<PAGE>
Prospectus
Penn Mutual Variable Annuity Account III
December 16, 1998
Pennant Select
Penn Series Funds, Inc.
May 1, 1998
Investment Advisers:
T. Rowe Price Associates, Inc.
OpCap Advisors
Independence Capital Management, Inc.
Vontobel USA, Inc.
Robertson Stephens Investment Management, Inc.
Neuberger & Berman
Advisers Management Trust
May 1, 1998
Investment Adviser:
Neuberger & Berman Management Incorporated
Fidelity Investments'
Variable Insurance Products Fund
Variable Insurance Products Fund II
May 1, 1998
Investment Adviser:
Fidelity Management & Research Company
Morgan Stanley Universal Funds Inc.
May 1, 1998
Investment Adviser:
Morgan Stanley Investment Management Inc.
Penn
Mutual
A better way of life
<PAGE>
The Penn Mutual Life Insurance Company
Philadelphia, PA 19172
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December 16, 1998
Pennant Select
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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 Contract. The Contract is more fully
described in the prospectus which accompanies this Profile.
Please read the prospectus carefully.
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1. The Annuity Contract
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The Contract offered in this prospectus is a combination variable and fixed
annuity contract between you, the owner, and The Penn Mutual Life Insurance
Company. The Contract provides a means for you to invest in one or more of the
available Funds listed in Section 4, or one or more of the fixed interest
accounts guaranteed and funded by Penn Mutual through its general account.
You determine (1) the amount and frequency of payments to make, (2) which
Funds will be used, (3) transfers between the 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.
2. Annuity Payments
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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 these as a variable annuity (except for a
specified number of years), a fixed annuity, or a combination of both.
3. Purchase
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The minimum initial purchase payment is $5,000. The minimum subsequent
purchase payment is $5,000.
4. Investment Options
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Independence Capital
Management, Inc.
Growth Equity Fund
Quality Bond Fund
Money Market Fund
OpCap Advisors
Value Equity Fund
Small Capitalization Fund
Morgan Stanley Dean Witter
Investment Management Inc.
Emerging Markets Equity (Int'l) Portfolio
ICMI/ Robertson Stephens
Emerging Growth Fund
T. Rowe Price Associates, Inc.
Flexibly Managed Fund
High Yield Bond Fund
Neuberger & Berman Management Incorporated
AMT Limited Maturity Bond Portfolio
AMT Balanced Portfolio
AMT Partners Portfolio
Fidelity Investments
VIP Equity Income Portfolio
VIP Growth Portfolio
VIP II Asset Manager Portfolio
VIP II Index 500 Portfolio
Vontobel USA, Inc.
International Equity Fund
<PAGE>
5. Expenses
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Each year we deduct a contract administration charge, the lessor of $40 or 2%
of the variable account value, unless the Variable Account Value is greater than
$100,000. We deduct a daily mortality and expense risk charge equal to an annual
rate of 1.20% of the daily net asset value of the Separate Account. In addition,
we deduct a daily administration charge equal to an annual rate of 0.15% of the
daily net asset value of the Separate Account. There are also expenses deducted
from the underlying Fund that have ranged 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. The following table shows the schedule of the contingent
deferred sales charge that will apply:
--------------------------------------------------------------
Number of Full Contract
Years Since Purchase Payment Applicable Charge
--------------------------------------------------------------
0 7.0%
1 7.0%
2 6.0%
3 5.0%
4 4.0%
5 3.0%
6 1.5%
7 and later No Charge
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The following chart 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
Annual Annual Total
Insurance Portfolio Annual
Fund Charges Charges Charges 1 Year 10 Years
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Growth Equity 1.40% 0.77% 2.17% $83 $254
Value Equity 1.40% 0.76% 2.16% $83 $253
Flexibly Managed 1.40% 0.76% 2.16% $83 $253
Small Capitalization 1.40% 0.85% 2.25% $84 $262
Emerging Growth 1.40% 1.15% 2.55% $87 $292
International Equity 1.40% 1.13% 2.53% $87 $290
Quality Bond 1.40% 0.75% 2.15% $83 $252
High Yield Bond 1.40% 0.81% 2.21% $84 $258
Money Market 1.40% 0.70% 2.10% $83 $247
Limited Maturity Bond 1.40% 0.77% 2.17% $83 $254
Balanced 1.40% 1.04% 2.44% $86 $281
Partners 1.40% 0.86% 2.26% $84 $263
Equity Income 1.40% 0.57% 1.97% $82 $233
Growth 1.40% 0.67% 2.07% $83 $243
Asset Manager 1.40% 0.64% 2.04% $82 $240
Index 500 1.40% 0.28% 1.68% $79 $202
Emerging Markets Equity 1.40% 1.75% 3.15% $93 $349
- -------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
6. Taxes
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Your earnings 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
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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 15% of the total purchase payments
free of the contingent deferred sales charge.
8. Performance
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The value of your 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 expenses 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 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Independence Capital
Growth Equity 25.02% 18.13% 24.73% -9.37% 10.90%
Quality Bond 6.56 2.72 18.51 -6.58 10.14
OpCap Advisors
Value Equity 23.25 23.48 35.62 1.53 5.62
Small Capitalization 21.35 18.12 n/a n/a n/a
T. Rowe Price
Flexibly Managed 14.11 14.73 20.65 2.72 14.22
High Yield Bond 14.21 12.32 14.83 -8.60 18.14
ICMI/ Robertson Stephens
Emerging Growth n/a n/a n/a n/a n/a
Vontobel
International Equity 8.90 15.27 12.25 -7.59 36.25
Neuberger & Berman
AMT Limited Maturity Bond 5.29 2.88 9.42 -1.52 5.17
AMT Balanced 17.35 5.43 22.08 -4.31 4.60
AMT Partners 29.47 27.81 34.62 n/a n/a
Fidelity Investments
VIP Equity Income 26.37 12.72 33.26 5.61 16.68
VIP Growth 21.80 13.14 33.53 -1.38 17.75
VIP II Asset Manager 19.01 13.04 15.36 -7.37 19.58
VIP II Index 500 31.01 21.04 35.33 -0.34 8.25
Morgan Stanley Dean Witter
Emerging Markets Equity -1.16 n/a n/a n/a n/a
Calendar Year
Fund 1992 1991 1990 1989 1988
- ------------------------------------------------------------------------------------------
Independence Capital
Growth Equity 4.51% 32.91% -12.35% 29.58% 11.14%
Quality Bond 5.11 14.05 6.48 11.37 6.06
OpCap Advisors
Value Equity 13.30 25.95 -9.31 11.43 27.88
Small Capitalization n/a n/a n/a n/a n/a
T. Rowe Price
Flexibly Managed 8.07 19.97 -2.17 19.54 17.33
High Yield Bond 14.22 35.16 -10.28 -1.95 16.18
ICMI/ Robertson Stephens
Emerging Growth n/a n/a n/a n/a n/a
Vontobel
International Equity n/a n/a n/a n/a n/a
Neuberger & Berman
AMT Limited Maturity Bond 3.74 9.83 6.85 9.26 5.70
AMT Balanced 6.58 21.01 0.56 n/a n/a
AMT Partners n/a n/a n/a n/a n/a
Fidelity Investments
VIP Equity Income 15.29 29.65 -16.45 15.75 21.04
VIP Growth 7.83 43.54 -12.94 29.73 14.00
VIP II Asset Manager 10.19 20.89 5.27 n/a n/a
VIP II Index 500 n/a n/a n/a n/a n/a
Morgan Stanley Dean Witter
Emerging Markets Equity n/a n/a n/a n/a n/a
</TABLE>
<PAGE>
9. Death Benefit
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If you, the owner, die prior to the Annuity Date we will pay the beneficiary
the Contract Value for the period that proof of death is received. If the
annuitant dies prior to the Annuity Date we will pay the beneficiary the Fixed
Account Value plus the greatest of (1) the Variable Account contract value for
the period that proof of death is received or (2) the sum of all variable
purchase payments, adjusted for withdrawals and contract transfers.
If the annuitant is 75 years old or less, you may purchase an enhanced
guaranteed minimum Death Benefit. For the cost of .20% (maximum of .25%) of the
average variable account value deducted from the contract annually, you may
choose either an Annual Step-up or 5% Rising Floor Optional Enhanced Death
Benefit. See the prospectus for more details.
If you die after the Annuity Date, the death benefit, if any, will be paid
according to the annuity option in effect.
10. Other Information.
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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 15% of the total
-----------------------
purchase payments 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 and Medically Related Surrenders. 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 Funds monthly or quarterly, theoretically
giving you a lower average cost per unit over time than a single one time
purchase.
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 Funds.
11. Inquiries
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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>
Prospectus -- December 16, 1998
Individual Variable and Fixed Annuity Contract - Flexible Purchase Payments
- -------------------------------------------------------------------------------
Penn Mutual Variable Annuity Account III
The Penn Mutual Life Insurance Company
Philadelphia, Pennsylvania 19172 o Telephone (215) 956-8000
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This Prospectus describes a combination variable and fixed annuity contract
offered by The Penn Mutual Life Insurance Company (the "Company"). Through Penn
Mutual Variable Annuity Account III (the "Separate Account"), you may allocate
amounts invested under the Contract among one or more of the funds as set forth
below:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
Penn Series Funds, Inc. Manager
Growth Equity Fund Independence Capital Management, Inc.
(a wholly owned subsidiary of The Penn Mutual Life
Insurance Company)
Value Equity Fund OpCap Advisors
Small Capitalization Fund OpCap Advisors
Emerging Growth Fund RS Investment Management, Inc.
Flexibly Managed Fund T. Rowe Price Associates, Inc.
International Equity Fund Vontobel USA, Inc.
Quality Bond Fund Independence Capital Management, Inc.
High Yield Bond Fund T. Rowe Price Associates, Inc.
Money Market Fund Independence Capital Management, Inc.
- ---------------------------------------------------------------------------------------------------------------------
Neuberger & Berman Advisers Management Trust Manager
Balanced Portfolio Neuberger & Berman Management Incorporated
Limited Maturity Bond Portfolio Neuberger & Berman Management Incorporated
Partners Fund Portfolio Neuberger & Berman Management Incorporated
- ---------------------------------------------------------------------------------------------------------------------
Fidelity Investments' Variable Insurance Products Fund Manager
Equity-Income Portfolio Fidelity Management and Research Company
Growth Portfolio Fidelity Management and Research Company
- ---------------------------------------------------------------------------------------------------------------------
Fidelity Investments' Variable Insurance Products Fund II Manager
Asset Manager Portfolio Fidelity Management and Research Company
Index 500 Portfolio Fidelity Management and Research Company
- ---------------------------------------------------------------------------------------------------------------------
Morgan Stanley Universal Funds, Inc. Manager
Emerging Markets Equity (International) Portfolio Morgan Stanley Dean Witter Investment Management Inc.
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
In addition, you may also invest in fixed accounts. The fixed accounts are
funded through and are backed by the
Company's general account.
For many persons, a combination variable and fixed annuity contract may be an
attractive long-term investment vehicle. Its benefits include the manner in
which earnings on accumulated funds are taxed, the availability of multiple
investment options, and the provision of annuity and death benefit guarantees.
The Contract is not intended as a short-term investment vehicle. Early
withdrawals of purchase payments from the contract may be subject to a
contingent deferred sales charge of up to 7%, and withdrawals by an owner before
age 59 1/2 may be subject to a 10% additional income tax.
A Contract may be returned within ten days of receipt for a full refund of
the Contract Value (or purchase payments, if required under applicable law).
Longer free look periods apply 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 (215) 956-8000. In addition, the Securities and Exchange Commission
maintains a Web site (http://www.sec.gov) that contains the Statement of
Additional Information, material incorporated by reference, and other
information regarding registrants that file electronically with the Commission.
The table of contents of the Statement Of Additional Information is at the end
of this Prospectus.
THIS PROSPECTUS MUST BE ACCOMPANIED 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
- --------------------------------------------------------------------------------
Special Terms .............................................................. 3
Expenses ................................................................... 4
Examples of Fees and Expenses .............................................. 6
The Penn Mutual Life Insurance Company ..................................... 7
The Separate Account ....................................................... 7
Penn Series Funds, Inc. ................................................. 8
Neuberger & Berman Advisers Management Trust ............................ 8
Fidelity Investments' Variable Insurance Products Fund .................. 8
Fidelity Investments' Variable Insurance Products Fund II ............... 9
Morgan Stanley Dean Witter Universal Funds Inc. ......................... 9
- --------------------------------------------------------------------------------
The Contract ............................................................... 9
Purchases ...............................................................10
Accumulation Units ......................................................10
Annuity Payments ........................................................10
Death Benefit ...........................................................11
Transfers ...............................................................12
Dollar Cost Averaging ................................................12
Automatic Rebalancing ................................................12
Withdrawals .............................................................12
Systematic Withdrawals ...............................................13
403(b) Withdrawals ...................................................13
Deferment of Payments and Transfers .....................................13
Charges .................................................................13
Administration Charges ...............................................13
Mortality and Expense Risk Charge ....................................13
Contingent Deferred Sales Charge .....................................13
Free Withdrawals .....................................................14
Enhanced Variable Account Death Benefit ..............................14
Premium Taxes ........................................................14
Performance Information .................................................15
- --------------------------------------------------------------------------------
Year 2000 ..................................................................15
- --------------------------------------------------------------------------------
The Fixed Accounts .........................................................15
General Information .....................................................16
Loans Under Section 403(b) Contracts ....................................16
- --------------------------------------------------------------------------------
Federal Income Tax Considerations ..........................................17
- --------------------------------------------------------------------------------
Financial Statements .......................................................18
- --------------------------------------------------------------------------------
Statement of Additional Information Contents ...............................19
- --------------------------------------------------------------------------------
2
<PAGE>
- --------------------------------------------------------------------------------
Special Terms
As used in this Prospectus, the following terms have the indicated meanings:
Accumulation Unit: A unit of measure used to compute the Variable Account
Value under the Contract prior to the Annuity Date.
Annuitant: The person during whose life annuity payments are made.
Annuity Date: The date on which annuity payments start.
Annuity Unit: A unit of measure used to calculate the amount of each
variable annuity payment.
Beneficiary: The person(s) named by the Contract Owner to receive the death
benefit payable upon the death of the Contract Owner or Annuitant.
Contract: The combination variable and fixed annuity contract described in
this Prospectus.
Contract Owner: The person specified in the Contract as the Contract Owner.
Contract Value: The sum of the Variable Account Value and the Fixed Account
Value.
Fixed Account Value: The value of amounts held under the Contract in all
fixed accounts.
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 Contract in all
subaccounts of the Separate Account.
Valuation Period: The period from one valuation of Separate Account assets
to the next. Valuation is performed on each day the New York Stock Exchange
is open for trading.
We or Us: A reference to "we" or "us" denotes The Penn Mutual Life
Insurance Company.
You: A reference to "you" denotes the Contract Owner or prospective
Contract Owner.
3
<PAGE>
Expenses
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
Contract Owner Transaction Expenses
Sales Load Imposed on Purchase Payments ................................ None
Maximum Contingent Deferred Sales Charge ............................... 7% of purchase
payments withdrawn(a)
Transfer Fee ........................................................... None
Maximum Annual Contract Administration Charge $40(b)
Separate Account Annual Expenses (as a percentage of Variable Account Value)
Mortality and Expense Risk Charge ...................................... 1.20%
Contract Administration Charge ......................................... 0.15%
----
Total Separate Account Annual Expenses ................................. 1.35%(c)
- --------------------------------------
</TABLE>
(a) The charge does not apply to withdrawals of purchase payment which were made
more than seven years prior to withdrawal.
