + T)n = FV. In the formula, P is a hypothetical
investment of $1,000 in Table 2 and $10,000 in Table 3; T is the average
annual total return; n is the number of years; and FV is the Contract account
value at the end of the periods shown. The contract or account administration
charge is prorated among the investment options available under the contract
according to the average number of contracts and accounts that have money
allocated to the investment option and the sum of the average number of
contracts and accounts that have money allocated to each of the investment
options, except in the case of the new Fidelity Investments' investment
options offered under the Diversifier II contracts. Since the Fidelity
Investments' investment options were not made available until May 1, 1995, the
contract administrative charge was pro-rated to those investment options by
assuming that money and contracts were allocated equally among all of the
investment options. The average annual rates of total returns reflect all
recurring charges, but do not reflect the contingent deferred sales charge
ranging from 7% to 1% in the case of the Diversifier II Variable/Fixed
Contracts or the contingent deferred sales charge of 5% in the case of the
Diversifier II Variable Contracts and the Penn Mutual Optimizer Group Variable
and Fixed Annuity Contracts which, if applicable, would reduce the amount that
may be withdrawn under the Contract.

B-9
<PAGE>

- -------------------------------------------------------------------------------
ANNUAL CHANGES IN ACCUMULATION UNIT VALUES

Table 4 shows the changes in values of accumulation units issued for each of
the Funds of the Penn Series Funds, Inc., TCI Portfolios, Inc. and Neuberger
and Berman Advisers Management Trust for each of the calendar years 1987
through 1995 for which the investment option was offered. Accumulation unit
values do not reflect the $30 annual contract or account administration charge
or the contingent deferred sales charge that may be applicable to a withdrawal
from the Contract.

TABLE 4 -- DIVERSIFIER II VARIABLE/FIXED CONTRACTS
DIVERSIFIER II VARIABLE CONTRACT
PENN MUTUAL OPTIMIZER GROUP VARIABLE AND FIXED ANNUITY CONTRACTS

<TABLE>
<CAPTION>
ANNUAL RATE OF CHANGE IN ACCUMULATION UNIT VALUES
---------------------------------------------------------------
FUND (MANAGER) 1995 1994 1993 1992 1991 1990 1989 1988 1987
- -------------- ------ ------ ------ ------ ------ ------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a)... 24.88% -9.26% 11.00% -4.60% 33.10% 12.30% 29.60% 11.30% 3.90%
Nonqualified Plans
(a).................. 24.88% -9.26% 11.00% -4.60% 3.10% 12.30% 29.60% 11.30% 3.90%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 35.77% 1.65% 5.70% 13.40% 26.10% -9.30% 11.50% 27.90% --
(OpCap)
Flexibly Managed (a).... 20.76% 2.85% 14.40% 8.20% 20.10% -2.10% 19.60% 17.40% 22.10%
(T. Rowe Price
Associates, Inc.)
Small Capitalization
(a).................... 11.71% -- -- -- -- -- -- -- --
(OpCap)
International Equity
(a).................... 12.39% -7.47% 36.40% -- -- -- -- -- --
(Vontobel USA, Inc.)
Quality Bond (a)........ 18.65% -6.47% 10.30% 5.20% 14.20% 6.60% 11.30% 6.10% --
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 14.97% -8.48% 18.30% 14.40% 35.20% -10.00% -1.90% 16.20% -2.0%
(T. Rowe Price
Associates, Inc.)
Money Market (a)........ 4.21% 2.43% 1.30% 1.80% 4.60% 5.60% 7.60% 5.80% 4.90%
(Independence Capital
Management, Inc.)
Growth Portfolio (b).... 29.47% -2.40% -- -- -- -- -- -- --
(Investors Research --
Twentieth Century)
Balanced Portfolio (c).. 22.22% -4.56% -- -- -- -- -- -- --
(Neuberger & Berman)
Limited Maturity Bond
Portfolio (c).......... 9.56% -1.39% -- -- -- -- -- -- --
(Neuberger & Berman)
Equity Income (d)....... 19.20% -- -- -- -- -- -- -- --
(Fidelity Investors
Research)
Growth (d).............. 23.59% -- -- -- -- -- -- -- --
(Fidelity Investors
Research)
Asset Manager (e)....... 11.53% -- -- -- -- -- -- -- --
(Fidelity Investors
Research)
</TABLE>
- -----------------------
(a) Penn Series Funds, Inc.
(b) TCI Portfolios, Inc. (not currently available to Penn Mutual Optimizer
Group Variable and Fixed Contracts).
(c) Neuberger and Berman Advisers Management Trust (not currently available to
Penn Mutual Optimizer Group Variable and Fixed Contracts).
(d) Fidelity Investments' Variable Insurance Products Fund (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity Con-
tracts).
(e) Fidelity Investments' Variable Insurance Products Fund II (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity Con-
tracts).

- -------------------------------------------------------------------------------
YIELDS (MONEY MARKET FUND)

The "yield" and "effective yield" of the Money Market Fund subaccount for
the seven days ended December 31, 1995 were 3.43% and 3.49%, respectively.
The yield is computed by determining the net change, exclusive of capital
changes, in the value of a hypothetical preexisting account having a balance
of one accumulation unit of the subaccount at the beginning of the period,
subtracting a hypothetical charge reflecting deductions from Contract Owner
accounts, and dividing the difference by the value of the

B-10
<PAGE>

account at the beginning of the base period to obtain the base period return,
and then multiplying the base period return by (365/7) with the resulting
figure carried to at least the nearest hundredth of 1%. The hypothetical charge
reflects deductions from Contract Owners' accounts in proportion to the length
of the base period. The contract or variable account administration charge is
prorated among investment options available under the contract. It is prorated
according to the average number of contracts or accounts that have money
allocated to the investment option in proportion to the sum of the average
number of contracts or accounts that have money allocated to each of the
investment options available under the same kind of contract.
The effective yield is obtained by taking the base period return as computed
above, and then compounding the base period return by adding 1, raising the sum
to a power equal to 365 divided by 7, and subtracting 1 from the result,
according to the following formula: Effective Yield = [(base period
return + 1)/3//6//5///7/] -1.
The yields do not reflect the contingent deferred sales charge ranging from
7% to 1% in the case of the Diversifier II Variable/Fixed Contracts or 5% in
the case of the Diversifier II Variable Contracts and the Penn Mutual Optimizer
Group Variable and Fixed Annuity Contracts. The deferred sales charge may or
may not be applicable to a withdrawal from a Contract, depending on when the
withdrawal is made.
THE YIELDS ON AMOUNTS HELD IN THE MONEY MARKET SUBACCOUNT NORMALLY WILL
FLUCTUATE ON A DAILY BASIS. THEREFORE, THE STATED YIELDS FOR ANY GIVEN PERIOD
ARE NOT AN INDICATION OR REPRESENTATION OF FUTURE YIELDS.

---------------------------------

THE PERFORMANCE INFORMATION SET FORTH ABOVE IS FOR PAST PERFORMANCE AND IS
NOT AN INDICATION OR REPRESENTATION OF FUTURE PERFORMANCE.

- --------------------------------------------------------------------------------
DISTRIBUTION OF CONTRACTS AND CERTIFICATES

Hornor, Townsend & Kent, Inc. (formerly Penn Mutual Equity Services, Inc.), a
wholly owned subsidiary of Penn Mutual, serves as principal underwriter of the
combination variable and fixed annuity contracts and the variable annuity
contracts. The address of Hornor, Townsend & Kent, Inc. is 600 Dresher Road,
Horsham, PA 19044. For 1995, 1994 and 1993, Penn Mutual paid Hornor, Townsend &
Kent, Inc. underwriting commissions of $357,316, $396,927, and $366,669,
respectively.
Hornor, Townsend & Kent, Inc. and CBL Equities, Inc. serve as principal
underwriters of certificates issued under the group variable and fixed annuity
contracts. CBL Equities, Inc. is a wholly owned subsidiary of Willis Corroon
Corporation. The address of CBL Equities, Inc. and Willis Corroon Corporation
is Twenty-Sixth Century Boulevard, Nashville, TN 37214. For 1995, 1994 and
1993, Penn Mutual paid CBL Equities, Inc. underwriting commissions of
approximately, $19,896, $25,064 and $10,575, respectively.
Applications for combination variable and fixed annuity contracts and the
variable annuity contracts and for certificates issued under group variable and
fixed annuity contracts are solicited on a continuous basis by life insurance
agents of Penn Mutual. The life insurance agents are broker-dealers or
associated with broker-dealers under federal securities laws. Agents are paid
commissions. Other allowances and overrides may also be paid. Total commissions
paid on purchase payments made under the contracts will not exceed 6%.

- --------------------------------------------------------------------------------
CUSTODIAN

Penn Mutual is custodian of the assets held in the Separate Account.

- --------------------------------------------------------------------------------
INDEPENDENT ACCOUNTANTS

The statement of assets and liabilities of Penn Mutual Variable Annuity Account
III as of December 31, 1995, and the related statement of operations for the
year then ended, and the statements of changes in net assets for each of the
two years or periods in the period then ended and the statements of financial
condition of The Penn Mutual Life Insurance Company as of December 31, 1995 and
1994, and the related statements of operations and surplus and cash flows for
each of the three years in the period ended December 31, 1995 included in this
Statement of Additional Information have been audited by Coopers & Lybrand
L.L.P., independent accountants. The reports and the financial statements have
been included upon the authority of said firm as experts in accounting and
auditing.

- --------------------------------------------------------------------------------
LEGAL MATTERS

Morgan, Lewis & Bockius LLP of Philadelphia, Pennsylvania, has provided advice
on certain matters relating to the federal securities laws and the offering of
the Contracts and Certificates.

B-11
<PAGE>

- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS

The financial statements of the Separate Account and Penn Mutual are set forth
on the following pages. The financial statements of Penn Mutual should be
distinguished from the financial statements of the Separate Account and should
be considered only as bearing upon Penn Mutual's ability to meet its
obligations under the Contracts.

