<PAGE>
May 1, 1997
The Penn Mutual Life Insurance Company
Philadelphia, PA
DIVERSIFIER II
- --------------------------------------------------------------------------------
PROFILE OF PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
This profile is a summary of some of the more important points that you should
consider and know before purchasing the Contracts. The Contracts are more fully
described in the prospectus which accompanies this Profile. Please read the
prospectus carefully
- --------------------------------------------------------------------------------
1. THE ANNUITY 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") between you, the owner, and The Penn Mutual Life Insurance
Company. The Contracts provide a means for you to invest in one or more of the
available investment funds listed in Section 4, or (for the "Variable/Fixed
Contract" only) one or more of the fixed interest accounts guaranteed and funded
by The Penn Mutual Life Insurance Company through its general account.
You determine (1) the amount and frequency of purchase payments, (2) the
investment funds, (3) transfers between the investment funds, (4) the type 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.
Purchase payments and investment gains allocated to the variable accounts vary
up and down with the investment experience of the underlying investment funds.
The investment risk is high or low, depending on the variable account selected.
Refer to section 8 to see calendar year performance of the investment funds
which will show you the range of historical returns.
2. ANNUITY PAYMENTS
- -----------------------------------
You may choose (1) an annuity for a specified number of years, (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) another form of an annuity that we may
agree upon. You may select any one of those as a variable annuity, a fixed
annuity, or a combination of both.
3. PURCHASE
- -----------------------------------
The Contracts may be purchased by individuals, corporations and other business
associations. They may be purchased under retirement plans that qualify for
special tax treatment under the Internal Revenue Code (Qualified Plan), or as a
Non-Qualified Plan.
<TABLE>
<CAPTION>
Variable/Fixed Contract Variable Contract
Minimum Minimum Minimum Minimum
Initial Subsequent Initial Subsequent
Payment Payment Payment Payment
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Qualified Plan $250 $50 $250 $40
Non-Qualified Plan $2,500 $300 $1,500 $300
</TABLE>
4. INVESTMENT OPTIONS
- -----------------------------------
Independence Capital
Management, Inc.
Growth Equity Fund
Quality Bond Fund
Money Market Fund
OpCap Advisors
Value Equity Fund
Small Capitalization Fund
Morgan Stanley Asset Management
Emerging Markets Equity (Int'l) Portfolio
Fidelity Investments
VIP Equity Income Portfolio
VIP Growth Portfolio
VIP II Asset Manager Portfolio
VIP II Index 500 Portfolio
American Century Investment Management, Inc.
VP Capital Appreciation Portfolio
Vontobel USA, Inc.
International Equity Fund
Neuberger & Berman Management Incorporated
AMT Limited Maturity Bond Portfolio
AMT Balanced Portfolio
AMT Partners Portfolio
T. Rowe Price Associates, Inc.
Flexibly Managed Fund
High Yield Bond Fund
ICMI/Robertson Stephens
Emerging Growth Fund
<PAGE>
5. EXPENSES
- -----------------------------------
Each year Penn Mutual deducts a contract administration charge of the lesser
of $30 or 2% of the variable account value. We deduct a daily expense risk
charge equal to an annual rate of 0.5% of the daily net asset value of the
variable account and a daily mortality risk charge equal to an annual rate of
0.75% of the daily net asset value of the variable account. The investment funds
underlying the variable accounts also incur expenses, which range from 0.28% to
1.75% of the fund's average daily value.
A contingent deferred sales charge may be deducted if you make a full or
partial withdrawal. For the Variable/Fixed Contract, the deferred sales charge
will equal:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
No Purchase Payments After 1st Contract Year
- ----------------------------------------------------------------
Deferred Sales Charge
Withdrawal During as a Percentage of
Contract Year 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>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
Purchase Payments After 1st Contract Year
- ----------------------------------------------------------------
Deferred Sales Charge
Withdrawal During as a Percentage of
Contract Year 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>
No deferred sales charge will be made on the portion of the first withdrawal
of each contract year that does not exceed 10% of the contract value
For the Variable Contract, the contingent deferred sales charge will be the
lesser of (a) 5% of the purchase payments made for the past seven years or (b)
5% of the amount withdrawn. Under no circumstances will the charge ever exceed
5% of the total purchase payments. No deferred sales charge will be made on the
portion of the first withdrawal that does not exceed 10% of the sum of purchase
payments made one or more years 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 your contract value:
<TABLE>
<CAPTION>
Contract Year Percentage
<S> <C>
Eighth 25%
Ninth 50%
Tenth 75%
</TABLE>
The following table is designed to help you understand the charges in your
Contract. The column "Total Annual Charges" shows the annual percentage charge
for contract administration (which is represented as .05%), insurance charges
and investment charges. The next columns show you two examples of the charges,
in dollars, you would pay under your Contract. The examples assume that you
invested $1,000 in a Contract which earns 5% annually and that you withdraw your
money at the end of the applicable period. The premium tax is assumed to be 0%
in both examples.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
Examples:
Total Annual
Expenses at the End of:
Total Total (Variable
Annual Annual Total /Fixed (Variable
Insurance Portfolio Annual Contract Contract
Fund Charges Charges Charges 1 Year 1 Year 10 Years
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Growth Equity 1.30% 0.80% 2.10% $86 $68 $246
Value Equity 1.30 0.78 2.08 86 68 243
Flexibly Managed 1.30 0.77 2.07 86 68 242
Small Capitalization 1.30 0.99 2.29 88 70 265
Emerging Growth 1.30 1.15 2.45 90 71 281
International Equity 1.30 1.17 2.47 90 71 283
Quality Bond 1.30 0.77 2.07 86 68 243
High Yield Bond 1.30 0.84 2.14 87 68 250
Money Market 1.30 0.73 2.03 86 67 238
VP Capital Appreciation 1.30 1.00 2.30 86 70 266
AMT Limited Maturity Bond 1.30 0.78 2.08 89 68 243
AMT Balanced 1.30 1.09 2.39 85 71 275
AMT Partners 1.30 0.95 2.25 88 69 261
VIP Equity Income 1.30 0.56 1.86 84 66 222
VIP Growth 1.30 0.67 1.97 86 67 234
VIP II Asset Manager 1.30 0.73 2.03 86 67 239
VIP II Index 500 1.30 0.28 1.58 81 63 190
Emerging Markets Equity (Int'l) 1.30 1.75 3.05 95 77 339
- --------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
6. TAXES
- -----------------------------------
Your gains under the Contracts are not taxed until you take them out. If you
take money out, earnings come out first and are taxed as income. If you are
younger than 59 1/2 when you take money out, you may be charged a 10% federal
tax penalty on the earnings. Payments during the income phase are considered
partly a return of your original investment. That part of each payment is not
taxable as income.
7. WITHDRAWALS
- -----------------------------------
You may withdraw all or part of your money at any time during the accumulation
phase. Once in each contract year on or after the last day of the first contract
year you may withdraw up to 10% of the Contract Value (determined as of the date
of withdrawal) free of the contingent deferred sales charge. A premature
withdrawal charge may be deducted from the money earned on the fixed interest
accounts if you take the money prior to maturity of your fixed interest account.
8. PERFORMANCE
- -----------------------------------
The value of the Contract will fluctuate depending upon the investment
performance of the fund(s) you choose. The following chart shows total returns
for each fund for the time periods shown. These numbers reflect the insurance
company charges and the investment charges of the fund, but do not reflect any
withdrawal charges, which would reduce the performance if they were applied.
Past performance is no guarantee of future results.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Calendar Year
Fund 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Independence Capital
Growth Equity 18.08% 24.68% -9.42% 10.85% 4.46% 33.02% -12.30% 29.60% 11.21% 3.90%
Quality Bond 2.67 18.46 -6.63 10.09 5.06 14.15 6.62 11.28 6.13 n/a
OpCap Advisors
Value Equity 23.40 35.55 1.48 5.57 13.24 26.08 -9.30 11.44 27.87 n/a
Small Capitalization 18.06 n/a n/a n/a n/a n/a n/a n/a n/a n/a
T. Rowe Price
Flexibly Managed 14.68 20.57 2.67 20.57 14.68 20.08 -2.16 19.50 17.29 21.93
High Yield Bond 12.27 14.78 -8.64 18.09 14.16 35.17 -10.03 -1.92 16.35 -2.19
ICMI/Robertson Stephens
Emerging Growth n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a
Vontobel
International Equity 15.20 12.21 -7.63 36.19 n/a n/a n/a n/a n/a n/a
American Century
VP Capital Appreciation -5.68 29.26 -2.57 8.77 -2.74 40.09 -2.53 27.19 -3.54 n/a
Neuberger & Berman
AMT Limited Maturity Bond 2.84 9.38 -1.56 5.12 -3.69 9.96 6.98 9.39 5.83 1.61
AMT Balanced 5.38 22.03 -4.72 4.55 6.53 21.14 0.67 n/a n/a n/a
AMT Partners 28.45 35.30 n/a n/a n/a n/a n/a n/a n/a n/a
Fidelity Investments
VIP Equity Income 12.64 32.36 4.96 16.63 15.24 29.80 -16.35 15.88 21.17 -2.37
VIP Growth 13.05 33.47 -1.43 17.69 7.78 43.69 -12.85 29.87 14.13 2.36
VIP II Asset Manager 12.99 15.32 -7.42 19.53 10.13 21.03 5.39 n/a n/a n/a
VIP II Index 500 21.65 36.01 0.17 8.79 n/a n/a n/a n/a n/a n/a
Morgan Stanley
Emerging Markets Equity (Int'l) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
9. DEATH BENEFIT
- -----------------------------------
If you die 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 period that proof of death is received
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.
If you die after the Annuity Date, 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.
10. OTHER INFORMATION
- -----------------------------------
Free Look. If you cancel your Contract within 10 days after receiving it
----------
(or whatever period is required in your state), we will send your money
back without assessing a withdrawal charge. You will receive whatever your
Contract is worth on the day we receive your request. This may be more or
less than your original payment.
No Probate. In most cases, when you die, the person you choose as your
-----------
beneficiary will receive the death benefit without going through probate.
Systematic Withdrawals. You can arrange to have up to 10% of your contract
-----------------------
value automatically sent to you on a modal basis while your Contract is
still in the accumulation phase. Of course, you'll have to pay taxes on
money you receive.
Disability. Under certain circumstances, you will have the ability to
-----------
withdraw your money free from the contingent deferred sales charge if you
become disabled.
Dollar Cost Averaging. You can arrange to have a regular amount of money
----------------------
automatically invested in the investment funds monthly or quarterly.
Automatic Asset Rebalancing. You can elect to have your investments
----------------------------
automatically rebalanced on a quarterly basis to maintain a specified
percentage allocation among your selected investment funds, which will not
include the fixed interset account.
11. INQUIRIES
- -----------------------------------
If you need more information, please contact us at:
The Penn Mutual Life Insurance Company
Customer Service Group
Philadelphia, PA 19172
1-800-523-0650
<PAGE>
PROSPECTUSES
Penn Mutual Variable Annuity Account III
May 1, 1997
DIVERSIFIER II
A Flexible Premium Variable And Fixed Annuity
Penn Series Funds, Inc.
May 1, 1997
Investment Advisers
T. Rowe Price Associates, Inc.
OpCap Advisors
Independence Capital Management, Inc.
Vontobel USA, Inc.
Robertson Stephens Investment Management, Inc.
American Century Variable Portfolios, Inc.
May 1, 1997
Investment Adviser:
American Century Investment Management, Inc.
Neuberger & Berman
Advisers Management Trust
May 1, 1997
Investment Adviser
Neuberger & Berman Management Incorporated
Fidelity Investments'
Variable Insurance Products Fund
Variable Insurance Products Fund II
April 30, 1997
Investment Adviser:
Fidelity Management & Research Company
Morgan Stanley Universal Funds, Inc.
May 1, 1997
Investment Adviser:
Morgan Stanley Asset Management
[LOGO OF PENN MUTUAL APPEARS HERE]
Investment Choices,
Retirement Opportunities
<PAGE>
No offering is made hereby in any jurisdiction in which
such offering may not lawfully be made.
No person is authorized to make any representations in
connection with this offering other than those
representations contained in the Prospectuses.
<PAGE>
PROSPECTUS -- MAY 1, 1997
INDIVIDUAL ANNUITY CONTRACTS WITH VARIABLE BENEFIT PROVISIONS--FLEXIBLE
PURCHASE PAYMENTS
- --------------------------------------------------------------------------------
DIVERSIFIER II
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
THE PENN MUTUAL LIFE INSURANCE COMPANY
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:
MANAGERS
Independence Capital Management, Inc. (a
PENN SERIES FUNDS, INC. subsidiary of Penn Mutual)
Growth Equity Fund
Value Equity Fund OpCap Advisors
Small Capitalization Fund OpCap Advisors
Emerging Growth Fund Independence Capital Management, Inc./
Robertson Stephens Investment Management
Inc.
T. Rowe Price Associates, Inc.
Flexibly Managed Fund
Vontobel USA Inc. (a subsidiary of
International Equity Fund Vontobel Holding Ltd.)
Independence Capital Management, Inc.
T. Rowe Price Associates, Inc.
Quality Bond Fund
High Yield Bond Fund Independence Capital Management, Inc.
Money Market Fund
- --------------------------------------------------------------------------------
AMERICAN CENTURY VARIABLE PORTFOLIOS, INC.
Capital Appreciation Portfolio American Century Investment Management,
Inc.
- --------------------------------------------------------------------------------
NEUBERGER & BERMAN ADVISERS MANAGEMENT TRUST
Limited Maturity Bond Portfolio Neuberger & Berman Management Incorporated
Balanced Portfolio Neuberger & Berman Management Incorporated
Partners Portfolio Neuberger & Berman Management Incorporated
- --------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND
Growth Portfolio Fidelity Management and Research Company
Fidelity Management and Research Company
Equity Income Portfolio
- --------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND II
Asset Manager Portfolio Fidelity Management and Research Company
Index 500 Portfolio Fidelity Management and Research Company
- --------------------------------------------------------------------------------
MORGAN STANLEY UNIVERSAL FUNDS, INC.
Morgan Stanley Asset Management Inc.
Emerging Markets Equity (International) Portfolio
- --------------------------------------------------------------------------------
Contract values and annuity payments based upon investment in one or more of
the investment funds vary in accordance with the investment experience of the
selected Funds.
Under the combination variable and fixed annuity contract, purchasers may al-
locate 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 with-
drawals 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% addi-
tional income tax.
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 vari-
able annuity contract may be returned within ten days of receipt for a full re-
fund of the contract value. Longer free look periods and full refund of pur-
chase 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, Philadelphia, PA 19172. Or, you
can call, toll free, 1-800-523-0650. 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
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY...................................... 13
The Separate Account...................................................... 13
Penn Series Funds, Inc.................................................... 13
American Century Variable Portfolios, Inc................................. 14
Neuberger & Berman Advisers Management Trust.............................. 14
Fidelity Investments' Variable Insurance Products Fund.................... 14
Fidelity Investments' Variable Insurance Products Fund II................. 15
Morgan Stanley Universal Funds, Inc. ..................................... 15
- --------------------------------------------------------------------------------
THE CONTRACTS............................................................... 15
Purchases................................................................. 16
Accumulation Units........................................................ 16
Annuity Payments.......................................................... 16
Payment on Death.......................................................... 17
Transfers................................................................. 18
Withdrawals............................................................... 18
Deferment of Payments and Transfers....................................... 19
Deductions and Expenses................................................... 19
- --------------------------------------------------------------------------------
THE FIXED INTEREST OPTIONS.................................................. 21
- --------------------------------------------------------------------------------
FEDERAL INCOME TAX CONSIDERATIONS........................................... 22
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION CONTENTS................................ 24
- --------------------------------------------------------------------------------
</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
<TABLE>
- ------------------------------------------------------------------------------
<S> <C>
CONTRACT OWNER TRANSACTION EXPENSES
Sales Load Imposed on Purchase Payments............................... None
Maximum Contingent Deferred Sales Load
Variable/Fixed Contract.............................................. 7%*
Variable Contract.................................................... 5%**
Exchange Fee.......................................................... None
MAXIMUM ANNUAL CONTRACT ADMINISTRATION CHARGE......................... $30
SEPARATE ACCOUNT ANNUAL EXPENSES (AS A PERCENTAGE OF VARIABLE ACCOUNT
VALUE)
Mortality and Expense Risk Charge..................................... 1.25%
Account Fees and Expenses............................................. None
-----
Total Separate Account Annual Expenses................................ 1.25%
</TABLE>
- -------
* As a percentage of the amount withdrawn, provided the charge will never be
more than 8 1/2% of the total of all purchase payments credited to the Sep-
arate Account. After the first contract year, the charge will not be made
on the first withdrawal in a contract year to the extent the withdrawal
does not exceed 10% of the contract value. See "Deductions and Expenses" in
this prospectus for information on the decline in the percentage charge
over time and other limitations on the charge.