(b) The charge is 2% of the Variable Account Value if less than $40. There is no
charge under Contracts with a Variable Account Value of more than $100,000.
(c) An enhanced Variable Account minimum death benefit rider may be purchased
with the Contract. An annual charge for the Rider is made against the
average annual Variable Account Value at the current rate of 0.20% with a
maximum possible rate of 0.25%. See "Charges" in this Prospectus.
- --------------------------------------------------------------------------------
Penn Series Funds, Inc.(a)
Underlying Fund Annual Expenses (as a % of portfolio avg. net assets)
<TABLE>
<CAPTION>
Management
Fees Other Total Fund
(after waiver) Expenses Expenses
-------------- -------- --------
<S> <C> <C> <C>
Growth Equity ................................................ 0.50% 0.27% 0.77%
Value Equity ................................................. 0.50% 0.26% 0.76%
Small Capitalization ......................................... 0.50% 0.35% 0.85%
Emerging Growth .............................................. 0.80% 0.35% 1.15%
Flexibly Managed ............................................. 0.50% 0.26% 0.76%
International Equity ......................................... 0.75% 0.38% 1.13%
Quality Bond ................................................. 0.45% 0.30% 0.75%
High Yield Bond .............................................. 0.50% 0.31% 0.81%
Money Market ................................................. 0.40% 0.30% 0.70%
</TABLE>
- -----------------------
(a) The expenses presented are for the last fiscal year. In the absence of fee
waivers by the investment adviser and administrator of the Fund, the total
expenses of the Emerging Growth Fund would have been 1.41%.
- --------------------------------------------------------------------------------
Neuberger & Berman Advisers Management Trust (a)
Underlying Fund Annual Expenses (as a % of portfolio average net assets)
<TABLE>
<CAPTION>
Management
Advisory and
Administration Other Total Fund
Fees Expenses Expenses
-------------- -------- ----------
<S> <C> <C> <C>
Limited Maturity Bond ........................................ 0.65% 0.12% 0.77%
Balanced ..................................................... 0.85% 0.19% 1.04%
Partners Fund ................................................ 0.80% 0.06% 0.86%
</TABLE>
- -----------------------
(a) 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's 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 "Expenses"
in the Trust's Prospectus.
4
<PAGE>
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Fidelity Investments' Variable Insurance Products Fund (a)
Underlying Fund Annual Expenses (as a % of portfolio avg. net assets)
Management Other Total Fund
Fee Expenses Expenses
---------- -------- ----------
Equity Income ................................. 0.50% 0.07% 0.57%
Growth ........................................ 0.60% 0.07% 0.67%
- --------------------
(a) The expenses presented are for the last fiscal year. A portion of the
brokerage commissions the fund paid was used to reduce its expenses. Without
this reduction, total expenses would have been 0.58% 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)
Management Other Total Fund
Fee Expenses Expenses
Asset Manager (a) ............................. 0.55% 0.09% 0.64%
Index 500 (b) ................................. 0.24% 0.04% 0.28%
- --------------------
(a) The expenses presented are for the last fiscal year. A portion of the
brokerage commissions the fund paid was used to reduce its expenses. Without
this reduction, total expenses would have been 0.65% for the Asset Manager
Portfolio.
(b) 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 0.40% for the Index 500 Portfolio.
- --------------------------------------------------------------------------------
Morgan Stanley Universal Funds, Inc.
Underlying Fund Annual Expenses (as a % of portfolio avg. net assets)
Management Other Total Fund
Fee Expenses Expenses
Emerging Markets Equity (International) ....... 1.25% 0.50% 1.75%
- --------------------------------------------------------------------------------
The purpose of the foregoing table is to assist you in understanding the
various costs and expenses that you will bear directly and indirectly. The table
shows Contract expenses and underlying fund expenses. See the prospectuses of
Penn Series Funds, 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
additional information on fund expenses.
Premium taxes may be applicable, but are not reflected in the tables above or
the examples below. See "Charges" in this Prospectus.
5
<PAGE>
- --------------------------------------------------------------------------------
Examples of Fees and Expenses
The following examples illustrate the cumulative dollar amount of all the
above expenses that would be incurred on each $1,000 invested.
If you surrender your Contract at the end of the applicable period, you would
pay the following expenses on a $1,000 investment, assuming 5% annual return on
assets:
<TABLE>
<CAPTION>
One Three Five Ten
Year Years Years Years
---- ----- ----- -----
<S> <C> <C> <C> <C>
Penn Series Growth Equity Fund ......................................... $83 $115 $147 $254
Penn Series Value Equity Fund .......................................... $83 $115 $147 $253
Penn Series Small Capitalization Fund .................................. $84 $117 $151 $262
Penn Series Emerging Growth Fund ....................................... $87 $126 $166 $292
Penn Series Flexibly Managed Fund ...................................... $83 $115 $147 $253
Penn Series International Equity Fund .................................. $87 $125 $165 $290
Penn Series Quality Bond Fund .......................................... $83 $115 $146 $252
Penn Series High Yield Bond Fund ....................................... $84 $116 $149 $258
Penn Series Money Market Fund .......................................... $83 $113 $144 $247
Neuberger & Berman Limited Maturity Bond Portfolio ..................... $83 $115 $147 $254
Neuberger & Berman Balanced Portfolio .................................. $86 $123 $161 $281
Neuberger & Berman Partners Portfolio .................................. $84 $118 $152 $263
Fidelity's Equity Income Portfolio ..................................... $82 $109 $137 $233
Fidelity's Growth Portfolio ............................................ $83 $112 $142 $243
Fidelity's Asset Manager Portfolio ..................................... $82 $111 $141 $240
Fidelity's Index 500 ................................................... $79 $101 $123 $202
Morgan Stanley Emerging Markets Equity (International) Portfolio ....... $93 $143 $194 $349
</TABLE>
If you do not surrender your Contract, or if you annuitize your Contract, you
would pay the following expenses on a $1,000 investment, assuming 5% annual
return on investments:
<TABLE>
<CAPTION>
One Three Five Ten
Year Years Years Years
---- ----- ----- -----
<S> <C> <C> <C> <C>
Penn Series Growth Equity Fund ......................................... $22 $69 $118 $254
Penn Series Value Equity Fund .......................................... $22 $69 $118 $253
Penn Series Small Capitalization Fund .................................. $23 $71 $122 $262
Penn Series Emerging Growth Fund ....................................... $26 $80 $137 $292
Penn Series Flexibly Managed Fund ...................................... $22 $69 $118 $253
Penn Series International Equity Fund .................................. $26 $80 $136 $290
Penn Series Quality Bond Fund .......................................... $22 $68 $117 $252
Penn Series High Yield Bond Fund ....................................... $23 $70 $120 $258
Penn Series Money Market Fund .......................................... $22 $67 $115 $247
Neuberger & Berman Limited Maturity Bond Portfolio ..................... $22 $69 $118 $254
Neuberger & Berman Balanced Portfolio .................................. $25 $77 $132 $281
Neuberger & Berman Partners Portfolio .................................. $23 $72 $123 $263
Fidelity's Equity Income Portfolio ..................................... $20 $63 $108 $233
Fidelity's Growth Portfolio ............................................ $21 $66 $113 $243
Fidelity's Asset Manager Portfolio ..................................... $21 $65 $111 $240
Fidelity's Index 500 ................................................... $17 $54 $ 93 $202
Morgan Stanley Emerging Markets Equity (International) Portfolio ....... $32 $98 $166 $349
</TABLE>
The examples are based upon fund data for the fiscal year ended December 31,
1997.
The examples should not be considered a representation of past or future
expenses under your Contract; actual expenses may be greater or lesser than
those shown.
6
<PAGE>
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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 600 Dresher Road, Horsham, PA 19044. Our mailing address is
Independence Square, Philadelphia, PA 19172.
- --------------------------------------------------------------------------------
The Separate Account
Penn Mutual Variable Annuity Account III was established as a separate
account of Penn Mutual on April 13, 1982. The Separate Account is registered
with the Securities and Exchange Commission as a unit investment trust under the
Investment Company Act of 1940 and qualifies as a "separate account" within the
meaning of the federal securities laws.
The Separate Account is divided into subaccounts for investment in shares of
different Funds of Penn Series Funds, Inc., Neuberger & Berman Advisers
Management Trust, Fidelity Investments' Variable Insurance Products Fund and
Variable Insurance Products Fund II and Morgan Stanley Universal Funds, Inc.
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,
Fidelity Investments; Variable Insurance Products Fund and 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 Neuberger & Berman Advisers Management Trust,
Fidelity Investments' Variable Insurance Products Fund and 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 and Morgan Stanley
Universal Funds, Inc., directly to qualified pension and retirement plans. For
information on possible conflicts involved in the Separate Account investing in
Funds that are so offered, see the accompanying Fund prospectuses.
7
<PAGE>
- --------------------------------------------------------------------------------
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;
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 prospectuses);
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 each of the Funds. OpCap Advisors, New York, New York, is investment
sub-adviser to the Value Equity and Small Capitalization Funds. T. Rowe Price
Associates, Baltimore, Maryland, is investment sub-adviser to the Flexibly
Managed and High Yield Bond Funds. Vontobel USA, Inc., New York, New York, is
investment sub-adviser to the International Equity Fund. RS Investment
Management, Inc., San Francisco, California, is investment sub-adviser to the
Emerging Growth Fund.
- --------------------------------------------------------------------------------
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.
Balanced Portfolio - seeks long-term capital growth and reasonable current
income without undue risk to principal through investment of a portion of its
assets in common stock and a portion in debt securities.
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 shareholders thirty days in advance of any proposed
material change.
Neuberger & Berman Management Incorporated, New York, New York, is investment
adviser to the Limited Maturity Bond Portfolio, the Balanced Portfolio and the
Partners Portfolio.
- --------------------------------------------------------------------------------
Fidelity Investments' Variable Insurance Products Fund:
Equity-Income Portfolio - seeks reasonable income by investing primarily in
income-producing equity securities. In choosing these securities, the fund will
also consider the potential for capital appreciation. The fund's goal is to
achieve a yield which exceeds the composite yield on the securities comprising
the Standard & Poor's 500 Composite Stock Price Index.
Growth Portfolio - seeks to achieve capital appreciation. The fund normally
purchases common stocks, although its investments are not restricted to any one
type of security. Capital appreciation may also be found in other types of
securities, including bonds and preferred stocks.
Fidelity Management & Research Company, Boston, Massachusetts, is investment
adviser to the Equity-Income Portfolio and the Growth Portfolio.
8
<PAGE>
- --------------------------------------------------------------------------------
Fidelity Investments' Variable Insurance Products Fund II:
Asset Manager Portfolio - seeks high total return with reduced risk over the
long-term by allocating its assets among domestic and foreign stocks, bonds and
short-term fixed income investments.
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 and the Index 500 Portfolio.
- --------------------------------------------------------------------------------
Morgan Stanley Universal Funds, Inc.:
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 Dean Witter Investment Management Inc., New York, New York, is
investment adviser to the Emerging Markets Equity (International) Portfolio.
- --------------------------------------------------------------------------------
For more information on the mutual funds in which the subaccounts invest, see
the prospectuses for Penn Series Funds, 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. You should read the prospectuses for the funds in which you
are interested before investing.
- --------------------------------------------------------------------------------
THE CONTRACT
The Contract described in this Prospectus is a combination variable and fixed
annuity contract. The Contract provides for investment, through subaccounts of
the Separate Account, in one or more of the available funds of Penn Series
Funds, 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. It also provides for
investment in one or more fixed interest accounts. The fixed accounts are
guaranteed and funded by the Company through its general account. See The Fixed
Accounts in this Prospectus. Currently, over the life of the Contract, amounts
may be allocated or transferred to one or more of the 17 funds and fixed
accounts. Transfers may not be made to the Six Month Fixed Account.
As the Contract Owner, you determine, within Contract limits (1) the amount
and frequency of the purchase payments to be made to the Company, (2) the
investment options to which the purchase payments are to be allocated, (3)
transfers among investment options, (4) the form of annuity to be paid after the
accumulation period and the person to whom it is to be paid, (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 variable annuity payout period, you (or the Beneficiary in the
event of your death or the Annuitant's death) may transfer Annuity Unit values
among up to four subaccounts of the Separate Account that must be selected at
the time of annuitization.
Upon the earlier of the death of the Contract Owner or 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. A spousal Beneficiary may elect to become the
Owner of the Contract.
The Contract may be amended at any time to conform to applicable laws or
governmental regulations. If, in our judgment, investment in any of the mutual
funds becomes inappropriate to the purposes of the Contract, we may, with
approval of the Securities and Exchange Commission and the governing state
insurance department, substitute another fund for existing and future
investments.
The Contracts are available to individuals and institutions for retirement
and other funding purposes. The Contracts may also be issued as individual
retirement annuities under section 408(b) of the Internal Revenue Code (the
"Code") in connection with IRA rollovers and as tax-deferred annuities under
Section 403(b) of the Code (often referred to as qualified Contracts).
Contract Owner inquiries may be made by writing The Penn Mutual Life
Insurance Company, Customer Service Group, Philadelphia, PA 19172. Or, you may
call (215) 956-8000.
9
<PAGE>
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Purchases
To purchase a Contract, your completed application, together with a check for
the first purchase payment, should be forwarded to our administrative offices in
Horsham, Pennsylvania. Normally, a completed application form received at our
administrative offices 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 to you unless you request that we
retain it while you complete the application. All subsequent purchase payments
are sent directly to our administrative office.
The minimum initial purchase payment is $5,000. The minimum subsequent
purchase payment that will be accepted is $5,000. We may, in our discretion,
reduce the minimum requirements for initial and subsequent purchase payments. We
will accept total purchase payments under your Contract of up to $1 million.
Total purchase payments in excess of $1 million require our prior approval.
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 administrative
office or, in a case of the first purchase payment, is accepted by us.
The principal underwriter of the Contract (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 available under the contract the
value of an Accumulation Unit will be $10 when the subaccount commences
operation. The value of an Accumulation Unit may increase or decrease from one
valuation period to the next.
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
mutual 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 charge
at an annual rate of 1.20% and contract administration charge at an annual rate
of 0.15% assessed against the subaccount. Under current law, no taxes are levied
against income or gain from investments held in a subaccount.
- --------------------------------------------------------------------------------
Annuity Payments
You may choose one of the following forms of annuity: (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) such
other form of annuity as we may agree upon. You may select any one of these
forms of annuity as a variable annuity (except for a specified number of years),
a fixed annuity, or a combination of both.
The level of the variable annuity payments is determined by various factors,
including the amount accumulated and applied under the Contract to the variable
annuity, the form of annuity chosen, the expected duration of the annuity
period, the performance of the applicable investment options, and the annuity
purchase rates and charges specified in the Contract.
You may choose annuity purchase rates based on an assumed interest rate of 3%
or based on an assumed interest rate of 5%. If the annual net investment return
during the annuity payout period is greater than the rate chosen, the level of
the annuity payment increases. If the annual net investment return is less than
the rate chosen, the level of the annuity payments decreases. The choice of a
higher assumed interest rate would mean a higher first annuity payment but more
slowly rising or more rapidly falling subsequent payments. The choice of a lower
assumed interest rate would have the opposite effect.
The level of fixed annuity payments under a Contract is determined by various
factors, including the amount accumulated and applied under the Contract to the
fixed annuity, the form of annuity chosen, the expected duration of the annuity
period, and a guaranteed 3% rate of return.