B-12
<PAGE>

- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE PENN MUTUAL LIFE INSURANCE COMPANY AND CONTRACT
OWNERS OF PENN MUTUAL VARIABLE ANNUITY ACCOUNT III:

We have audited the accompanying statements of assets and liabilities of the
Penn Mutual Variable Annuity Account III [comprising, respectively, the Money
Market Fund, Quality Bond Fund, High Yield Bond Fund, Growth Equity Fund--
Qualified, Growth Equity Fund--Non-Qualified, Value Equity Fund, Flexibly
Managed Fund, Small Capitalization Fund, International Equity Fund, Limited
Maturity Bond Portfolio, Balanced Portfolio, TCI Growth Portfolio, Equity-
Income Portfolio, Growth Portfolio, and Asset Manager Portfolio] as of December
31, 1995, and the related statements of operations for the year or period then
ended, and the statements of changes in net assets for each of the two years or
periods in the period then ended. These financial statements are the
responsibility of the management of the Penn Mutual Variable Annuity Account
III. Our responsibility is to express an opinion on these financial statements
based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining on a test basis, evidence
supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of securities owned as of December 31, 1995 by
correspondence with the transfer agents. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Penn Mutual Variable
Annuity Account III as of December 31, 1995, the results of its operations for
the year or period then ended and changes in net assets for each of the two
years or periods in the period then ended in conformity with generally accepted
accounting principles.

/s/ Coopers & Lybrand

COOPERS & LYBRAND, L.L.P.

2400 Eleven Penn Center
Philadelphia, Pennsylvania
April 4, 1996

B-13
<PAGE>

- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENT OF ASSETS AND LIABILITIES - DECEMBER 31, 1995
<TABLE>
<CAPTION>
GROWTH EQUITY
MONEY MARKET QUALITY BOND HIGH YIELD FUND
TOTAL FUND+ FUND+ BOND FUND+ QUALIFIED+
------------ ------------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C>
INVESTMENT IN COMMON STOCK
Number of shares......... 19,158,448 3,372,559 3,686,442 3,246,511
Identified cost.......... $542,719,961 $19,158,448 $34,458,484 $35,117,644 $60,716,146
ASSETS:
Investments at value..... $610,020,093 $19,158,448 $34,535,004 $31,113,572 $64,930,217
Dividends receivable..... 89,056 89,056 0 0 0
LIABILITIES:
Due from (to) the Penn
Mutual Life Insurance
Company................. (68,624) 32,913 (6,304) (5,531) (10,394)
------------ ----------- ----------- ----------- -----------
NET ASSETS................ $610,040,525 $19,280,417 $34,528,700 $31,108,041 $64,919,823
============ =========== =========== =========== ===========
Variable annuity
accumulation units....... 1,062,385 1,869,975 1,194,944 1,991,646
Accumulation unit values.. $ 18.15 $ 18.46 $ 26.03 $ 32.60

- -----------------------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENT OF OPERATIONS - FOR THE YEAR ENDED DECEMBER 31, 1995
<CAPTION>
GROWTH EQUITY
MONEY MARKET QUALITY BOND HIGH YIELD FUND
TOTAL FUND+ FUND+ BOND FUND+ QUALIFIED+
------------ ------------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C>
INVESTMENT INCOME:
Dividends................ $ 15,189,291 $ 846,961 $1,970,222 $ 2,698,956 $ 259,624
EXPENSE:
Mortality and expense
risk charges............ 6,747,379 198,958 408,098 380,907 792,058
------------ ----------- ----------- ----------- -----------
Net investment income
(loss).................. 8,441,912 648,003 1,562,124 2,318,049 (532,434)
------------ ----------- ----------- ----------- -----------
REALIZED AND UNREALIZED
GAINS (LOSSES) ON
INVESTMENTS:
Realized gains (losses)
from redemption of fund
shares.................. 461,585 0 71,119 128,692 371,248
Capital gains distribu-
tions................... 24,209,023 0 0 0 8,555,988
------------ ----------- ----------- ----------- -----------
Net realized gains
losses)................. 24,670,608 0 71,119 128,692 8,927,236
Net change in unrealized
appreciation/depreciation
of investments.......... 69,875,494 0 3,759,594 1,679,183 5,026,395
------------ ----------- ----------- ----------- -----------
Net realized and
unrealized gains (loss-
es) on investments...... 94,546,102 0 3,830,713 1,807,875 13,953,631
------------ ----------- ----------- ----------- -----------
NET INCREASE (DECREASE)
IN NET ASSETS RESULTING
FROM OPERATIONS......... $102,988,014 $ 648,003 $ 5,392,837 $ 4,125,924 $13,421,197
============ =========== =========== =========== ===========
</TABLE>
- -----------------------
(a) For the period from May 1, 1995 (date funds became available for investment
to contractholders) to December 31, 1995.
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust
+++ Investment in TCI Portfolios, Inc.
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.

The accompanying notes are an integral part of these financial statements.

B-14
<PAGE>

- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
GROWTH EQUITY FLEXIBLY SMALL INTERNATIONAL LIMITED
FUND VALUE EQUITY MANAGED CAPITALIZATION EQUITY BALANCED MATURITY BOND
NON-QUALIFIED+ FUND+ FUND+ FUND+ FUND+ PORTFOLIO++ PORTFOLIO++
- -------------- ------------ ------------ -------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
1,090,079 6,487,151 12,187,362 140,327 3,380,708 1,046,742 332,780
$20,935,214 $ 80,715,688 $185,226,469 $1,544,358 $43,618,383 $16,025,025 $4,803,493
$21,801,582 $105,610,826 $212,060,096 $1,537,981 $48,918,846 $18,338,914 $4,895,190
0 0 0 0 0 0 0
(3,492) (18,250) (36,279) (266) (8,666) (3,110) (869)
----------- ------------ ------------ ---------- ----------- ----------- ----------
$21,798,090 $105,592,576 $212,023,817 $1,537,715 $48,910,180 $18,335,804 $4,894,321
=========== ============ ============ ========== =========== =========== ==========
674,290 4,235,839 4,946,241 137,653 3,388,479 1,468,254 444,986
$ 32.33 $ 24.93 $ 42.87 $ 11.17 $ 14.43 $ 12.49 $ 11.00
- ---------------------------------------------------------------------------------------------------
<CAPTION>
FLEXIBLY SMALL LIMITED
GROWTH EQUITY VALUE EQUITY MANAGED CAPITALIZATION INTERNATIONAL BALANCED MATURITY
NON-QUALIFIED+ FUND+ FUND+ FUND+(a) FUND+ PORTFOLIO++ PORTFOLIO++
- -------------- ------------ ------------ -------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
$ 87,146 $ 1,489,565 $ 6,145,649 $ 11,857 $ 1,107,927 $ 244,587 $ 252,911
261,386 1,164,815 2,331,565 5,073 567,961 198,699 58,940
----------- ------------ ------------ ---------- ----------- ----------- ----------
(174,240) 324,750 3,814,084 6,784 539,966 45,888 193,971
----------- ------------ ------------ ---------- ----------- ----------- ----------
4,457 18,453 18,767 24 (181,261) 2,845 9,224
2,871,936 5,411,111 7,260,205 31,166 0 78,617 0
----------- ------------ ------------ ---------- ----------- ----------- ----------
2,876,393 5,429,564 7,278,972 31,190 (181,261) 81,462 9,224
1,712,271 20,695,460 22,379,827 (6,377) 4,887,624 2,774,061 221,946
----------- ------------ ------------ ---------- ----------- ----------- ----------
4,588,664 26,125,024 29,658,799 24,813 4,706,363 2,855,523 231,170
----------- ------------ ------------ ---------- ----------- ----------- ----------
$ 4,414,424 $ 26,449,774 $ 33,472,883 $ 31,597 $ 5,246,329 $ 2,901,411 $ 425,141
=========== ============ ============ ========== =========== =========== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

B-15
<PAGE>

- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENT OF ASSETS AND LIABILITIES - DECEMBER 31, 1995 (CONT'D.)
<TABLE>
<CAPTION>
TCI
GROWTH EQUITY INCOME GROWTH ASSET MANAGER
PORTFOLIO+++ PORTFOLIO++++ PORTFOLIO++++ PORTFOLIO++++
------------ ----------------- ---------------- ----------------
<S> <C> <C> <C> <C>
INVESTMENT IN COMMON STOCK
Number of shares......... 2,515,701 359,897 292,346 82,859
Identified cost.......... $24,098,011 $6,521,040 $8,548,035 $1,233,523
ASSETS:
Investments at value..... $30,339,353 $6,935,209 $8,536,518 $1,308,337
Dividends receivable..... 0 0 0 0
LIABILITIES:
Due from (to) the Penn
Mutual
Life Insurance Company.. (5,594) (1,221) (1,344) (217)
----------- ---------- ---------- ----------
NET ASSETS................ $30,333,759 $6,933,988 $8,535,174 $1,308,120
=========== ========== ========== ==========
Variable annuity accumu-
lation units............ 2,157,888 581,691 690,602 117,290
Accumulation unit values. $ 14.06 $ 11.92 $ 12.36 $ 11.15

- ---------------------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENT OF OPERATIONS - FOR THE YEAR ENDED DECEMBER 31, 1995 (CONT'D.)
<CAPTION>
TCI
GROWTH EQUITY INCOME GROWTH ASSET MANAGER
PORTFOLIO+++ PORTFOLIO++++(a) PORTFOLIO++++(a) PORTFOLIO++++(a)
------------ ----------------- ---------------- ----------------
<S> <C> <C> <C> <C>
INVESTMENT INCOME:
Dividends................ $ 22,425 $ 51,461 $ 0 $ 0
EXPENSE:
Mortality and expense
risk charges............ 325,112 22,068 26,504 5,235
----------- ---------- ---------- ----------
Net investment income
(loss).................. (302,687) 29,393 (26,504) (5,235)
----------- ---------- ---------- ----------
REALIZED AND UNREALIZED
GAINS (LOSSES) ON
INVESTMENTS:
Realized gains (losses)
from redemption of fund
shares.................. 16,768 651 709 (111)
Capital gains distribu-
tions................... 0 0 0 0
----------- ---------- ---------- ----------
Net realized gains (loss-
es)..................... 16,768 651 709 (111)
Net change in unrealized
appreciation/depreciation
of investments.......... 6,268,045 414,169 (11,518) 74,814
----------- ---------- ---------- ----------
Net realized and
unrealized gains (loss-
es) on investments...... 6,284,813 414,820 (10,809) 74,703
----------- ---------- ---------- ----------
NET INCREASE (DECREASE)
IN NET ASSETS RESULTING
FROM OPERATIONS......... $ 5,982,126 $ 444,213 $ (37,313) $ 69,468
=========== ========== ========== ==========
</TABLE>
- -----------------------
(a) For the period from May 1, 1995 (date funds became available for investment
to contractholders) to December 31, 1995.
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust.
+++ Investment in TCI Portfolios, Inc.
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.

