<PAGE>
[INTEGRITY LIFE INSURANCE COMPANY LETTERHEAD]
May 19, 1998
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Separate Account VUL of Integrity Life Insurance Company ("Registrant")
Rule 497(e) Filing of Financial Statements
Registration No. 2-99809
Pursuant to Rule 497(e) under the Securities Act of 1933, we are filing updated
financial statements which have been provided to policyholders of the
Registrant's Portfolio Life product. Registrant is no longer issuing the
product, and in accordance with a no-action position of the Securities and
Exchange Commission, the prospectus has been "evergreened."
Sincerely,
/s/ Cara M. Page
Cara M. Page
Paralegal
<PAGE>
Financial Statements
Separate Account VUL
of
Integrity Life Insurance Company
DECEMBER 31, 1997
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
Separate Account VUL
of
Integrity Life Insurance Company
Financial Statements
December 31, 1997
CONTENTS
Report of Independent Auditors. . . . . . . . . . . . . . . . . . . . . . .1
Audited Financial Statements
Statement of Assets and Liabilities . . . . . . . . . . . . . . . . . . . .2
Statement of Operations . . . . . . . . . . . . . . . . . . . . . . . . . .3
Statements of Changes in Net Assets . . . . . . . . . . . . . . . . . . . .4
Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . .6
<PAGE>
Report of Independent Auditors
Policyholders
Separate Account VUL of Integrity Life Insurance Company
We have audited the accompanying statement of assets and liabilities of
Separate Account VUL of Integrity Life Insurance Company (comprising,
respectively, the Common Stock, Money Market, Balanced, Aggressive Stock,
High Yield, and Global Divisions) as of December 31, 1997, the related
statement of operations for the year then ended and statements of changes in
net assets for the years ended December 31, 1997 and 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
Our procedures included confirmation of mutual fund shares owned in The
Hudson River Trust (the "Trust") as of December 31, 1997, by correspondence
with the transfer agent of the Trust. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of each of the respective
divisions constituting Separate Account VUL of Integrity Life Insurance
Company at December 31, 1997, the results of their operations for the year
then ended, and changes in their net assets for the years ended December 31,
1997 and 1996, in conformity with generally accepted accounting principles.
Louisville, Kentucky
April 17, 1998
1
<PAGE>
<TABLE>
<CAPTION>
Separate Account VUL of Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1997
COMMON STOCK MONEY MARKET BALANCED AGGRESSIVE STOCK HIGH YIELD GLOBAL
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION TOTAL
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Investments in The Hudson River
Trust at value (cost of
$26,307,446 in the aggregate) $ 16,381,266 $ 917,594 $ 5,695,728 $ 6,700,792 $ 450,759 $ 1,253,039 $ 31,399,178
LIABILITIES
Payable to (receivable from)
the general account of
Integrity 25,671 20 4,028 8,373 (11) 1,380 39,461
------------------------------------------------------------------------------------------------
NET ASSETS $ 16,355,595 $ 917,574 $ 5,691,700 $ 6,692,419 $ 450,770 $ 1,251,659 $ 31,359,717
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
Unit value $ 501.49 $ 180.27 $ 289.33 $ 566.53 $ 302.53 $ 309.97
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
Units outstanding 32,614 5,090 19,672 11,813 1,490 4,038
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
2
<PAGE>
<TABLE>
<CAPTION>
Separate Account VUL of Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1997
COMMON STOCK MONEY MARKET BALANCED AGGRESSIVE STOCK HIGH YIELD GLOBAL
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION TOTAL
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Reinvested dividends from
The Hudson River Trust $ 1,322,589 $ 44,145 $ 462,370 $ 573,027 $ 58,182 $ 104,865 $ 2,565,178
EXPENSES
Mortality and expense risk
and administrative charges 91,488 5,091 33,499 41,193 2,715 7,730 181,716
------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME 1,231,101 39,054 428,871 531,834 55,467 97,135 2,383,462
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS
Net realized gain on sales
of investments 1,013,552 2,615 137,227 235,552 5,932 112,601 1,507,479
Net unrealized appreciation
of investments:
Beginning of period 2,742,610 8,814 105,122 496,888 6,243 104,038 3,463,715
End of period 4,340,259 6,697 283,082 411,740 18,540 31,414 5,091,732
------------------------------------------------------------------------------------------------
Change in net unrealized
appreciation during the
period 1,597,649 (2,117) 177,960 (85,148) 12,297 (72,624) 1,628,017
------------------------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED
GAIN ON INVESTMENTS 2,611,201 498 315,187 150,404 18,229 39,977 3,135,496
------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS $ 3,842,302 $ 39,552 $ 744,058 $ 682,238 $ 73,696 $ 137,112 $ 5,518,958
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