** As a percentage of the sum of all purchase payments made within seven years
of withdrawal or as a percentage of the amount withdrawn, whichever is
less. The charge will not be made on that portion of the first withdrawal
in a contract year that does not exceed 10% of purchase payments made one
year or more prior to the withdrawal. See "Deductions and Expenses" in this
prospectus for information on the decline in the percentage charge over
time and other limitations on the charge.
- -------------------------------------------------------------------------------
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........... 0.50% 0.15% 0.08% 0.07% 0.80%
Value Equity............ 0.50% 0.15% 0.07% 0.06% 0.78%
Small Capitalization.... 0.50% 0.15% 0.27% 0.07% 0.99%
Emerging Growth......... 0.80% 0.15% 0.07% 0.13% 1.15%
Flexibly Managed........ 0.50% 0.15% 0.06% 0.06% 0.77%
International Equity.... 0.75% 0.15% 0.09% 0.18% 1.17%
Quality Bond............ 0.45% 0.15% 0.08% 0.09% 0.77%
High Yield Bond......... 0.50% 0.15% 0.08% 0.11% 0.84%
Money Market............ 0.40% 0.15% 0.08% 0.10% 0.73%
</TABLE>
- -------
** The expenses presented are for the last fiscal year, except expenses for
the Emerging Growth Fund, a new Fund, are estimated. 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 0.81% and 0.78% re-
spectively. In the absence of voluntary fee waivers by the investment ad-
viser and administrator of the Fund, the total expenses of the Money Market
and the Small Capitalization Funds would have been 0.74% and 1.06%, respec-
tively.
4
<PAGE>
- -------------------------------------------------------------------------------
AMERICAN CENTURY VARIABLE 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>
Capital Appreciation.................. 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% 0.13% 0.78%
Balanced..................................... 0.85% 0.24% 1.09%
Partners Fund................................ 0.84% 0.11% 0.95%
</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% 0.05% 0.56%
Growth........................................... 0.61% 0.06% 0.67%
</TABLE>
- -------
++ The expenses presented are for the last fiscal year. A portion of the bro-
kerage commissions the fund paid was used to reduce its expenses. Without
this reduction, total expenses would have been 0.58% for the Equity Income
Portfolio and 0.69% for the Growth Portfolio.
- -------------------------------------------------------------------------------
FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND II
UNDERLYING FUND ANNUAL EXPENSES (AS A % OF PORTFOLIO AVG. NET ASSETS)
<TABLE>
<CAPTION>
MANAGEMENT OTHER TOTAL FUND
FEES EXPENSES EXPENSES
---------- -------- ----------
<S> <C> <C> <C>
++Asset Manager.................................. 0.64% 0.09% 0.73%
+++Index 500..................................... 0.13% 0.15% 0.28%
</TABLE>
- -------
++ The expenses presented are for the last fiscal year. A portion of the bro-
kerage commissions the fund paid was used to reduce its expenses. Without
this reduction, total expenses would have been 0.74% for the Asset Manager
Portfolio.
+++ The expenses presented are for the last fiscal year. In the absence of
voluntary fee waivers by the investment adviser, total expenses would have
been 0.43% for the Index 500 Portfolio.
- -------------------------------------------------------------------------------
MORGAN STANLEY UNIVERSAL FUNDS, INC.
UNDERLYING FUND ANNUAL EXPENSES (AS A % OF PORTFOLIO AVG. NET ASSETS)
<TABLE>
<CAPTION>
MANAGEMENT OTHER TOTAL FUND
FEES EXPENSES EXPENSES
---------- -------- ----------
<S> <C> <C> <C>
Emerging Markets Equity (International) Portfo-
lio............................................ 1.25% 0.50% 1.75%
</TABLE>
- -------------------------------------------------------------------------------
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.,
American Century Variable Portfolios, Inc., Neuberger & Berman Advisers
Management Trust, Fidelity Investments' Variable Insurance Products Fund,
Fidelity Investments' Variable Insurance Products Fund II and Morgan Stanley
Universal Funds, Inc. 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 Money Market Fund........................... $86 $113 $142 $238
Penn Series Quality Bond Fund........................... $86 $115 $144 $243
Penn Series High Yield Bond Fund........................ $87 $117 $147 $250
Penn Series Growth Equity Fund.......................... $86 $115 $145 $246
Penn Series Value Equity Fund........................... $86 $115 $144 $243
Penn Series Flexibly Managed Fund....................... $86 $115 $144 $242
Penn Series International Equity Fund................... $90 $126 $163 $283
Penn Series Small Capitalization Fund................... $88 $121 $155 $265
Penn Series Emerging Growth Fund........................ $90 $126 $162 $281
Capital Appreciation Portfolio.......................... $86 $115 $144 $243
Neuberger & Berman Limited Maturity Bond Portfolio...... $89 $124 $159 $275
Neuberger & Berman Balanced Portfolio................... $85 $112 $140 $234
Neuberger & Berman Partners Portfolio................... $88 $120 $153 $261
Fidelity's Growth Portfolio............................. $85 $112 $140 $234
Fidelity's Equity Income Portfolio...................... $84 $109 $134 $222
Fidelity's Asset Manager Portfolio...................... $86 $114 $142 $239
Fidelity's Index 500.................................... $81 $100 $119 $190
Morgan Stanley Emerging Markets Equity (International)
Portfolio.............................................. $95 $143 $191 $339
- -------------------------------------------------------------------------------
</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 Money Market Fund........................... $86 $113 $147 $250
Penn Series Quality Bond Fund........................... $86 $115 $149 $255
Penn Series High Yield Bond Fund........................ $87 $117 $152 $262
Penn Series Growth Equity Fund.......................... $86 $115 $150 $258
Penn Series Value Equity Fund........................... $86 $115 $149 $255
Penn Series Flexibly Managed Fund....................... $86 $115 $149 $254
Penn Series International Equity Fund................... $90 $126 $168 $295
Penn Series Small Capitalization Fund................... $88 $121 $160 $277
Penn Series Emerging Growth Fund........................ $90 $126 $167 $293
Capital Appreciation Portfolio.......................... $86 $115 $149 $255
Neuberger & Berman Limited Maturity Bond Portfolio...... $89 $124 $165 $287
Neuberger & Berman Balanced Portfolio................... $85 $112 $145 $246
Neuberger & Berman Partners Portfolio................... $88 $120 $158 $273
Fidelity's Growth Portfolio............................. $86 $114 $147 $251
Fidelity's Equity Income Portfolio...................... $84 $109 $139 $235
Fidelity's Asset Manager Portfolio...................... $86 $114 $147 $251
Fidelity's Index 500.................................... $81 $100 $124 $202
Morgan Stanley Emerging Markets Equity (International)
Portfolio.............................................. $95 $143 $196 $350
</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 invest-
ed, 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 $114 $160 $238
Penn Series Quality Bond Fund........................... $68 $115 $163 $243
Penn Series High Yield Bond Fund........................ $68 $117 $166 $250
Penn Series Growth Equity Fund.......................... $68 $116 $164 $246
Penn Series Value Equity Fund........................... $68 $115 $163 $243
Penn Series Flexibly Managed Fund....................... $68 $115 $162 $242
Penn Series International Equity Fund................... $71 $127 $183 $283
Penn Series Small Capitalization Fund................... $70 $121 $174 $265
Penn Series Emerging Growth Fund........................ $71 $126 $182 $281
Capital Appreciation Portfolio.......................... $70 $122 $174 $266
Neuberger & Berman Limited Maturity Bond Portfolio...... $68 $115 $163 $243
Neuberger & Berman Balanced Portfolio................... $71 $124 $179 $275
Neuberger & Berman Partners Portfolio................... $69 $120 $172 $261
Fidelity's Growth Portfolio............................. $67 $113 $158 $234
Fidelity's Equity Income Portfolio...................... $66 $110 $153 $222
Fidelity's Asset Manager Portfolio...................... $67 $114 $161 $239
Fidelity's Index 500.................................... $63 $100 $137 $190
Morgan Stanley Emerging Markets Equity (International)
Portfolio.............................................. $77 $143 $211 $339
</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 ap-
plicable time period, you would pay the following expenses on each $1,000 in-
vested, 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 $110 $238
Penn Series Quality Bond Fund........................... $21 $66 $113 $243
Penn Series High Yield Bond Fund........................ $22 $68 $116 $250
Penn Series Growth Equity Fund.......................... $22 $66 $114 $246
Penn Series Value Equity Fund........................... $21 $66 $113 $243
Penn Series Flexibly Managed Fund....................... $21 $66 $112 $242
Penn Series International Equity Fund................... $25 $78 $133 $283
Penn Series Small Capitalization Fund................... $23 $72 $124 $265
Penn Series Emerging Growth Fund........................ $25 $77 $132 $281
Capital Appreciation Portfolio.......................... $21 $66 $113 $243
Neuberger & Berman Limited Maturity Bond Portfolio...... $24 $75 $129 $275
Neuberger & Berman Balanced Portfolio................... $20 $63 $108 $234
Neuberger & Berman Partners Portfolio................... $23 $71 $122 $261
Fidelity's Growth Portfolio............................. $21 $65 $111 $239
Fidelity's Equity Income Portfolio...................... $19 $60 $103 $222
Fidelity's Asset Manager Portfolio...................... $21 $65 $111 $239
Fidelity's Index 500.................................... $16 $50 $ 87 $190
Morgan Stanley Emerging Markets Equity (International)
Portfolio.............................................. $31 $95 $161 $339
</TABLE>
The examples are based upon data for the fiscal year ended December 31, 1996
and assume an average Variable Account Value or Contract Value of approximately
$8,200. 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,
- -----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
- -----------------------------------------------------------------------------------------------------------------------
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........ $ 32.596 $ 32.327 $ 26.102 $ 25.887 $ 28.766 $ 28.528 $ 25.906 $ 25.692 $ 24.756 $ 24.552
Accumulation Unit
Value, end of pe-
riod............. $ 38.550 $ 38.235 $ 32.596 $ 32.327 $ 26.102 $ 25.887 $ 28.766 $ 28.528 $ 25.906 $ 25.692
Number of Accumu-
lation Units out-
standing, end of
period........... 1,830,081 620,903 1,991,646 674,290 2,119,836 717,328 2,042,023 685,110 2,004,015 669,679
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------------------------------------------
1991 1990 1989 1988 1987
- ----------------------------------------------------------------------------------------------------------------------
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........ $ 18.605 $ 18.451 $ 21.204 $ 21.029 $ 16.356 $ 16.221 $ 14.702 $ 14.581 $ 14.145 $ 14.029
Accumulation Unit
Value, end of
period........... $ 24.756 $ 24.552 $ 18.605 $ 18.451 $ 21.204 $ 21.029 $ 16.356 $ 16.221 $ 14.702 $ 14.581
Number of
Accumulation
Units
outstanding, end
of period........ 1,680,322 518,717 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.
8
<PAGE>
- --------------------------------------------------------------------------------
PENN SERIES VALUE EQUITY FUND SUBACCOUNT (A)
Values of an Accumulation Unit Outstanding Throughout Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ---------------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987(B)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation
Unit Value
beginning of
period......... $ 24.928 $ 18.361 $ 18.062 $ 17.080 $ 15.058 $ 11.939 $ 13.157 $ 11.802 $ 9.226 $ 10.000
Accumulation
Unit Value, end
of period...... $ 30.819 $ 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.. 4,907,784 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,
- -----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Val-
ue, beginning of pe-
riod................. $ 42.865 $ 35.496 $ 34.514 $ 30.179 $ 27.893 $ 23.215 $ 23.712 $ 19.832 $16.898 $13.851
Accumulation Unit
Value, end of period. $ 49.262 $ 42.865 $ 35.496 $ 34.514 $ 30.179 $ 27.893 $ 23.215 $ 23.712 $19.832 $16.898
Number of Accumulation
Units outstanding,
end of period........ 5,711,843 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
- -----------------------------------------------------------------------------------------------------------------------
</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,
- -------------------------------------------------------------------------------
1996 1995 1994 1993 1992(A)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period....... $ 14.434 $ 12.843 $ 13.880 $ 10.175 $10.00
Accumulation Unit Value,
end of period............. $ 16.659 $ 14.434 $ 12.843 $ 13.880 $10.175
Number of Accumulation
Units outstanding, end of
period.................... 4,012,762 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
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987(B)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Val-
ue, beginning of pe-
riod................. $ 18.465 $ 15.562 $ 16.639 $ 15.088 $ 14.336 $ 12.558 $ 11.776 $ 10.580 $ 9.968 $10.000
Accumulation Unit
Value, end of period. $ 18.990 $ 18.465 $ 15.562 $ 16.639 $ 15.088 $ 14.336 $ 12.558 $ 11.776 $ 10.580 $ 9.968
Number of Accumulation
Units outstanding,
end of period........ 1,664,378 1,869,975 1,890,869 1,953,188 1,337,087 1,229,163 1,075,187 769,467 274,657 130,130
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Fixed 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 HIGH YIELD BOND FUND SUBACCOUNT
Values of an Accumulation Unit Outstanding Throughout Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value
beginning of period.... $ 26.033 $ 22.644 $ 24.742 $ 20.918 $ 18.291 $ 13.534 $ 15.035 $ 15.325 $ 13.193 $ 13.461
Accumulation Unit Value
end of period.......... $ 29.276 $ 26.033 $ 22.644 $ 24.742 $ 20.918 $ 18.291 $ 13.534 $ 15.035 $ 15.325 $ 13.193
Number of Accumulation
Units outstanding, end
of period.............. 1,185,318 1,194,944 1,264,890 1,257,271 705,414 594,530 613,408 817,147 708,838 469,236
</TABLE>
- --------------------------------------------------------------------------------
PENN SERIES SMALL CAPITALIZATION FUND SUBACCOUNT
Values of an Accumulation Unit Outstanding Throughout Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------
1996 1995(A)
- -------------------------------------------------------------------------------
<S> <C> <C>
Accumulation Unit Value, beginning of period........... $ 11.171 $ 10.000
Accumulation Unit Value, end of period................. $ 13.211 $ 11.171
Number of Accumulation Units outstanding, end of peri-
od.................................................... 587,385 137,653
- -------------------------------------------------------------------------------
</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,
- -------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $ 18.148 $ 17.416 $17.003 $ 16.791 $ 16.491 $ 15.732 $ 14.893 $ 13.844 $ 13.089 $12.482
Accumulation Unit Value,
end of period.......... $ 18.817 $ 18.148 $17.416 $ 17.003 $ 16.791 $ 16.491 $ 15.732 $ 14.893 $ 13.844 $13.089
Number of Accumulation
Units outstanding, end
of period.............. 1,192,388 1,062,385 825,274 658,620 698,584 769,958 965,117 753,052 319,671 242,494
</TABLE>
- --------------------------------------------------------------------------------
10
<PAGE>
- --------------------------------------------------------------------------------
AMERICAN CENTURY CAPITAL APPRECIATION PORTFOLIO SUBACCOUNT (A)
Values of an Accumulation Unit Outstanding Throughout Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------
1996 1995 1994 1993(B)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Accumulation Unit Value, beginning of
period................................. $ 14.057 $ 10.857 $ 11.124 $ 10.000
Accumulation Unit Value, end of period.. $ 13.282 $ 14.057 $ 10.857 $ 11.124
Number of Accumulation Units outstand-
ing, end of period..................... 2,183,381 2,157,888 1,791,799 716,404
</TABLE>
- --------------------------------------------------------------------------------
(a)TCI Growth Portfolio Subaccount prior to May 1, 1997
(b) 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 Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------
1996 1995 1994 1993(A)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Accumulation Unit Value, beginning of peri-
od......................................... $ 10.999 $ 10.039 $10.181 $ 10.000
Accumulation Unit Value, end of period...... $ 11,330 $ 10.999 $10.039 $ 10.181
Number of Accumulation Units outstanding,
end of period.............................. 459,223 444,986 448,825 311,665
</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 Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------
1996 1995 1994 1993(A)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Accumulation Unit Value, beginning of
period................................. $ 12.488 $ 10.218 $ 10.706 $ 10.000
Accumulation Unit Value, end of period.. $ 13.182 $ 12.488 $ 10.218 $ 10.706
Number of Accumulation Units outstand-
ing, end of period..................... 1,535,496 1,468,254 1,223,496 621,326
- -------------------------------------------------------------------------------
</TABLE>
(a) For the period May 1, 1993 (date subaccount was established) through
December 31, 1993
- --------------------------------------------------------------------------------
FIDELITY INVESTMENT'S EQUITY INCOME FUND SUBACCOUNT
Values of an Accumulation Unit Outstanding Throughout Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- --------------------------------------------------------------------------------
1996 1995(A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Accumulation Unit Value, beginning of period.......... $ 11.920 $ 10.000
Accumulation Unit Value, end of period................ $ 13.453 $ 11.920
Number of Accumulation Units outstanding, end of peri-
od................................................... 2,498,343 581,691
- --------------------------------------------------------------------------------
(a) For the period May 1, 1995 (date subaccount was established) through Decem-
ber 31, 1995.