The accompanying notes are an integral part of these financial statements.

B-16
<PAGE>

- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENTS OF CHANGES IN NET ASSETS - FOR THE YEARS ENDED DECEMBER 31, 1995 AND
1994
<TABLE>
<CAPTION>
TOTAL MONEY MARKET FUND+ QUALITY BOND FUND+
-------------------------- ------------------------ ------------------------
1995 1994 1995 1994 1995 1994
------------ ------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET
ASSETS RESULTING FROM:
OPERATIONS:
Net investment income
(loss).................. $ 8,441,912 $ 6,217,348 $ 648,003 $ 308,572 $ 1,562,124 $ 1,480,918
Net realized gain (loss)
from investment
transactions............ 24,670,608 8,825,107 0 0 71,119 (207,338)
Net change in unrealized
appreciation/depreciation
of investments.......... 69,875,494 (26,880,298) 0 0 3,759,594 (3,498,614)
------------ ------------ ----------- ----------- ----------- -----------
NET INCREASE (DECREASE)
IN NET ASSETS RESULTING
FROM OPERATIONS........ 102,988,014 (11,837,843) 648,003 308,572 5,392,837 (2,225,034)
------------ ------------ ----------- ----------- ----------- -----------
ANNUITY ACTIVITIES:
Purchase payments under
variable annuity
contracts............... 77,587,218 93,502,143 8,771,642 6,556,863 2,453,615 5,534,942
Surrender benefits....... (34,698,835) (20,846,264) (1,708,626) (2,078,381) (2,011,032) (1,656,100)
Net transfers............ 20,273,647 19,503,429 (2,665,534) (1,323,507) (280,451) (4,367,636)
Death benefits........... (2,369,383) (1,447,359) (34,313) (180,481) (184,002) (106,371)
Contract administration
charges................. (642,187) (539,815) (16,259) (17,739) (31,981) (32,415)
Deferred sales charges... (672,390) (525,527) (27,491) (70,610) (47,106) (41,816)
Annuity benefits......... (1,281,020) (699,738) (59,711) (20,489) (189,666) (177,209)
------------ ------------ ----------- ----------- ----------- -----------
Net increase (decrease) in
net assets resulting from
variable annuity
activities............... 58,197,050 88,946,869 4,259,708 2,865,656 (290,623) (846,605)
------------ ------------ ----------- ----------- ----------- -----------
Total increase
(decrease) in net
assets................. 161,185,064 77,109,026 4,907,711 3,174,228 5,102,214 (3,071,639)
NET ASSETS:
Beginning of period...... 448,855,461 371,746,435 14,372,706 11,198,478 29,426,486 32,498,125
------------ ------------ ----------- ----------- ----------- -----------
END OF PERIOD............ $610,040,525 $448,855,461 $19,280,417 $14,372,706 $34,528,700 $29,426,486
============ ============ =========== =========== =========== ===========
<CAPTION>
GROWTH EQUITY FUND+ GROWTH EQUITY FUND+
HIGH YIELD BOND FUND+ QUALIFIED NON-QUALIFIED
-------------------------- ------------------------ ------------------------
1995 1994 1995 1994 1995 1994
------------ ------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
INCREASE IN NET ASSETS
RESULTING FROM:
OPERATIONS:
Net investment income
(loss).................. $ 2,318,049 $ 2,560,555 $ (532,434) $ (293,548) $ (174,240) $ (100,592)
Net realized gain (loss)
from investment
transactions............ 128,692 (170,624) 8,927,236 1,136,154 2,876,393 378,020
Net change in unrealized
appreciation/depreciation
of investments.......... 1,679,183 (5,193,690) 5,026,395 (6,401,925) 1,712,271 (2,173,908)
------------ ------------ ----------- ----------- ----------- -----------
NET INCREASE (DECREASE)
IN NET ASSETS RESULTING
FROM OPERATIONS........ 4,125,924 (2,803,759) 13,421,197 (5,559,319) 4,414,424 (1,896,480)
------------ ------------ ----------- ----------- ----------- -----------
ANNUITY ACTIVITIES:
Purchase payments under
variable annuity
contracts............... 2,547,820 6,654,141 5,446,648 7,413,734 568,384 1,934,231
Surrender benefits....... (2,132,204) (1,317,107) (5,623,602) (3,969,109) (995,989) (757,117)
Net transfers............ (1,838,084) (4,602,232) (3,202,517) (1,011,011) (572,409) (197,999)
Death benefits........... (11,530) (237,383) (186,731) (56,543) (125,564) (7,625)
Contract administration
charges................. (35,262) (35,290) (111,047) (113,420) (17,899) (18,044)
Deferred sales charges... (45,719) (32,100) (101,767) (88,285) (25,359) (22,462)
Annuity benefits......... (144,799) (92,082) (54,068) (24,171) (16,821) (10,320)
------------ ------------ ----------- ----------- ----------- -----------
Net increase (decrease) in
net assets resulting from
variable annuity
activities............... (1,659,778) 337,947 (3,833,084) 2,151,195 (1,185,657) 920,664
------------ ------------ ----------- ----------- ----------- -----------
Total increase
(decrease) in net
assets................. 2,466,146 (2,465,812) 9,588,113 (3,408,124) 3,228,767 (975,816)
NET ASSETS:
Beginning of period...... 28,641,895 31,107,707 55,331,710 58,739,834 18,569,323 19,545,139
------------ ------------ ----------- ----------- ----------- -----------
END OF PERIOD............ $ 31,108,041 $ 28,641,895 $64,919,823 $55,331,710 $21,798,090 $18,569,323
============ ============ =========== =========== =========== ===========
</TABLE>
- -----------------------
(a) For the period from May 1, 1995 (date funds became available for investment
to contractholders) to December 31, 1995.
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust.
+++ Investment in TCI Portfolios, Inc.
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.

The accompanying notes are an integral part of these financial statements.

B-17
<PAGE>

- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENTS OF CHANGES IN NET ASSETS - FOR THE YEARS ENDED DECEMBER 31, 1995 AND
1994 (CONT'D.)
<TABLE>
<CAPTION>
SMALL
CAPITALIZATION
VALUE EQUITY FUND+ FLEXIBLY MANAGED FUND+ FUND+
------------------------- -------------------------- --------------
1995 1994 1995 1994 1995(A)
------------ ----------- ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
INCREASE IN NET ASSETS
RESULTING FROM:
OPERATIONS:
Net investment income
(loss).................. $ 324,750 $ 220,806 $ 3,814,084 $ 2,488,247 $ 6,784
Net realized gain (loss)
from investment
transactions............ 5,429,564 1,002,557 7,278,972 6,443,641 31,190
Net change in unrealized
appreciation/depreciation
of investments.......... 20,695,460 (148,726) 22,379,827 (5,343,774) (6,377)
------------ ----------- ------------ ------------ ----------
Net increase (decrease) in
net assets
resulting from
operations............... 26,449,774 1,074,637 33,472,883 3,588,114 31,597
------------ ----------- ------------ ------------ ----------
ANNUITY ACTIVITIES:
Purchase payments under
variable annuity
contracts............... 8,872,997 8,736,389 28,450,036 29,059,165 $560,354
Surrender benefits....... (5,589,166) (3,798,916) (10,136,231) (5,273,593) (15,648)
Net transfers............ 5,501,620 (843,507) 12,950,139 14,092,038 961,830
Death benefits........... (618,712) (258,953) (906,304) (464,064) (85)
Contract administration
charges................. (96,737) (86,298) (220,042) (172,266) (328)
Deferred sales charges... (102,162) (88,160) (190,920) (136,658) (5)
Annuity benefits......... (182,722) (93,120) (418,286) (167,822) 0
------------ ----------- ------------ ------------ ----------
Net increase (decrease) in
net assets resulting from
variable annuity
activities............... 7,785,118 3,567,435 29,528,392 36,936,800 1,506,118
------------ ----------- ------------ ------------ ----------
Total increase (decrease)
in net assets............ 34,234,892 4,642,072 63,001,275 40,524,914 1,537,715
NET ASSETS:
Beginning of period...... 71,357,684 66,715,612 149,022,542 108,497,628 0
------------ ----------- ------------ ------------ ----------
END OF PERIOD............ $105,592,576 $71,357,684 $212,023,817 $149,022,542 $1,537,715
============ =========== ============ ============ ==========
<CAPTION>
EQUITY
LIMITED MATURITY TCI INCOME
BOND PORTFOLIO++ GROWTH PORTFOLIO+++ PORTFOLIO++++
------------------------- -------------------------- --------------
1995 1994 1995 1994 1995(a)
------------ ----------- ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
INCREASE IN NET ASSETS RESULTING FROM:
OPERATIONS:
Net investment income
(loss).................. $ 193,971 $ (34,415) $ (302,687) $ (177,764) $ 29,393
Net realized gain (loss)
from investment
transactions............ 9,224 135,890 16,768 (3,386) 651
Net change in unrealized
appreciation/depreciation
of investments.......... 221,946 (159,726) 6,268,045 (178,321) 414,169
------------ ----------- ------------ ------------ ----------
Net increase (decrease) in
net assets
resulting from
operations............... 425,141 (58,251) 5,982,126 (359,471) 444,213
------------ ----------- ------------ ------------ ----------
ANNUITY ACTIVITIES:
Purchase payments under
variable annuity
contracts............... 611,343 1,161,377 4,678,063 7,276,860 2,349,355
Surrender benefits....... (1,263,358) (136,524) (1,740,845) (454,334) (19,798)
Net transfers............ 670,831 388,258 2,162,323 5,068,078 4,164,428
Death benefits........... (16,238) (2,090) (98,451) (12,478) (86)
Contract administration
charges................. (3,886) (2,295) (28,544) (12,463) (865)
Deferred sales charges... (7,582) (4,901) (44,419) (8,759) (45)
Annuity benefits......... (27,852) (12,837) (30,932) (12,406) (3,214)
------------ ----------- ------------ ------------ ----------
Net increase (decrease) in
net assets resulting from
variable annuity
activities............... (36,742) 1,390,988 4,897,195 11,844,498 6,489,775
------------ ----------- ------------ ------------ ----------
Total increase (decrease)
in net assets............ 388,399 1,332,737 10,879,321 11,485,027 6,933,988
NET ASSETS:
Beginning of period...... 4,505,922 3,173,185 19,454,438 7,969,411 0
------------ ----------- ------------ ------------ ----------
END OF PERIOD............ $ 4,894,321 $ 4,505,922 $ 30,333,759 $ 19,454,438 $6,933,988
============ =========== ============ ============ ==========
</TABLE>
- -----------------------
(a)For the period from May 1, 1995 (date funds became available for investment
to contractholders) to December 31, 1995.
+Investment in Penn Series Funds, Inc.
++Investment in Neuberger & Berman Advisers Management Trust.
+++Investment in TCI Portfolios, Inc.
++++Investment in Fidelity Investments' Variable Insurance Products Funds I and
II.