Separate Account VUL of Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1997
COMMON STOCK MONEY MARKET BALANCED AGGRESSIVE STOCK HIGH YIELD GLOBAL
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION TOTAL
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET
ASSETS FROM OPERATIONS
Net investment income $ 1,231,101 $ 39,054 $ 428,871 $ 531,834 $ 55,467 $ 97,135 $ 2,383,462
Net realized gain on
sales of investments 1,013,552 2,615 137,227 235,552 5,932 112,601 1,507,479
Change in net unrealized
appreciation during
the period 1,597,649 (2,117) 177,960 (85,148) 12,297 (72,624) 1,628,017
------------------------------------------------------------------------------------------------
Net increase in net assets
resulting from operations 3,842,302 39,552 744,058 682,238 73,696 137,112 5,518,958
INCREASE (DECREASE) IN NET
ASSETS FROM POLICY RELATED
TRANSACTIONS
Contributions from
policyholders 709,747 35,370 430,872 320,929 23,214 87,418 1,607,550
Policy terminations and
benefits (2,154,973) (140,037) (901,177) (948,774) (114,746) (234,685) (4,494,392)
Net transfers among
investment divisions (23,918) 96,046 (10,426) (46,467) 5,397 (4,872) 15,760
------------------------------------------------------------------------------------------------
Net decrease in net assets from
policy related transactions (1,469,144) (8,621) (480,731) (674,312) (86,135) (152,139) (2,871,082)
------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS 2,373,158 30,931 263,327 7,926 (12,439) (15,027) 2,647,876
Net assets, beginning of year 13,982,437 886,643 5,428,373 6,684,493 463,209 1,266,686 28,711,841
------------------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR $ 16,355,595 $ 917,574 $ 5,691,700 $ 6,692,419 $ 450,770 $ 1,251,659 $ 31,359,717
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 1,630 200 1,579 605 83 294
Terminations and benefits (4,823) (799) (3,335) (1,792) (412) (802)
Net transfers (5) 535 (17) 4 16 15
-----------------------------------------------------------------------------------
Increase (decrease) in units (3,198) (64) (1,773) (1,183) (313) (493)
-----------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
<TABLE>
<CAPTION>
Separate Account VUL of Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1996
COMMON STOCK MONEY MARKET BALANCED AGGRESSIVE STOCK HIGH YIELD GLOBAL
DIVISION DIVISION DIVISION DIVISION DIVISION DIVISION TOTAL
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET
ASSETS FROM OPERATIONS
Net investment income $ 1,446,900 $ 44,400 $ 579,575 $ 1,182,969 $ 69,407 $ 72,737 $ 3,395,988
Net realized gain on
sales of investments 378,824 8,131 90,167 483,807 7,135 54,711 1,022,775
Change in net unrealized
appreciation/depreciation
during the period 938,827 9,969 (103,882) (448,179) 7,769 31,944 436,448
------------------------------------------------------------------------------------------------
Net increase in net assets
resulting from operations 2,764,551 62,500 565,860 1,218,597 84,311 159,392 4,855,211
INCREASE (DECREASE) IN NET ASSETS
FROM POLICY RELATED
TRANSACTIONS
Contributions from
policyholders 798,258 43,289 436,431 379,732 19,391 92,436 1,769,537
Policy terminations and
benefits (1,761,363) (792,326) (850,555) (824,163) (38,748) (202,987) (4,470,142)
Net transfers among investment
divisions 45,099 (127,532) (111,948) 131,368 31,422 84,250 (52,659)
------------------------------------------------------------------------------------------------
Net increase (decrease) in net
assets from policy related
transactions (918,006) (876,569) (526,072) (313,063) 12,065 (26,301) (2,647,946)
------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS 1,846,545 (814,069) 39,788 905,534 96,376 133,091 2,207,265
Net assets, beginning of year 12,135,892 1,700,712 5,388,585 5,778,959 366,833 1,133,595 26,504,576
------------------------------------------------------------------------------------------------
NET ASSETS, END OF YEAR $ 13,982,437 $ 886,643 $ 5,428,373 $ 6,684,493 $ 463,209 $ 1,266,686 $ 28,711,841
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 2,328 258 1,840 793 83 355
Terminations and benefits (5,152) (4,688) (3,580) (1,726) (163) (781)
Net transfers 241 (766) (445) 282 139 338
-----------------------------------------------------------------------------------
Increase (decrease) in units (2,583) (5,196) (2,185) (651) 59 (88)
-----------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
Separate Account VUL
of
Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1997
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF OPERATIONS
Integrity Life Insurance Company ("Integrity") established Separate Account
VUL (the "Separate Account") on May 14, 1986 for the purpose of issuing
variable life insurance policies ("policies"). The Separate Account is a
unit investment trust registered with the Securities and Exchange Commission
under the Investment Company Act of 1940, as amended. Variable life
insurance policies have not been offered by Integrity since 1990, but
policies are still outstanding. Net premiums may be received under existing
policies. The operations of the Separate Account are part of Integrity.