- --------------------------------------------------------------------------------
FIDELITY INVESTMENTS' GROWTH FUND SUBACCOUNT
Values of an Accumulation Unit Outstanding Throughout Each Period
<CAPTION>
YEAR ENDED DECEMBER 31,
- --------------------------------------------------------------------------------
1996 1995(A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Accumulation Unit Value, beginning of period.......... $ 12.359 $ 10.000
Accumulation Unit Value, end of period................ $ 14.000 $ 12.359
Number of Accumulation Units outstanding, end of peri-
od................................................... 2,620,543 690,602
- --------------------------------------------------------------------------------
</TABLE>
(a) For the period May 1, 1995 (date subaccount was established) through Decem-
ber 31, 1995.
11
<PAGE>
- --------------------------------------------------------------------------------
FIDELITY INVESTMENTS' ASSET MANAGER FUND SUBACCOUNT
Values of an Accumulation Unit Outstanding Throughout Each Period
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
- --------------------------------------------------------------------------------
1996 1995(A)
- --------------------------------------------------------------------------------
<S> <C> <C>
Accumulation Unit Value, beginning of period.................. $ 11.153 $ 10.000
Accumulation Unit Value, end of period........................ $ 12.623 $ 11.153
Number of Accumulation Units outstanding, end of period....... 383,267 117,290
- --------------------------------------------------------------------------------
</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, 1996 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 The Penn Mutual Life Insurance Company, 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 investment
portfolios of Penn Series Funds, Inc., American Century Variable Portfolios,
Inc., Neuberger & Berman Advisers Management Trust, Fidelity Investments'
Variable Insurance Products Fund, Variable Insurance Products Fund II and
Morgan Stanley Universal 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 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,
American Century Variable Portfolios, Inc., Fidelity Investments' Variable
Insurance Products Fund, Variable Insurance Products Fund II and Morgan Stanley
Universal Funds, Inc.
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 American Century Variable Portfolios, Inc.,
Neuberger & Berman Advisers Management Trust, Fidelity Investments' Variable
Insurance Products Fund, Variable Insurance Products Fund II and Morgan Stanley
Universal Funds, Inc. 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;
SMALL CAPITALIZATION FUND - seeks capital appreciation through investment in
a diversified portfolio of securities consisting primarily of equity securities
of companies with market capitalizations under $1 billion.
13
<PAGE>
EMERGING GROWTH FUND - seeks capital appreciation by investing primarily in
common stocks of emerging growth companies with above-average growth prospects;
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 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. Independence Capital Management, Inc.
is also investment adviser, and Robertson Stephens Investment Management, Inc.,
San Francisco, California is investment sub-adviser to the Emerging Growth
Fund.
- --------------------------------------------------------------------------------
AMERICAN CENTURY VARIABLE PORTFOLIOS, INC.:
CAPITAL APPRECIATION PORTFOLIO - seeks capital growth by investing primarily
in common stocks believed to have better-than-average prospects for
appreciation.
American Century Investment Management, Inc., Kansas City, Missouri, is
investment adviser to the Capital Appreciation 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.
PARTNERS PORTFOLIO - seeks capital growth by investing primarily in common
stocks of established companies, using the value oriented investment approach.
Neuberger & Berman reserves the right to make changes in the investment
objective, but will notify shareholder thirty days in advance of any proposed
material change.
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.
14
<PAGE>
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.
- -------------------------------------------------------------------------------
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.
INDEX 500 PORTFOLIO - seeks to match the total return of the S&P 500 while
keeping expenses low. The S&P 500 is an index of 500 common stocks, most of
which trade on the New York Stock Exchange.
Fidelity Management & Research Company, Boston, Massachusetts, is investment
adviser to the Asset Manager Portfolio.
- -------------------------------------------------------------------------------
MORGAN STANLEY UNIVERSAL FUNDS, INC.:
MORGAN STANLEY EMERGING MARKETS EQUITY (INTERNATIONAL) PORTFOLIO - seeks
long term capital appreciation by investing primarily in equity securities of
emerging market country issuers. The Portfolio will focus on economies which
are developing strongly and in which the markets are becoming more
sophisticated.
Morgan Stanley Asset Management Inc. is investment adviser to the Emerging
Markets Equity (International) Portfolio.
- -------------------------------------------------------------------------------
FOR MORE INFORMATION ON THE FUNDS AND PORTFOLIOS IN WHICH THE SUBACCOUNTS
INVEST, SEE THE ACCOMPANYING PROSPECTUSES FOR PENN SERIES FUNDS, INC.,
AMERICAN CENTURY VARIABLE PORTFOLIOS, INC., NEUBERGER & BERMAN ADVISERS
MANAGEMENT TRUST, AND FIDELITY INVESTMENTS' VARIABLE INSURANCE PRODUCTS FUND,
VARIABLE INSURANCE PRODUCTS FUND II AND MORGAN STANLEY UNIVERSAL FUNDS, INC.
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.,
American Century Variable Portfolios, Inc., Neuberger & Berman Advisers
Management Trust, and Fidelity Investments' Variable Insurance Products Fund,
Variable Insurance Products Fund II and Morgan Stanley Universal Funds, Inc.
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
18 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., American Century Variable Portfolios, Inc., Neuberger & Berman Advisers
Management Trust, and Fidelity Investments' Variable Insurance Products Fund,
Variable Insurance Products Fund II and Morgan Stanley Universal Funds, Inc.
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.
15
<PAGE>
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, Philadelphia, PA 19172. Or, you can
call, toll free, 1-800-523-0650.
- --------------------------------------------------------------------------------
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.
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, 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.
16
<PAGE>
The mortality and expense risk charges specified in the Contracts are as-
sessed 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 in-
volving 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 deter-
mined 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 option by giving written notice at our serv-
ice 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. Howev-
er, if any payment would be less than $50, we may change the frequency of annu-
ity 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 pay-
ments, adjusted for withdrawals and contract transfers, (2) the Contract Value
for the valuation period in which proof of death and any other required infor-
mation 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 Ac-
count 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, ad-
justed for subsequent purchase payments and adjusted for withdrawals and con-
tract 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 withdraw-
als and contract transfers. With respect to Contracts sold in Texas, if the An-
nuitant (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 benefi-
ciary 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 dece-
dent, the beneficiary may elect an annuity option that was available to the de-
cedent. 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 speci-
fied 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 be-
fore the death of the Contract Owner or Annuitant, whichever occurs first. Own-
ers of Variable Contracts may change the beneficiary while the Annuitant is
alive.
17
<PAGE>
- --------------------------------------------------------------------------------
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 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
18
<PAGE>
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 2% of the
current value of the variable accounts, whichever is less, 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 canceling 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.
19
<PAGE>
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
------------------------------------------------------------------------
Second, if purchase payments have been made in any contract year after the
first, the deferred sales charge will equal:
<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 pay-
ments made within seven years prior to the date of withdrawal or (b) 5% of the
amount withdrawn. Under no circumstances will the charge ever exceed 5% of to-
tal 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 pay-
ments 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 per-
centages 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 pur-
chase payments made one year or more prior to the first withdrawal.
20
<PAGE>
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 Sec-
tion 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 re-
duce 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 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 pre-
mature withdrawal charge invade the Contract Owner's principal investment in
the applicable fixed interest option. In accordance with state law, we may de-
fer 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 priv-
ilege, including minimum and maximum loan amounts, repayment terms, and re-
strictions on prepayments. The following paragraphs describe how exercise of
the loan privilege may relate to the Variable Account Value.
21
<PAGE>
First, at the time a contract loan is made and in accordance with the Con-
tract 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 Ac-
count will be transferred to the Contract Owner's investment options in accor-
dance 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 Re-
stricted Account to the Fixed Holding Account. Contract Owners may then trans-
fer amounts from the Fixed Holding Account to the other investment options of-
fered under the Contract.
Fourth, if a payment or the entire loan is in default as defined in the Con-
tract, Penn Mutual will report the amount of the default to the Internal Reve-
nue 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 bal-
ance, plus interest, if the entire loan is in default, plus any applicable con-
tingent deferred sales charge, will be withdrawn by Penn Mutual from the Con-
tract'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 out-
standing 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 pay-
ments 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 para-
graph. 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 Re-
tirement 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 fi-
duciary to ensure that any Contract loans comply with plan qualification re-
quirements, 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 Account-
ing 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 legis-
lative 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 with-
drawal 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 taxable portion
is taxed at ordinary income tax rates. Designation of a beneficiary who is ei-
ther 37 1/2 years younger than the Contract Owner or a grandchild of the Con-
tract Owner may have Generation Skipping Transfer Tax consequences under Sec-
tion 2601 of the Internal Revenue Code.
For annuity payments, the taxable portion is generally determined by a for-
mula 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 ba-
sis, 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 total and
permanent disability (as defined in the Code). Further, there will be no
additional tax on distributions within certain other exceptions to the general
rule.
22
<PAGE>
The transfer of a Contract may result in the transferor incurring tax. If the
transfer is for less than adequate consideration 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 in-
come 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 in-
come tax purposes, the income on the Contract is treated as ordinary income re-
ceived 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 certain other types of plans (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, American Century
Variable Portfolios, Inc., Neuberger & Berman Advisers Management Trust and
Fidelity Investments' Variable Insurance Products Fund, Variable Insurance
Products Fund II and Morgan Stanley Universal Funds, Inc., intends to comply
with those requirements. The requirements are briefly discussed in the
accompanying prospectuses for the underlying Funds.
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 retire-
ment 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 quali-
fied 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 pro-
visions 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 appli-
cable. For further information, a prospective purchaser should consult quali-
fied tax counsel.
23
<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-11
Yields (Money Market Fund)............................................... B-11
- --------------------------------------------------------------------------------
DISTRIBUTION OF CONTRACTS AND CERTIFICATES................................. B-12
- --------------------------------------------------------------------------------
CUSTODIAN.................................................................. B-12
- --------------------------------------------------------------------------------
INDEPENDENT ACCOUNTANTS.................................................... B-12
- --------------------------------------------------------------------------------
LEGAL MATTERS.............................................................. B-13
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS....................................................... B-13
- --------------------------------------------------------------------------------
</TABLE>
24
<PAGE>
[LOGO OF PENN MUTUAL APPEARS HERE]
The Penn Mutual Life Insurance Company
Independence Square, Philadelphia, PA 19172
EB 1474 5/97
<PAGE>
PROSPECTUS -- MAY 1, 1997
CERTIFICATES ISSUED UNDER GROUP VARIABLE AND FIXED ANNUITY CONTRACTS --
FLEXIBLE PURCHASE PAYMENTS
- --------------------------------------------------------------------------------
OPTIMIZER
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
THE PENN MUTUAL LIFE INSURANCE COMPANY
PHILADELPHIA, PA 19172 . TELEPHONE (215) 956-8000
- --------------------------------------------------------------------------------
The variable account provisions of the group variable and fixed annuity
contracts described in this prospectus 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"), accumulation values and annuity
payment reserves are invested, at the direction of the account owner, in one or
more of the following Funds of Penn Series Funds, Inc.
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
International Equity Fund T. Rowe Price Associates, Inc.
Quality Bond Fund Vontobel USA Inc. (a subsidiary of
High Yield Bond Fund Vontobel Holding Ltd.)
Money Market Fund 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.
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, Philadelphia, PA 19172. Or, you
can call, toll free, 1-800-523-0650. 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.
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............................................. 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........................................................ 11
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 Participant's
fixed account value. See "Deductions and Expenses" in this prospectus.
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>
MANAGEMENT ADMINISTRATIVE
FEES AND CORPORATE TOTAL
(AFTER SERVICES FEES ACCOUNTING OTHER FUND
WAIVER) (AFTER WAIVER) FEES EXPENSES EXPENSES
---------- -------------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Growth Equity............ 0.50% 0.15% 0.08% 0.07% 0.80%
Value Equity............. 0.50% 0.15% 0.07% 0.06% 0.78%
Flexibly Managed......... 0.50% 0.15% 0.06% 0.06% 0.77%
International Equity..... 0.75% 0.15% 0.09% 0.18% 1.17%
Quality Bond............. 0.45% 0.15% 0.08% 0.09% 0.77%
High Yield Bond.......... 0.50% 0.15% 0.08% 0.11% 0.84%
Money Market............. 0.40% 0.15% 0.08% 0.10% 0.73%
</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 0.81% 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 certificates and surrender your certificates 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 $163 $255
Penn Series Quality Bond Fund............................ $68 $115 $165 $259
Penn Series High Yield Bond Fund......................... $68 $117 $168 $266
Penn Series Growth Equity Fund........................... $68 $115 $166 $262
Penn Series Value Equity Fund............................ $68 $115 $165 $260
Penn Series Flexibly Managed Fund........................ $68 $115 $164 $259
Penn Series International Equity Fund.................... $71 $126 $184 $299
Penn Series Emerging Growth Fund......................... $71 $126 $183 $297
</TABLE>
- --------------------------------------------------------------------------------
EXAMPLE
If you own certificates and do not surrender your certificates, 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 $110 $238
Penn Series Quality Bond Fund............................ $21 $66 $113 $243
Penn Series High Yield Bond Fund......................... $22 $68 $116 $250
Penn Series Growth Equity Fund........................... $22 $66 $114 $246
Penn Series Value Equity Fund............................ $21 $66 $113 $243
Penn Series Flexibly Managed Fund........................ $21 $66 $112 $242
Penn Series International Equity Fund.................... $25 $78 $133 $283
Penn Series Emerging Growth Fund......................... $25 $77 $132 $281
</TABLE>
The example is based upon data for the fiscal year ended December 31, 1996
and assumes an average Participant's Variable Account Value of approximately
$8,200. 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,
- -------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------------
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.... $32.596 $32.327 $26.102 $25.887 $28.766 $28.528 $25.906 $25.692 $24.756 $24.552
Accumulation Unit Value,
end of period.......... $38.550 $38.235 $32.596 $32.327 $26.102 $25.887 $28.766 $28.528 $25.906 $25.692
Number of Accumulation
Units outstanding, end
of period.............. 1,830,081 620,903 1,991,646 674,290 2,119,836 717,328 2,042,023 685,110 2,004,015 669,679
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------------
1991 1990 1989 1988 1987
- -------------------------------------------------------------------------------------------------------------------
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.... $18.605 $18.451 $21.204 $21.029 $16.356 $16.221 $14.702 $14.581 $14.145 $14.029
Accumulation Unit Value,
end of period.......... $24.756 $24.552 $18.605 $18.451 $21.204 $21.029 $16.356 $16.221 $14.702 $14.581
Number of Accumulation
Units outstanding, end
of period.............. 1,680,322 518,717 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,
- -----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987(B)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit
Value,
beginning of period.. $24.928 $18.361 $18.062 $17.080 $15.058 $11.939 $13.157 $11.802 $9.226 $10.000
Accumulation Unit
Value,
end of period........ $30.819 $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........ 4,907,784 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,
- -----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit
Value, beginning of
period............... $42.865 $35.496 $34.514 $30.179 $27.893 $23.215 $23.712 $19.832 $16.898 $13.851
Accumulation Unit
Value, end of period. $49.262 $42.865 $35.496 $34.514 $30.179 $27.893 $23.215 $23.712 $19.832 $16.898
Number of Accumulation
Units outstanding,
end of period........ 5,711,843 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
- -----------------------------------------------------------------------------------------------------------------------
</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,
- --------------------------------------------------------------------------------
1996 1995 1994 1993 1992(A)
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Accumulation Unit Value, begin-
ning of period................ $14.434 $12.843 $13.880 $10.175 $10.000
Accumulation Unit Value, end of
period........................ $16.659 $14.434 $12.843 $13.880 $10.175
Number of Accumulation Units
outstanding, end of period.... 4,012,762 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
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987(B)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $18.465 $15.562 $16.639 $15.088 $14.336 $12.558 $11.776 $10.580 $9.968 $10.000
Accumulation Unit Value,
end of period.......... $18.990 $18.465 $15.562 $16.639 $15.088 $14.336 $12.558 $11.776 $10.580 $9.968
Number of Accumulation
Units outstanding, end
of period.............. 1,664,378 1,869,975 1,890,869 1,953,188 1,357,087 1,229,163 1,075,187 769,467 274,657 130,130
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Fixed Income Fund Subaccount prior to November 1, 1992.