The accompanying notes are an integral part of these financial statements.

B-18
<PAGE>

- --------------------------------------------------------------------------------

INTERNATIONAL EQUITY FUND+ BALANCED PORTFOLIO++
- ---------------------------------- ---------------------------------
1995 1994 1995 1994
- ------------ ------------- ----------- -----------
<S> <C> <C> <C>
$ 539,966 $ (299,620) $ 45,888 $ 64,189
(181,261) (6,786) 81,462 116,979

4,887,624 (3,152,128) 2,774,061 (629,486)
----------- ----------- ----------- -----------

5,246,329 (3,458,534) 2,901,411 (448,318)
----------- ----------- ----------- -----------
6,138,208 14,229,731 2,746,683 4,944,710
(2,835,474) (1,132,959) (528,250) (272,124)
(5,032,885) 10,628,364 928,069 1,672,583
(65,950) (115,534) (121,242) (5,837)
(60,126) (40,975) (17,685) (8,610)
(65,303) (23,932) (13,775) (7,844)
(86,198) (64,187) (60,583) (25,095)
----------- ----------- ----------- -----------

(2,007,728) 23,480,508 2,933,217 6,297,783
----------- ----------- ----------- -----------
3,238,601 20,021,974 5,834,628 5,849,465
45,671,579 25,649,605 12,501,176 6,651,711
----------- ----------- ----------- -----------
$48,910,180 $45,671,579 $18,335,804 $12,501,176
=========== =========== =========== ===========
<CAPTION>
ASSET
GROWTH MANAGER
PORTFOLIO++++ PORTFOLIO++++
- ------------- -------------
1994(a) 1995(a)
- ------------- -------------
<S> <C>
$ (26,504) $ (5,235)
709 (111)

(11,518) 74,814
----------- -----------

(37,313) 69,468
----------- -----------
2,816,988 575,082
(94,193) (4,419)
5,857,679 668,608
(90) (85)
(1,167) (359)
(737) 0
(5,993) (175)
----------- -----------

8,572,487 1,238,652
----------- -----------
8,535,174 1,308,120
0 0
----------- -----------
$ 8,535,174 $ 1,308,120
=========== ===========
</TABLE>

The accompanying notes are an integral part of these financial statements.

B-19
<PAGE>

- -------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
NOTES TO FINANCIAL STATEMENTS - DECEMBER 31, 1995
- -------------------------------------------------------------------------------
NOTE 1.

The significant accounting policies of Penn Mutual Variable Annuity Account
III (Account III) are as follows:

GENERAL - Account III was established by The Penn Mutual Life Insurance
Company (Penn Mutual) under the provisions of the Pennsylvania Insurance
Law. Penn Mutual has structured Account III as a unit investment trust
registered under the Investment Company Act of 1940. Account III offers
units to variable annuity contractholders to provide for the accumulation
of value and for the payment of annuities. The preparation of the
accompanying financial statements require management to make estimates and
assumptions that affect the reported values of assets and liabilities as of
December 31, 1995 and the reported amounts from operations and contract
transactions during 1995 and 1994. Actual results could differ from those
estimates.

INVESTMENTS - Assets of Account III are invested in shares of Penn Series
Funds, Inc. (Penn Series): Money Market, Quality Bond, High Yield Bond,
Growth Equity, Value Equity, Flexibly Managed, International Equity, and
Small Capitalization Funds; Neuberger and

- -------------------------------------------------------------------------------
NOTE 2.

For the years ended December 31, 1995 and 1994, share transactions of
Account III were as follows:
<TABLE>
<CAPTION>

HIGH YIELD
MONEY MARKET FUND+ QUALITY BOND FUND+ BOND FUND+
------------------------ ----------------------- ------------------------
1995 1994 1995 1994 1995 1994
----------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Shares purchased........ 12,453,799 11,731,562 352,662 567,279 296,961 844,452
Shares received from
reinvestment of:
Net investment income. 820,099 428,156 192,405 205,998 319,782 371,269
Capital gains
distributions........ 0 0 0 0 0 0
----------- ----------- ----------- ---------- ----------- -----------
Total shares acquired... 13,273,898 12,159,718 545,067 773,277 616,743 1,215,721
Shares redeemed......... (8,418,094) (9,032,589) (427,974) (708,005) (537,976) (866,422)
----------- ----------- ----------- ---------- ----------- -----------
Net increase (decrease)
in shares owned........ 4,855,804 3,127,129 117,093 65,272 78,767 349,299
Shares owned, beginning
of period.............. 14,302,644 11,175,515 3,255,466 3,190,194 3,607,675 3,258,376
----------- ----------- ----------- ---------- ----------- -----------
Shares owned, end of
period................. 19,158,448 14,302,644 3,372,559 3,255,466 3,686,442 3,607,675
=========== =========== =========== ========== =========== ===========
Cost of shares acquired. $13,273,898 $12,159,718 $ 5,531,251 $7,467,034 $ 5,272,237 $10,893,594
Proceeds from shares
redeemed............... $ 8,418,094 $ 9,032,589 $ 4,256,372 $6,839,749 $ 4,611,481 $ 8,001,826
<CAPTION>

INTERNATIONAL BALANCED LIMITED MATURITY
EQUITY FUND+ PORTFOLIO++ BOND PORTFOLIO++
------------------------ ----------------------- ------------------------
1995 1994 1995 1994 1995 1994
----------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Shares purchased........ 321,422 1,791,592 226,636 458,117 128,705 143,858
Shares received from
reinvestment of:
Net investment income. 76,567 13,569 16,504 7,544 18,582 9,643
Capital gains
distributions........ 0 0 5,305 12,464 0 1,429
----------- ----------- ----------- ---------- ----------- -----------
Total shares acquired... 397,989 1,805,161 248,445 478,125 147,287 154,930
Shares redeemed......... (528,180) (134,889) (63,375) (42,430) (135,944) (50,012)
----------- ----------- ----------- ---------- ----------- -----------
Net increase (decrease)
in shares owned........ (130,191) 1,670,272 185,070 435,695 11,343 104,918
Shares owned, beginning
of period.............. 3,510,899 1,840,627 861,672 425,977 321,437 216,519
----------- ----------- ----------- ---------- ----------- -----------
Shares owned, end of
period................. 3,380,708 3,510,899 1,046,742 861,672 332,780 321,437
=========== =========== =========== ========== =========== ===========
Cost of shares acquired. $5,475,849 $25,018,799 $ 4,080,178 $7,101,185 $ 2,108,317 $ 2,189,576
Proceeds from shares
redeemed............... $6,940,160 $ 1,841,428 $ 1,021,029 $ 625,518 $ 1,950,837 $ 697,584
</TABLE>

The cost of shares redeemed is determined on a last-in, first-out basis.
- -----------------------
(a) For the period from May 1, 1995 (date funds became available for investment
to contractholders) to December 31, 1995.
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust.
+++ Investment in TCI Portfolios, Inc.
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
- -------------------------------------------------------------------------------
NOTE 3.

Operations are charged for mortality and expense risks assumed by Penn
Mutual as determined daily at an annual rate of 1.25% of the average value
of Account III.

B-20
<PAGE>

- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NOTE 1., CONT'D.

Berman Advisers Management Trust (AMT): Limited Maturity Bond and Balanced
Portfolios; TCI Portfolios, Inc. (TCI): TCI Growth Portfolio; and Fidelity
Investments' Variable Insurance Products (Fidelity): Equity Income, Growth,
and Asset Manager Portfolios. Penn Series, AMT, TCI, and Fidelity are open-
end diversified investment companies. The shares are carried at market
value as determined by the underlying net asset value of the respective
funds or portfolios. Dividend income is recorded on the ex-dividend date.
Investment transactions are accounted for on a trade date basis.

FEDERAL INCOME TAXES - Penn Mutual is taxed under federal law as a life
insurance company. Account III is part of Penn Mutual's total operations
and is not taxed separately. Under existing federal law, no taxes are
payable on investment income and realized gains of Account III.

<TABLE>
- -----------------------------------------------------------------------------------------------
<CAPTION>
SMALL
CAPITALIZATION
GROWTH EQUITY FUND+ VALUE EQUITY FUND+ FLEXIBLY MANAGED FUND+ FUND+
- ------------------------ --------------------------- ------------------------- --------------
1995 1994 1995 1994 1995 1994 1995(a)
- ----------- ----------- ------------- ------------- ------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
165,899 401,705 706,599 567,306 1,909,325 2,439,626 138,561
17,339 28,387 91,497 84,952 353,198 270,376 1,082
571,396 84,644 332,378 79,862 417,253 424,847 2,844
- ----------- ----------- ----------- ---------- ----------- ----------- ----------
754,634 514,736 1,130,474 732,120 2,679,776 3,134,849 142,487
(456,843) (297,943) (275,894) (362,798) (304,008) (236,173) (2,160)
- ----------- ----------- ----------- ---------- ----------- ----------- ----------
297,791 216,793 854,580 369,322 2,375,768 2,898,676 140,327
4,038,799 3,822,006 5,632,571 5,263,249 9,811,594 6,912,918 0
- ----------- ----------- ----------- ---------- ----------- ----------- ----------
4,336,590 4,038,799 6,487,151 5,632,571 12,187,362 9,811,594 140,327
=========== =========== =========== ========== =========== =========== ==========
$15,244,644 $ 9,797,915 $17,742,122 $9,472,800 $45,850,893 $49,635,265 $1,567,584
$ 9,537,239 $ 5,590,164 $ 4,209,884 $4,688,111 $ 5,227,508 $ 3,776,398 $ 23,250
<CAPTION>
TCI EQUITY INCOME GROWTH ASSET MANAGER
GROWTH PORTFOLIO+++ PORTFOLIO++++ PORTFOLIO++++ PORTFOLIO++++
- ------------------------ ------------- ------------- -------------
1995 1994 1995(a) 1995(a) 1995(a)
- ----------- ----------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
544,314 1,318,043 362,089 294,937 83,857
2,462 144 2,757 0 0
0 0 0 0 0
- ----------- ----------- ----------- ---------- -----------
546,776 1,318,187 364,846 294,937 83,857
(143,709) (60,908) (4,949) (2,591) (998)
- ----------- ----------- ----------- ---------- -----------
403,067 1,257,279 359,897 292,346 82,859
2,112,634 855,355 0 0 0
- ----------- ----------- ----------- ---------- -----------
2,515,701 2,112,634 359,897 292,346 82,859
=========== =========== =========== ========== ===========
$ 6,094,633 $12,213,985 $ 6,606,484 $8,622,762 $ 1,248,666
$ 1,497,448 $ 546,830 $ 86,095 $ 75,436 $ 15,032
</TABLE>

- -------------------------------------------------------------------------------
NOTE 3. CONT'D.