Unless you specify otherwise, you or such other person you designate will
receive a life annuity with payments guaranteed for 10 years except for tax
deferred annuities under Section 403(b) of the Code. Annuitants under those
Contracts will receive a joint and survivor annuity. Unless you specify
otherwise, the annuity will be split between fixed and variable in the same
proportions as the Contract Value on the Annuity Date with the variable portion
invested in up to four funds selected by the Company.
10
<PAGE>
Unless you specify otherwise, the Annuity Date will be the later of (1) the
first day of the next month after the Annuitant's 95th birthday or (2) 10 years
after the contract date, unless state law requires an earlier Annuity Date. The
Annuity Date under the Contract must be on the first day of a month.
You may change the Annuity Date or annuity option by giving written notice at
our administrative office at least 30 days prior to the current Annuity Date. If
the Contract Value of a Contract is less than $5,000, we may elect to pay such
amount in a lump sum in place of an annuity. Annuity payments are generally
monthly, starting with the Annuity Date, but may also be made quarterly,
semiannually or annually at your request. However, if any payment would be less
than $50, we may change the frequency of annuity payments so that payments are
at least $50 each.
For information on the treatment of annuity payments, see Federal Income Tax
Considerations in this Prospectus.
- --------------------------------------------------------------------------------
Death Benefit
Upon the earlier of death of the Contract Owner or the Annuitant, prior to
the Annuity Date, we will pay a death benefit to the Beneficiary.
If the Contract Owner dies prior to the Annuity Date, we will pay the
Beneficiary 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
administrative office. If Contract Owner is also the Annuitant and dies before
the Annuity Date we will pay the Beneficiary the death benefit described in the
next paragraph.
If the Annuitant dies before the Annuity Date, we will pay a death benefit to
the Beneficiary equal to the sum of the Variable Account death benefit and the
Fixed Account death benefit as of the date we receive proof of death. The
Variable Account death benefit is the greater of (1) the Variable Account Value
or (2) all purchase payments allocated and transfers made to the Variable
Account less withdrawals from the amounts so allocated and transferred. The
Fixed Account death benefit is the Fixed Account Value. The death benefit
generally will be paid within seven days after we receive proof of death and all
information necessary to make payment to the Beneficiary.
If the Annuitant is 75 years of age or less, you may purchase an enhanced
guaranteed minimum death benefit as part of your Contract. The enhanced
guaranteed minimum death benefit is paid in place of the Variable Account death
benefit, if it is greater, and if the Annuitant dies before the Annuity Date and
before age 90. We offer two different enhanced guaranteed minimum death benefits
- - a guaranteed minimum death benefit step-up and a guaranteed minimum death
benefit rising floor. You may purchase one of them only at the time you purchase
your Contract.
The guaranteed minimum death benefit step-up is the highest Variable Account
Value on the current and each of the prior Contract anniversary dates, adjusted
as follows. The death benefit on an anniversary date will be increased by the
amount of any purchase payments allocated and transfers made to the Variable
Account after the anniversary date and before the anniversary date and decreased
by an amount that is in the same proportion that the Variable Account Value was
decreased by transfers and withdrawals (including any deferred sales charge)
after the anniversary date and before the next anniversary date.
The guaranteed minimum death benefit rising floor is the sum of all purchase
payments allocated and transfers made to the Variable Account minus a reduction
(as described below) for any withdrawals or transfers made from the Variable
Account plus interest at 5%, calculated as follows. Interest is reflected from
the dates amounts are allocated to or withdrawn or transferred from the Variable
Account to the date the guaranteed death benefit is paid, or the date the
Annuitant attains 80 years of age, if earlier. If a withdrawal or transfer is
made from the Variable Account, the guaranteed minimum death benefit will be
reduced by an amount that is in the same proportion that the amount withdrawn or
transferred from the Variable Account (including any contingent deferred sales
charge) was to the Variable Account Value on the date of the withdrawal or
transfer.
The enhanced guaranteed minimum death benefit will terminate if you withdraw
or transfer the full Variable Account Value from your Contract. For information
on the cost of the enhanced guaranteed minimum death benefits, see "Charges."
Within one year of the date of death of the Contract Owner, the Beneficiary
may elect to receive the death benefit in single sum or in the form of an
annuity. If the death benefit becomes payable upon death of the Annuitant who is
not the Contract Owner, an election to receive the death benefit in the form of
an annuity must be made within 60 days of the death of the Annuitant. If payment
is to be received in a single sum, it must be paid within five years of the date
of death (until paid out, the death benefit will be allocated to subaccounts of
the Separate Account and/or fixed interest options as directed by the
Beneficiary). If an annuity is selected, payments must commence within one year
of the date of death and must be made over the Beneficiary's life or over a
period not longer than the Beneficiary's life expectancy. If an election is not
made within one year of the date of death of the Contract Owner or within 60
days of the death of Annuitant (who is not the Contract Owner), the death
benefit will be paid to the Beneficiary in a single sum. If the Contract Owner
dies and the Beneficiary is the Contract
11
<PAGE>
Owner's surviving spouse, the surviving spouse has the right to become the
Contract Owner rather than receive the death benefit. If there is more than one
surviving Beneficiary, the beneficiaries must choose their respective portions
of the death benefit in accordance with the above options.
If the Annuitant dies on or after the Annuity Date, the death benefit
payable, if any, will be paid in accordance with the annuity option in force.
You may designate a Beneficiary in your application. You may change the
Beneficiary at any time before your death or the death of the Annuitant,
whichever occurs first.
For information on the tax treatment of death benefits, see Federal Income
Tax Considerations in this Prospectus.
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Transfers
Prior to the Annuity Date, you may transfer amounts from one subaccount of
the Separate Account to another subaccount of the Separate Account. Within
certain additional limitations stated in the Contract, you may also transfer
amounts from the subaccounts of the Separate Account to the One Year Fixed
Account prior to the Annuity Date. You may not transfer amounts from the
subaccounts of the Separate Account to the Six Month Fixed Account. You may make
a transfer from the One Year Fixed Interest Account to the Variable Account only
at the completion of the interest period or within 25 days thereafter. You may
make a transfer from the Six Month Fixed Interest Account to the Variable
Account as described under "Dollar Cost Averaging" below or 100% at any time.
After the Annuity Date and during an annuity payout period, you may transfer
amounts (upon which the annuity payments are based) from one subaccount of the
Separate Account to another. Transfers are limited to the four subaccounts
selected at the time of annuitization. Upon your death or the death of the
Annuitant, a beneficiary who is receiving annuity payments may transfer amounts
among the subaccounts of the Separate Account.
Transfers will be based on values at the end of the valuation period in which
the transfer request is received at our service office.
The minimum amount that may be transferred is $250 or, if less, the amount
held in the subaccount or the fixed account. In the case of partial transfers,
the amount remaining in the subaccount or the fixed account must be at least
$250.
A 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
Separate Account and the Company 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 request for transfer made
over the telephone.
Dollar Cost Averaging: You may elect to have a fixed percentage of your
initial or subsequent purchase payments transferred monthly or quarterly from
one source account to other accounts. These transfers may be made only from one
of the following accounts: Money Market Subaccount, Limited Maturity Bond
Subaccount, Quality Bond Subaccount, or the Six Month Fixed Interest Account.
The dollar cost averaging term may run up to 60 months with a maximum of 6
months for the Six Month Fixed Interest Account, or until you give notice of a
change in allocation or cancellation of the feature. If you terminate the dollar
cost averaging program, any amounts remaining in the Six Month Fixed Interest
Account will be transferred into the One Year Fixed Interest Account.
Automatic Rebalancing: If you have a Contract Value of at least $10,000 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 Annuity Date and prior to the earlier of the death of the
Contract Owner and Annuitant, you may withdraw all or part of your Contract
Value. Withdrawals will be based on values at the end of the valuation period in
which a proper written request for withdrawal (and the Contract, in case of a
full withdrawal) is received at our administrative office. Payment will normally
be made within seven days of receipt of the written request and the Contract, if
required. A withdrawal may result in certain tax consequences, including an
additional 10% tax under certain circumstances. For information on the tax
treatment of withdrawals, see Federal Income Tax Considerations in this
Prospectus.
The minimum withdrawal is $500 or, if it is the first withdrawal in each
Contract Year, the Free Withdrawal Amount if this amount is less than $500. The
Free Withdrawal Amount is equal to 15% of the purchase payments as of the date
of the request.
12
<PAGE>
A partial withdrawal may be made from a subaccount of the Separate Account or a
fixed account only if the amount remaining in the contract is at least $5,000
and the balance remaining in each subaccount or the fixed account is at least
$250. If you request a partial withdrawal without specifying allocation of the
withdrawal among investment options, it will be taken pro rata from the variable
subaccounts; if the partial withdrawal exhausts your Variable Account Value,
then any remaining withdrawal will be taken from the fixed interest options
beginning with the fixed interest option with the shortest interest period.
Systematic Withdrawals: You may make a request for a systematic withdrawal if
there is no previous withdrawal in the current contract year. The maximum value
of a systematic withdrawal request is equal to the Free Withdrawal Amount (as
defined above). A level systematic withdrawal will begin one modal period after
the date of receipt of the request. The systematic withdrawals may be made on a
monthly, quarterly, semiannual or annual basis. The minimum Contract Value that
is eligible for a systematic withdrawal is $25,000. The minimum amount of each
withdrawal payment is $100. This provides a convenient way to take advantage of
the ability to withdraw a limited percentage of purchase payments without
incurring a contingent deferred sales charge. See "Free Withdrawals" below. For
information on the tax treatment of withdrawals, see Federal Income Tax
Considerations in this Prospectus.
403(b) Withdrawals: With respect to Contracts qualifying under Section 403(b)
of the Code, there are certain restrictions on withdrawals. Withdrawals may
generally be made only if the Contract Owner is over the age of 591/2, 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). For information on the tax treatment of withdrawals under Section 403(b)
Contracts, see Federal Income Tax Considerations in this Prospectus.
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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.
- --------------------------------------------------------------------------------
Charges
Administration Charges: Charges are assessed to reimburse us for the expenses
we incur in administering the Contract and the Separate Account. First, on an
annual basis, we deduct from the Variable Account Value a contract
administration charge which will be no greater than the lesser of $40 or 2% of
the Variable Account Value. We will not, however, deduct this charge if the
Variable Account Value is greater than $100,000. The charge is made by canceling
Accumulation Units credited to the Contract, with the charge allocated pro rata
among the subaccounts comprising the Variable Account Value. Second, we deduct
from the Separate Account a daily administration charge which will not exceed an
effective annual rate of 0.15% of the daily net asset value of the Separate
Account. These administration charges are guaranteed not to increase and are
intended to cover our average anticipated administration expenses over the
periods the Contracts are in force.
Mortality and Expense Risk Charge: We deduct a daily mortality and expense
risk charge which will not exceed an effective annual rate of 1.20% of the daily
net asset value of the Separate Account. This charge is to compensate us for the
mortality-related guarantees we make under the Contract (e.g., the death benefit
and the guarantee that the annuity factors will never be decreased even if
mortality experience is substantially different than originally assumed), and
for the risk that our administration charges will be insufficient to cover
administration expenses over the life of the Contracts. The mortality and
expense risk charge is assessed during both the accumulation and variable
annuity pay-out phases of the Contract.
Contingent Deferred Sales Charge: A contingent deferred sales charge may be
deducted from withdrawals of purchase payments prior to the Annuity Date. 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
the Company, which may include proceeds from the mortality and expense risk
charge.
A contingent deferred sales charge, if applicable, will be imposed only on a
withdrawal of a purchase payment in cases where the purchase payment was made
within seven years of the date of the withdrawal. The following table shows the
schedule of the contingent deferred sales charge that will be applied to
withdrawal of a purchase payment, after allowing for the free withdrawals which
are described in the next subsection. Purchase payments will be treated as
withdrawn on a first-in, first-out basis.
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<PAGE>
Number of Full Contract
Years Since Purchase Payment Applicable Charge
---------------------------------------------------------------
0 7%
---------------------------------------------------------------
1 7%
---------------------------------------------------------------
2 6%
---------------------------------------------------------------
3 5%
---------------------------------------------------------------
4 4%
---------------------------------------------------------------
5 3%
---------------------------------------------------------------
6 1.5%
---------------------------------------------------------------
7+ 0%
---------------------------------------------------------------
The contingent deferred sales charge may be reduced on Contracts sold to a
trustee, employer or similar party pursuant to a retirement plan or to a group
of individuals, if such sales are expected to involve reduced sales expenses.
The amount of reduction will depend upon such factors as the size of the group,
any prior or existing relationship with the purchaser or group, the total amount
of purchase payments and other relevant factors that might tend to reduce
expenses incurred in connection with such sales. The reduction will not be
unfairly discriminatory to any Contract Owner.
Free Withdrawals:
Seven-Year-Old Purchase Payments. You may withdraw any purchase payment which
---------------------------------
was made more than 7 years before the withdrawal without incurring a contingent
deferred sales charge.
Annual Withdrawals of 15% of Purchase Payments. On the last day of the first
-----------------------------------------------
contract year and once each contract year thereafter, you may withdraw, without
incurring a contingent deferred sales charge, 15% of total purchase payments as
of the date of the request. You may take a free withdrawal on a single sum basis
or systematically, but not both. The free withdrawal amount will be applied to
purchase payments on a first-in, first-out basis. With respect to any withdrawal
in excess of the free withdrawal limit in a contract year, the contingent
deferred sales charge schedule set forth above will apply to the remainder of
the purchase payments so withdrawn on a first-in, first-out basis. This free
withdrawal applies only to the first withdrawal request made in a contract year
and the amount is not cumulative from year to year.
Medically Related Withdrawal. Subject to applicable state law, after the
-----------------------------
first contract year and before the Annuity Date, you may withdraw, without
incurring a contingent deferred sales charge, all or part of your Contract Value
if certain medically related contingencies occur. This free withdrawal is
available if you are (1) first confined in a nursing home or hospital while this
Contract is in force and remain confined for at least 90 days in a row or (2)
first diagnosed as having a fatal illness (an illness expected to result in
death within 2 years for 80% of diagnosed cases) while this Contract is in
force. The precise terms and conditions of this benefit are set forth in the
Contract. It is not available if your age at issue is greater than 75. The
medically related contingencies that must be met for free withdrawal vary in
some states.
Disability Related Withdrawal. You may withdraw, without incurring a
------------------------------
contingent deferred sales charge, part or all of your Contract Value if you (you
or the Annuitant for qualified Contracts) become totally disabled as defined in
the Contract.
Other Withdrawals. There is no contingent deferred sales charge imposed upon
------------------
minimum distributions under qualified contracts which are required by the Code.
Enhanced Variable Account Death Benefit (Optional): If you purchase an
enhanced Variable Account death benefit as part of your Contract, we will deduct
a guaranteed minimum death benefit charge from the Variable Account Value. The
charge is currently 0.20% of the average annual Variable Account Value, but may
be raised to a maximum rate of 0.25% at the discretion of Penn Mutual. The
charge will be made on each Contract anniversary and at any time the Variable
Account Value is withdrawn or transferred in full. The charge will be deducted
by canceling Accumulation Units credited to your Contract, with the charge
allocated pro rata among the subaccounts comprising the Variable Account Value.
Premium Taxes: Some states and municipalities impose premium taxes on
purchase payments received by insurance companies. Generally, any premium taxes
payable will be deducted upon annuitization, although we reserve the right to
deduct such taxes when due in jurisdictions that impose such taxes on purchase
payments. Currently, state premium taxes on purchase payments range from 0% to
3 1/2%.