(b) For the period March 17, 1987 (date subaccount was established) through De-
cember 31, 1987.
7
<PAGE>
- --------------------------------------------------------------------------------
PENN SERIES HIGH YIELD BOND FUND SUBACCOUNT
Values of an Accumulation Unit Outstanding Throughout Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $26.033 $22.644 $24.742 $20.918 $18.291 $13.534 $15.035 $15.325 $13.193 $13.461
Accumulation Unit Value,
end of period.......... $29.276 $26.033 $22.644 $24.742 $20.918 $18.291 $13.534 $15.035 $15.325 $13.193
Number of Accumulation
Units outstanding, end
of period.............. 1,185,318 1,194,944 1,264,890 1,257,271 705,414 594,530 613,408 817,147 708,838 469,236
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
PENN SERIES MONEY MARKET FUND SUBACCOUNT
Values of an Accumulation Unit Outstanding Throughout Each Period
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Accumulation Unit Value,
beginning of period.... $18.148 $17.416 $17.003 $16.791 $16.491 $15.732 $14.893 $13.844 $13.089 $12.482
Accumulation Unit Value,
end of period.......... $18.817 $18.148 $17.416 $17.003 $16.791 $16.491 $15.732 $14.893 $13.844 $13.089
Number of Accumulation
Units outstanding, end
of period.............. 1,192,388 1,062,385 825,274 658,620 698,584 769,958 965,117 753,052 319,671 242,494
- -------------------------------------------------------------------------------------------------------------
</TABLE>
The financial statements of the Separate Account for the year ended December
31, 1996 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 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 The Penn Mutual Life Insurance Company, 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. 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, Philadelphia, PA 19172. Or, you can call, toll
free, 1-800-523-0650.
- --------------------------------------------------------------------------------
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.
10
<PAGE>
- --------------------------------------------------------------------------------
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 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.
11
<PAGE>
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 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
canceling 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
12
<PAGE>
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.
If the contingent deferred sales charge applies, it will be 5% of the amount
withdrawn and will be made by canceling 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,
13
<PAGE>
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.
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
14
<PAGE>
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.
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 -- MAY 1, 1997
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
THE PENN MUTUAL LIFE INSURANCE COMPANY
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, 1997. 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, Philadelphia, PA 19172. Or, you may
call, toll free, 1-800-523-0650.
- --------------------------------------------------------------------------------
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-11
Yields (Money Market Fund)............................................... B-11
- --------------------------------------------------------------------------------
DISTRIBUTION OF CONTRACTS AND CERTIFICATES................................. B-12
- --------------------------------------------------------------------------------
CUSTODIAN.................................................................. B-12
- --------------------------------------------------------------------------------
INDEPENDENT ACCOUNTANTS.................................................... B-12
- --------------------------------------------------------------------------------
LEGAL MATTERS.............................................................. B-13
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS....................................................... B-13
- --------------------------------------------------------------------------------
</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., American Century Variable Portfolios, Inc., Neuberger
and Berman Advisers Management Trust, Fidelity Investments' Variable Insurance
Products Fund, Variable Insurance Products Fund II and Morgan Stanley Universal
Funds, Inc., for periods ended December 31, 1996, 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 12/31/96 ENDED 12/31/96 ENDED 12/31/96 12/31/96
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a)...... 08/11/83 10.41% 8.29% 10.26% 10.35%
Nonqualified Plans (a)... 06/01/83 10.41% 8.29% 10.26% 10.12%
(Independence Capital
Management, Inc.)
Value Equity (a).......... 03/17/87 15.40% 14.39% N/A 11.70%
(OpCap)
Small Capitalization (a).. 03/01/95 10.76% N/A N/A 12.79%
(OpCap)
Flexibly Managed (a)...... 07/31/84 6.99% 10.85% 13.12% 13.34%
(T. Rowe Price Associ-
ates, Inc.)
International Equity (a).. 11/01/92 7.78% N/A N/A 11.95%
(Vontobel USA, Inc.)
Quality Bond (a).......... 03/17/87 -3.80% 5.05% N/A 6.62%
(Independence Capital
Management, Inc.)
High Yield Bond (a)....... 08/06/84 5.16% 9.09% 7.91% 8.91%
(T. Rowe Price Associ-
ates, Inc.)
Capital Appreciation Port-
folio (b)..................11/20/87 -11.68% 3.90% N/A 9.17%
(American Century Invest-
ment Management, Inc.)
Balanced Portfolio (c).... 02/28/89 -1.21% 5.99% N/A 8.74%
(Neuberger & Berman)
Limited Maturity Bond (c). 09/10/84 -3.52% 3.41% 5.33% 6.94%
(Neuberger & Berman)
Partners Fund (c)......... 03/22/94 20.19% N/A N/A 18.53%
(Nerberger & Berman)
Equity Income (d)......... 10/09/86 5.64% 15.63% 12.17% 11.87%
(Fidelity Investments)
Growth Portfolio (d)...... 10/09/86 5.99% 12.98% 13.62% 13.30%
(Fidelity Investments)
Asset Manager (e)......... 09/06/89 6.02% 9.24% N/A 10.29%
(Fidelity Investments)
Index 500 (e)............. 08/27/92 13.82% N/A N/A 15.18%
(Fidelity Investments)
</TABLE>
- -------
*Represents the date the underlying fund was established.
(a)Penn Series Funds, Inc.
(b)American Century Variable 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 12/31/96 ENDED 12/31/96 ENDED 12/31/96 12/31/96
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 10.41% 8.18% 10.16% 10.35%
Nonqualified Plans (a). 06/01/83 10.41% 8.18% 10.16% 10.12%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 15.40% 14.28% N/A 11.60%
(OpCap)
Small Capitalization
(a).................... 03/01/95 10.76% N/A N/A 12.79%
(OpCap)
Flexibly Managed (a).... 07/31/84 6.99% 10.74% 13.02% 13.34%
(T. Rowe Price Associ-
ates, Inc.)
International Equity
(a).................... 11/01/92 7.78% N/A N/A 11.83%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 -3.80% 4.96% N/A 6.52%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 5.16% 8.99% 7.82% 8.91%
(T. Rowe Price Associ-
ates, Inc.)
Capital Appreciation
Portfolio (b).......... 11/20/87 -11.68% 3.81% N/A 9.06%
(American Century In-
vestment Management,
Inc.)
Balanced Portfolio (c).. 02/28/89 -1.21% 5.89% N/A 8.49%
(Neuberger & Berman)
Limited Maturity Bond
(c).................... 09/10/84 -3.52% 3.31% 5.23% 6.94%
(Neuberger & Berman)
Partners Fund (c)....... 03/22/94 20.19% N/A N/A 18.53%
(Neuberger & Berman)
Equity Income (d)....... 10/09/86 5.64% 15.52% 12.06% 11.87%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 5.99% 12.88% 13.52% 13.30%
(Fidelity Investments)
Asset Manager (e)....... 09/06/89 6.02% 9.14% N/A 10.01%
(Fidelity Investments)
Index 500 (e)........... 08/27/92 13.82% N/A N/A 15.06%
(Fidelity Investments)
</TABLE>
- -------
*Represents the date the underlying fund was established.
(a)Penn Series Funds, Inc.
(b)American Century Variable 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 -- DIVERSIFIER II VARIABLE CONTRACT
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
---------------------------------------------------------------------
FROM INCEPTION
INCEPTION ONE YEAR FIVE YEARS TEN YEARS DATE THROUGH
FUND (MANAGER) DATE* ENDED 12/31/96 ENDED 12/31/96 ENDED 12/31/96 12/31/96
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 12.86% 8.16% 10.05% 10.35%
Nonqualified Plans (a). 06/01/83 12.86% 8.16% 10.05% 10.12%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 18.19% 14.44% N/A 11.51%
(OpCap)
Small Capitalization
(a).................... 03/01/95 13.21% N/A N/A 13.83%
(OpCap)
Flexibly Managed (a).... 07/31/84 9.23% 10.80% 12.95% 13.34%
(T. Rowe Price Associ-
ates, Inc.)
International Equity
(a).................... 11/01/92 10.05% N/A N/A 11.86%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 -1.97% 4.82% N/A 6.33%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 7.52% 8.99% 7.66% 8.91%
(T. Rowe Price Associ-
ates, Inc.)
Capital Appreciation
Portfolio (b).......... 11/20/87 -9.95% 3.62% N/A 8.90%
(American Century In-
vestment Management,
Inc.)
Balanced Portfolio (c).. 02/28/89 0.67% 5.79% N/A 8.38%
(Neuberger & Berman)
Limited Maturity Bond
(c).................... 09/10/84 -1.68% 3.11% 5.01% 6.94%
(Neuberger & Berman)
Partners Fund (c)....... 03/22/94 23.28% N/A N/A 19.21%
(Neuberger & Berman)
Equity Income (d)....... 10/09/86 7.75% 15.71% 11.99% 11.87%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 8.13% 12.99% 13.46% 13.30%
(Fidelity Investments)
Asset Manager (e)....... 09/06/89 8.15% 9.15% N/A 9.92%
(Fidelity Investments)
Index 500 (e)........... 08/27/92 16.48% N/A N/A 15.20%
(Fidelity Investments)
</TABLE>
- -------
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
(b) American Century Variable 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
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
---------------------------------------------------------------------
FROM INCEPTION
INCEPTION ONE YEAR FIVE YEARS TEN YEARS DATE THROUGH
FUND (MANAGER) DATE* ENDED 12/31/96 ENDED 12/31/96 ENDED 12/31/96 12/31/96
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Quality Plans (a)...... 08/11/83 12.54% 7.88% 10.12% 10.35%
Nonqualified Plans (a). 06/01/83 12.54% 7.88% 10.12% 10.12%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 17.62% 13.96% N/A 11.18%
(OpCap)
Flexibly Managed (a).... 07/31/84 9.06% 10.43% 12.98% 13.34%
(T. Rowe Price Associ-
ates, Inc.)
Quality Bond (a)........ 03/17/87 -1.95% 4.66% N/A 6.12%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 7.19% 8.68% 7.78% 8.91%
(T. Rowe Price Associ-
ates, Inc.)
International Equity
(a).................... 11/01/92 9.85% N/A N/A 11.45%
(Vontobel USA, Inc.)
</TABLE>
- -------
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
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., American Century Variable Portfolios, Inc., Neuberger and
Berman Advisers Management Trust, Fidelity Investments' Variable Insurance
Products Fund, Variable Insurance Products Fund II and Morgan Stanley Universal
Funds, Inc., for periods ended December 31, 1996, 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 12/31/96 ENDED 12/31/96 ENDED 12/31/96 12/31/96
- -------------- --------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 17.86% 8.88% 10.26% 10.35%
Nonqualified Plans (a). 06/01/83 17.86% 8.88% 10.26% 10.12%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 23.19% 15.02% N/A 11.70%
(OpCap)
Small Capitalization
(a).................... 03/01/95 18.21% N/A N/A 16.24%
(OpCap)
Flexibly Managed (a).... 07/31/84 14.23% 11.46% 13.12% 13.34%
(T. Rowe Price Associ-
ates, Inc.)
International Equity
(a).................... 11/01/92 15.05% N/A N/A 12.69%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 2.68% 5.63% N/A 6.62%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 12.25% 9.69% 7.91% 8.91%
(T. Rowe Price Associ-
ates, Inc.)
Capital Appreciation
Portfolio (b).......... 11/20/87 -5.73% 4.48% N/A 9.17%
(American Century In-
vestment Management,
Inc.)
Balanced Portfolio (c).. 02/28/89 5.44% 6.57% N/A 8.74%
(Neuberger & Berman)
Limited Maturity Bond
(c).................... 09/10/84 2.97% 3.98% 5.33% 6.94%
(Neuberger & Berman)
Partners Fund (c)....... 03/22/94 28.28% N/A N/A 20.52%
(Neuberger & Berman)
Equity Income (d)....... 10/09/86 12.75% 16.26% 12.17% 11.87%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 13.13% 13.60% 13.62% 13.30%
(Fidelity Investments)
Asset Manager (e)....... 09/06/89 13.15% 9.84% N/A 10.29%
(Fidelity Investments)
Index 500 (e)........... 08/27/92 21.48% N/A N/A 15.91%
(Fidelity Investments)
</TABLE>
- -------
*Represents the date the underlying Fund was established.
(a)Penn Series Funds, Inc. (some Funds not currently available to Penn Mutual
Optimizer Group Variable and Fixed Annuity Contracts).
(b)American Century Variable 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
Contracts).
(e)Fidelity Investments' Variable Insurance Products Fund II (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity
Contracts).
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., American Century Variable Portfolios, Inc., Neuberger and
Berman Advisers Management Trust and Fidelity Investments' Variable Insurance
Products Fund, Variable Insurance Products Fund II and Morgan Stanley Universal
Funds, Inc., for period ended December 31, 1996, 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 12/31/96 ENDED 2/31/96 ENDED 12/31/96 12/31/96
- -------------- --------- -------------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 08/11/83 18.22% 9.22% 10.51% 10.57%
Nonqualified Plans (a). 06/01/83 18.22% 9.22% 10.51% 10.34%
(Independence Capital
Management, Inc.)
Value Equity (a)........ 03/17/87 23.58% 15.35% N/A 11.99%
(OpCap)
Small Capitalization
(a).................... 03/01/95 18.25% N/A N/A 16.28%
(OpCap)
Flexibly Managed (a).... 07/31/84 14.85% 11.98% 13.48% 13.66%
(T. Rowe Price Associ-
ates, Inc.)
International Equity
(a).................... 11/01/92 15.37% N/A N/A 13.00%
(Vontobel USA, Inc.)
Quality Bond (a)........ 03/17/87 2.82% 5.76% N/A 6.73%
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 08/06/84 12.43% 9.84% 8.06% 9.03%
(T. Rowe Price Associ-
ates, Inc.)
Capital Appreciation
Portfolio (b).......... 11/20/87 -5.54% 4.65% N/A 9.31%
(American Century In-
vestment Management,
Inc.)