As reimbursement for expenses incurred in administering the contract, Penn
Mutual receives $30 per year from each annuity contract prior to the
contract's date of maturity. The $30 charge is waived on certain contracts.

If a policy is surrendered within the first 11 years, a contingent deferred
sales charge may be assessed. This charge will be deducted before any
surrender proceeds are paid. See original contract documents for specified
charges assessed.

B-21
<PAGE>

- -----------------------------------------------------
THIS PAGE LEFT INTENTIONALLY BLANK

B-22
<PAGE>

- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS

THE BOARD OF TRUSTEES
THE PENN MUTUAL LIFE INSURANCE COMPANY
PHILADELPHIA, PENNSYLVANIA

We have audited the accompanying statements of financial condition of The Penn
Mutual Life Insurance Company as of December 31, 1995 and 1994, and the related
statements of operations and surplus and cash flows for each of the three years
in the period ended December 31, 1995. 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 financial statements referred to above present fairly, in
all material respects, the financial position of The Penn Mutual Life Insurance
Company as of December 31, 1995 and 1994, and the results of its operations and
cash flows for each of the three years in the period ended December 31, 1995,
in conformity with the accounting principles prescribed or permitted by the
Insurance Department of the Commonwealth of Pennsylvania, which are considered
generally accepted accounting principles for mutual life insurance companies.

As discussed in Note 2 to the financial statements, during 1995, the Company
changed its accounting methods for certain components of the federal income tax
expense and the valuation of reserves of certain annuity products.

/s/ Coopers & Lybrand L.L.P.

Coopers & Lybrand L.L.P.

2400 Eleven Penn Center
Philadelphia, Pennsylvania
January 26, 1996

B-23
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
STATEMENTS OF FINANCIAL CONDITION

<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
(in thousands of dollars)
ASSETS
Bonds.................................................... $3,695,516 $3,693,295
Stocks
Preferred............................................... 15,049 31,574
Common--affiliated...................................... 171,193 236,266
--unaffiliated.................................... 8,182 1,986
Mortgage loans........................................... 960,692 950,219
Real estate.............................................. 138,329 218,268
Policy loans............................................. 422,865 438,500
Cash and short-term investments.......................... 75,962 7,796
Other invested assets 59,561 64,362
---------- ----------
TOTAL................................................... 5,547,349 5,642,266
Investment income due and accrued........................ 94,350 101,027
Premiums due and deferred................................ 26,926 28,060
Other assets............................................. 41,082 36,104
Separate account assets 911,683 658,074
---------- ----------
TOTAL ASSETS............................................ $6,621,390 $6,465,531
========== ==========
LIABILITIES
Reserves and funds for payment of future life and annuity
benefits................................................ $5,064,298 $5,139,779
Dividends to policyholders payable in the following year. 72,653 72,400
Policy claims in process................................. 27,241 39,295
Interest maintenance reserve............................. 36,084 5,355
Asset valuation reserve.................................. 83,157 111,885
Other liabilities........................................ 77,063 130,108
Separate account liabilities 905,960 651,388
---------- ----------
TOTAL................................................... 6,266,456 6,150,210
SURPLUS
Special surplus funds.................................... 1,576 1,523
Unassigned surplus....................................... 353,358 313,798
---------- ----------
TOTAL................................................... 354,934 315,321
---------- ----------
TOTAL LIABILITIES AND SURPLUS.......................... $6,621,390 $6,465,531
========== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

B-24
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
STATEMENTS OF OPERATIONS AND SURPLUS

<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands of dollars)
INCOME
Premium and annuity considerations............. $ 707,048 $ 768,534 $ 626,374
Net investment income.......................... 456,108 446,354 464,663
Other income................................... (2,238) 13,510 7,887
--------- --------- ---------
TOTAL INCOME.................................. 1,160,918 1,228,398 1,098,924
--------- --------- ---------
BENEFITS AND EXPENSES
Benefits paid to policyholders and beneficia-
ries.......................................... 859,798 766,598 839,310
Increase (decrease) in reserves and funds for
the payment of future life and annuity bene-
fits.......................................... (50,775) 54,380 (141,412)
Commissions.................................... 38,044 45,579 38,955
Operating expenses............................. 116,673 124,920 122,806
Net transfers to separate accounts............. 86,944 128,773 124,007
--------- --------- ---------
TOTAL BENEFITS AND EXPENSES................... 1,050,684 1,120,250 983,666
--------- --------- ---------
INCOME FROM OPERATIONS BEFORE DIVIDENDS AND
FEDERAL INCOME TAXES......................... 110,234 108,148 115,258
Dividends to policyholders..................... 70,057 69,098 71,129
--------- --------- ---------
INCOME FROM OPERATIONS BEFORE FEDERAL INCOME
TAXES........................................ 40,177 39,050 44,129
Federal income tax expense (benefit)........... (52,442) 197 (23,717)
--------- --------- ---------
INCOME FROM OPERATIONS........................ 92,619 38,853 67,846
Net realized capital losses, net of taxes...... 91,890 37,399 35,396
--------- --------- ---------
NET INCOME.................................... 729 1,454 32,450
SURPLUS
Change in asset valuation reserve.............. 28,728 29,060 (4,729)
Change in net unrealized capital gains and
losses........................................ 2,395 (3,376) 33,958
Changes in accounting methods.................. 7,984 -- --
Other.......................................... (223) 8,618 760
--------- --------- ---------
TOTAL CONTRIBUTION TO SURPLUS................. 39,613 35,756 62,439
Surplus, Beginning of Year.................... 315,321 279,565 217,126
--------- --------- ---------
SURPLUS, END OF YEAR.......................... $ 354,934 $ 315,321 $ 279,565
========= ========= =========
</TABLE>

The accompanying notes are an integral part of these financial statements.

B-25
<PAGE>

- ------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1995 1994 1993
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands of dollars)
CASH PROVIDED
Net cash from operations:
Premium and annuity considerations.......... $ 708,301 $ 767,017 $ 629,725
Net investment income....................... 439,508 420,917 456,516
Other income................................ (2,511) 15,704 16,660
---------- ---------- ----------
1,145,298 1,203,638 1,102,901
Benefits to policyholders................... 871,983 750,019 834,700
Commissions................................. 38,139 45,540 38,947
Operating expenses and taxes................ 152,907 96,050 111,224
Net transfers to separate accounts.......... 86,944 129,858 128,299
Dividends to policyholders.................. 69,804 70,246 69,818
Net decrease in policy loans................ (15,202) (22,361) (35,734)
---------- ---------- ----------
NET CASH FROM OPERATIONS.................... (59,277) 134,286 (44,353)
---------- ---------- ----------
Investments sold, matured or repaid:
Bonds....................................... 1,410,126 1,038,593 1,844,108
Stocks...................................... 95,347 197,503 1,042,421
Mortgage loans.............................. 102,394 45,255 112,448
Real estate and other invested assets....... 10,837 12,701 17,057
---------- ---------- ----------
Total investments sold, matured or repaid.. 1,618,704 1,294,052 3,016,034
Taxes on realized investment gains........... 3,253 (17,722) (14,963)
Other cash provided.......................... 4,275 10,035 1,190
---------- ---------- ----------
1,626,232 1,286,365 3,002,261
---------- ---------- ----------
TOTAL CASH PROVIDED......................... 1,566,955 1,420,651 2,957,908
---------- ---------- ----------
CASH APPLIED
Cost of investments acquired:
Bonds....................................... 1,357,008 1,218,880 1,858,996
Stocks...................................... 26,114 131,248 958,060
Mortgage loans.............................. 100,466 71,427 96,435
Real estate and other invested assets....... 8,970 14,909 13,417
---------- ---------- ----------
Total cost of investments acquired......... 1,492,558 1,436,464 2,926,908
Other cash applied........................... 6,231 24,452 27,125
---------- ---------- ----------
TOTAL CASH APPLIED.......................... 1,498,789 1,460,916 2,954,033
---------- ---------- ----------
Net change in cash and short-term invest-
ments....................................... 68,166 (40,265) 3,875
CASH AND SHORT-TERM INVESTMENTS:
Beginning of year........................... 7,796 48,061 44,186
---------- ---------- ----------
END OF YEAR................................. $ 75,962 $ 7,796 $ 48,061
========== ========== ==========
</TABLE>

The accompanying notes are an integral part of these financial statements.

B-26
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
(IN THOUSANDS OF DOLLARS)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

NATURE OF OPERATIONS
The Penn Mutual Life Insurance Company (the "Company"), is a mutual life
insurance company which concentrates primarily in the sale of individual life
insurance and annuity products. The primary products that the Company currently
markets are traditional whole life, yearly renewable term, universal life,
immediate annuities, variable life insurance and variable annuities. The
Company markets its products through a network of career agents, independent
agents, and independent marketing organizations. The Company sells its products
in all fifty states, the District of Columbia and five Canadian provinces.