14
<PAGE>
- --------------------------------------------------------------------------------
Performance Information
The Company may advertise total return performance and 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 sub-accounts of the Separate Account has been in existence. In
addition, performance information may be based on the hypothetical assumption
that the sub-accounts of the Separate Account invested in the underlying
portfolios from the date those portfolios were first available to other
insurance company separate accounts. Average annual total return figures will
show the average annual rates of increase or decrease in investments in the
subaccounts, assuming a hypothetical $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 fund and Contract 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 withdrawals 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.
- --------------------------------------------------------------------------------
Year 2000
The services provided by Penn Mutual to Contract Owners and the Separate
Account depend on the smooth functioning of computer systems. Many computer
systems in use today cannot recognize the Year 2000, but revert to 1900 or some
other date, due to the manner in which dates were encoded and calculated earlier
in this century. If not corrected, many computer applications could fail or
create erroneous results by or at the Year 2000. Failure of computer systems
could affect pricing, account services, and the handling of investment
transactions, among other things. We began addressing the Year 2000 problem
actively in 1996. The effort involves assessing all of our computers, computer
programs and related equipment, making the necessary changes and ensuring that
all systems process dates correctly. We believe that we have designed and
implemented an efficient process for identifying what needs to be changed. We
are working to correct and test systems that our research shows will be affected
by dates in the Year 2000 and beyond, and expect our computer systems to be Year
2000 compliant.
<PAGE>
Penn Mutual, and the mutual funds that serve as investment options for the
Separate Account, have relationships with investment advisers, broker-dealers,
transfer agents, custodians, and other service providers that are not affiliated
with Penn Mutual. We are contacting these vendors and service providers to
obtain assurances that such service providers have taken appropriate measures to
address the Year 2000 problem. Where practicable, we will assess and attempt to
mitigate risks that outside service providers are not Year 2000 ready. We
cannot, however, give assurance that the failure of outside service providers to
complete adequate preparations in a timely manner, and any resulting systems
interruptions or other consequences, would not have an adverse affect, directly
or indirectly, on the Separate Account, including, without limitation, its
operation or the valuation of its assets and units.
The costs of addressing the Year 2000 problem are significant but not
material to our financial condition or results of operations. We will continue
to incur costs in addressing the Year 2000, but do not anticipate that the costs
will be material going forward. Year 2000 costs will not affect the Separate
Account or Contract Owners.
The foregoing statements are designated Year 2000 Readiness Disclosure within
the meaning of The Year 2000 Information and Readiness Disclosure Act (P.L.
105-271, S. 2392).
- --------------------------------------------------------------------------------
The Fixed Accounts
Because of exemptive and exclusionary provisions, interests in the Company'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.
Hence this Prospectus generally discusses only the variable portion of the
Contract. The Company 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.
15
<PAGE>
- --------------------------------------------------------------------------------
General Information
You may allocate or transfer amounts to the One Year Fixed Interest Account.
We periodically declare an effective annual interest rate applicable to
allocations to the One Year Fixed Interest Account. For each amount allocated to
the One Year Fixed Interest Account we credit interest at a rate declared by us
in the month in which the allocation is made. The declared rate of interest will
apply through the end of the 12-month period which begins on the first day of
the calendar month in which the allocation is made. We will not declare an
effective annual rate of interest on allocations and transfers to the One Year
Fixed Interest Account of less than 3%.
In conjunction with the election of the dollar cost averaging program, you
may allocate amounts to the Six Month Fixed Interest Account. For each amount
allocated to the Six Month Fixed Interest Account, we credit interest at a rate
of declared by us from the date you pay the initial or subsequent purchase
payment through the end of a six month interest period. The rate will be renewed
on the first of the month following the end of the period. The rate will never
be less than 3%. If you terminate dollar cost averaging prior to six months
after your allocation to this account, any balance will be transferred as
directed or, otherwise, transferred to the One Year Fixed Interest Account.
You may transfer amounts in the Fixed Accounts to subaccounts of the Separate
Account subject to the conditions and limitations in the fixed account
provisions of your Contract. Amounts in the One Year Fixed Interest Account not
withdrawn or reallocated within 25 days after the end of an interest period are
rolled over and treated as a new allocation to the One Year Fixed Interest
Account. 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 the Company's
general account is not feasible.
- --------------------------------------------------------------------------------
Loans Under Section 403(b) Contracts
Subject to compliance with applicable state law, Contract Owners qualifying
under Section 403(b) of the Code may be able to borrow against a portion of the
amount credited to the Fixed Account under their Contract, provided the loan
privilege has been approved in the applicable state. The loan will be made from
the general account of the Company. Because this Prospectus generally is limited
to describing the variable portion of the Contract, you should review the
Contract loan endorsement or consult your Company representative for a complete
description of the terms of the loan privilege, including minimum and maximum
loan amounts, repayment terms, and restrictions on prepayments. The following
paragraphs describe how exercise of the loan privilege may relate to the
Variable Account Value.
First, at the time a Contract loan is made and in accordance with your
direction, an amount equal to the initial loan amount will be transferred from
the Contract's investment options to an account in the Company'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
earn interest at a current rate of 1 1/2 percentage points less than the rate of
interest charged on the loan with a minimum possible rate of 2 1/2 percentage
points less than the rate charged on the loan.
Second, on your Contract Anniversary, the accrued interest in the Restricted
Account will be transferred to your investment options in accordance with your
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 Money Market subaccount. You may then transfer amounts from the
Money Market subaccount 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, the Company will report the amount of the default to the Internal
Revenue Service as a taxable distribution and, if you are then under age 591/2,
as a premature distribution that may be subject to a 10% penalty. 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 us from your investment options in accordance with your direction
in the Loan Request and Agreement. We will use the net proceeds from the
withdrawal 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, we will check the
Contract to determine if there is an outstanding loan balance for which one or
more payments have been missed. If so, we will withdraw from your investment
options, in accordance with your direction in the Loan Request and Agreement,
funds necessary to pay the overdue amount, plus any applicable contingent
deferred sales charge. While a loan balance is outstanding, any withdrawal or
death benefit proceeds must first be used to pay the loan.
16
<PAGE>
Loans are subject to the terms of your Contract, your Section 403(b) plan and
the Code, and, in the case of plans subject to the Employee Retirement Income
Security Act of 1974, the ERISA regulations on plan loans, all of which may
impose restrictions. The Company 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, which may be changed by
legislative, judicial or administration action. The summary is general in nature
and does not consider any applicable state or local tax laws. For further
information, you should consult qualified tax counsel.
Under current law, no federal income taxes are imposed on increases in the
value of a Contract until distribution occurs, either in the form of a
withdrawal or death benefit or as annuity payment 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
either 37 1/2 years younger than the Contract Owner or a grandchild of the
Contract Owner may have Generation Skipping Transfer Tax consequences under
Section 2601 of the Code.
In the case of a nonqualified Contract and death of an Annuitant who was not
the Contract Owner, an election to receive the death benefit in the form of
annuity payment must be made within 60 days. If such election is not made, the
gain from the Contract will generally be taxed as a lump sum payment, as
described in the preceding paragraph.
For annuity payments, the taxable portion is generally determined by a
formula that establishes the ratio of the cost basis of the Contract (as
adjusted for any refund feature) to the expected return under the Contract. The
taxable portion, which is the amount of the annuity payment in excess of the
cost basis, is taxed at ordinary income tax rates.
An additional income tax of 10% may be imposed on the taxable portion of an
early withdrawal or distribution unless one of several exceptions apply. There
will be no additional income tax on early withdrawals which are part of a series
of substantially equal periodic payments (not less frequently than annually)
made for life (or life expectancy) of the taxpayer or the joint lives (or joint
life expectancies) of the taxpayer and a Beneficiary, or on withdrawals made on
or after age 591/2. There also will be no additional tax on distributions made
after death or on withdrawals attributable to total and permanent disability.
Further, there will be no additional tax on distributions within certain other
exceptions to the general rule.
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
income tax law and to be accorded the tax treatment described in the preceding
paragraphs. If a contract is not treated as an annuity contract for federal
income tax purposes, the income on the Contract is treated as ordinary income
received or accrued by the Contract Owner during the taxable year.
Section 817(h) of the Code provides that the investments of a separate
account underlying a variable annuity contract which is not purchased under a
qualified retirement plan or 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 the Penn Series Funds, Inc.,
Neuberger & Berman Advisers Management Trust, Variable Insurance Products Fund,
Variable Insurance Products Fund II, and Morgan Stanley Dean Witter 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, the Contracts may need to be modified to comply with them.
17
<PAGE>
The Contracts may be used in connection with certain retirement plans that
qualify for special tax treatment under the Code. The plans include rollover
individual retirement annuities qualified under Section 408(b) of the Code
(referred to as IRAs) and certain tax deferred annuities qualified under Section
403(b) of the Code. Qualified Contracts have special provisions in order to be
treated as qualified 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.
Distribution must generally commence from individual retirement annuities and
from contracts qualified under Section 403(b) no later than the April 1
following the calendar year in which the Contract Owner attains age 70 1/2.
Failure to make such required minimum distributions may result in a 50% tax on
the amount of the required distribution.
Generally, under a nonqualified annuity or rollover 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 the Company
believes are includable in gross income for tax purposes will be subject to
mandatory withholding to meet federal income tax obligations. The same treatment
will apply to distributions from a 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 withholding, unless an election is made to receive the distribution as
a direct rollover to another eligible retirement plan.
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.
- --------------------------------------------------------------------------------
Financial Statements
The consolidated financial statements of The Penn Mutual Life Insurance
Company at December 31, 1997, and for the year then ended appear in the
Statement of Additional Information. The consolidated financial statements of
Penn Mutual should be considered only as bearing upon Penn Mutual's ability to
meet its obligations under the Contracts.
New subaccounts of the Separate Account have been established under the
Contracts. There are, therefore, no financial statements for the subaccounts at
this time.
18
<PAGE>
- --------------------------------------------------------------------------------
Statement of Additional Information Contents
- --------------------------------------------------------------------------------
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-3
Average Annual Total Return ........................................... B-3
Yields (Money Market Fund) ............................................ B-7
- --------------------------------------------------------------------------------
Administrative and Recordkeeping Services ................................ B-8
- --------------------------------------------------------------------------------
Distribution of Contracts ................................................ B-8
- --------------------------------------------------------------------------------
Custodian ................................................................ B-8
- --------------------------------------------------------------------------------
Independent Auditors ..................................................... B-8
- --------------------------------------------------------------------------------
Legal Matters ............................................................ B-8
- --------------------------------------------------------------------------------
Financial Statements ..................................................... B-8
19
<PAGE>
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This Page Left Intentionally Blank
<PAGE>
Penn
Mutual
A better way of life
The Penn Mutual
Life Insurance Company
Philadelphia, PA 19172
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION -- DECEMBER 16, 1998
LOGO
Penn Mutual Variable Account III
The Penn Mutual Life Insurance Company
Philadelphia, Pennsylvania 19172 o Telephone (215) 956-8000
This statement of additional information is not a prospectus. It should be read
in conjunction with the current Prospectus for the Pennant Select Contract,
dated December 16, 1998. The Contract is funded through Penn Mutual Variable
Account III (referred to 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 (215) 956-8000. Terms used in this
statement of additional information have the same meaning as the Prospectus.
TABLE OF CONTENTS
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-3
Average Annual Total Return ...................... B-3
Yields (Money Market Fund) ....................... B-7
- ----------------------------------------------------
ADMINISTRATIVE AND RECORDKEEPING SERVICES ......... B-8
- ----------------------------------------------------
DISTRIBUTION OF CONTRACTS ......................... B-8
- ----------------------------------------------------
CUSTODIAN ......................................... B-8
- ----------------------------------------------------
INDEPENDENT AUDITORS .............................. B-8
- ----------------------------------------------------
LEGAL MATTERS ..................................... B-8
- ----------------------------------------------------
FINANCIAL STATEMENTS .............................. B-8
B-1
<PAGE>
VARIABLE ANNUITY PAYMENTS
First Variable Annuity Payment
When a variable annuity is effected, we will first deduct applicable
premium taxes, if any, from the Contract Value. The dollar amount of the first
monthly annuity payment will be determined by applying the net Contract 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, based on the Annuitant's
age at the Annuity Date. The annuity tables are based on the Annuity 2000 Basic
Table with interest rates at 3% or 5%.
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. The Company 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 of your
annuity units will not change as a result of investment experience.
Value of Annuity Units
The value of an annuity unit for each subaccount 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 an assumed interest rate of 3% or 5%, as
applicable, built into 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 mutual 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
mutual 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).
Where (b) is:
The net asset value per share of the mutual 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 mortality and expense risk charge and the daily
administration charge. On an annual basis, the sum of such charges equals
1.35% of the daily net asset value of the subaccount.
B-2
<PAGE>
Assumed Interest Rate
Assumed interest rates of 3% or 5% are included in the annuity tables in
the contracts. A higher assumption would mean a higher first annuity payment
but more slowly rising or more rapidly falling subsequent payments. A lower
assumption would have the opposite effect. If the actual net investment rate on
an annual basis is equal to the assumed interest rate you have selected,
annuity payments will be level.
Valuation Period
Valuation period is the period from one valuation of underlying fund
assets to the next. Valuation is performed each day the New York Stock Exchange
is open for trading.
PERFORMANCE DATA
Average Annual Total Return
Although the subaccounts of the Separate Account were not available until
the effective date of this registration statement, the returns calculated below
reflect a hypothetical return as if the sub-accounts had invested in the
underlying funds for the indicated periods.
Table 1 shows the average annual rates of total return on hypothetical
investments of $1,000, through the Separate Account, in funds of Penn Series
Funds, Inc., Neuberger and Berman Advisers Management Trust, Fidelity
Investments' Variable Insurance Products Fund and Fidelity Investments'
Variable Insurance Products Fund II, and Morgan Stanley Universal Funds, Inc.
for the periods ended December 31, 1997 and assume withdrawal of the
investments at the end of the period.
B-3
<PAGE>
Table 1
<TABLE>
<CAPTION>
Average Annual Total Return
-------------------------------------------------------------------
From Ten Five One
Inception Years Years Year
Inception Through Ended Ended Ended
Fund (Manager) Date* 10/31/97 10/31/97 10/31/97 10/31/97
- --------------------------------------------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Growth Equity (a) 06/01/83 12.75% 12.89% 13.57% 12.07%
(Independence Capital)
Value Equity (a) 03/17/87 12.24% 12.57% 16.32% 2.18%
(OpCap)
Small-Cap Fund 03/01/95 8.24% n/a n/a -20.81%
(OpCap)
Emerging Growth Fund (a) 05/01/97 21.69% n/a n/a -12.29%
(RS Investment Management)
Flexibly Managed (a) 07/31/84 13.33% 11.17% 10.50% -0.64%
(T. Rowe Price)
International Equity (a) 11/01/92 11.29% n/a 7.31% 1.37%
(Vontobel)
Quality Bond (a) 03/17/87 6.76% 7.28% 4.92% 3.01%
(Independence Capital)
High Yield Bond (a) 08/06/84 8.56% 7.90% 5.59% -5.16%
(T. Rowe Price)
Balanced Portfolio (b) 02/28/89 8.38% n/a 6.33% -6.77%
(Neuberger & Berman)
Limited Maturity Bond Portfolio (b) 09/10/84 6.37% 5.10% 2.92% -3.11%
(Neuberger & Berman)
Partners Portfolio (b) 03/22/94 17.06% n/a n/a -6.08%
(Neuberger & Berman)
Equity-Income Portfolio (c) 10/09/86 11.66% 12.28% 13.37% -4.53%
(Fidelity Investments)
Growth Portfolio (c) 10/09/86 13.12% 14.28% 12.37% -0.59%
(Fidelity Investments)
Asset Manager Portfolio (d) 09/06/89 9.01% n/a 5.83% -10.34%
(Fidelity Investments)
Index 500 (d) 08/27/92 17.79% n/a 18.58% 12.51%
(Fidelity Investments)
Emerging Markets Equity (International) (e) 10/01/96 -16.78% n/a n/a -35.76%
(Morgan Stanley Dean Witter)
</TABLE>
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
(b) Neuberger and Berman Advisers Management Trust
(c) Variable Insurance Products Fund
(d) Variable Insurance Products Fund II
(e) Morgan Stanley Universal Funds, Inc.