Balanced Portfolio (c).. 02/28/89 5.54% 6.66% N/A 8.81%
(Neuberger & Berman)
Limited Maturity Bond
(c).................... 09/10/84 3.00% 4.00% 5.35% 6.95%
(Neuberger & Berman)
Partners Fund (c)....... 03/22/94 28.43% N/A N/A 20.66%
(Neuberger & Berman)
Equity Income (d)....... 10/09/86 12.84% 16.34% 12.23% 11.94%
(Fidelity Investments)
Growth Portfolio (d).... 10/09/86 13.26% 13.71% 13.70% 13.38%
(Fidelity Investments)
Asset Manager (e)....... 09/06/89 13.17% 9.86% N/A 10.31%
(Fidelity Investments)
Index 500 (e)........... 08/27/92 21.63% N/A N/A 16.05%
(Fidelity Investments)
</TABLE>
- -------
*Represents the date the underlying fund was established.
(a)Penn Series Funds, Inc. (some Funds not currently available to Penn Mutual
Optimizer Group Variable and Fixed Annuity Contracts).
(b)American Century Variable 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
Contracts).
(e)Fidelity Investments' Variable Insurance Products Fund II (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity
Contracts).
B-9
<PAGE>
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-10
<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., American Century Variable Portfolios,
Inc., Neuberger and Berman Advisers Management Trust and Fidelity Investment's
Variable Insurance Product Fund and Fund II for each of the calendar years 1987
through 1996 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. Changes in values of accumulation units for Funds added
after the commencement of 1996 are not included.
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) 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- -------------- ----- ----- ----- ------ ----- ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Growth Equity
Qualified Plans (a).... 18.27% 24.88% 9.26% -11.00% 4.60% -33.10% 12.30% 29.60% 11.30% 3.90%
Nonqualified Plans (a). 18.27% 24.88% 9.26% -11.00% 4.60% -3.10% 12.30% 29.60% 11.30% 3.90%
(Independence Capital
Management)
Value Equity (a)........ 23.63% 35.77% 1.65% 5.70% 13.40% 26.10% 9.30% -11.50% 27.90% --
(OpCap)
Small Capitalization
(a).................... 18.26% 11.71% N/A N/A N/A N/A N/A N/A N/A --
(OpCap)
Flexibly Managed (a).... 14.92% 20.76% 2.85% 14.40% 8.20% 20.10% 2.10% -19.60% 17.40% 22.10%
(T. Rowe Price
Associates, Inc.)
International Equity
(a).................... 15.41% 13.39% 7.47% -36.40% N/A N/A N/A N/A N/A N/A
(Vontobel USA, Inc.)
Quality Bond (a)........ 2.84% 18.65% 6.47% -10.30% 5.20% 14.20% 6.60% 11.30% 6.10% N/A
(Independence Capital
Management, Inc.)
High Yield Bond (a)..... 12.46% 14.97% 8.48% -18.30% 14.40% 35.20% -10.00% 1.90% -16.20% -2.0%
(T. Rowe Price Associ-
ates, Inc.)
Money Market (a)........ 3.69% 4.21% 2.43% 1.30% 1.80% 4.60% 5.60% 7.60% 5.80% 4.90%
(Independence Capital
Management, Inc.)
Capital Appreciation
Portfolio (b).......... 5.51% 29.47% -2.40% N/A N/A N/A N/A N/A N/A N/A
(American Century Investment
Management, Inc.)
Balanced Portfolio (c).. 5.56% 22.22% -4.56% N/A N/A N/A N/A N/A N/A N/A
(Neuberger & Berman)
Limited Maturity Bond
(c).................... 3.01% 9.56% -1.39% N/A N/A N/A N/A N/A N/A N/A
(Neuberger & Berman)
Equity Income (d)....... 12.86% 19.20% N/A N/A N/A N/A N/A N/A N/A N/A
(Fidelity Investors Re-
search)
Growth (d).............. 13.28% 23.59% N/A N/A N/A N/A N/A N/A N/A N/A
(Fidelity Investors Re-
search)
Asset Manager (e)....... 13.18% 11.53% N/A N/A N/A N/A N/A N/A N/A N/A
(Fidelity Investors Re-
search)
</TABLE>
- -------
(a) Penn Series Funds, Inc. (some Funds not currently available to Penn Mutual
Optimizer Group Variable and Fixed Annuity Contracts).
(b) American Century Variable 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
Contracts).
(e) Fidelity Investments' Variable Insurance Products Fund II (not currently
available to Penn Mutual Optimizer Group Variable and Fixed Annuity
Contracts).
- --------------------------------------------------------------------------------
YIELDS (MONEY MARKET FUND)
The "yield" and "effective yield" of the Money Market Fund subaccount for the
seven days ended December 31, 1996 were 3.15% and 3.20%, respectively.
B-11
<PAGE>
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 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)/365/7/]-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 1996, 1995 and 1994, Penn Mutual paid Hornor, Townsend &
Kent, Inc. underwriting commissions of $403,603.91, $357,316 and $396,927
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 and 1994, Penn
Mutual paid CBL Equities, Inc. underwriting commissions of approximately,
$19,896 and $25,064 respectively. For 1996, Penn Mutual paid no underwriting
commissions to CBL Equities, Inc.
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, 1996, 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 statutory statements of
financial condition of The Penn Mutual Life Insurance Company as of December
31, 1996 and 1995, and the related statutory statements of operations, surplus
and cash flows for the three years in the period ended December 31, 1996
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.
B-12
<PAGE>
- --------------------------------------------------------------------------------
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.
- --------------------------------------------------------------------------------
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-13
<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 statement of assets and liabilities of the
Penn Mutual Variable Annuity Account III [comprising, respectively, 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, Balanced
Portfolio, Limited Maturity Bond Portfolio, Capital Appreciation Portfolio
(formerly TCI Growth Portfolio) Equity Income Portfolio, Growth Portfolio, and
Asset Manager Portfolio] as of December 31, 1996, 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. These financial
statements are the responsibility of the management of 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, 1996 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 Penn Mutual Variable Annuity
Account III as of December 31, 1996, the results of its operations for the year
then ended and its changes in net assets for each of the two years or periods
in the period then ended in conformity with generally accepted accounting
principles.
COOPERS & LYBRAND L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
April 7, 1997
B-14
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENT OF ASSETS AND LIABILITIES - DECEMBER 31, 1996
<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....... 22,338,989 3,161,674 3,895,794 3,288,732
Identified cost........ $705,813,655 $22,338,989 $32,364,847 $37,128,722 $62,064,559
ASSETS:
Investments at value... $820,018,580 $22,338,989 $31,616,743 $34,711,525 $70,576,187
Dividends receivable... 90,184 90,184 0 0 0
LIABILITIES:
Due to (from) The Penn
Mutual Life Insurance
Company............... 249,086 (6,950) 9,946 10,688 22,330
------------ ----------- ----------- ----------- -----------
NET ASSETS.............. $819,859,678 $22,436,123 $31,606,797 $34,700,837 $70,553,857
============ =========== =========== =========== ===========
Variable annuity accumu-
lation units........... 1,192,388 1,664,378 1,185,318 1,830,081
Accumulation unit val-
ues.................... $ 18.82 $ 18.99 $ 29.28 $ 38.55
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENT OF OPERATIONS - FOR THE YEAR ENDED DECEMBER 31, 1996
<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.............. $ 20,696,055 $ 1,024,770 $ 1,970,299 $ 2,531,187 $ 316,577
EXPENSE:
Mortality and expense
risk charges.......... 9,163,988 265,455 425,420 411,546 859,446
------------ ----------- ----------- ----------- -----------
Net investment income
(loss)................ 11,532,067 759,315 1,544,879 2,119,641 (542,869)
------------ ----------- ----------- ----------- -----------
REALIZED AND UNREALIZED
GAINS (LOSSES) ON
INVESTMENTS:
Realized gains (losses)
from redemption of
fund shares........... 773,663 0 150,371 118,824 396,588
Capital gains distribu-
tions................. 37,196,249 0 0 0 7,028,128
------------ ----------- ----------- ----------- -----------
Net realized gains..... 37,969,912 0 150,371 118,824 7,424,716
Net change in
unrealized apprecia-
tion (depreciation) of
investments........... 46,904,331 0 (824,626) 1,586,645 4,297,206
------------ ----------- ----------- ----------- -----------
Net realized and
unrealized gains
(losses) on
investments........... 84,874,243 0 (674,255) 1,705,469 11,721,922
------------ ----------- ----------- ----------- -----------
NET INCREASE (DECREASE)
IN NET ASSETS RESULT-
ING FROM OPERATIONS... $ 96,406,310 $ 759,315 $ 870,624 $ 3,825,110 $11,179,053
============ =========== =========== =========== ===========
</TABLE>
- -------
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust.
+++ Investment in American Century Variable Portfolios, Inc. .(TCI Growth
Portfolio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
The accompanying notes are an integral part of these financial statements.
B-15
<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>
1,106,594 7,831,289 15,019,682 619,514 4,283,657 1,271,785 370,420
$21,436,832 $105,851,269 $237,979,433 $7,257,726 $57,559,236 $19,552,323 $5,348,005
$23,747,503 $151,300,503 $281,468,841 $7,762,509 $66,867,886 $20,246,811 $5,204,400
0 0 0 0 0 0 0
7,514 46,378 88,525 2,414 20,416 6,214 1,620
----------- ------------ ------------ ---------- ----------- ----------- ----------
$23,739,989 $151,254,125 $281,380,316 $7,760,095 $66,847,470 $20,240,597 $5,202,780
=========== ============ ============ ========== =========== =========== ==========
620,903 4,907,784 5,711,843 587,385 4,012,762 1,535,496 459,223
$ 38.23 $ 30.82 $ 49.26 $ 13.21 $ 16.66 $ 13.18 $ 11.33
- --------------------------------------------------------------------------------
<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>
$ 106,593 $ 1,663,053 $ 9,100,274 $ 42,157 $ 2,936,044 $ 444,255 $ 448,138
289,682 1,625,718 3,146,150 58,254 739,842 251,577 67,309
----------- ------------ ------------ ---------- ----------- ----------- ----------
(183,089) 37,335 5,954,124 (16,097) 2,196,202 192,678 380,829
----------- ------------ ------------ ---------- ----------- ----------- ----------
163,021 5,973 9,970 1,484 4,504 11,456 12,163
2,366,416 6,210,011 11,871,325 290,281 2,203,993 2,470,491 0
----------- ------------ ------------ ---------- ----------- ----------- ----------
2,529,437 6,215,984 11,881,295 291,765 2,208,497 2,481,947 12,163
1,444,325 20,554,315 16,655,730 511,160 4,008,191 (1,619,401) (235,270)
----------- ------------ ------------ ---------- ----------- ----------- ----------
3,973,762 26,770,299 28,537,025 802,925 6,216,688 862,546 (223,107)
----------- ------------ ------------ ---------- ----------- ----------- ----------
$ 3,790,673 $ 26,807,634 $ 34,491,149 $ 786,828 $ 8,412,890 $ 1,055,224 $ 157,722
=========== ============ ============ ========== =========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-16
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENT OF ASSETS AND LIABILITIES - DECEMBER 31, 1996 (CONT'D)
<TABLE>
<CAPTION>
CAPITAL
APPRECIATION EQUITY INCOME GROWTH ASSET MANAGER
PORTFOLIO+++ PORTFOLIO++++ PORTFOLIO++++ PORTFOLIO++++
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
INVESTMENT IN COMMON
STOCK
Number of shares....... 2,833,733 1,598,747 1,178,494 285,842
Identified cost........ $ 27,573,607 $30,533,269 $34,415,869 $4,408,969
ASSETS:
Investments at value... $ 29,017,423 $33,621,652 $36,698,309 $4,839,299
Dividends receivable... 0 0 0 0
LIABILITIES:
Due to (from) The Penn
Mutual Life Insurance
Company............... 17,285 10,389 10,822 1,495
------------ ----------- ----------- ----------
NET ASSETS.............. $ 29,000,138 $33,611,263 $36,687,487 $4,837,804
============ =========== =========== ==========
Variable annuity accu-
mulation units........ 2,183,381 2,498,343 2,620,543 383,267
Accumulation unit val-
ues................... $ 13.28 $ 13.45 $ 14.00 $ 12.62
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
STATEMENT OF OPERATIONS - FOR THE YEAR ENDED DECEMBER 31, 1996 (CONT'D.)
<CAPTION>
CAPITAL
APPRECIATION EQUITY INCOME GROWTH ASSET MANAGER
PORTFOLIO+++ PORTFOLIO++++ PORTFOLIO++++ PORTFOLIO++++
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
INVESTMENT INCOME:
Dividends.............. $ 0 $ 15,452 $ 30,496 $ 66,760
EXPENSE:
Mortality and expense
risk charges.......... 387,639 279,844 314,679 41,427
------------ ----------- ----------- ----------
Net investment income
(loss)................ (387,639) (264,392) (284,183) 25,333
------------ ----------- ----------- ----------
REALIZED AND UNREALIZED
GAINS (LOSSES) ON
INVESTMENTS:
Realized gains (losses)
from redemption of
fund
shares................ (95,467) (2,032) (5,088) 1,896
Capital gains distribu-
tions................. 3,487,573 442,968 770,015 55,048
------------ ----------- ----------- ----------
Net realized gains..... 3,392,106 440,936 764,927 56,944
Net change in
unrealized apprecia-
tion (depreciation) of
investments........... (4,797,632) 2,674,214 2,293,958 355,516
------------ ----------- ----------- ----------
Net realized and
unrealized gains
(losses) on
investments........... (1,405,526) 3,115,150 3,058,885 412,460
------------ ----------- ----------- ----------
NET INCREASE (DECREASE)
IN NET ASSETS RESULT-
ING FROM OPERATIONS... $ (1,793,165) $ 2,850,758 $ 2,774,702 $ 437,793
============ =========== =========== ==========
</TABLE>
- -------
+ Investment in Penn Series Funds, Inc.
++ Investment in Neuberger & Berman Advisers Management Trust.