BASIS OF PRESENTATION
The financial statements of the Company have been prepared in conformity with
accounting principles prescribed or permitted by the Insurance Department of
the Commonwealth of Pennsylvania, which are considered generally accepted
accounting principles for mutual life insurance companies. Prescribed statutory
accounting principles include state laws, regulations, and general
administrative rules, as well as a variety of publications of the National
Association of Insurance Commissioners (NAIC). Permitted statutory accounting
principles encompass all accounting practices that are not prescribed. In
accordance with Pennsylvania Insurance Laws and Regulations, the Company's
subsidiaries are not consolidated for statutory filing purposes. The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.
In April 1993, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 40, "Applicability of Generally Accepted Accounting
Principles to Mutual Life Insurance and Other Enterprises" (Interpretation No.
40), which was amended by Statement of Financial Accounting Standards (SFAS)
No. 120, "Accounting and Reporting by Mutual Life Insurance Enterprises for
Certain Long-Duration Participating Contracts". SFAS No. 120 deferred the
effective date of Interpretation No. 40 to fiscal years beginning after
December 15, 1995. Under Interpretation No. 40, the financial statements of
mutual life insurance companies which are prepared on the basis of statutory
accounting principles can no longer be described as prepared in conformity with
generally accepted accounting principles (GAAP). After 1995, the Company will
continue to issue financial statements prepared in accordance with statutory
accounting principles for regulatory purposes.
When the Company prepares financial statements in conformity with
Interpretation No. 40, the accounting treatment for certain items, such as
policy reserves, new business acquisition costs, asset valuation reserves,
employee benefit liabilities and income taxes will be different than for
financial statements issued in conformity with statutory accounting principles.
In addition, the Company believes surplus presented in accordance with
Interpretation No. 40 will be greater than surplus presented in accordance with
statutory accounting principles.

VALUATION OF INVESTMENTS
Bonds and stocks are carried in the accompanying Statements of Financial
Condition at values prescribed by the NAIC. In general, bonds are stated at
amortized cost, preferred stocks at cost and unaffiliated common stocks at
market value. The Company's subsidiaries are carried on the equity basis with
the net income from subsidiaries recorded in net investment income. Real estate
is carried at cost less encumbrances and accumulated depreciation. Real estate
acquired through foreclosure is recorded at the lower of cost or market value
at the time of foreclosure. Real estate is depreciated using the straight-line
method. Mortgage loans are carried at the unpaid principal amount, less any
unamortized discount. Policy loans are stated at the unpaid principal balance
less amounts unsecured by cash surrender and dividend accumulation values. Cash
and short-term investments include cash on deposit and securities purchased
with a maturity date of less than one year. Short-term investments are valued
at cost, which approximates market. Other invested assets include joint venture
real estate partnerships, which are valued on the equity basis, and venture
capital limited partnerships, which are carried at market value. Certain assets
which are considered to be non-admitted for statutory purposes have been
excluded from the Statement of Financial Condition by a direct charge to
surplus.
Financial instruments utilized to hedge the Company's assets are recorded using
a valuation method consistent with the valuation method of the assets hedged.
Gains and losses on financial futures contracts used as hedges against interest
rate fluctuations are deferred and recognized in the Statements of Operations
over the remaining life of the hedged securities.

B-27
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
Changes in the market value of financial futures contracts used as hedges
against market fluctuations of equity securities are reported as unrealized
gains or losses. They are recognized as realized gains or losses when the
hedged securities are sold.
Statutory accounting principles require insurance companies to hold an Asset
Valuation Reserve (AVR) and an Interest Maintenance Reserve (IMR). The purpose
of the AVR is to maintain consistent and prescribed valuation reserves for
invested assets. Changes in the AVR are recorded directly to surplus. The
purpose of the IMR is to defer recognition of realized gains and losses which
result from interest rate movements and to amortize these gains and losses into
income over the original expected life of the investment sold. Amortization of
gains and losses included in the IMR are reflected as a component of net
investment income.
Realized gains and losses are determined on the specific identification method
and are presented in the Statements of Operations net of taxes and excluding
net gains and losses transferred to the IMR. Unrealized gains and losses are
accounted for as direct increases or decreases in surplus.

RESERVES AND FUNDS FOR THE PAYMENT OF FUTURE LIFE AND ANNUITY BENEFITS
Reserves and funds for the payment of future life and annuity benefits are
developed using actuarial methods based on statutory mortality and interest
requirements. Reserves for life insurance are computed principally on the net
level or modified preliminary term methods using the 1941, 1958 and 1980
Commissioners' Standard Ordinary Mortality and American Experience Tables and
assumed interest rates ranging from 2.25% to 4.5%. Reserves for annuity
contracts are based principally on the 1949, 1971 and 1983 Individual Annuity
Mortality Tables for individual annuities and the 1971 and 1983 Group Annuity
Mortality Tables for group annuities and assumed interest rates ranging from
2.5% to 13.25%. Policy claims in process include provisions for payments to be
made on reported claims and claims incurred but not reported. Any adjustments
that are made to the reserve balances are reflected in the Statements of
Operations in the year in which such adjustments are made, with the exception
of changes in valuation bases which are accounted for as a charge or credit to
surplus.

REVENUE AND RELATED EXPENSE RECOGNITION
Premiums are recognized as income over the premium payment period of the
related policies. Annuity considerations are recognized as income as they are
received. Premium and annuity considerations are recorded net of reinsurance
premiums. Benefits are reported net of the amounts received from reinsurers.
Commissions and other expenses related to the acquisition of new policies are
charged to operations as incurred.

FEDERAL INCOME TAXES
The Company files a consolidated federal income tax return with its insurance
and non-insurance subsidiaries. Each subsidiary's tax liability or refund is
accrued on a separate company basis. The Company reimburses subsidiaries for
losses utilized in the consolidated return based on inter-company tax
allocation agreements. In accordance with statutory accounting practices, no
deferred taxes are provided for temporary differences between pre-tax
accounting income and taxable income.

POLICYHOLDER DIVIDENDS
All insurance policies are participating. A liability for the dividends to be
paid or credited to policyholders during the following calendar year is
established at each year end. The amount of dividends to be paid is approved
annually by the Board of Trustees.

SEPARATE ACCOUNTS
Separate Account assets and liabilities represent segregated funds administered
and invested by the Company primarily for the benefit of variable life
insurance policyholders and annuity and pension contractholders, including
certain of the Company's benefit plans. The value of the assets in the Separate
Accounts reflects the actual investment performance of the respective accounts
and is not guaranteed by the Company. The carrying value for Separate Account
assets and liabilities approximates the estimated fair value of the underlying
assets.

RECLASSIFICATIONS
Certain 1994 and 1993 amounts have been reclassified to conform with the 1995
presentation.

B-28
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)

NOTE 2 - ACCOUNTING CHANGES:

The sections of the Internal Revenue Code (IRC) applicable to mutual life
insurance companies require that mutual, but not stock, life insurance
companies include the Differential Earnings Amount (DEA) in each year's taxable
income. This amount is computed by multiplying the Company's average taxable
equity base by a rate that represents the difference between stock and mutual
companies' earnings rates. Under the IRC, the enacted DEA rate for the current
year is an Internal Revenue Service (IRS) estimate and is recomputed in the
following year to reflect the actual industry results.
Prior to 1995, the Company recorded its federal income tax expense for the DEA
based on the enacted IRS rates for the current year along with any adjustment
to the DEA related to the recomputation of the prior year's estimate. The
portion of the Company's federal income tax expense associated with the DEA was
recorded directly to surplus.
In 1995, the Company changed its method of accounting for the DEA to record the
tax based on management's best estimate of the final DEA rates. The impact of
this accounting change resulting in a $16,723 direct charge to surplus in 1995.
In addition, in 1995 the Company began recording the portion of its federal
income tax expense associated with the DEA in the Statement of Operations.
During 1995, the Company changed the reserve valuation bases for certain of its
annuity products. These changes resulted in the release of $24,707 of
policyholder reserves and a corresponding credit directly to surplus.

NOTE 3 - INVESTMENTS

DEBT SECURITIES
The following summarizes the statement value and estimated fair value of the
Company's investment in debt securities, including redeemable preferred stocks,
as of December 31, 1995 and 1994.

<TABLE>
<CAPTION>
DECEMBER 31, 1995
-------------------------------------------
GROSS GROSS ESTIMATED
STATEMENT UNREALIZED UNREALIZED FAIR
VALUE GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
United States Government........... $ 63,477 $ 1,875 $ -- $ 65,352
Other governmental units........... 103,090 2,893 -- 105,983
Public utility..................... 509,120 51,946 347 560,719
Industrial and other............... 2,184,414 197,075 13,208 2,368,281
Mortgage and other asset-backed
securities........................ 835,415 32,504 3,951 863,968
---------- -------- -------- ----------
3,695,516 286,293 17,506 3,964,303
Redeemable preferred stocks........ 3,964 -- 237 3,727
---------- -------- -------- ----------
TOTAL............................. $3,699,480 $286,293 $ 17,743 $3,968,030
========== ======== ======== ==========
<CAPTION>
DECEMBER 31, 1994
-------------------------------------------
GROSS GROSS ESTIMATED
STATEMENT UNREALIZED UNREALIZED FAIR
VALUE GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
United States Government........... $ 10,216 $ -- $ 289 $ 9,927
Other governmental units........... 162,618 129 8,761 153,986
Public utility..................... 667,737 5,891 37,122 636,506
Industrial and other............... 2,248,385 34,377 86,461 2,196,301
Mortgage and other asset-backed
securities........................ 604,339 3,797 48,812 559,324
---------- -------- -------- ----------
3,693,295 44,194 181,445 3,556,044
Redeemable preferred stocks........ 4,378 25 211 4,192
---------- -------- -------- ----------
TOTAL............................. $3,697,673 $ 44,219 $181,656 $3,560,236
========== ======== ======== ==========
</TABLE>

B-29
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The following summarizes the statement value and estimated fair value of debt
securities as of December 31, 1995, by contractual maturity.

<TABLE>
<CAPTION>
STATEMENT ESTIMATED
VALUE FAIR VALUE
---------- ----------
<S> <C> <C>
Maturity:
Within one year......................................... $ 102,028 $ 103,261
After one year through five years....................... 654,102 676,888
After five years through ten years...................... 265,388 283,297
After ten years through twenty years.................... 413,267 471,355
After twenty years...................................... 1,425,316 1,565,534
Mortgage and other asset-backed securities.............. 835,415 863,968
---------- ----------
3,695,516 3,964,303
Redeemable preferred stocks............................. 3,964 3,727
---------- ----------
TOTAL.................................................. $3,699,480 $3,968,030
========== ==========
</TABLE>

Expected maturities may differ from contractual maturities because certain
borrowers have the right to call or prepay obligations with or without call or
prepayment penalties.
During 1995, 1994 and 1993, proceeds from dispositions of investments in debt
securities amounted to $1,410,126, $1,038,593, and $1,844,108, respectively.
The gross gains realized on those dispositions were $57,295, $5,876 and
$37,797, and the gross losses realized on those dispositions were $10,069,
$27,348 and $15,935 during 1995, 1994 and 1993, respectively. Net realized
gains, net of taxes, transferred to the IMR in 1995 were $32,211. Net realized
losses, net of taxes, transferred to the IMR in 1994 were $14,089. Net realized
gains, net of taxes, transferred to the IMR, in 1993 were $11,144. Amortization
of the IMR included in net investment income amounted to $1,482, $1,056 and
$964 in 1995, 1994 and 1993, respectively.
The Company's investment portfolio of debt securities is comprised
predominantly of investment grade securities. As of December 31, 1995 and 1994,
debt securities totaling $100,013 and $125,737, respectively, were classified
by the NAIC as less than investment grade. The Company did not hold any debt
securities which were non-income producing for the preceding twelve months as
of December 31, 1995. The statement value of debt securities which were non-
income producing for the preceding twelve months was $900 as of December 31,
1994.