The average annual rates of total return shown in Table 1 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 annual contract administration charge is reflected
assuming an anticipated average Contract Value and assuming that the Contract
Value is allocated equally across all available subaccounts by an average
contract owner. The performance information in Table 1 is calculated in
accordance with the standard formula prescribed by the Securities and Exchange
Commission.
B-4
<PAGE>
Table 2 below shows the average annual rates of return on hypothetical
initial investments of $1,000, through the Separate Account, in funds of the
Penn Series Funds, Inc., Neuberger and Berman Advisers Management Trust,
Fidelity Investments' Variable Insurance Products Fund, Fidelity Investments'
Variable Insurance Products Fund II, and Morgan Stanley Universal Funds, Inc.
for the periods ended December 31, 1997 and assumes the investments are not
withdrawn at the end of the period.
Table 2
<TABLE>
<CAPTION>
Average Annual Total Return
-------------------------------------------------------------------
From Ten Five One
Inception Years Years Year
Inception Through Ended Ended Ended
Fund (Manager) Date* 10/31/97 10/31/97 10/31/97 10/31/97
- --------------------------------------------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Growth Equity (a) 06/01/83 12.75% 12.89% 14.16% 19.17%
(Independence Capital)
Value Equity (a) 03/17/87 12.24% 12.57% 16.92% 8.66%
(OpCap)
Small-Cap Fund 03/01/95 8.24% n/a n/a -15.78%
(OpCap)
Emerging Growth Fund (a) 05/01/97 21.69% n/a n/a -6.72%
(RS Investment Management)
Flexibly Managed (a) 07/31/84 13.33% 11.17% 11.07% 5.66%
(T. Rowe Price)
International Equity (a) 11/01/92 11.29% n/a 7.86% 7.80%
(Vontobel)
Quality Bond (a) 03/17/87 6.76% 7.28% 5.46% 9.54%
(Independence Capital)
High Yield Bond (a) 08/06/84 8.56% 7.90% 6.13% 0.85%
(T. Rowe Price)
Balanced Portfolio (b) 02/28/89 8.38% n/a 6.89% -0.86%
(Neuberger & Berman)
Limited Maturity Bond Portfolio (b) 09/10/84 6.37% 5.10% 3.45% 3.04%
(Neuberger & Berman)
Partners Portfolio (b) 03/22/94 17.06% n/a n/a -0.13%
(Neuberger & Berman)
Equity-Income Portfolio (c) 10/09/86 11.66% 12.28% 13.96% 1.52%
(Fidelity Investments)
Growth Portfolio (c) 10/09/86 13.13% 14.28% 12.95% 5.72%
(Fidelity Investments)
Asset Manager Portfolio (d) 09/06/89 9.01% n/a 6.38% -4.65%
(Fidelity Investments)
Index 500 (d) 08/27/92 17.79% n/a 19.19% 19.64%
(Fidelity Investments)
Emerging Markets Equity (International) (e) 10/01/96 -16.78% n/a n/a -31.68%
(Morgan Stanley Dean Witter)
</TABLE>
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
(b) Neuberger and Berman Advisers Management Trust
(c) Variable Insurance Products Fund
(d) Variable Insurance Products Fund II
(e) Morgan Stanley Universal Funds, Inc.
B-5
<PAGE>
Table 3 below shows the average annual rates of return on hypothetical
initial investments of $10,000, through the Separate Account, in funds of the
Penn Series Funds, Inc., Neuberger and Berman Advisers Management Trust,
Fidelity Investments' Variable Insurance Products Fund, Fidelity Investments'
Variable Insurance Products Fund II, and Morgan Stanley Universal Funds, Inc.
for the periods ended December 31, 1997 and assumes the investments are not
withdrawn at the end of the period.
Table 3
<TABLE>
<CAPTION>
Average Annual Total Return
-------------------------------------------------------------------
From Ten Five One
Inception Years Years Year
Inception Through Ended Ended Ended
Fund (Manager) Date* 10/31/97 10/31/97 10/31/97 10/31/97
- --------------------------------------------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Growth Equity (a) 06/01/83 12.85% 13.03% 14.35% 19.39%
(Independence Capital)
Value Equity (a) 03/17/87 12.38% 12.73% 17.08% 8.88%
(OpCap)
Small-Cap Fund 03/01/95 8.43% n/a n/a -15.57%
(OpCap)
Emerging Growth Fund (a) 05/01/97 21.91% n/a n/a -6.51%
(RS Investment Management)
Flexibly Managed (a) 07/31/84 13.42% 11.31% 11.25% 5.87%
(T. Rowe Price)
International Equity (a) 11/01/92 11.44% n/a 8.05% 8.01%
(Vontobel)
Quality Bond (a) 03/17/87 6.92% 7.44% 5.66% 9.75%
(Independence Capital)
High Yield Bond (a) 08/06/84 8.69% 8.06% 6.33% 1.06%
(T. Rowe Price)
Balanced Portfolio (b) 02/28/89 8.54% n/a 7.07% -0.65%
(Neuberger & Berman)
Limited Maturity Bond Portfolio (b) 09/10/84 6.51% 5.27% 3.66% 3.25%
(Neuberger & Berman)
Partners Portfolio (b) 03/22/94 17.24% n/a n/a 0.08%
(Neuberger & Berman)
Equity-Income Portfolio (c) 10/09/86 11.80% 12.42% 14.12% 1.73%
(Fidelity Investments)
Growth Portfolio (c) 10/09/86 13.25% 14.41% 13.12% 5.93%
(Fidelity Investments)
Asset Manager Portfolio (d) 09/06/89 9.17% n/a 6.57% -4.44%
(Fidelity Investments)
Index 500 (d) 08/27/92 17.97% n/a 19.36% 19.85%
(Fidelity Investments)
Emerging Markets Equity (International) (e) 10/01/96 -16.45% n/a n/a -31.47%
(Morgan Stanley Dean Witter)
</TABLE>
* Represents the date the underlying fund was established.
(a) Penn Series Funds, Inc.
(b) Neuberger and Berman Advisers Management Trust
(c) Variable Insurance Products Fund
(d) Variable Insurance Products Fund II
(e) Morgan Stanley Universal Funds, Inc.
B-6
<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
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 Value at the end of the
periods shown. The annual contract administrative charge is reflected assuming
an anticipated average Contract Value and assuming that the average Contract
Value is allocated equally across all available subaccounts by an average
contract owner. 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% which, if applicable, would reduce the amount that may be withdrawn
under the Contract. The performance information in Tables 2 and 3 is not
calculated in accordance with the standard formula prescribed by the Securities
and Exchange Commission.
- --------------------------------------------------------------------------------
Yields (Money Market Fund)
From time to time, advertisements and sales literature may quote the
current or effective yield of the Money Market subaccount.
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 annual contract administrative charge is reflected assuming an
anticipated average Contract Value and assuming that the average Contract Value
is allocated equally across all available subaccounts by an average contract
owner.
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) to the power of 365/7] -1.
The yields do not reflect the contingent deferred sales charge ranging
from 7% to 1%. 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 of the
Funds, assuming the subaccounts of the Separate Account had invested in the
Funds from their inception, and is not an indication or representation of
future performance.
B-7
<PAGE>
- --------------------------------------------------------------------------------
ADMINISTRATIVE AND RECORDKEEPING SERVICES
The Company performs all data processing, recordkeeping and other related
services with respect to the Contracts and the Separate Accounts.
- --------------------------------------------------------------------------------
DISTRIBUTION OF CONTRACTS
Hornor, Townsend & Kent, Inc., a wholly owned subsidiary of The Penn
Mutual Life Insurance Company ("Penn Mutual"), serves as principal underwriter
of the Contracts. The address of Hornor, Townsend & Kent, Inc. is 600 Dresher
Road, Horsham, PA 19044.
The Contracts will be distributed by Hornor, Townsend & Kent, Inc. through
broker-dealers. Total commissions on purchase payments made under the Contract
will not exceed 7% and trailer commissions based on a percentage of Contract
Value may be paid. The offering of the Contracts is continuous, and the Company
does not anticipate discontinuing the offering of the Contract, although we
reserve the right to do so.
- --------------------------------------------------------------------------------
CUSTODIAN
The Company is custodian of the assets held in the Separate Account.
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS
Ernst & Young serves as independent auditors of The Penn Mutual Life
Insurance Company and Penn Mutual Variable Annuity Account III. Their offices
are located at 2001 Market Street, Suite 4000, Philadelphia, PA.
The consolidated financial statements of the Penn Mutual Life Insurance
Company at December 31, 1997, and for the year then ended, appearing in this
Statement of Additional Information and Registration Statement have been audited
by Ernst & Young, independent auditors, and at December 31, 1996, and for each
of the two years in the period ended December 31, 1996, by
PricewaterhouseCoopers LLP, independent auditors, as set forth in their
respective reports thereon appearing herein, and are included in reliance upon
such reports given upon the authority of such firms as experts in accounting and
auditing.
- --------------------------------------------------------------------------------
LEGAL MATTERS
Morgan, Lewis & Bockius LLP has provided advice on certain matters
relating to the federal securities laws and the offering of the Contracts.
Their offices are located at 2000 One Logan Square, Philadelphia, PA.
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
The consolidated financial statements of Penn Mutual are set forth on the
following pages. The consolidated financial statements of Penn Mutual should be
considered only as bearing upon Penn Mutual's ability to meet its obligations
under the Contracts.
B-8
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
THE BOARD OF TRUSTEES
THE PENN MUTUAL LIFE INSURANCE COMPANY
PHILADELPHIA, PENNSYLVANIA
We have audited the accompanying consolidated balance sheet of The Penn Mutual
Life Insurance Company and subsidiaries as of December 31, 1997 and the related
consolidated income statement, statement of changes in equity and statement of
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit. The
financial statements of the Company as of December 31, 1996 and for each of the
two years in the period ended December 31, 1996 were audited by other auditors
whose report dated January 31, 1997 expressed an unqualified opinion on those
statements and included an explanatory paragraph that disclosed the Company's
adoption of several accounting principles which were not previously required to
be adopted. These changes are described in Note 1 to the financial statements.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, the 1997 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of The Penn Mutual Life Insurance Company and subsidiaries as of December 31,
1997, and the results of their operations and their cash flows for the year
then ended, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG
Philadelphia, Pennsylvania
January 30, 1998
B-9
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
THE BOARD OF TRUSTEES OF
THE PENN MUTUAL LIFE INSURANCE COMPANY
PHILADELPHIA, PENNSYLVANIA
We have audited the accompanying consolidated balance sheet of The Penn Mutual
Life Insurance Company as of December 31, 1996 and the related consolidated
statements of income, changes in equity and statement of cash flows for the two
years in the period ended December 31, 1996. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial condition of The
Penn Mutual Life Insurance Company and subsidiaries as of December 31, 1996, and
the results of their operations and their cash flows for the two years in the
period ended December 31, 1996, in conformity with generally accepted accounting
principles.
As discussed in Note 1 to the consolidated financial statements, in 1996 the
Company adopted Financial Accounting Standards Board Interpretation No. 40 (FIN
40) and Statement of Financial Accounting Standards No. 120 (SFAS 120), which
required implementation of several accounting pronouncements not previously
adopted. The effects of adopting FIN 40 and SFAS 120 were retroactively applied
to the Company's previously issued financial statements, consistent with the
implementation guidance of those standards.
/s/ PricewaterhouseCoopers LLP
2400 Eleven Penn Center
Philadelphia, Pennsylvania
January 31, 1997
B-10
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
(in thousands)
ASSETS
Debt securities, at fair value........................... $5,427,652 $5,214,788
Equity securities, at fair value......................... 12,502 16,745
Mortgage loans on real estate............................ 52,996 124,914
Real estate, net of accumulated depreciation............. 22,358 97,805
Policy loans............................................. 642,989 656,073
Short-term investments................................... 43,470 37,515
Other invested assets.................................... 88,928 94,369
---------- ----------
TOTAL INVESTMENTS....................................... 6,290,895 6,242,209
Cash and cash equivalents................................ 37,064 37,314
Investment income due and accrued........................ 103,072 103,132
Deferred acquisition costs............................... 384,542 412,595
Amounts recoverable from reinsurers...................... 63,211 58,882
Broker/dealer receivables................................ 526,797 449,150
Other assets............................................. 92,203 85,382
Separate account assets.................................. 1,869,094 1,368,384
---------- ----------
TOTAL ASSETS............................................ $9,366,878 $8,757,048
========== ==========
LIABILITIES
Reserves for payment of future policy benefits........... $2,770,015 $2,782,621
Other policyholder funds................................. 2,973,434 3,053,412
Policyholders' dividends payable......................... 35,273 35,395
Broker/dealer payables................................... 333,104 303,089
Accrued income tax payable:
Current................................................. 17,476 25,487
Deferred................................................ 75,096 35,783
Other liabilities........................................ 283,666 282,501
Separate account liabilities............................. 1,869,094 1,368,384
---------- ----------
TOTAL LIABILITIES....................................... 8,357,158 7,886,672
---------- ----------
EQUITY
Unrealized gains/(losses) on investment securities, net
of taxes and amortization of deferred acquisition costs. 152,009 85,730
Retained earnings........................................ 857,711 784,646
---------- ----------
TOTAL EQUITY............................................ 1,009,720 870,376
---------- ----------
TOTAL LIABILITIES AND EQUITY........................... $9,366,878 $8,757,048
========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
B-11
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1997 1996 1995
- --------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
REVENUES
Premium and annuity considerations.......... $ 195,220 $ 199,821 $ 187,907
Policy fee income........................... 102,398 89,349 80,652
Net investment income....................... 460,206 475,315 489,773
Net realized capital gains/(losses)......... 9,655 (10,078) 14,112
Broker/dealer fees and commissions.......... 290,005 241,068 200,223
Other income................................ 11,851 11,544 31,646
---------- ---------- ----------
TOTAL REVENUE.............................. 1,069,335 1,007,019 1,004,313
---------- ---------- ----------
BENEFITS AND EXPENSES
Benefits paid to policyholders and benefi-
ciaries.................................... 480,234 462,412 486,559
Policyholder dividends...................... 67,412 67,596 69,807
Increase/(decrease) in liability for future
policy benefits............................ (11,972) 42,652 38,038
General expenses............................ 202,731 178,554 186,204
Broker/dealer sales expense................. 160,730 132,724 109,492
Amortization of deferred acquisition costs.. 43,223 46,137 36,794
---------- ---------- ----------
TOTAL BENEFITS AND EXPENSES................ 942,358 930,075 926,894
---------- ---------- ----------
INCOME BEFORE INCOME TAXES................. 126,977 76,944 77,419
---------- ---------- ----------
Income taxes:
Current.................................... 50,061 37,944 11,740
Deferred................................... 3,851 (9,919) (33,179)
---------- ---------- ----------
NET INCOME................................. $ 73,065 $ 48,919 $ 98,858
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
B-12
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION
(DEPRECIATION)
OF INVESTMENT RETAINED TOTAL
FOR THE YEARS ENDED DECEMBER 31, SECURITIES EARNINGS EQUITY
- --------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
BALANCE AT JANUARY 1, 1995.................. $(57,212) $636,869 $ 579,657
Net income for 1995........................ -- 98,858 98,858
Unrealized appreciation of securities...... 216,153 -- 216,153
-------- -------- ----------
BALANCE AT DECEMBER 31, 1995................ 158,941 735,727 894,668
Net income for 1996........................ -- 48,919 48,919
Unrealized depreciation of securities...... (73,211) -- (73,211)
-------- -------- ----------
BALANCE AT DECEMBER 31, 1996................ 85,730 784,646 870,376
Net income for 1997........................ -- 73,065 73,065
Unrealized appreciation of securities...... 66,279 -- 66,279
-------- -------- ----------
BALANCE AT DECEMBER 31, 1997................ $152,009 $857,711 $1,009,720
======== ======== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
B-13
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1997 1996 1995
- ----------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................ $ 73,065 $ 48,919 $ 98,858
Adjustments to reconcile net income to net
cash provided by operations:
Capitalization of policy acquisition
costs................................... (64,427) (60,234) (52,147)
Amortization of deferred acquisition
costs................................... 43,223 46,137 36,794
Policy fees on universal life and invest-
ment contracts.......................... (104,342) (89,349) (80,652)
Interest credited on universal life and
investment contracts.................... 160,417 171,051 186,549
Depreciation and amortization............ 18,682 11,613 13,260
Premiums due and other receivables....... (7,291) (105) (2,219)
Realized capital (gains)/losses.......... (9,655) 10,078 (14,112)
(Increase)/decrease in accrued investment
income.................................. 60 6,474 7,880
(Increase)/decrease in amounts due from
reinsurers.............................. (4,329) (14,200) 9,994
(Increase)/decrease in net broker dealer
receivables............................. (47,632) 296 (37,142)
Increase/(decrease) in future policy ben-
efit reserves........................... (13,358) 58,697 9,276
Increase/(decrease) in claims payable.... -- -- (16,322)
Increase/(decrease) in income tax pay-
able.................................... (4,526) 7,798 (59,512)
Other, net............................... (6,693) 39,625 (5,232)
----------- ----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVI-
TIES................................... 33,194 236,800 95,273
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of investments:
Debt securities available for sale....... 1,235,274 927,905 1,201,541
Equity securities........................ 20,374 25,413 153,985
Real estate.............................. 87,875 40,209 20,461
Other.................................... 14,355 15,284 10,834
Maturity and other principal repayments:
Debt securities available for sale....... 472,474 278,290 276,806
Equity securities........................ -- -- 1,992
Mortgage loans........................... 61,813 156,643 138,396
Cost of investments acquired:
Debt securities available for sale....... (1,772,007) (1,427,048) (1,448,184)
Equity securities........................ (15,268) (11,752) (80,999)
Mortgage loans........................... 0 (36,155) (115,047)
Real estate.............................. (15,600) (8,542) (15,428)
Other.................................... (15,503) (8,789) (8,420)
Change in policy loans, net............... 13,084 1,234 (18,708)
(Increase)/decrease in short-term invest-
ments, net............................... (5,955) 51,290 (80,740)
Purchases of furniture and equipment, net. (4,116) (6,449) (5,369)
----------- ----------- -----------
NET CASH (USED)/PROVIDED BY INVESTING
ACTIVITIES............................. 76,800 (2,467) 31,120
----------- ----------- -----------
</TABLE>
- CONTINUED -
The accompanying notes are an integral part of the consolidated financial
statements.