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth Port-
folio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ 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, 1996 AND
1995
<TABLE>
<CAPTION>
TOTAL MONEY MARKET FUND+ QUALITY BOND FUND+
-------------------------- ------------------------- ------------------------
1996 1995 1996 1995 1996 1995
------------ ------------ ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)............... $ 11,532,067 $ 8,441,912 $ 759,315 $ 648,003 $ 1,544,879 $ 1,562,124
Net realized gain
(loss) from
investment
transactions......... 37,969,912 24,670,608 0 0 150,371 71,119
Net change in
unrealized
appreciation
(depreciation) of
investments.......... 46,904,331 69,875,494 0 0 (824,626) 3,759,594
------------ ------------ ------------ ----------- ----------- -----------
Net increase in net as-
sets resulting from
operations............ 96,406,310 102,988,014 759,315 648,003 870,624 5,392,837
------------ ------------ ------------ ----------- ----------- -----------
VARIABLE ANNUITY ACTIV-
ITIES:
Purchase payments
under variable
annuity contracts.... 251,158,386 77,587,218 27,162,076 8,771,642 6,765,457 2,453,615
Surrender benefits.... (50,680,346) (34,698,835) (4,072,749) (1,708,626) (3,808,199) (2,011,032)
Net transfers......... (80,968,012) 20,273,647 (20,416,508) (2,665,534) (6,221,731) (280,451)
Death benefits........ (2,139,229) (2,369,383) (142,708) (34,313) (115,236) (184,002)
Contract administra-
tion charges......... (743,327) (642,187) (17,054) (16,259) (29,245) (31,981)
Deferred sales
charges.............. (771,701) (672,390) (41,242) (27,491) (62,768) (47,106)
Annuity benefits...... (2,442,928) (1,281,020) (75,424) (59,711) (320,805) (189,666)
------------ ------------ ------------ ----------- ----------- -----------
Net increase (decrease)
in net assets result-
ing from variable an-
nuity activities...... 113,412,843 58,197,050 2,396,391 4,259,708 (3,792,527) (290,623)
------------ ------------ ------------ ----------- ----------- -----------
Total increase (de-
crease) in net as-
sets................ 209,819,153 161,185,064 3,155,706 4,907,711 (2,921,903) 5,102,214
NET ASSETS:
Beginning of period... 610,040,525 448,855,461 19,280,417 14,372,706 34,528,700 29,426,486
------------ ------------ ------------ ----------- ----------- -----------
END OF PERIOD......... $819,859,678 $610,040,525 $ 22,436,123 $19,280,417 $31,606,797 $34,528,700
============ ============ ============ =========== =========== ===========
<CAPTION>
GROWTH EQUITY FUND+ GROWTH EQUITY FUND+
HIGH YIELD BOND FUND+ QUALIFIED NON-QUALIFIED
-------------------------- ------------------------- ------------------------
1996 1995 1996 1995 1996 1995
------------ ------------ ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)............... $ 2,119,641 $ 2,318,049 $ (542,869) $ (532,434) $ (183,089) $ (174,240)
Net realized gain
(loss) from
investment
transactions......... 118,824 128,692 7,424,716 8,927,236 2,529,437 2,876,393
Net change in
unrealized
appreciation
(depreciation) of
investments.......... 1,586,645 1,679,183 4,297,206 5,026,395 1,444,325 1,712,271
------------ ------------ ------------ ----------- ----------- -----------
Net increase in net as-
sets resulting from
operations............ 3,825,110 4,125,924 11,179,053 13,421,197 3,790,673 4,414,424
------------ ------------ ------------ ----------- ----------- -----------
VARIABLE ANNUITY ACTIV-
ITIES:
Purchase payments
under variable
annuity contracts.... 7,610,868 2,547,820 7,716,325 5,446,648 2,314,525 568,384
Surrender benefits.... (2,415,269) (2,132,204) (6,856,237) (5,623,602) (1,678,052) (995,989)
Net transfers......... (5,087,882) (1,838,084) (5,990,576) (3,202,517) (2,254,703) (572,409)
Death benefits........ (135,215) (11,530) (105,136) (186,731) (153,472) (125,564)
Contract administra-
tion charges......... (33,369) (35,262) (104,241) (111,047) (17,455) (17,899)
Deferred sales
charges.............. (34,353) (45,719) (118,248) (101,767) (21,783) (25,359)
Annuity benefits...... (137,094) (144,799) (86,906) (54,068) (37,834) (16,821)
------------ ------------ ------------ ----------- ----------- -----------
Net increase (decrease)
in net assets result-
ing from variable an-
nuity activities...... (232,314) (1,659,778) (5,545,019) (3,833,084) (1,848,774) (1,185,657)
------------ ------------ ------------ ----------- ----------- -----------
Total increase (de-
crease) in net as-
sets................ 3,592,796 2,466,146 5,634,034 9,588,113 1,941,899 3,228,767
NET ASSETS:
Beginning of period... 31,108,041 28,641,895 64,919,823 55,331,710 21,798,090 18,569,323
------------ ------------ ------------ ----------- ----------- -----------
END OF PERIOD......... $ 34,700,837 $ 31,108,041 $ 70,553,857 $64,919,823 $23,739,989 $21,798,090
============ ============ ============ =========== =========== ===========
</TABLE>
- -----------------------
(a) For the period from May 1, 1995 (date funds became available for investment
to contract owners) to December 31, 1995.
+ Investment in Penn Series Funds, Inc.
++ Investment in Newberger & Berman Advisers Management Trust
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth
Portfolio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ 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>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY-ACCOUNT III
STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEARS ENDED DECEMBER 31, 1996 AND
1995 (CONT'D.)
<TABLE>
<CAPTION>
SMALL
VALUE EQUITY FUND+ FLEXIBLY MANAGED FUND+ CAPITALIZATION FUND+
---------------------------- ---------------------------- -------------------------
1996 1995 1996 1995 1996 1995(A)
------------- ------------- ------------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)............... $ 37,335 $ 324,750 $ 5,954,124 $ 3,814,084 $ (16,097) $ 6,784
Net realized gain
(loss) from invest-
ment transactions.... 6,215,984 5,429,564 11,881,295 7,278,972 291,765 31,190
Net change in
unrealized
appreciation
(depreciation) of
investments.......... 20,554,315 20,695,460 16,655,730 22,379,827 511,160 (6,377)
------------- ------------- ------------- ------------- ------------ -----------
Net increase in net
assets resulting from
operations............ 26,807,634 26,449,774 34,491,149 33,472,883 786,828 31,597
------------- ------------- ------------- ------------- ------------ -----------
VARIABLE ANNUITY ACTIV-
ITIES:
Purchase payments un-
der variable annuity
contracts............ 35,030,873 8,872,997 64,098,837 28,450,036 6,357,984 560,354
Surrender benefits.... (8,798,687) (5,589,166) (15,678,381) (10,136,231) (209,690) (15,648)
Net transfers......... (6,534,934) 5,501,620 (11,363,445) 12,950,139 (698,991) 961,830
Death benefits........ (294,674) (618,712) (802,242) (906,304) 0 (85)
Contract administra-
tion charges......... (116,868) (96,737) (259,447) (220,042) (3,494) (328)
Deferred sales
charges.............. (104,693) (102,162) (230,482) (190,920) (2,503) (5)
Annuity benefits...... (327,102) (182,722) (899,490) (418,286) (7,754) 0
------------- ------------- ------------- ------------- ------------ -----------
Net increase (decrease)
in net assets result-
ing from variable an-
nuity activities...... 18,853,915 7,785,118 34,865,350 29,528,392 5,435,552 1,506,118
------------- ------------- ------------- ------------- ------------ -----------
Total increase (de-
crease) in net as-
sets................ 45,661,549 34,234,892 69,356,499 63,001,275 6,222,380 1,537,715
NET ASSETS:
Beginning of period... 105,592,576 71,357,684 212,023,817 149,022,542 1,537,715 0
------------- ------------- ------------- ------------- ------------ -----------
END OF PERIOD......... $ 151,254,125 $ 105,592,576 $ 281,380,316 $ 212,023,817 $ 7,760,095 $ 1,537,715
============= ============= ============= ============= ============ ===========
<CAPTION>
LIMITED MATURITY CAPITAL EQUITY INCOME
BOND PORTFOLIO++ APPRECIATION PORTFOLIO+++ PORTFOLIO++++
---------------------------- ---------------------------- -------------------------
1996 1995 1996 1995 1996 1995(A)
------------- ------------- ------------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
OPERATIONS:
Net investment income
(loss)............... $ 380,829 $ 193,971 $ (387,639) $ (302,687) $ (264,392) $ 29,393
Net realized gain
(loss) from invest-
ment transactions.... 12,163 9,224 3,392,106 16,768 440,936 651
Net change in
unrealized
appreciation
(depreciation) of
investments.......... (235,270) 221,946 (4,797,632) 6,268,045 2,674,214 414,169
------------- ------------- ------------- ------------- ------------ -----------
Net increase in net
assets resulting from
operations............ 157,722 425,141 (1,793,165) 5,982,126 2,850,758 444,213
------------- ------------- ------------- ------------- ------------ -----------
VARIABLE ANNUITY ACTIV-
ITIES:
Purchase payments un-
der variable annuity
contracts............ 1,719,265 611,343 9,581,789 4,678,063 26,675,848 2,349,355
Surrender benefits.... (188,216) (1,263,358) (1,543,486) (1,740,845) (499,331) (19,798)
Net transfers......... (1,309,181) 670,831 (7,344,134) 2,162,323 (2,196,161) 4,164,428
Death benefits........ (26,031) (16,238) (98,132) (98,451) (24,282) (86)
Contract administra-
tion charges......... (3,677) (3,886) (35,108) (28,544) (14,190) (865)
Deferred sales
charges.............. (3,176) (7,582) (35,717) (44,419) (11,243) (45)
Annuity benefits...... (38,247) (27,852) (65,668) (30,932) (104,124) (3,214)
------------- ------------- ------------- ------------- ------------ -----------
Net increase (decrease)
in net assets result-
ing from variable an-
nuity activities...... 150,737 (36,742) 459,544 4,897,195 23,826,517 6,489,775
------------- ------------- ------------- ------------- ------------ -----------
Total increase (de-
crease) in net as-
sets................ 308,459 388,399 (1,333,621) 10,879,321 26,677,275 6,933,988
NET ASSETS:
Beginning of period... 4,894,321 4,505,922 30,333,759 19,454,438 6,933,988 0
------------- ------------- ------------- ------------- ------------ -----------
END OF PERIOD......... $ 5,202,780 $ 4,894,321 $ 29,000,138 $ 30,333,759 $ 33,611,263 $ 6,933,988
============= ============= ============= ============= ============ ===========
</TABLE>
- -------
(a) For the period from May 1, 1995 (date funds became available for investment
to contract owners) to December 31, 1995.
+ Investment in Penn Series Funds, Inc.
++ Investment in Newberger & Berman Advisers Management Trust.
+++ Investment in American Century Variable Portfolios, Inc. (TCI Growth Port-
folio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ Investment in Fidelity Investments' Variable Insurance Products Funds I
and II.
The accompanying notes are an integral part of these financial statements.
B-19
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INTERNATIONAL EQUITY FUND+ BALANCED PORTFOLIO++
- ---------------------------------- --------------------------------------------
1996 1995 1996 1995
- ------------- ------------- ------------ ------------
<S> <C> <C> <C>
$ 2,196,202 $ 539,966 $ 192,678 $ 45,888
2,208,497 (181,261) 2,481,947 81,462
4,008,191 4,887,624 (1,619,401) 2,774,061
- ------------- ------------- ------------ ------------
8,412,890 5,246,329 1,055,224 2,901,411
- ------------- ------------- ------------ ------------
16,887,411 6,138,208 5,405,171 2,746,683
(2,870,226) (2,835,474) (1,105,007) (528,250)
(4,015,394) (5,032,885) (3,239,725) 928,069
(173,872) (65,950) (67,321) (121,242)
(65,435) (60,126) (20,861) (17,685)
(59,387) (65,303) (21,260) (13,775)
(178,697) (86,198) (101,428) (60,583)
- ------------- ------------- ------------ ------------
9,524,400 (2,007,728) 849,569 2,933,217
- ------------- ------------- ------------ ------------
17,937,290 3,238,601 1,904,793 5,834,628
48,910,180 45,671,579 18,335,804 12,501,176
- ------------- ------------- ------------ ------------
$ 66,847,470 $ 48,910,180 $ 20,240,597 $ 18,335,804
============= ============= ============ ============
</TABLE>
<TABLE>
<CAPTION>
GROWTH ASSET MANAGER
PORTFOLIO++++ PORTFOLIO++++
- ---------------------------------- ------------------------------------------------
1996 1995(A) 1996 1995(A)
- ------------ ----------- ----------- -----------
<S> <C> <C> <C>
$ (284,183) $ (26,504) $ 25,333 $ (5,235)
764,927 709 56,944 (111)
2,293,958 (11,518) 355,516 74,814
- ------------ ----------- ----------- -----------
2,774,702 (37,313) 437,793 69,468
- ------------ ----------- ----------- -----------
30,085,364 2,816,988 3,746,593 575,082
(859,014) (94,193) (97,802) (4,419)
(3,748,070) 5,857,679 (546,577) 668,608
(908) (90) 0 (85)
(20,135) (1,167) (2,748) (359)
(22,973) (737) (1,873) 0
(56,653) (5,993) (5,702) (175)
- ------------ ----------- ----------- -----------
25,377,611 8,572,487 3,091,891 1,238,652
- ------------ ----------- ----------- -----------
28,152,313 8,535,174 3,529,684 1,308,120
8,535,174 0 1,308,120 0
- ------------ ----------- ----------- -----------
$ 36,687,487 $ 8,535,174 $ 4,837,804 $ 1,308,120
============ =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-20
<PAGE>
- --------------------------------------------------------------------------------
PENN MUTUAL VARIABLE ANNUITY ACCOUNT III
NOTES TO FINANCIAL STATEMENTS - DECEMBER 31, 1996
- --------------------------------------------------------------------------------
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 contract owners to provide for the accumulation
of value and for the payment of annuities. The preparation of the
accompanying financial statements requires management to make estimates and
assumptions that affect the reported values of assets and liabilities as of
December 31, 1996 and the reported amounts from operations and contract
transactions during 1996 and 1995. 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 Funds
and Small Capitalization Funds; Neuberger and
- --------------------------------------------------------------------------------
NOTE 2.
For the years ended December 31, 1996 and 1995, share transactions of
Account III were as follows:
<TABLE>
<CAPTION>
HIGH YIELD
MONEY MARKET FUND+ QUALITY BOND FUND+ BOND FUND+
------------------------- ---------------------- ----------------------
1996 1995 1996 1995 1996 1995
------------ ----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Shares purchased........ 17,593,852 12,453,799 330,924 352,662 484,617 296,961
Shares received from re-
investment of:
Net investment income. 1,023,642 820,099 197,030 192,405 284,084 319,782
Capital gains distri-
bution............... 0 0 0 0 0 0
------------ ----------- ---------- ---------- ---------- ----------
Total shares acquired... 18,617,494 13,273,898 527,954 545,067 768,701 616,743
Shares redeemed......... (15,436,953) (8,418,094) (738,839) (427,974) (559,349) (537,976)
------------ ----------- ---------- ---------- ---------- ----------
Net increase (decrease)
in shares owned........ 3,180,541 4,855,804 (210,885) 117,093 209,352 78,767
Shares owned beginning
of period.............. 19,158,448 14,302,644 3,372,559 3,255,466 3,686,442 3,607,675
------------ ----------- ---------- ---------- ---------- ----------
Shares owned end of pe-
riod................... 22,338,989 19,158,448 3,161,674 3,372,559 3,895,794 3,686,442
============ =========== ========== ========== ========== ==========
Cost of shares acquired. $ 18,617,494 $13,273,898 $5,361,098 $5,531,251 $6,874,436 $5,272,237
============ =========== ========== ========== ========== ==========
Proceeds from shares re-
deemed................. $ 15,436,953 $ 8,418,094 $7,605,105 $4,256,372 $4,982,181 $4,611,481
============ =========== ========== ========== ========== ==========
<CAPTION>
INTERNATIONAL LIMITED MATURITY
EQUITY FUND+ BOND PORTFOLIO++ BALANCED PORTFOLIO++
------------------------- ---------------------- ----------------------
1996 1995 1996 1995 1996 1995
------------ ----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Shares purchased........ 715,483 321,422 96,495 128,705 215,796 226,636
Shares received from re-
investment of:
Net investment income. 141,191 76,567 33,269 18,582 29,112 16,504
Capital gains distri-
bution............... 188,087 0 0 0 161,893 5,305
------------ ----------- ---------- ---------- ---------- ----------
Total shares acquired... 1,044,761 397,989 129,764 147,287 406,801 248,445
Shares redeemed......... (141,812) (528,180) (92,124) (135,944) (181,758) (63,375)
------------ ----------- ---------- ---------- ---------- ----------
Net increase (decrease)
in shares owned........ 902,949 (130,191) 37,640 11,343 225,043 185,070
Shares owned beginning
of period.............. 3,380,708 3,510,899 332,780 321,437 1,046,742 861,672
------------ ----------- ---------- ---------- ---------- ----------
Shares owned end of pe-
riod................... 4,283,657 3,380,708 370,420 332,780 1,271,785 1,046,742
============ =========== ========== ========== ========== ==========
Cost of shares acquired. $ 16,162,996 $ 5,475,849 $1,802,687 $2,108,317 $6,351,229 $4,080,178
============ =========== ========== ========== ========== ==========
Proceeds from shares re-
deemed................. $ 2,226,649 $ 6,940,160 $1,270,338 $1,950,836 $2,835,387 $1,021,029
============ =========== ========== ========== ========== ==========
</TABLE>
The cost of net redemptions is determined on a last-in, first-out basis.
- -------
(a) For the period 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 American Century Variable Portfolios, Inc. (TCI Growth Port-
folio changed to Capital Appreciation Portfolio as of May 1, 1997).
++++ 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. 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.
B-21
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NOTE 1., CONT'D.