MORTGAGE LOANS
The following summarizes the statement value of mortgage loans, by property
type and geographic concentration, as of December 31, 1995 and 1994.

<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
PROPERTY TYPE
Office buildings.............................................. $296,976 $300,156
Retail........................................................ 230,902 263,178
Dwellings..................................................... 223,192 219,860
Other......................................................... 209,622 167,025
-------- --------
TOTAL........................................................ $960,692 $950,219
======== ========
GEOGRAPHIC CONCENTRATION
Northeast..................................................... $328,397 $373,627
Midwest....................................................... 358,203 299,239
South......................................................... 132,382 136,416
West.......................................................... 139,979 138,793
Canada........................................................ 1,731 2,144
-------- --------
TOTAL........................................................ $960,692 $950,219
======== ========
</TABLE>

B-30
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The Company originates commercial mortgage loans through a network of
commercial mortgage bankers throughout the country. All mortgage loans are
collateralized by the underlying real estate and insurance is required on all
properties up to their replacement values. The maximum and minimum lending
rates for mortgage loans originated during 1995 were 10.05% and 7.50%,
respectively. For loans originated during 1995, the maximum percentage of any
one loan to the value of the collateral at the time of the loan, exclusive of
insured, guaranteed and purchase money mortgages, was 75%. The Company controls
credit risk through credit approvals, limits and monitoring procedures. The
Company's investments included $27,295 and $21,684 of mortgage loans delinquent
over 90 days, including $8,033 and $14,889 of mortgage loans which were non-
income producing for the preceding twelve months as of December 31, 1995 and
1994, respectively. The mortgage loan portfolio includes $19,928 and $27,405 of
restructured mortgage loans as of December 31, 1995 and 1994, respectively.
Restructured mortgage loans include commercial loans for which the basic terms,
such as interest rate, amortization, maturity date, or collateral have been
changed as a result of actual or anticipated delinquency. Restructures do not
include mortgages refinanced prior to or upon maturity at or above current
market terms.

REAL ESTATE
As of December 31, 1995 and 1994, accumulated depreciation on real estate
amounted to $43,069 and $33,580, respectively. Depreciation expense on real
estate totaled $10,019, $8,445 and $10,824 for the years ended December 31,
1995, 1994 and 1993, respectively. The Company's investments include $27,944
and $21,889 of foreclosed real estate as of December 31, 1995 and 1994,
respectively. The statement value of the Company's largest real estate
investment amounted to $54,858 and $130,756 as of December 31, 1995 and 1994,
respectively. During 1995, the Company wrote down the statement value of this
property by $76,500 to its current estimated fair value. This write down
reflects the Company's determination that the value of the property was
permanently impaired due in part to the notification by the major tenant that
it did not intend to exercise lease extension options. In addition, the Company
no longer intends to hold this property as a long-term investment. The write
down has been recognized as a realized loss in the Statement of Operations.

NOTE 4 - RESERVES AND FUNDS FOR PAYMENT OF FUTURE LIFE AND ANNUITY BENEFITS:
The following summarizes the withdrawal characteristics of the Company's
reserves and deposit funds as of December 31, 1995.

<TABLE>
<CAPTION>
STATEMENT
VALUE
-----------
<S> <C>
Total policyholders' reserves and funds including separate account
liabilities...................................................... $ 5,970,258
Amounts not subject to discretionary withdrawal................... (1,242,000)
-----------
AMOUNTS SUBJECT TO DISCRETIONARY WITHDRAWAL...................... $ 4,728,258
===========
</TABLE>

Of the total reserves and deposit funds which are subject to discretionary
withdrawal, $1,927,100, which is net of applicable policy loans, may be
withdrawn without the policyholder incurring surrender charges or market value
adjustments to the funds.

B-31
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTE 5 - FAIR VALUE OF FINANCIAL INSTRUMENTS AND OFF-BALANCE-SHEET RISK:
The following table summarizes the statement value and estimated fair value of
the Company's financial instruments as of December 31, 1995 and 1994.

<TABLE>
<CAPTION>
1995 1994
--------------------- ---------------------
STATEMENT ESTIMATED STATEMENT ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Debt securities
Bonds............................. $3,695,516 $3,964,303 $3,693,295 $3,556,044
Redeemable preferred stocks....... 3,964 3,727 4,378 4,192
Equity securities
Common stock--unaffiliated........ 8,182 8,182 1,986 1,986
Non-redeemable preferred stocks... 11,085 13,607 27,196 27,498
Mortgage loans
Commercial........................ 958,079 1,000,003 946,031 917,062
Residential....................... 2,613 2,930 4,188 4,562
Policy loans....................... 422,865 405,721 438,500 417,121
Venture capital limited partner-
ships............................. 30,325 30,325 36,305 36,305
Separate account assets............ 911,683 911,683 658,074 658,704
FINANCIAL LIABILITIES:
Investment-type contracts
Individual annuities.............. $1,248,138 $1,287,644 $1,186,097 $1,203,684
Guaranteed investment contracts... 222,991 226,255 408,479 409,470
Other group annuities............. 216,686 219,857 222,863 221,696
Dividends to policyholders payable
in the following year............. 72,653 72,653 72,400 72,400
Separate account liabilities....... 905,960 905,960 651,388 651,388
</TABLE>

The estimated fair values for the Company's investments in debt and equity
securities are based on quoted market prices, where available. In situations
where market prices are not readily available, primarily private placements,
fair values are estimated using a formula pricing method based on fair values
of securities with similar characteristics. The fair value of currently
performing mortgage loans is estimated by discounting the cash flows associated
with the investment, using an interest rate currently offered for similar loans
to borrowers with similar credit ratings. Loans with similar credit quality,
characteristics and time to maturity are aggregated for purposes of estimating
fair value. Assumptions regarding credit risk, cash flows and discount rates
are determined using the available market and borrower-specific information.
The estimated fair value for non-performing loans is based on the estimated
fair value of the underlying real estate, which is based on recent appraisals
or other estimation techniques. The estimated fair value of policy loans is
calculated by discounting estimated future cash flows using interest rates
currently being offered for similar loans. Loans with similar characteristics
are aggregated for purposes of estimating fair value. The statement of values
of cash and short-term investments and separate account assets approximate
their fair values. The estimated fair value for venture capital limited
partnerships is based on values determined by the partnerships' managing
general partners. The resulting estimated fair values may not be indicative of
the value negotiated in an actual sale.
The fair values of the Company's liabilities for individual annuities,
guaranteed investment contracts and other group annuities are estimated by
discounting the cash flows associated with the contracts, using an interest
rate currently offered for similar contracts with maturities similar to those
remaining for the contracts being valued. The statement value for certain of
the other group annuities, totaling $43,490 and $42,472 as of December 31, 1995
and 1994, respectively, approximates the fair value due to the nature of the
contracts. The statement values of dividends to policyholders payable in the
following year and separate account liabilities approximate their fair values.
Currently, disclosure of estimated fair values is not required for all of the
Company's assets and liabilities. Therefore, presentation of the estimated fair
value of a significant portion of assets without a corresponding valuation of
liabilities associated with insurance contracts can be misinterpreted. The
continuing management of the relationship between the maturities of the
Company's investments and the amounts due under insurance contracts reduces the
Company's exposure to changing interest rates.

B-32
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The Company is exposed to interest risk on its interest sensitive products. The
Company's investment strategy is designed to minimize interest risk by managing
the durations and anticipated cash flows of the Company's assets and
liabilities.
To minimize exposure and reduce risk from exchange and interest rate
fluctuations in the normal course of business, the Company is party to
financial instruments with off-balance-sheet risk. As of December 31, 1995 and
1994, the Company had interest rate swaps with aggregate notional amounts equal
to $115,000 with average unexpired terms of 39 and 51 months, respectively.
Interest rate swap agreements involve the exchange of fixed and floating rate
interest payment obligations without an exchange of the underlying notional
principal amounts. During the term of the swap, the net settlement amount is
accrued as an adjustment to interest income. If the counterparty defaults, the
Company is exposed only to the loss of the interest rate differential. If the
positions were closed as of December 31, 1995 and 1994, the Company would have
recognized gains of $12,880 and $4,479, respectively. The fair value for
interest rate swaps and futures contracts are based on dealers' quotes and
represent the estimated amounts the Company would receive to terminate the
contracts taking into account current interest rates and the creditworthiness
of the counterparties, where appropriate.
In the normal course of business, the Company loans securities under
arrangements in which collateral is obtained in amounts greater than the
current market value of loaned securities. This collateral is held in the form
of cash, cash equivalents or securities issued or guaranteed by the United
States Government. The Company is at risk to the extent the value of loaned
securities exceeds the value of the collateral obtained. The Company controls
this risk by requiring collateral of the highest quality and requiring that
additional collateral be deposited when the market value of loaned securities
increases in relation to the collateral held or the value of the collateral
decreases in relation to the value of the loaned securities. The Company had no
loaned securities outstanding as of December 31, 1995 and 1994.

NOTE 6 - BENEFIT PLANS:
The Company maintains both qualified and non-qualified defined benefit plans as
well as qualified defined contribution plans covering substantially all of its
employees and full-time agents. The total pension expense related to these
plans, including amounts allocated to the Company's subsidiaries, amounted to
$8,848, $7,757 and $11,591 in 1995, 1994 and 1993, respectively.