B-14
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1997 1996 1995
- ----------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits for universal life and investment con-
tracts......................................... $ 653,233 $ 625,816 $ 602,956
Withdrawals from universal life and investment
contracts...................................... (552,311) (567,697) (608,416)
Transfers to separate accounts.................. (236,008) (269,735) (114,332)
Issuance/(repayment) of debt.................... 24,842 (18,424) 1,354
--------- --------- ---------
NET CASH USED BY FINANCING ACTIVITIES......... (110,244) (230,040) (118,438)
--------- --------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS..... (250) 4,293 7,955
CASH AND CASH EQUIVALENTS
Beginning of the year.......................... 37,314 33,021 25,066
--------- --------- ---------
End of the year................................ $ 37,064 $ 37,314 $ 33,021
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income Taxes................................... $ 54,507 $ 20,228 $ 46,286
Interest Paid.................................. 1,384 939 5,239
</TABLE>
See Note 2 for information on unrealized gains and losses and a 1996 non-cash
transaction related to mortgage loans.
The accompanying notes are an integral part of the consolidated financial
statements.
B-15
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS OF DOLLARS)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION AND BASIS OF PRESENTATION
The Penn Mutual Life Insurance Company (the "Company") was founded and
commenced business in 1847 as a mutual life insurance company. The Company
concentrates primarily on the sale of individual life insurance and annuity
products. The primary products that the Company currently markets are
traditional whole life, term life, 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 is also involved in the
broker-dealer business which offers a variety of investment products and
services and is conducted through the Company's non-insurance subsidiaries.
The Company sells its products in all fifty states and the District of
Columbia.
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles and include the
accounts of The Penn Mutual Life Insurance Company, its wholly owned life
insurance subsidiary, The Penn Insurance and Annuity Company ("PIA"), and non-
insurance subsidiaries (principally broker/dealer, investment advisory and
real estate subsidiaries) (the "Company"). All significant intercompany
accounts and transactions have been eliminated in consolidation. The
preparation of financial statements requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and notes to the consolidated financial statements.
ACCOUNTING CHANGES
As of January 1, 1996, the Company adopted Financial Accounting Standards
Board Interpretation No. 40 (FIN 40), "Applicability of Generally Accepted
Accounting Principles to Mutual Life Insurance and Other Enterprises", as
amended by Statement of Financial Accounting Standards (SFAS) No. 120,
"Accounting and Reporting by Mutual Life Insurance Enterprises for Certain
Long-Duration Participating Contracts". The initial effect of applying these
pronouncements has been reported retroactively, as of January 1, 1993. SFAS
No. 120 requires financial statements referred to as prepared in accordance
with generally accepted accounting principles (GAAP) to apply all applicable
authoritative GAAP pronouncements. Prior to the adoption of SFAS No. 120,
statutory financial statements were permitted to be referred to as being
prepared in accordance with GAAP. The significant GAAP authoritative
pronouncements requiring initial application were as follows:
o SFAS No. 60, "Accounting and Reporting by Insurance Enterprises",
o SFAS No. 87, "Employers' Accounting for Pensions",
o SFAS No. 94, "Consolidation of All Majority-Owned Subsidiaries",
o SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain
Long Duration Contracts and for Realized Gains and Losses from the Sale of
Investments",
o SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions" ,
o SFAS No. 109, "Accounting for Income Taxes",
o SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration
and Long-Duration Contracts",
o Statement of Position (SOP) 95-1, "Accounting for Certain Insurance
Activities of Mutual Life Insurance Enterprises".
The cumulative effect of applying SFAS No. 120 and FIN 40 primarily consists
of the initial deferral of acquisition costs, the establishment of deferred
taxes, the change in methodology for insurance reserves, and the elimination
of the statutory asset valuation reserve and interest maintenance reserve and
the establishment of investment valuation allowances. In connection with the
adoption of FIN 40, the Company also adopted SFAS No. 115, "Accounting for
Certain Debt and Equity Securities" as of January 1, 1994.
B-16
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
As a result of the change in accounting principles, net income as previously
reported, has been restated as follows:
<TABLE>
<CAPTION>
1995
---------
<S> <C>
Net income, as previously reported.............................. $ 729
Add adjustments for the cumulative effect on prior years
Deferred acquisition costs..................................... 15,353
Policy reserves................................................ (12,079)
Deferred taxes................................................. 32,341
Investment reserves............................................ 46,640
Other, net..................................................... 15,874
Total.......................................................... 98,129
---------
Net income, as adjusted......................................... $ 98,858
=========
As a result of the change in accounting principles, equity, as previously
reported has been restated as follows:
<CAPTION>
1995
---------
<S> <C>
Balance at beginning of year, as previously reported............ $ 315,321
---------
Add adjustments for the cumulative effect on prior years of ap-
plying retroactively the new basis of accounting
Deferred acquisition costs..................................... 466,446
Policy reserves................................................ (67,526)
Deferred taxes................................................. (527)
Investment reserves............................................ 13,651
Unrealized gains/(losses)...................................... (145,759)
Other, net..................................................... (1,949)
---------
Total.......................................................... 264,336
---------
Balance at beginning of year, as adjusted....................... 579,657
---------
Net income...................................................... 98,858
Net change in unrealized gains/(losses) on investment securi-
ties........................................................... 216,153
---------
315,011
---------
Balance at end of year.......................................... $ 894,668
=========
</TABLE>
INVESTMENTS
Debt securities (bonds, notes, redeemable preferred stocks and mortgage-backed
securities) which might be sold prior to maturity are classified as available
for sale. These securities are carried at fair value, with the change in
unrealized gains and losses reported through a separate component of equity.
Interest on debt securities is credited to income as it is earned.
Equity securities are classified as available for sale and carried at fair
value. Dividends on equity securities are credited to income on their ex-
dividend dates.
The Company regularly evaluates the carrying value of debt and equity
securities based on current economic conditions, past credit loss experience
and other circumstances of the investee. A decline in a security's fair value
that is deemed to be other than temporary is treated as a realized loss and a
reduction in the cost basis of the security.
Mortgage loans on real estate are stated at unpaid principal balances, net of
unamortized discounts and valuation allowances. Valuation allowances on
impaired loans are based on the present value of expected future cash flows
discounted at the loan's original effective interest rate or the collateral
value if the loan is collateral dependent. However, if foreclosure is or
becomes probable, the measurement method used is collateral value.
Investment real estate, which the Company has the intent to hold, is carried at
cost less accumulated depreciation and valuation reserves. The Company
establishes valuation reserves for investment real estate when declines in
value are deemed to be permanent based on an analysis of discounted future cash
flows. Properties held for sale are carried at the lower of
B-17
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
depreciated cost or fair value less selling costs. Valuation reserves are
established for properties held for sale when the fair value less estimated
selling costs is below depreciated cost. Real estate acquired through
foreclosure is recorded at the lower of cost or fair value less estimated
selling costs at the time of foreclosure. Depreciation is calculated using the
straight-line method over the estimated useful lives of the real estate.
Policy loans are carried at the unpaid principal balances.
Short-term investments include securities purchased with a maturity date of 90
days to less than one year. Short-term investments are valued at cost.
Other invested assets primarily include joint venture real estate partnerships,
which are valued on the equity basis, and venture capital limited partnerships,
which are carried at fair value.
Realized gains and losses are determined by specific identification and are
included in income on the trade date. Unrealized gains and losses, net of
appropriate taxes and amortization of deferred acquisition costs, are accounted
for as a separate component of equity.
The Company utilizes various financial instruments, such as interest rate swaps
and financial futures, to hedge against interest rate fluctuation. These
instruments are recorded using a valuation method consistent with the valuation
method of the assets hedged. Gains and losses on these instruments are deferred
and recognized in the Consolidated Income Statements over the remaining life of
the hedged security. Changes in the fair value of these instruments are
reported as unrealized gains or losses. Realized gains or losses are recognized
when the hedged securities are sold.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, money market instruments and
other debt securities with a maturity of 90 days or less when purchased.
OTHER ASSETS
Property and equipment and leasehold improvements are stated at cost, less
accumulated depreciation and amortization. Depreciation is calculated using the
straight-line method over the estimated useful lives of the related assets.
Amortization of leasehold improvements is calculated using the straight-line
method over the lesser of the term of the leases or the estimated useful life
of the improvements. Accumulated depreciation and amortization on property and
equipment and leasehold improvements was $44,329 and $40,671 at December 31,
1997 and 1996, respectively. Related depreciation and amortization expense was
$8,183, $7,510 and $6,914 for the years ended December 31, 1997, 1996 and 1995,
respectively.
Goodwill represents the excess of the cost of the businesses acquired over the
fair value of their net assets. These costs are amortized on a straight-line
basis over not more than 40 years and are included in other assets in the
Consolidated Balance Sheets. Unamortized goodwill amounted to $16,932 and
$17,740 at December 31, 1997 and 1996 respectively. Goodwill amortization was
$808, $909 and $907 for 1997, 1996 and 1995, respectively.
DEFERRED ACQUISITION COSTS
Costs of acquiring new insurance and annuity contracts, which vary with and are
primarily related to the production of new business, have been deferred to the
extent that such costs are deemed recoverable from future gross profits. Such
costs include commissions, certain costs of policy issuance and underwriting,
and certain variable agency expenses.
Deferred acquisition costs related to participating traditional and universal
life insurance policies and annuity products without mortality risk, that
include significant surrender charges, are being amortized over the lesser of
the estimated or actual contract life in proportion to estimated gross profits
arising principally from interest, mortality, expense margins and surrender
charges. The effects on amortization of deferred acquisition costs of revisions
to estimated gross profits are reflected in earnings in the period such
estimated gross profits are revised. Deferred acquisition costs are reviewed to
determine that the unamortized portion of such costs is recoverable from future
estimated gross profits. Certain costs and expenses reported in the
Consolidated Income Statements are net of amounts deferred.
B-18
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
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.
INSURANCE LIABILITIES AND REVENUE RECOGNITION
Participating Traditional Life and Life Contingent Annuity Products
Future policy benefits include reserves for participating traditional life
insurance and life contingent annuity products and are established in amounts
adequate to meet the estimated future obligations of the policies in force.
Liabilities for participating traditional life products are computed using the
net level premium method, using assumptions for investment yields, mortality,
morbidity and withdrawals, which are consistent with the dividend fund interest
rate and mortality rates used in calculating cash surrender values. Interest
rate assumptions used in the calculation of the liabilities for participating
traditional life products ranged from 2.25% to 4.5%. Premiums are recognized as
income when due. Death and surrender benefits are reported in expense as
incurred.
Liabilities for life contingent annuity products are computed by estimating
future benefits and expenses. Assumptions are based on Company experience
projected at the time of policy issue, with provision for adverse deviations.
Interest rate assumptions range from 2.25% to 13.25%. Premiums are recognized
as income as they are received. Death and surrender benefits are reported in
expense as incurred.
Universal Life Products and Other Annuity Products
Other policyholder funds represent liabilities for universal life and
investment-type annuity products. The liabilities for these products are based
on the contract account value which consists of deposits received from
customers and investment earnings on the account value, less administrative and
expense charges. The liability for universal life products is also reduced by
mortality charges. Liabilities for the non-life contingent annuity products are
computed by estimating future benefits and expenses. Assumptions are based on
Company experience projected at the time of policy issue. Interest rate
assumptions range from 2.0% to 11.25%.
Contract charges assessed against account value for universal life and
investment-type annuities are reflected as policy fee income in revenue.
Interest credited to account values and universal life benefit claims in excess
of fund values are reflected as benefit expense.
Policyholders' Dividends
The majority of the Company's insurance products have been issued on a
participating basis. As of December 31, 1997, participating insurance expressed
as a percentage of insurance in force is 91%, and as a percentage of premium
income is 80%. The amount of policyholders' dividends to be paid is approved
annually by the Board of Trustees. The aggregate amount of policyholders'
dividends is calculated based on actual interest, mortality, morbidity and
expense experience for the year and on management's judgment as to the
appropriate level of equity to be retained by the Company. The carrying value
of this liability approximates the earned amount and fair value at December 31,
1997.