Berman Advisers Management Trust (AMT): Limited Maturity Bond and Balanced
Portfolios; American Century Variable Portfolios, Inc. (American Century):
Capital Appreciation Portfolio; and Fidelity Investments' Variable
Insurance Products (Fidelity): Equity Income, Growth, and Asset Manager
Portfolios. Penn Series, AMT, American Century, 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 the 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+ FLEXIBILITY MANAGED FUND+ FUND+
- ---------------------------- ----------------------- --------------------------------------------------
1996 1995 1996 1995 1996 1995 1996 1995(A)
- ------------- ------------- ----------- ---------- ------------ ------------------------ ----------
<S> <C> <C> <C> <C> <C> <C> <C>
169,060 165,899 1,164,470 706,599 2,076,707 1,909,325 485,158 138,561
19,719 17,339 86,079 91,497 485,607 353,198 3,365 1,082
437,770 571,396 321,429 332,378 633,475 417,253 23,236 2,844
- ------------- ------------- ----------- ---------- ------------ ------------ ---------- ----------
626,549 754,634 1,571,978 1,130,474 3,195,789 2,679,776 511,759 142,487
(567,813) (456,843) (227,840) (275,894) (363,469) (304,008) (32,572) (2,160)
- ------------- ------------- ----------- ---------- ------------ ------------ ---------- ----------
58,736 297,791 1,344,138 854,580 2,832,320 2,375,768 479,187 140,327
4,336,590 4,038,799 6,487,151 5,632,571 12,187,362 9,811,594 140,327 0
- ------------- ------------- ----------- ---------- ------------ ------------ ---------- ----------
4,395,326 4,336,590 7,831,289 6,487,151 15,019,682 12,187,362 619,514 140,327
============= ============= =========== ========== ============ ============ ========== ==========
$ 13,550,324 $ 15,244,644 $29,281,270 $9,472,800 $ 59,505,713 $ 45,850,893 $6,110,211 $1,567,584
============= ============= =========== ========== ============ ============ ========== ==========
$ 12,259,901 $ 9,537,239 $ 4,151,661 $4,688,111 $ 6,762,719 $ 5,227,508 $ 397,931 $ 23,250
============= ============= =========== ========== ============ ============ ========== ==========
<CAPTION>
CAPITAL EQUITY ASSET
APPRECIATION PORTFOLIO+++ INCOME PORTFOLIO++++ GROWTH PORTFOLIO++++ MANAGER PORTFOLIO++++
- ---------------------------- ----------------------- --------------------------------------------------
1996 1995 1996 1995(A) 1996 1995(A) 1996 1995(A)
- ------------- ------------- ----------- ---------- ------------ ------------------------ ----------
<S> <C> <C> <C> <C> <C> <C> <C>
412,781 544,314 1,248,554 362,089 879,192 294,937 220,911 83,857
0 2,462 819 2,757 1,098 0 4,421 0
326,246 0 23,487 0 27,718 0 3,646 0
- ------------- ------------- ----------- ---------- ------------ ------------ ---------- ----------
739,027 546,776 1,272,860 364,846 908,008 294,937 228,978 83,857
(420,995) (143,709) (34,010) (4,949) (21,860) (2,591) (25,995) (998)
- ------------- ------------- ----------- ---------- ------------ ------------ ---------- ----------
318,032 403,067 1,238,850 359,897 886,148 292,346 202,983 82,859
2,515,701 2,112,634 359,897 0 292,346 0 82,859 0
- ------------- ------------- ----------- ---------- ------------ ------------ ---------- ----------
2,833,733 2,515,701 1,598,747 359,897 1,178,494 292,346 285,842 82,859
============= ============= =========== ========== ============ ============ ========== ==========
$ 8,096,102 $ 6,094,633 $24,711,104 $6,606,484 $ 26,546,059 $ 8,622,762 $3,580,092 $1,248,666
============= ============= =========== ========== ============ ============ ========== ==========
$ 4,525,040 $ 1,497,448 $ 696,843 $ 86,095 $ 673,136 $ 75,436 $ 406,541 $ 15,032
============= ============= =========== ========== ============ ============ ========== ==========
</TABLE>
- -------------------------------------------------------------------------------
NOTE 3. CONT'D.
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 special
charges assessed.
B-22
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF TRUSTEES OF
THE PENN MUTUAL LIFE INSURANCE COMPANY
PHILADELPHIA, PENNSYLVANIA
We have audited the accompanying statutory statements of financial condition of
The Penn Mutual Life Insurance Company as of December 31, 1996 and 1995, and
the related statutory statements of operations, surplus and cash flows for the
three years in the period ended December 31, 1996. These statutory 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.
As described more fully in Note 1 to the financial statements, the Company
prepared these financial statements using accounting practices prescribed or
permitted by the Insurance Department of the Commonwealth of Pennsylvania
(SAP), which practices differ from generally accepted accounting principles
(GAAP). The effects on the financial statements of the variances between SAP
and GAAP are described in Note 1 to the financial statements.
In our report dated January 26, 1996, we expressed our opinion that the 1995
and 1994 financial statements, prepared using SAP, presented fairly, in all
material respects, the financial position of The Penn Mutual Life Insurance
Company as of December 31, 1995, and the results of its operations, and its
cash flows for the two years then ended in conformity with GAAP. As described
in Note 1 to the financial statements, financial statements of mutual life
insurance enterprises issued or reissued after 1996, which are prepared in
accordance with SAP, are no longer considered to be presented in conformity
with GAAP. Accordingly, our present opinion on the 1995 and 1994 financial
statements as presented herein is different from that expressed in our previous
report.
In our opinion, because of the effects of the matter discussed in the second
preceding paragraph, the financial statements referred to above do not present
fairly, in conformity with GAAP, the financial position of The Penn Mutual Life
Insurance Company as of December 31, 1996 and 1995, or the results of its
operations or its cash flows for the three years in the period ended December
31, 1996.
In our opinion, the statutory financial statements referred to above present
fairly, in all material respects, the financial condition of The Penn Mutual
Life Insurance Company as of December 31, 1996 and 1995, and the results of its
operations and its cash flows for the three years in the period ended December
31, 1996, on the basis of accounting described in Note 1.
As discussed in Note 2 to the financial statements, during 1995, the Company
changed its accounting method for certain components of the federal income tax
expense. Also as discussed in Note 2, in 1996 and 1995, the Company changed the
reserve valuation basis for disability income and certain annuity contracts,
respectively.
Coopers & Lybrand L.L.P
2400 Eleven Penn Center
Philadelphia, Pennsylvania
January 28, 1997
B-23
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31, 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
(in thousands of dollars)
ASSETS
Bonds.................................................... $4,541,972 $3,695,516
Stocks
Preferred............................................... 13,042 15,049
Common--affiliated...................................... 205,574 171,193
- --unaffiliated........................................... 160 8,182
Mortgage loans........................................... 117,046 960,692
Real estate.............................................. 99,575 138,329
Policy loans............................................. 409,344 422,865
Cash and short-term investments.......................... 14,532 75,962
Other invested assets.................................... 76,500 59,561
---------- ----------
TOTAL CASH AND INVESTED ASSETS.......................... 5,477,745 5,547,349
Investment income due and accrued........................ 83,573 94,350
Premiums due and deferred................................ 25,297 26,926
Other assets............................................. 36,479 41,082
Separate account assets.................................. 1,225,038 911,683
---------- ----------
TOTAL ASSETS............................................ $6,848,132 $6,621,390
========== ==========
LIABILITIES
Reserves and funds for payment of future life and annuity
benefits................................................ $4,948,254 $5,064,298
Dividends to policyholders payable in the following year. 69,445 72,653
Policy claims in process................................. 25,626 27,241
Interest maintenance reserve............................. 18,716 36,084
Asset valuation reserve.................................. 77,408 83,157
Other liabilities........................................ 103,871 77,063
Separate account liabilities............................. 1,225,038 905,960
---------- ----------
TOTAL LIABILITIES....................................... 6,468,358 6,266,456
---------- ----------
SURPLUS
Special surplus funds.................................... 1,629 1,576
Unassigned surplus....................................... 378,145 353,358
---------- ----------
TOTAL................................................... 379,774 354,934
---------- ----------
TOTAL LIABILITIES AND SURPLUS.......................... $6,848,132 $6,621,390
========== ==========
</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, 1996 1995 1994
- ---------------------------------------------------------------------------------
(in thousands of dollars)
<S> <C> <C> <C>
INCOME
Premium and annuity considerations.......... $ 641,183 $ 710,442 $ 771,547
Net investment income....................... 455,278 456,108 446,354
Other income................................ 3,340 (5,632) 10,497
---------- ---------- ----------
TOTAL INCOME............................... 1,099,801 1,160,918 1,228,398
---------- ---------- ----------
BENEFITS AND EXPENSES
Benefits paid to policyholders and benefi-
ciaries.................................... 816,583 859,798 766,598
Increase (decrease) in reserves and funds
for payment of future life and annuity
benefits................................... (135,705) (50,775) 54,380
Commissions................................. 37,487 38,044 45,579
Operating expenses.......................... 110,194 116,673 124,920
Net transfers to separate accounts.......... 125,532 86,944 128,773
---------- ---------- ----------
TOTAL BENEFITS AND EXPENSES................ 954,091 1,050,684 1,120,250
---------- ---------- ----------
INCOME FROM OPERATIONS BEFORE DIVIDENDS AND
FEDERAL INCOME TAXES...................... 145,710 110,234 108,148
Dividends to policyholders.................. 65,996 70,057 69,098
---------- ---------- ----------
INCOME FROM OPERATIONS BEFORE FEDERAL IN-
COME TAXES................................ 79,714 40,177 39,050
Federal income tax expense (benefit)........ 13,073 (52,442) 197
---------- ---------- ----------
INCOME FROM OPERATIONS..................... 66,641 92,619 38,853
Net realized capital losses, net of taxes... 40,736 91,890 37,399
---------- ---------- ----------
NET INCOME................................. 25,905 729 1,454
SURPLUS
Change in asset valuation reserve........... 5,749 28,728 29,060
Change in net unrealized capital gains and
losses..................................... 5,433 2,395 (3,376)
Changes in accounting methods, net of taxes. (14,773) 7,984 --
Other....................................... 2,526 (223) 8,618
---------- ---------- ----------
TOTAL CONTRIBUTION TO SURPLUS.............. 24,840 39,613 35,756
Surplus, Beginning of Year................. 354,934 315,321 279,565
---------- ---------- ----------
SURPLUS, END OF YEAR....................... $ 379,774 $ 354,934 $ 315,321
========== ========== ==========
</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, 1996 1995 1994
- ---------------------------------------------------------------------------------
(in thousands of dollars)
<S> <C> <C> <C>
CASH PROVIDED
Net cash from operations:
Premium and annuity considerations.......... $ 642,997 $ 708,301 $ 767,017
Net investment income....................... 429,532 439,508 420,917
Other income................................ 76,756 (2,511) 15,704
---------- ---------- ----------
1,149,285 1,145,298 1,203,638
Benefits to policyholders................... 816,297 871,983 750,019
Commissions................................. 37,456 38,139 45,540
Operating expenses and taxes................ 107,115 152,907 96,050
Net transfers to separate accounts.......... 165,495 86,944 129,858
Dividends to policyholders.................. 69,204 69,804 70,246
Net decrease in policy loans................ (12,884) (15,202) (22,361)
---------- ---------- ----------
NET CASH FROM OPERATIONS................... (33,398) (59,277) 134,286
---------- ---------- ----------
Investments sold, matured or repaid:
Bonds....................................... 1,079,993 1,410,126 1,038,593
Stocks...................................... 27,131 95,347 197,503
Mortgage loans.............................. 819,237 102,394 45,255
Real estate and other invested assets....... 36,968 10,837 12,701
---------- ---------- ----------
Total investments sold, matured or repaid.. 1,963,329 1,618,704 1,294,052
Taxes on realized investment gains........... (3,694) 3,253 (17,722)
Other cash provided.......................... 5,852 4,275 10,035
---------- ---------- ----------
1,965,487 1,626,232 1,286,365
---------- ---------- ----------
TOTAL CASH PROVIDED........................ 1,932,089 1,566,955 1,420,651
---------- ---------- ----------
CASH APPLIED
Cost of investments acquired:
Bonds....................................... 1,916,791 1,357,008 1,218,880
Stocks...................................... 15,035 26,114 131,248
Mortgage loans.............................. 38,768 100,466 71,427
Real estate and other invested assets....... 17,456 8,970 14,909
---------- ---------- ----------
Total cost of investments acquired......... 1,988,050 1,492,558 1,436,464
Other cash applied........................... 5,469 6,231 24,452
---------- ---------- ----------
TOTAL CASH APPLIED......................... 1,993,519 1,498,789 1,460,916
---------- ---------- ----------
Net change in cash and short-term invest-
ments....................................... (61,430) 68,166 (40,265)
Cash and short-term investments:
Beginning of year........................... 75,962 7,796 48,061
---------- ---------- ----------
END OF YEAR................................. $ 14,532 $ 75,962 $ 7,796
========== ========== ==========
</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
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
(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, variable life, immediate annuities and deferred annuities, both fixed
and variable. 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 and the District of Columbia.
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 (SAP). Prescribed SAP include state laws,
regulations, and general administrative rules, as well as a variety of
publications of the National Association of Insurance Commissioners (NAIC).
Permitted SAP encompass all accounting practices that are not prescribed.
These principles were considered to be in conformity with generally accepted
accounting principles (GAAP) prior to the issuance of Financial Accounting
Standards Board Interpretation No. 40, "Applicability of Generally Accepted
Accounting Principles to Mutual Life Insurance and other Enterprises," (FIN
No. 40) and Statement of Financial Accounting Standards (SFAS) No. 120,
"Accounting and Reporting by Mutual Life Insurance Enterprises and by
Insurance Enterprises for Certain Long-Duration Participating Contracts".
Effective for fiscal years beginning after December 15, 1995, in accordance
with FIN No. 40, the financial statements of mutual life insurance companies
which are prepared on the basis of SAP can no longer be described as prepared
in conformity GAAP. Therefore, as required by generally accepted auditing
standards, the opinion expressed by our independent accountants on the 1995
and 1994 financial statements is different from that expressed in their
previous report.
In financial statements prepared in conformity with SAP, the accounting
treatment of certain items is different than for financial statements issued
in conformity with GAAP. Significant differences include:
. Policy acquisition costs, such as commissions and other costs incurred in
connection with acquiring new and renewal business, are expensed when
incurred; under GAAP, such costs are deferred and amortized over the
expected premium paying period.
. Premiums for universal life and investment-type products are recognized as
revenue when due; under GAAP, they are accounted for as deposits and
excluded from revenue.
. Policy reserves are based on statutory mortality and interest requirements
and without consideration of withdrawals and are reported net of reinsurance
reserve credits; under GAAP, the reserves are based on expected investment
yield, mortality and withdrawals and are reported gross of reinsurance
reserve credits. Changes in reserves on account of change in valuation basis
during the year are charged directly to surplus rather than reflected in the
net gain from operations, as is the case under GAAP.
. No provision is made for deferred income taxes; under GAAP, deferred taxes
result from temporary differences between the tax basis of assets and
liabilities and their reported amounts in the financial statements.
. An asset valuation reserve (AVR) is established as a liability to offset
potential investment losses and changes in the AVR are charged or credited
to surplus; under GAAP, reserves are established for invested assets based
on evaluation of impairment and are recorded through realized
gains/(losses).
. An interest maintenance reserve (IMR) is established as a liability to
capture gains and losses, net of tax, on the sale of fixed maturities
resulting from changes in the general level of interest rates; no such
reserve is required under GAAP.
. Investments in bonds and preferred stocks are generally carried at amortized
cost; under GAAP, investments in bonds and preferred stocks, other than
those classified as held to maturity, are carried at fair value.
. Certain assets, designated as nonadmitted, are excluded from assets by a
direct charge to surplus; under GAAP, such assets are carried on the
statement of financial condition with appropriate valuation allowances.
B-27
<PAGE>
- -------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
. Pension expense for the qualified noncontributory pension plan (Plan) is
recognized when pension contributions are deductible for federal income tax
purposes, rather than incurred over the service lives of employees
participating in the Plan, as is the case under GAAP.