DEFINED BENEFIT PLANS
The Company's expense and funding policy for the qualified defined benefit plan
is to contribute an amount between the minimum required contribution and the
maximum deductible amount in accordance with the Internal Revenue Code. The
benefits for the plan are based on years of service and the employee's
compensation prior to termination of employment.
The following summarizes the accumulated plan benefits, calculated using the
projected unit credit method and plan net assets for the Company's qualified
defined benefit plan as of December 31, 1995 and 1994.

<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Actuarial present value of accumulated plan benefits:
Vested........................................................ $29,744 $21,105
Non-vested.................................................... 763 526
------- -------
TOTAL........................................................ $30,507 $21,631
======= =======
Net assets available for plan benefits......................... $34,067 $27,029
======= =======
</TABLE>

The actuarial present value of accumulated plan benefits was determined using a
7.0% and an 8.75% assumed discount rate for December 31, 1995 and 1994,
respectively.
The Company also sponsors defined benefit plans for certain employees in excess
of limits for qualified retirement plans. Pension assets are maintained in the
Company's general account. As of December 31, 1995, the plans' total
accumulated benefit obligation, determined in accordance with SFAS No. 87 and
based on a 7% assumed discount rate amounted to $17,609. As of December 31,
1994, the plans' total accumulated benefit obligation, determined in accordance
with SFAS No. 87 and based on an 8.75% assumed discount rate amounted to
$13,690. The additional obligation for future salary increases was $2,539 and
$2,363 as of December 31, 1995 and 1994, respectively.

B-33
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
DEFINED CONTRIBUTION PLANS
Defined contribution plan benefits are based on the participant's account
balance. Designated contributions of up to 8% of each employee's annual
compensation are eligible to be matched by the Company. As of December 31, 1995
and 1994, the estimated fair value of the defined contribution plans' assets
was $126,378 and $116,698, respectively.

POSTRETIREMENT BENEFITS
The Company also provides certain health care and life insurance benefits
(postretirement benefits) for retired employees. Substantially all employees
become eligible for these benefits if they reach retirement age eligibility
while working for the Company.
In 1993, the Company changed its method of accounting for the costs of these
postretirement benefits to an accrual method and elected to amortize the
transition obligation of $33,744 over 20 years. As of December 31, 1995 and
1994, the unamortized transition obligation was $28,683 and $30,370,
respectively.
Postretirement benefit expense for the year ended December 31, 1995, 1994 and
1993 was $4,426, $4,346, and $4,366 respectively, which includes the expected
cost of postretirement benefits for newly eligible or vested employees,
interest cost, service cost, and amortization of the transition obligation. The
interest cost and service cost were $2,471 and $268, respectively, for the year
ended December 31, 1995. The interest and cost and service cost were $2,366 and
$293, respectively, for the year ended December 31, 1994. The interest cost was
$2,679 for the year ended December 31, 1993. The Company made contributions to
the plans of $2,629, $2,438 and $2,594 in 1995, 1994 and 1993, respectively, as
claims were incurred.
As of December 31, 1995 and 1994, the unfunded postretirement benefit
obligation for retirees and other full, eligible or vested plan participants
was $36,150 and $32,678, respectively. For December 31, 1995 the discount rate
used in determining the accumulated postretirement benefit obligation was 7.0%,
and the health care cost trend rate was 9.0%, graded to 5.0% over 9 years. For
December 31, 1994, the discount rate used in determining the accumulated
postretirement benefit obligation was 8.75%, and the health care cost trend
rate was 9.5%, graded to 5.0% over 10 years.
The health care cost trend rate assumption has a significant effect on the
amount reported. To illustrate, increasing the assumed health care cost trend
rate by one percentage point in each year would increase the postretirement
benefit obligation as of January 1, 1995 by $2,974 and the estimated
eligibility cost and interest cost components of net periodic postretirement
benefit cost for the year ended December 31, 1995 by $186.

NOTE 7 - FEDERAL INCOME TAXES:
The provision for federal income taxes is computed in accordance with the
sections of the Internal Revenue Code applicable to mutual life insurance
companies.
The taxable income reflected in the Company's federal tax return differs from
statutory income as reflected in the accompanying Statements of Operations.
Significant differences relate to the DEA, treatment of policy acquisition
costs, differences in policy reserve valuation methods, and settled tax issues.
The IRS has examined the Company's income tax returns through the year 1987 and
is currently examining years 1988 through 1990. Management believes that an
adequate provision has been made for potential assessments.
In 1995, the Company settled various tax issues with the IRS, including an
issue surrounding the tax treatment of certain traditional life insurance
policy updates. As a result of these settlements, the 1995 federal income tax
expense was decreased in the Statement of Operations by approximately $57,000.
During 1993, the Company resolved a tax issue related to reserves held on its
universal life insurance contracts. As a result, previously recorded provisions
of $32,500 were reduced and recorded in the Statement of Operations as a
reduction to federal income tax expense in 1993.

B-34
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTE 8 - REINSURANCE:
The Company has assumed and ceded reinsurance on certain life and annuity
contracts under various agreements. The Company remains primarily liable as the
direct insurer on all risks reinsured, and performs due diligence to ensure
that amounts due from reinsurers are collectable. The table below includes the
reinsurance amounts recorded in the accompanying financial statements, which
are presented net of reinsurance activity.

<TABLE>
<CAPTION>
ASSUMED CEDED TO
GROSS FROM OTHER OTHER NET
AMOUNT COMPANIES COMPANIES AMOUNT
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1995:
Life Insurance in-force.......... $26,290,414 $7,668,076 $4,982,235 $28,976,255
Premium and annuity considera-
tions........................... 720,794 19,762 33,508 707,048
Reserves and funds for payment of
future life and annuity bene-
fits............................ 5,364,721 3,937 304,360 5,064,298
DECEMBER 31, 1994:
Life Insurance in-force.......... $26,226,662 $7,668,048 $5,067,815 $28,826,895
Premium and annuity considera-
tions........................... 769,448 40,418 41,332 768,534
Reserves and funds for payment of
future life and annuity bene-
fits............................ 5,439,027 19,533 318,781 5,139,779
</TABLE>

During 1993, the Company had gross premiums of $634,003, assumed premiums of
$36,623 and ceded premiums of $40,497.
Under reinsurance agreements with The Penn Insurance and Annuity Company (PIA),
a wholly-owned subsidiary, the Company has assumed and ceded certain risks. As
a result of these reinsurance agreements with PIA, net life insurance in-force
ceded to PIA totaled $342,694 and $368,473 as of December 31, 1995 and 1994,
respectively. The Company reduced its reserves by $242,691 and $226,751 as of
December 31, 1995 and 1994, respectively. Net premium and annuity
considerations ceded to PIA in 1995 were $11,056, which includes an experience
refund of $2,257. Net premium and annuity considerations assumed from PIA in
1994 and 1993 were $10,069 and $5,288, respectively.
During 1995, PIA recaptured its single premium immediate annuity business which
it had previously ceded entirely to the Company. The transaction resulted in
the transfer of approximately $31,000 of invested assets and policyholder
liabilities from the Company to PIA.
During 1995, the Company recaptured the portion of its disability income
business that was previously reinsured under a quota share and excess
reinsurance agreement with the Monarch Life Insurance Company ("Monarch"). As a
result of this recapture, approximately $21,200 of cash and policyholder
reserves were transferred to the Company from Monarch.

NOTE 9 - RELATED PARTIES:
The following summarizes the statement value of the Company's unconsolidated
subsidiaries and affiliates as of December 31, 1995 and 1994. As of December
31, 1995, the Company owned 100% of the common stock of these subsidiaries
(except as noted below).

<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
Independence Square Properties, Inc. ........................ $ 88,607 $ 69,544
PIA.......................................................... 65,601 56,523
Penn CMO Corp. (0%).......................................... -- 39,315
Independence Capital Group of Funds:
Total Return Bond (0%)...................................... -- 19,231
Total Return Growth (0%).................................... -- 18,670
Opportunities (0%).......................................... -- 15,712
Other affiliates............................................. 16,985 17,271
-------- --------
TOTAL...................................................... $171,193 $236,266
======== ========
</TABLE>

B-35
<PAGE>

- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The Company's unconsolidated subsidiaries had combined assets of $1,373,745 and
$1,306,729, and combined liabilities of $1,202,552 and $1,070,463 as of
December 31, 1995 and 1994, respectively. The Company recorded earnings from
these subsidiaries of $23,642, $24,311 and $16,833 for the years ended December
31, 1995, 1994 and 1993, respectively.
As of December 31, 1995 and 1994, bonds include notes receivable from
subsidiaries of $31,130 and $37,035, respectively. Investment income on notes
receivable from subsidiaries amounted to $3,118, $2,527 and $2,805 for 1995,
1994 and 1993, respectively.
During 1995, Penn CMO Corp. (Penn CMO), a wholly-owned subsidiary of the
Company, which had debt obligations outstanding that were collateralized by
mortgages owned by Penn CMO, was dissolved. Sufficient funds were collected
from these mortgages to satisfy the outstanding principal on the debt
obligations and the remaining assets of $40,395 were transferred to the Company
as a return of capital. As of December 31, 1994, Penn CMO had $24,887 of debt
obligations outstanding, which were collateralized by mortgages of $62,661.
Pursuant to a service agreement with Penn CMO, the Company was obligated to
advance delinquent payments of principal and interest on the mortgages and to
purchase or substitute other mortgages in place of delinquent and defective
mortgages. The Company purchased $5,878 and $2,761 of mortgages during 1995 and
1994, respectively. No substitutions were made under this agreement in 1995 and
1994.

NOTE 10 - COMMITMENTS AND CONTINGENCIES:
The Company and its subsidiaries are respondents in a number of proceedings,
some of which involve extra-contractual damage in addition to other damages. In
addition, insurance companies are subject to assessments, up to statutory
limits, by state guaranty funds for losses of policyholders of insolvent
insurance companies. In the opinion of management, the outcome of the
proceedings and assessments are not likely to have a material adverse effect on
the financial position of the Company.
The Company has undertaken to its wholly-owned subsidiary, PIA, to provide
sufficient financial support so that PIA will have adequate capital and surplus
as required by applicable laws to meet its obligations to its policyholders
under the terms of PIA's policies and contracts.
The Company, in the ordinary course of business, extends commitments relating
to its investment activities. As of December 31, 1995, the Company had
outstanding commitments totaling $8,725 relating to these investment
activities. The fair value of these commitments approximates the face amount.
As of December 31, 1995, unused lines of credit available to the Company
amounted to $40,000.

B-36