BROKER/DEALER REVENUE RECOGNITION
Broker-dealer transactions in securities and listed options, including related
commission revenue and expense, are recorded on a settlement-date basis.
FEDERAL INCOME TAXES
The Company files a consolidated federal income tax return with its life and
non-life insurance subsidiaries. Federal income taxes are charged or credited
to operations based upon amounts estimated to be payable or recoverable as a
result of taxable operations for the current year. Deferred income tax assets
and liabilities are established to reflect the impact of temporary differences
between the amount of assets and liabilities recognized for financial reporting
purposes and such amounts recognized for tax purposes. These deferred tax
assets or liabilities are measured by using the enacted tax rates expected to
apply to taxable income in the period in which the deferred tax liabilities or
assets are expected to be settled or realized.
B-19
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
REINSURANCE
In the normal course of business, the Company seeks to limit its exposure to
loss on any single insured and to recover a portion of benefits paid by ceding
reinsurance to other insurance enterprises or reinsurers under excess coverage
and coinsurance contracts. The Company has set its retention limit for
acceptance of risk on life insurance policies at various levels up to $1,250.
Insurance liabilities are reported before the effects of reinsurance.
Reinsurance receivables (including amounts related to insurance liabilities)
are reported as assets. Estimated reinsurance receivables are recognized in a
manner consistent with the liabilities related to the underlying reinsured
contracts.
RECLASSIFICATIONS
Certain 1996 and 1995 amounts have been reclassified to conform with 1997
presentation.
NOTE 2 - INVESTMENTS:
DEBT SECURITIES
The following tables summarize the Company's investment in debt securities,
including redeemable preferred stocks. All debt securities are classified as
available for sale and are carried at estimated fair value. Amortized cost is
net of cumulative writedowns for other than temporary declines in value of
$1,208 and $1,390 as of December 31, 1997 and 1996, respectively.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and U.S.
Government and agency securities.. $ 107,539 $ 6,302 $ -- $ 113,841
States and political subdivisions.. 12,085 569 -- 12,654
Foreign governments................ 20,397 3,049 -- 23,446
Corporate securities............... 2,854,234 218,145 6,748 3,065,631
Mortgage and other asset-backed se-
curities.......................... 2,133,758 76,160 757 2,209,161
---------- -------- ------ ----------
Total bonds........................ 5,128,013 304,225 7,505 5,424,733
Redeemable preferred stocks........ 3,085 -- 166 2,919
---------- -------- ------ ----------
TOTAL............................. $5,131,098 $304,225 $7,671 $5,427,652
========== ======== ====== ==========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and U.S.
Government and agency securities.. $ 42,928 $ 653 $ -- $ 43,581
States and political subdivisions.. 477 21 -- 498
Foreign governments................ 20,333 2,038 -- 22,371
Corporate securities............... 2,819,418 134,505 11,911 2,942,012
Mortgage and other asset-backed se-
curities.......................... 2,192,353 27,135 16,471 2,203,017
---------- -------- ------- ----------
Total bonds........................ 5,075,509 164,352 28,382 5,211,479
Redeemable preferred stocks........ 3,575 -- 266 3,309
---------- -------- ------- ----------
TOTAL............................. $5,079,084 $164,352 $28,648 $5,214,788
========== ======== ======= ==========
</TABLE>
B-20
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The following tables summarize the amortized cost and estimated fair value of
debt securities, including redeemable preferred stocks, by contractual
maturity.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------
AMORTIZED ESTIMATED
COST FAIR VALUE
---------- ----------
<S> <C> <C>
Maturity:
Within one year.......................................... $ 241,759 $ 240,871
After one year through five years........................ 606,900 620,792
After five years through ten years....................... 613,951 644,749
After ten years through twenty years..................... 428,492 495,854
After twenty years....................................... 1,103,153 1,213,305
Mortgage and other asset-backed securities............... 2,133,758 2,209,162
---------- ----------
Total bonds............................................. 5,128,013 5,424,733
Redeemable preferred stocks.............................. 3,085 2,919
---------- ----------
TOTAL.................................................. $5,131,098 $5,427,652
========== ==========
</TABLE>
Expected maturities may differ from contractual maturities because certain
borrowers have the right to call or prepay obligations with or without call or
prepayment penalties. Mortgage and other asset-backed securities are presented
separately in the maturity schedule due to the potential for prepayment. The
weighted average life of these securities is 7.8 years.
At December 31, 1997, the Company held $2,209,162 in mortgage and other asset-
backed securities. The structured securities portfolio consists of commercial
and residential mortgage pass-through holdings totaling $1,961,662 and
securities backed by credit card receivables, auto loans, home equity and
manufactured housing loans totaling $247,500. These securities follow a
structured principal repayment schedule and are of high credit quality.
Securities totaling $1,810,481 are rated AAA and include $27,854 of interest
only tranches that were retained from the securitization of the Company's
mortgage loan portfolio.
At December 31, 1997, the largest industry concentration of the Company's
portfolio was investments in the finance industry of $734,428, representing 14%
of the total debt portfolio.
Effective November 30, 1995, the Company adopted the implementation guidance
contained in the Financial Accounting Series Special Report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities." As a result of adopting this guidance, the Company
reclassified all of its held-to-maturity securities to available-for-sale based
upon a reassessment of the appropriateness of the classifications of all
securities held at that time. The amortized cost and net unrealized gain of the
securities reclassified were $546,834 and $47,348 respectively, at November 30,
1995.
Proceeds during 1997, 1996 and 1995 from sales of available for sale securities
were $1,235,274, $927,905 and $1,201,541, respectively. Gross gains and gross
losses realized on those sales were $21,799 and $8,990, respectively during
1997, $15,932 and $6,899, respectively during 1996 and $62,216 and $10,201,
respectively during 1995. The change in net unrealized gains and losses on debt
securities classified as available for sale included as a separate component of
equity was $160,850, $(149,259) and $438,883 for 1997, 1996 and 1995,
respectively.
The Company's investment portfolio of debt securities is predominantly
comprised of investment grade securities. At December 31, 1997 and 1996, debt
securities with amortized cost totaling $198,943 and $184,719, respectively,
were less than investment grade. At December 31, 1997 and 1996, the Company did
not hold any securities which are either in default as to principal and/or
interest payments, are to be restructured pursuant to commenced negotiations or
are in situations where the borrowers went into bankruptcy subsequent to
acquisition (collectively, "problem debt securities"). The Company did not hold
any debt securities which were non-income producing for the preceding twelve
months as of December 31, 1997 and 1996.
EQUITY SECURITIES
During 1997, 1996 and 1995, the proceeds from sales of equity securities
amounted to $20,374, $25,413 and $153,985, respectively. The gross gains and
gross losses realized on those sales were $975 and $558, $1,369 and $247, and
$9,604 and $3,753, for 1997, 1996 and 1995, respectively.
B-21
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
MORTGAGE LOANS
On August 29, 1996, the Company securitized the majority of its mortgage loan
portfolio by transferring the loans to a trust which qualifies as a REMIC (Real
Estate Mortgage Investment Conduit) under the Internal Revenue Code. Prior to
transferring the loans with a principal value of $781,564 and a book value of
$780,942, the loans were written down to a fair market value of $755,559, and
the related reserve of $25,285 was released. The trust issued sixteen classes
of Commercial Mortgage Pass-Through Certificates with a total par value of
$781,564. 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 $98
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.
The Company retained the highest quality classes of certificates with a par
value of $715,126 and a fair market value of $734,326 at the time of the
securitization. As of December 31, 1997, the par value and fair value of these
securities was $570,130 and $597,248, respectively. The Company sold the lowest
rated classes of certificates with a par value of $66,438 and a fair market
value of $24,838.
The mortgage loans which were not included in the securitization and were
retained by the Company had a book value of $171,555 with a related reserve of
$21,907 and an estimated fair value of $153,405 on the date of the
securitization. Loans which the Company intended 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 $99,817 and an estimated net realizable value
of $81,310 at the time of the securitization. The writedown of $18,507 was
fully offset by a release in mortgage loss reserve. As of December 31, 1997,
the Company held $12,368 of these loans. The Company intended to hold mortgage
loans with a book value of $71,738 on the date of the securitization, through
their remaining terms. As of December 31, 1997, the Company continued to hold
$44,428 of these mortgages. The Company discontinued the origination of
commercial mortgage loans in 1996.
The following tables summarize the carrying value of mortgage loans, by
property type and geographic concentration, at December 31.
<TABLE>
<CAPTION>
1997 1996
------- --------
<S> <C> <C>
Property Type
Office buildings............................................. $20,012 $ 51,510
Retail....................................................... 7,862 39,090
Dwellings.................................................... 25,237 33,540
Other........................................................ 3,685 4,174
Valuation allowance.......................................... (3,800) (3,400)
------- --------
TOTAL....................................................... $52,996 $124,914
======= ========
</TABLE>
<TABLE>
<CAPTION>
1997 1996
------- --------
<S> <C> <C>
Geographic Concentration
Northeast.................................................... $23,313 $ 49,438
Midwest...................................................... 5,922 22,920
South........................................................ 12,502 20,717
West......................................................... 15,059 35,239
Valuation allowance.......................................... (3,800) (3,400)
------- --------
TOTAL....................................................... $52,996 $124,914
======= ========
</TABLE>
B-22
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The following table presents changes in the mortgage loan valuation allowance
for the years presented:
<TABLE>
<CAPTION>
1997 1996
------ -------
<S> <C> <C>
Balance at January 1............................................ $3,400 $47,192
Provision....................................................... 400 --
Charge offs..................................................... -- (43,792)
------ -------
BALANCE AT DECEMBER 31......................................... $3,800 $ 3,400
====== =======
</TABLE>
As of December 31, 1997 and 1996, the Company's mortgage loan portfolio
contained $0 and $15,726, respectively, of loans delinquent over 60 days or in
foreclosure. As of December 31, 1997 and 1996, there were no non-income
producing mortgage loans for the preceding twelve months.
During 1997, the Company did not restructure the terms of any outstanding
mortgages. During 1996, the Company restructured the terms of outstanding
mortgages with a carrying value of $4,000. As of December 31, 1997 and 1996,
the mortgage loan portfolio included $2,834 and $7,110, respectively, of
restructured mortgage loans. Restructured mortgage loans include commercial
loans for which the basic terms, such as interest rate, maturity date,
collateral or guaranty have been changed as a result of actual or anticipated
delinquency. Restructures do not include mortgages refinanced upon maturity at
or above current market rates. Gross interest income on restructured mortgage
loans on real estate that would have been recorded in accordance with the
original terms of such loans amounted to $298 and $893 in 1997 and 1996,
respectively. Gross interest income from these loans included in net investment
income totaled $262 and $674 in 1997 and 1996, respectively.
At December 31, 1997, the recorded investment in loans that are considered to
be impaired was $12,368 that, as a result of write-downs, do not have a
valuation allowance. The average recorded investment in impaired loans during
the year ended December 31, 1997 was approximately $38,096. During 1997, $1,454
was received on these impaired loans which was applied to the outstanding
principal balance or will be applied to principal at the date of foreclosure.
REAL ESTATE
The following table summarizes the carrying value of the Company's real estate
holdings at December 31.
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Investment.................................................... $19,999 $33,386
Properties held for sale...................................... 7,828 73,260
Less: valuation allowance (5,469) (8,841)
------- -------
TOTAL........................................................ $22,358 $97,805
======= =======
</TABLE>
At December 31, 1997 and 1996, accumulated depreciation on real estate amounted
to $6,498 and $38,781, respectively. Depreciation expense on real estate
totaled $5,709, $6,488 and $10,091 for the years ended December 31, 1997, 1996
and 1995, respectively. During 1997, the Company sold its largest real estate
investment for $65,007 cash to an unrelated buyer. At the date of the sale,
this property had a carrying value of $61,914, net of related reserves,
resulting in a gain of $3,093. During 1996, the Company wrote down the
statement value of this property by $16,000 to its estimated fair value, based
on changes in future valuation assumptions.
OTHER
Investments on deposit with regulatory authorities as required by law were
$7,106 and $7,085 at December 31, 1997 and 1996, respectively.
As of December 31, 1997 and 1996, the Company's investments included $597,248
and $725,806, respectively, of the tranches retained from the 1996
securitization of the Company's commercial mortgage loan portfolio. These
investments represented 59% and 86% of equity at December 31, 1997 and 1996,
respectively.
B-23
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTE 3 - INVESTMENT INCOME AND CAPITAL GAINS:
The following table summarizes the sources of investment income, excluding
investment gains/(losses), for the year ended December 31.
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Debt securities..................................... $390,852 $356,669 $331,644
Equity securities................................... 1,371 1,313 2,602
Mortgages........................................... 12,098 62,454 99,109
Real estate......................................... 17,519 24,143 31,661
Policy loans........................................ 40,921 40,580 41,762
Short-term investments.............................. 2,426 6,052 3,934
Other invested assets............................... 21,268 14,665 18,016
Cash and cash equivalents........................... 2 44 34
-------- -------- --------
Gross investment income............................. 486,457 505,920 528,762
Less: Investment expenses.......................... 26,251 30,605 38,989
-------- -------- --------
Investment income, net.............................. $460,206 $475,315 $489,773
======== ======== ========
</TABLE>
The following table summarizes net realized capital gains/(losses) on
investments for the year ended December 31. Net realized capital gains/(losses)
include decreases in valuation allowances of $3,154, $44,164 and $2,463 in
1997, 1996 and 1995, respectively.
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
Debt securities..................................... $12,991 $ 10,412 $51,873
Equity securities................................... 417 1,122 6,652
Mortgage loans...................................... 280 (2,821) (2,799)
Real estate......................................... (684) (22,356) (41,617)
Other............................................... (811) 3,565 3
Amortization of deferred acquisition costs.......... (2,538) -- --
------- -------- -------
Realized gains/(losses)............................. $ 9,655 $(10,078) $14,112
======= ======== =======
</TABLE>
The following table summarizes the change in unrealized gains and losses for
investments carried at fair value for the year ended December 31.
<TABLE>
<CAPTION>
1997 1996 1995
-------- --------- --------
<S> <C> <C> <C>
Unrealized Gains/(Losses):
Debt securities.................................. $160,850 $(149,259) $438,883
Equity securities................................ 408 (582) 2,340
Other............................................ (14,581) (1,545) 11,190
-------- --------- --------
146,677 (151,386) 452,413
-------- --------- --------
Less:
Deferred policy acquisition costs................ (45,043) 38,324 (116,992)
Deferred income taxes............................ (35,355) 39,851 (119,268)
-------- --------- --------
Net change in unrealized gains/(losses).......... $ 66,279 $ (73,211) $216,153
======== ========= ========
</TABLE>
B-24
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTE 4 - FAIR VALUE INFORMATION:
The following table summarizes the carrying value and estimated fair value of
the Company's financial instruments as of December 31, 1997 and 1996.