. Postretirement benefits are recognized for vested employees and current
retirees, rather than accruing an obligation over the service period for all
eligible employees, as is the case under GAAP.
. In accordance with Pennsylvania Insurance Laws and Regulations, the Company's
subsidiaries are not consolidated for statutory filing purposes; under GAAP,
majority-owned subsidiaries are consolidated.
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.
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. 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 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 to 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, modified preliminary term or CRVM 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
2.25% 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
B-28
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
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 1995 and 1994 amounts have been reclassified to conform with the 1996
presentation.
NOTE 2 - ACCOUNTING CHANGES:
During 1996, the Company changed its valuation basis for disability income and
certain other contracts. The increase in reserves of $14,773, net of taxes, was
taken as a direct charge to surplus.
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 resulted 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.
B-29
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
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, 1996 and 1995.
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-------------------------------------------
GROSS GROSS ESTIMATED
STATEMENT UNREALIZED UNREALIZED FAIR
VALUE GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
United States Government........... $ 15,541 $ 549 $ -- $ 16,090
Other governmental units........... 34,451 1,601 -- 36,052
Public utility..................... 415,874 28,379 2,020 442,233
Industrial and other............... 2,102,134 100,466 8,138 2,194,462
Mortgage and other asset-backed se-
curities.......................... 1,973,972 24,969 15,587 1,983,354
---------- -------- ------- ----------
4,541,972 155,964 25,745 4,672,191
Redeemable preferred stocks........ 3,575 -- 266 3,309
---------- -------- ------- ----------
TOTAL............................. $4,545,547 $155,964 $26,011 $4,675,500
========== ======== ======= ==========
</TABLE>
<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 se-
curities.......................... 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
========== ======== ======= ==========
</TABLE>
The following summarizes the statement value and estimated fair value of debt
securities as of December 31, 1996 by contractual maturity.
<TABLE>
<CAPTION>
ESTIMATED
STATEMENT FAIR
VALUE VALUE
---------- ----------
<S> <C> <C>
Maturity:
Within one year......................................... $ 211,786 $ 211,591
After one year through five years....................... 621,748 631,662
After five years through ten years...................... 296,615 307,622
After ten years through twenty years.................... 435,475 478,638
After twenty years...................................... 1,002,376 1,059,324
Mortgage and other asset-backed securities.............. 1,973,972 1,983,354
---------- ----------
4,541,972 4,672,191
Redeemable preferred stocks.............................. 3,575 3,309
---------- ----------
TOTAL................................................... $4,545,547 $4,675,500
========== ==========
</TABLE>
B-30
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
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. Mortgage and other asset-backed securities consist of
commercial and residential mortgage pass-through holdings and securities backed
by credit card receivables, auto loans and home equity and manufactured housing
loans. These securities follow a structured principal repayment schedule and
are of high credit quality. These securities are rated investment grade, other
than $60,547 in commercial mortgage-backed securities retained from the
securitization of the Company's commercial mortgage loan portfolio. The
mortgage and other asset-backed securities portfolio is presented separately in
the maturity schedule due to the potential for prepayment. The weighted average
life of this portfolio is 7.6 years.
During 1996, 1995 and 1994, proceeds from dispositions of investments in debt
securities amounted to $1,079,993, $1,410,126, and $1,038,593, respectively.
The gross gains realized on those dispositions were $13,794, $57,295 and
$5,876, and the gross losses realized on those dispositions were $6,535,
$10,069 and $27,348 during 1996, 1995 and 1994, respectively. Total net
realized losses, net of taxes, transferred to the IMR in 1996 were $16,208.
Total net realized gains, net of taxes, transferred to the IMR in 1995 were
$32,211. Total net realized losses, net of taxes, transferred to the IMR, in
1994 were $14,089. Amortization of the IMR included in net investment income
amounted to $1,160, $1,482 and $1,056 in 1996, 1995 and 1994, respectively.
The Company's investment portfolio of debt securities is comprised
predominantly of investment grade securities. As of December 31, 1996 and 1995,
debt securities totaling $168,313 and $100,013, 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, 1996 and 1995.
MORTGAGE LOANS
On August 29, 1996, the Company securitized the majority of its mortgage loan
portfolio, by transferring mortgage loans with a principal value of $715,712
and a book value of $715,121 to a trust which qualifies as a REMIC (Real Estate
Mortgage Investment Conduit) under the Internal Revenue Code. The trust issued
sixteen classes of Commercial Mortgage Pass-Through Certificates with a total
par value of $715,912. The certificates evidence the entire beneficial
ownership interest in the trust. The cash flow from the mortgages will be used
to repay the certificates over an average life of 4.28 years. The actual date
on which the principal amount of the notes may be paid in full could be
substantially earlier or later based on performance of the mortgages. The cash
flows of the assets of the trust will be the sole source of payments on the
notes. The Company has not guaranteed these certificates or the mortgage loans
held by the trust. As a result of this transaction, the Company recognized a
loss of $23,029 upon the transfer of the mortgages to the trust, representing
the difference between the fair market value of the certificates and the book
value of the mortgage loans transferred to the trust. This loss was deferred
through the Interest Maintenance Reserve (IMR), net of related taxes, and will
be amortized into income over the remaining life of the mortgages sold.
Included in the Company's bond portfolio are the highest quality classes of
certificates with a par value of $655,055 and a fair market value of $672,643
at the time of the securitization, which the Company retained. The Company sold
the lowest rated classes of certificates with a par value of $60,857 and a fair
market value of $22,752.
The mortgage loans which were not included in the securitization were retained
by the Company and had a book value of $152,480 and an estimated fair value of
$140,691 on the date of the securitization. Loans which the Company intends to
dispose of within a period of 6 to 24 months were written down to their
estimated net realizable value. These loans had a book value of $83,428 and an
estimated net realizable value of $67,642, which resulted in a credit-related
realized loss of $15,786. The Company intends to hold mortgage loans with a
book value of $69,052 on the date of the securitization, through their
remaining terms. The Company has discontinued the origination of commercial
mortgage loans.
B-31
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The following summarizes the statement value of mortgage loans, by property
type and geographic concentration, as of December 31, 1996 and 1995.
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Property Type
Office buildings.............................................. $ 40,243 $296,976
Retail........................................................ 39,090 230,902
Dwellings..................................................... 33,539 223,192
Other......................................................... 4,174 209,622
-------- --------
Total........................................................ $117,046 $960,692
======== ========
Geographic Concentration
Northeast..................................................... $ 43,552 $328,397
Midwest....................................................... 17,539 358,203
South......................................................... 20,715 132,382
West.......................................................... 35,240 139,979
Canada........................................................ -- 1,731
-------- --------
Total........................................................ $117,046 $960,692
======== ========
</TABLE>
The Company's investments at December 31, 1996 included $12,983 of mortgage
loans delinquent over 60 days and no mortgage loans which were non-income
producing for the preceding twelve months as of December 31, 1996. The
Company's investments at December 31, 1995 included $27,295 of mortgage loans
delinquent over 60 days, including $8,033 of mortgage loans which were non-
income producing for the preceding twelve months as of December 31, 1995. The
mortgage loan portfolio includes $7,110 and $19,928 of restructured mortgage
loans as of December 31, 1996 and 1995, 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, 1996 and 1995, accumulated depreciation on real estate
amounted to $32,592 and $43,069, respectively. Depreciation expense on real
estate totaled $5,769, $10,019 and $8,445 for the years ended December 31,
1996, 1995 and 1994, respectively. The Company's investments include $14,330
and $27,944 of foreclosed real estate as of December 31, 1996 and 1995,
respectively. The statement value of the Company's largest real estate
investment amounted to $49,923 and $54,858 as of December 31, 1996 and 1995,
respectively. During 1996, the Company wrote down the statement value of this
property by $16,000 to its current estimated fair value based on changes in
future valuation assumptions. During 1995, the Company wrote down the statement
value of this property by $76,500 to its estimated fair value at that date.
This write down reflected 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,
as of 1995, the Company no longer intended to hold this property as a long-term
investment.
NOTE 4 - RESERVES AND FUNDS FOR PAYMENT OF FUTURE LIFE AND ANNUITY BENEFITS:
The following summarizes the withdrawal characteristics of the Company's
reserve and deposit funds as of December 31, 1996.
<TABLE>
<CAPTION>
STATEMENT
VALUE
-----------
<S> <C>
Total policyholders' reserves and funds, including separate ac-
count liabilities................................................ $ 6,173,292
Amounts not subject to discretionary withdrawal................... (1,207,000)
-----------
Amounts subject to discretionary withdrawal...................... $ 4,966,292
===========
</TABLE>
B-32
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
Of the total reserves and deposit funds which are subject to discretionary
withdrawal, $1,958,656, which is net of applicable policy loans, may be
withdrawn without the policyholder incurring surrender charges or market value
adjustments to those funds.
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, 1996 and 1995.
<TABLE>
<CAPTION>
1996 1995
--------------------- ---------------------
STATEMENT ESTIMATED STATEMENT ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Debt securities
Bonds............................. $4,541,972 $4,672,192 $3,695,516 $3,964,303
Redeemable preferred stocks....... 3,575 3,309 3,964 3,727
Equity securities
Common stock--unaffiliated........ 160 160 8,182 8,182
Non-redeemable preferred stocks... 9,467 12,112 11,085 13,607
Mortgage loans
Commercial........................ 117,046 120,281 958,079 1,000,003
Residential....................... -- -- 2,613 2,930
Policy loans....................... 409,344 387,562 422,865 405,721
Venture capital limited partner-
ships............................. 37,792 37,792 30,325 30,325
Separate account assets............ 1,225,038 1,225,038 911,683 911,683
FINANCIAL LIABILITIES:
Investment-type contracts
Individual annuities.............. 1,216,161 1,246,695 $1,248,138 $1,287,644
Guaranteed investment contracts... 111,276 112,300 222,991 226,255
Other group annuities............. 188,565 189,853 216,686 219,857
Dividends to policyholders payable
in the following year............. 69,445 69,445 72,653 72,653
Separate account liabilities....... 1,225,038 1,225,038 905,960 905,960
</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 investments, 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 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 $34,803 and $43,490 as of December 31, 1996
and 1995, respectively, approximates the fair value due
B-33
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
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.
The Company is exposed to interest rate risk on its interest sensitive
products. The Company's investment strategy is designed to minimize interest
risk by managing the duration of both assets and liabilities 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, 1996 and
1995, the Company had interest rate swaps with aggregate notional amounts equal
to $115,000, with average unexpired terms of 29 and 39 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, 1996 and 1995, the Company would have
recognized gains of $7,605 and $12,880, respectively. The fair values for
interest rate swaps and futures contracts are based on dealers' quotes and
represent the estimated amount 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, 1996 and 1995.
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
$8,310, $8,848 and $7,757 in 1996, 1995 and 1994, 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, 1996 and 1995.
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Actuarial present value of accumulated plan benefits:
Vested........................................................ $32,572 $29,744
Non-vested.................................................... 935 763
------- -------
TOTAL........................................................ $33,507 $30,507
======= =======
Net assets available for plan benefits......................... $37,938 $34,067
======= =======
</TABLE>
B-34
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The actuarial present value of accumulated plan benefits was determined using a
7.5% and a 7.0% assumed discount rate for December 31, 1996 and 1995,
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, 1996, the plans' total
accumulated benefit obligation, determined in accordance with SFAS No. 87 and
based on a 7.5% assumed discount rate amounted to $16,439. As of December 31,
1995, the plans' total accumulated benefit obligation, determined in accordance
with SFAS No. 87 and based on an 7.0% assumed discount rate amounted to
$17,609. The additional obligation for future salary increases was $1,899 and
$2,539 as of December 31, 1996 and 1995, respectively.
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, 1996
and 1995, the estimated fair value of the defined contribution plans' assets
was $134,778 and $126,378, 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.
The Company accounts for the costs of postretirement benefits using an accrual
method and is amortizing a transition obligation of $33,744 over 20 years. As
of December 31, 1996 and 1995, the unamortized transition obligation was
$26,996 and $28,683, respectively.
Postretirement benefit expense for the year ended December 31, 1996, 1995 and
1994 was $3,778, $4,426, and $4,346 respectively, which includes the expected
cost of postretirement benefits for vested employees, interest cost, service
cost, and amortization of the transition obligation and the unrecognized
gains/(losses) on the obligation. The interest cost, service cost and
amortization of the unrecognized gain on the obligation were $1,948, $590 and
$447, respectively, for the year ended December 31, 1996. The interest cost and
service cost were $2,471 and $268, respectively, for the year ended December
31, 1995. The interest cost and service cost were $2,366 and $293,
respectively, for the year ended December 31, 1994. There was no unrecognized
gain/(losses) on the obligation in 1995 and 1994. The Company made
contributions to the plans of $2,107, $2,629 and $2,438 in 1996, 1995 and 1994,
respectively, as claims were incurred.
As of December 31, 1996 and 1995, the unfunded postretirement benefit
obligation for retirees and other fully eligible or vested plan participants
was $25,960 and $36,150, respectively. For December 31, 1996 the discount rate
used in determining the accumulated postretirement benefit obligation was 7.5%,
and the health care cost trend rate was 8.5%, graded to 5% over 8 years. 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.
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, 1996 by $1,833 and the estimated
eligibility cost and interest cost components of net periodic postretirement
benefit cost for the year ended December 31, 1996 by $135.
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.
B-35
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The IRS has examined the Company's income tax returns through the year 1990 and
is currently examining years 1991 through 1994. 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 with 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.
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, 1996:
Life Insurance in-force.......... $26,822,820 $7,829,755 $5,517,369 $29,135,206
Premium and annuity considera-
tions........................... 656,437 17,831 33,085 641,183
Reserves and funds for payment of
future life and annuity bene-
fits............................ 5,942,388 3,945 320,167 5,626,166
DECEMBER 31, 1995:
Life Insurance in-force.......... $26,290,414 $7,668,076 $4,982,235 $28,976,255
Premium and annuity considera-
tions........................... 724,188 19,762 33,508 710,442
Reserves and funds for payment of
future life and annuity bene-
fits............................ 5,364,721 3,937 304,360 5,064,298
</TABLE>
During 1994, the Company had gross premiums of $772,461, assumed premiums of
$40,418 and ceded premiums of $41,332.
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 $327,897 and $342,694 as of December 31, 1996 and 1995,
respectively. The Company reduced its reserves by $243,426 and $242,691 as of
December 31, 1996 and 1995, respectively. Net premium and annuity
considerations ceded to PIA were $11,620 and $11,056, which include an
experience refund paid of $4,461 and $2,257 in 1996 and 1995, respectively. Net
premium and annuity considerations assumed from PIA in 1994 were $10,069.
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.
B-36
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTE 9 - RELATED PARTIES:
The following summarizes the statement value of the Company's unconsolidated
subsidiaries and affiliates as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Independence Square Properties, Inc. ........................ $108,817 $ 88,607
PIA.......................................................... 82,102 65,601
Other affiliates............................................. 14,655 16,985
-------- --------
TOTAL....................................................... $205,574 $171,193
======== ========
</TABLE>
The Company's unconsolidated subsidiaries had combined assets of $1,545,888 and
$1,373,745, and combined liabilities of $1,340,314 and $1,202,552 as of
December 31, 1996 and 1995, respectively. The Company records earnings from
these subsidiaries through investment income. The majority of the earnings of
$37,981, $23,642 and $24,311 for the years ended December 31, 1996, 1995 and
1994, respectively, relate to broker/dealer subsidiaries.
As of December 31, 1996 and 1995, bonds include notes receivable from
subsidiaries of $27,304 and $31,130, respectively. Investment income on notes
receivable from subsidiaries amounted to $1,989, $3,118 and $2,527 for 1996,
1995 and 1994, respectively.
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, 1996, the Company had
outstanding commitments totaling $13,079 relating to these investment
activities. The fair value of these commitments approximates the face amount.
As of December 31, 1996, unused lines of credit available to the Company
amounted to $40,000.
B-37