<TABLE>
<CAPTION>
1997 1996
------------------------- -------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Debt securities
Available for sale........ $5,427,652 $5,427,652 $5,214,788 $5,214,788
Equity securities
Common stock.............. 3,051 3,051 660 660
Non-redeemable preferred
stocks................... 9,451 9,451 16,085 16,085
Mortgage loans............. 52,996 57,224 124,914 131,577
Policy loans............... 642,989 606,681 656,073 634,291
Cash & cash equivalents.... 37,064 37,064 37,314 37,314
Short-term investments..... 43,470 43,470 37,515 37,515
Separate account assets.... 1,869,094 1,869,094 1,368,384 1,368,384
Other invested assets...... 88,928 88,928 94,369 94,369
FINANCIAL LIABILITIES:
Investment-type contracts
Individual annuities...... $1,225,192 $1,260,639 $1,281,965 $1,317,257
Guaranteed investment con-
tracts................... 59,809 61,456 111,224 112,247
Other group annuities..... 147,061 148,257 161,889 163,524
Other policyholder funds.. 1,541,372 1,541,372 1,498,334 1,498,334
---------- ---------- ---------- ----------
Total policyholder funds. 2,973,434 3,011,724 3,053,412 3,091,362
Policyholders' dividends
payable................... 35,273 35,273 35,395 35,395
Separate account liabili-
ties...................... 1,869,094 1,869,094 1,368,384 1,368,384
</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 estimated fair value of
currently performing mortgage loans is estimated by discounting the cash flows
associated with the investment, using an interest rate currently offered for
similar loans to borrowers with similar credit ratings. Loans with similar
credit quality, characteristics and time to maturity are aggregated for
purposes of discounted cash flow analysis. 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 the calculations.
The carrying values of cash, cash equivalents, short-term investments and
separate account assets approximate their fair values. The estimated fair value
for the venture capital limited partnerships are 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 certain 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 approximates their fair value due to the nature of
the contracts. The statement values of other policyholder funds, policyholders'
dividends payable and separate account liabilities approximate their fair
values.
Currently, disclosure of estimated fair values is not required for all 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
B-25
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
insurance contracts can be misinterpreted. The estimated fair values of
liabilities under all of the Company's contracts are considered in the overall
management of interest rate risk. 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 durations and anticipated cash flows of the Company's
assets and liabilities.
To minimize exposure and reduce risk from exchange and interest rate
fluctuations in the normal course of business, the Company enters into interest
rate swap programs for purposes other than trading. As of December 31, 1997 and
1996, the Company had interest rate swaps with aggregate notional amounts equal
to $105,000 and $115,000, respectively, with average unexpired terms of 19 and
29 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. Gross
unrealized gains and losses, which represent fair value based on dealer-quoted
prices, were $5,164 and $0, respectively at December 31, 1997 and $7,605 and
$0, respectively, at December 31, 1996. These fair values represent the amount
at risk if the counterparties default and the amount that the Company would
receive to terminate the contracts, taking into account current interest rates
and, where appropriate, the current credit worthiness of the counterparties.
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
held decreases in relation to the value of the loaned securities. The Company
had loaned securities outstanding of $155,356 and $0 as of December 31, 1997
and 1996, respectively.
NOTE 5 - INCOME TAXES:
The Company follows the asset and liability method of accounting for income
taxes whereby current and deferred tax assets and liabilities are recognized
utilizing currently enacted tax laws and rates. Deferred taxes are adjusted to
reflect tax rates at which future tax liabilities or assets are expected to be
settled or realized.
Deferred income taxes reflect the impact for financial statement reporting
purposes of temporary differences between the financial statement carrying
amounts and tax bases of assets and liabilities. The significant temporary
differences that give rise to the deferred tax assets and liabilities at
December 31 relate to the following:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
DEFERRED TAX ASSETS
Future policy benefits...................................... $ 88,172 $ 83,327
Dividend award.............................................. 11,970 12,005
Allowances for investment losses............................ 3,667 8,411
Employee benefit liabilities................................ 27,979 27,113
Other....................................................... 23,467 27,530
-------- --------
Total deferred tax asset................................... 155,255 158,386
-------- --------
DEFERRED TAX LIABILITIES
Deferred acquisition costs.................................. 127,495 124,660
Real estate................................................. (1,261) 299
Unrealized gains............................................ 81,553 48,233
Other....................................................... 22,564 20,977
-------- --------
Total deferred tax liability............................... 230,351 194,169
-------- --------
Net deferred tax liability.................................. $ 75,096 $ 35,783
======== ========
</TABLE>
B-26
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The federal income taxes attributable to consolidated net income are different
from the amounts determined by multiplying consolidated net income before
federal income taxes by the expected federal income tax rate. The difference
between the amount of tax at the U.S. federal income tax rate of 35% and the
consolidated tax provision is summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- --------
<S> <C> <C> <C>
Tax expense at 35%................................ $44,442 $26,930 $ 27,096
Increase/(decrease) in income taxes resulting
from:
Differential earnings amount..................... 6,942 500 3,878
Resolution of tax issues......................... -- -- (57,000)
Other............................................ 2,528 595 4,587
------- ------- --------
Federal income tax expense/(benefit).............. $53,912 $28,025 $(21,439)
======= ======= ========
</TABLE>
As a mutual life insurance company, the Company is subject to Internal Revenue
Code provisions which require mutual, but not stock, life insurance companies
to 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 prescribed rate, which is intended to reflect the difference
between stock and mutual companies' earnings rates.
In 1995, the Company settled various tax issues with the IRS, including an
issue surrounding the tax treatment of certain traditional life insurance
policy updates. As a result of these settlements, the 1995 federal income tax
expense was decreased in the Income Statement by approximately $57,000, which
included $22,300 of interest, net of tax.
The Internal Revenue Service 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.
NOTE 6 - BENEFIT PLANS:
The Company maintains qualified and non-qualified defined benefit pension plans
covering substantially all of its employees. The plans are non-contributory and
provide pension benefits based on years of service and average annual
compensation (measured over 60 consecutive months of highest earnings in a 120-
month period). Contributions are determined by using the Projected Unit Credit
Method. The total pension expense related to these plans amounted to $5,917,
$5,963 and $5,054 in 1997, 1996 and 1995, respectively.
The Company's funding policy for its qualified defined benefit plans is to
contribute an amount between the minimum required contribution and the maximum
deductible amount in accordance with the Internal Revenue Code. The following
table summarizes the components of net periodic pension cost for the Company's
qualified defined benefit plans:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- --------
<S> <C> <C> <C>
Service cost...................................... $ 2,161 $ 2,506 $ 1,827
Interest cost on projected benefit obligation..... 4,050 3,540 2,909
Actual return on assets........................... (4,925) (3,095) (5,515)
Net amortization and deferrals.................... 2,367 919 3,736
------- ------- --------
Net periodic pension cost......................... $ 3,653 $ 3,870 $ 2,957
======= ======= ========
</TABLE>
B-27
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The following table summarizes the funded status of the Company's qualified
defined benefit plans:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Actuarial present value of benefit obligation:
Vested.......................................... $ 44,964 $ 32,572 $ 29,744
Non-vested...................................... 924 935 763
-------- -------- --------
Accumulated benefit obligation................... 45,888 33,507 30,507
Provision for future salary increases............ 16,769 15,162 17,147
-------- -------- --------
Projected benefit obligation..................... 62,657 48,669 47,654
Plan assets at fair value........................ (42,783) (37,938) (34,067)
-------- -------- --------
Projected benefit obligation in excess of plan
assets.......................................... 19,874 10,731 13,587
Unrecognized prior service cost.................. (178) (203) (228)
Unrecognized net (gain) loss from past experi-
ence............................................ (9,605) (2,430) (6,859)
Unrecognized net asset obligation at transition.. (1,288) (1,609) (1,931)
-------- -------- --------
Accrued pension cost at December 31.............. $ 8,803 $ 6,489 $ 4,569
======== ======== ========
</TABLE>
The assumptions used to measure the actuarial present value of the projected
benefit obligation were:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Discount rate.................................... 7.00% 7.50% 7.00%
Expected long-term rate of return on plan assets. 8.00% 8.00% 8.00%
Salary scale..................................... 5.50% 5.50% 5.50%
</TABLE>
The qualified defined benefit pension plan's assets are held in trust and
administered under a participatory group annuity contract issued by the Company
with assets invested in various separate accounts of the Company. A non-
participatory annuity contract issued by the Company funds benefits accrued
prior to 1986.
The Company maintains four defined contribution pension plans for substantially
all of its employees and full-time agents. For two plans, designated
contributions of up to 6% or 8% of annual compensation are eligible to be
matched by the Company. Contributions for the third plan are based on tiered
earnings of full time agents. The last plan, which covers employees of a
subsidiary, are determined on a discretionary basis by the Board of Directors
of that subsidiary. At December 31, 1997, 1996 and 1995, the expense recognized
for these plans was $8,345, $6,092 and $5,083, respectively. The estimated fair
value of the defined contribution plans' assets were $229,378, $201,679 and
$176,832, respectively.
The Company also provides certain medical, life insurance and other welfare
benefits (postretirement benefits) for retired employees and full-time agents.
Substantially all employees and full-time agents become eligible for these
benefits if they reach retirement age while working for the Company and have at
least 10 years of service. Employees retiring after January 1, 1993 receive a
defined dollar benefit under the medical plan. The Company continues to fund
postretirement benefit costs on a pay-as-you-go basis.
B-28
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
The following table sets forth the postretirement benefits plan's status,
reconciled to amounts recognized in the Company's Consolidated Balance Sheet
and Income Statements at December 31.
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Actuarial present value of accumulated
post retirement benefit obligation:
Retirees.......................................... $22,638 $21,301 $32,473
Fully eligible active plan participants........... 2,707 2,547 2,826
Other active plan participants.................... 6,068 5,710 5,672
------- ------- -------
Total............................................ 31,413 29,558 40,971
Plan assets at fair value.......................... -- -- --
------- ------- -------
Accumulated postretirement benefits obligation in
excess of plan assets............................. 31,413 29,558 40,971
Unrecognized prior service cost.................... -- -- --
Unrecognized net gain from past experience......... 13,730 16,261 5,129
------- ------- -------
Accrued postretirement benefits cost............... $45,143 $45,819 $46,100
======= ======= =======
Net periodic postretirement benefits cost includes
the following components:
Service cost...................................... 393 434 355
Interest cost on accumulated postretirement bene-
fits obligation.................................. 2,182 2,206 2,910
Actual return on assets........................... -- -- --
Net amortization and deferral..................... (1,060) (815) (573)
------- ------- -------
Net periodic postretirement benefits cost.......... $ 1,515 $ 1,825 $ 2,692
======= ======= =======
</TABLE>
At December 31, 1997, the assumed health care cost trend rate used in measuring
the accumulated postretirement benefit obligation was 8.5% in 1998, grading to
5.0% in the year 2004. The weighted-average discount rate used in determining
the accumulated postretirement benefit obligation was 7.00% at December 31,
1997. At December 31, 1996, the assumed health care cost trend rate used in
measuring the accumulated postretirement benefit obligation was 8.5% in 1997,
grading to 5.0% in the year 2004. The weighted-average discount rate used in
determining the accumulated postretirement benefit obligation was 7.5% at
December 31, 1996. At December 31, 1995, the assumed health care cost trend
rate used in measuring the accumulated postretirement benefit obligation was
9.0% in 1996, grading to 5.0% in the year 2004. The weighted-average discount
rate used in determining the accumulated postretirement benefit obligation was
7.0% at December 31, 1995.
If the health care cost trend rate was increased by one percentage point for
each future year, the accumulated postretirement benefit obligation as of
December 31, 1997 would increase by $1,948. The effect of this change on the
sum of the service cost and interest cost, before taxes, would be an increase
of $136.
B-29
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTE 7 - REINSURANCE:
The Company has assumed and ceded reinsurance on certain life and annuity
contracts under various agreements. Reinsurance permits recovery of a portion
of losses from reinsurers, although the Company remains primarily liable as the
direct insurer on all risks reinsured. The Company evaluates the financial
strength of potential reinsurers and continually monitors the financial
condition of present reinsurers to ensure that amounts due from reinsurers are
collectable. The table below highlights the amounts shown in the accompanying
financial statements.
<TABLE>
<CAPTION>
ASSUMED CEDED TO
GROSS FROM OTHER OTHER NET
AMOUNT COMPANIES COMPANIES AMOUNT
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1997:
Life Insurance in Force.......... $31,027,764 $5,217,856 $4,620,599 $31,625,021
Premiums......................... 190,754 11,189 6,723 195,220
Benefits......................... 330,432 14,293 26,916 317,809
Reserves......................... 5,741,456 1,993 59,322 5,684,127
DECEMBER 31, 1996:
Life Insurance in Force.......... $30,057,996 $5,420,951 $3,186,567 $32,292,380
Premiums......................... 196,897 12,745 9,821 199,821
Benefits......................... 293,270 16,466 16,808 292,928
Reserves......................... 5,833,970 2,063 56,632 5,779,401
</TABLE>
During 1995, the Company had gross premiums of $184,362, assumed premiums of
$13,453 and ceded premiums of $9,908 and gross benefits of $303,911, assumed
benefits of $13,265 and ceded benefits of $14,700.
Reinsurance receivables with a carrying value of $50,617 and $50,522 were
associated with a single reinsurer at December 31, 1997 and 1996, respectively.
During 1995, the Company recaptured the portion of its disability income
business that was previously reinsured under a quota share and excess
reinsurance agreement with the Monarch Life Insurance Company ("Monarch"). As a
result of this recapture, approximately $21,200 of cash and policyholder
reserves were transferred to the Company from Monarch.
NOTE 8 - 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, in the ordinary course of business, extends commitments relating
to its investment activities. As of December 31, 1997, the Company had
outstanding commitments totaling $38,326 relating to these investment
activities. The fair value of these commitments approximates the face amount.
NOTE 9 - STATUTORY INFORMATION:
State insurance regulatory authorities prescribe or permit statutory accounting
practices for calculating net income and capital and surplus which differ in
certain respects from generally accepted accounting principles (GAAP). The
significant differences relate to deferred acquisition costs, which are charged
to expenses as incurred; federal income taxes, which reflect amounts that are
currently taxable; and benefit reserves, which are determined using prescribed
mortality, morbidity and interest assumptions, and which, when considered in
light of the assets supporting these reserves, adequately provide for
obligations under policies and contracts. In addition, the recording of
impairments in the value of investments generally lags recognition under GAAP.
The combined insurance companies' statutory capital and surplus at December 31,
1997 and 1996 was $435,861 and $379,774, respectively. The combined insurance
companies' net income, determined in accordance with statutory accounting
practices, for the years ended December 31, 1997, 1996 and 1995, was $63,615,
$25,905 and $729, respectively.
B-30
<PAGE>
- --------------------------------------------------------------------------------
THE PENN MUTUAL LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTE 10 - BUSINESS SEGMENT INFORMATION:
The operations of the Company are conducted principally through two business
units: Insurance and Broker-Dealer. The insurance operations offer a diverse
portfolio of life insurance products and both individual and group annuity
products. The Broker-Dealer operations provide broad financial and investment
services.
Assets are held directly by each business unit in amounts necessary to both
fund liabilities and to provide a margin to cover business risks.
The table below summarizes the information concerning the business units:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
REVENUES
Insurance...................................... $ 778,179 $ 765,210 $ 803,276
Broker-Dealer.................................. 291,156 241,809 201,037
---------- ---------- ----------
TOTAL......................................... $1,069,335 $1,007,019 $1,004,313
========== ========== ==========
PRETAX INCOME
Insurance...................................... $ 84,722 $ 43,765 $ 53,337
Broker-Dealer.................................. 42,255 33,178 24,082
---------- ---------- ----------
TOTAL......................................... $ 126,977 $ 76,943 $ 77,419
========== ========== ==========
<CAPTION>
DECEMBER 31,
---------------------
1997 1996
---------- ----------
<S> <C> <C> <C>
IDENTIFIABLE ASSETS
Insurance...................................... $8,784,570 $8,259,309
Broker-Dealer.................................. 582,308 497,739
---------- ----------
TOTAL......................................... $9,366,878 $8,757,048
========== ==========
</TABLE>
B-31