Integrity is an indirect wholly owned subsidiary of ARM Financial Group, Inc.
("ARM"). ARM specializes in the growing asset accumulation business with
particular emphasis on retirement savings and investment products.
Policyholders may allocate or transfer their account values to one or more of
the Separate Account's investment divisions or to a guaranteed interest
division provided by Integrity, or both. The Separate Account divisions
invest in shares of the corresponding portfolios of The Hudson River Trust
(the "Trust"), a mutual fund managed by Alliance Capital Management, L.P.
The policyholder's account value in a Separate Account division will vary
depending on the performance of the corresponding portfolio. The Separate
Account currently has six investment divisions available. The investment
objective of each division and its corresponding portfolio are the same. Set
forth below is a summary of the investment objectives of the portfolios of
the Trust.
COMMON STOCK PORTFOLIO seeks to obtain long-term growth of capital and
increasing income. It invests primarily in common and preferred stocks and
other equity type instruments.
6
<PAGE>
Separate Account VUL
of
Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MONEY MARKET PORTFOLIO seeks to obtain as high a level of current income as
is consistent with preserving capital and providing liquidity. It invests
primarily in high quality short-term money market instruments.
BALANCED PORTFOLIO seeks a high return through a combination of current
income and capital appreciation. It invests primarily in common stocks,
publicly-traded debt securities and high quality money market instruments.
AGGRESSIVE STOCK PORTFOLIO seeks to obtain long term growth of capital. It
invests primarily in common stocks and other equity-type securities issued
by medium and smaller sized companies with strong growth potential.
HIGH YIELD PORTFOLIO seeks a high return by maximizing current income and,
to the extent consistent with that objective, capital appreciation. It
invests primarily in a diversified mix of high yield, fixed income
securities involving greater volatility of price and risk of principal and
income than high quality fixed income securities.
GLOBAL PORTFOLIO seeks long term growth of capital as a fundamental
objective. It invests primarily in equity securities of non-United States
as well as United States companies.
The assets of the Separate Account are owned by Integrity. The portion of the
Separate Account's assets supporting the policies may not be used to satisfy
liabilities arising out of any other business of Integrity.
BASIS OF PRESENTATION
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles for unit investment trusts.
INVESTMENTS
Investments in shares of the Trust are valued at the net asset values of the
respective portfolios, which approximates fair value. The difference between
cost and fair value is reflected as unrealized appreciation and depreciation of
investments.
7
<PAGE>
Separate Account VUL
of
Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Dividends from income and capital gain distributions are recorded on the
ex-dividend date. Dividends and distributions from the Trust portfolios are
reinvested in the respective portfolios and are reflected in the unit value of
the divisions of the Separate Account.
Share transactions are recorded on the trade date. Realized gains and losses on
sales of Trust shares are determined based on the identified cost basis.
UNIT VALUE
Unit values for the Separate Account divisions are computed at the end of each
business day. The unit value is equal to the unit value for the preceding
business day multiplied by a net investment factor. This net investment factor
is determined based on the value of the underlying mutual fund portfolios of the
Separate Account, reinvested dividends and capital gains, new premium deposits
or withdrawals, and the daily asset charge for the mortality and expense risk
and administrative charges. Unit values are adjusted daily for all activity in
the Separate Account.
TAXES
Operations of the Separate Account are included in the income tax return of
Integrity, which is taxed as a life insurance company under the Internal
Revenue Code. The Separate Account will not be taxed as a regulated
investment company under Subchapter M of the Internal Revenue Code. Under
the provisions of the policies, Integrity has the right to charge the
Separate Account for federal income tax attributable to the Separate Account.
No charge is currently being made against the Separate Account for such tax
since, under current tax law, Integrity pays no tax on investment income and
capital gains reflected in variable life insurance policy reserves. However,
Integrity retains the right to charge for any federal income tax incurred
which is attributable to the Separate Account if the law is changed. Charges
for state and local taxes, if any, attributable to the Separate Account may
also be made.
8
<PAGE>
Separate Account VUL
of
Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
2. INVESTMENTS
The aggregate cost of portfolio shares purchased and proceeds from portfolio
shares sold during the year ended December 31, 1997 and the cost of shares held
at December 31, 1997 for each division were as follows:
<TABLE>
<CAPTION>
DIVISION PURCHASES SALES COST
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Common Stock $2,303,289 $2,517,485 $12,041,007
Money Market 600,913 570,379 910,897
Balanced 766,091 814,406 5,412,646
Aggressive Stock 875,989 1,010,757 6,289,052
High Yield 101,292 132,049 432,219
Global 548,665 602,482 1,221,625
-----------
$26,307,446
-----------
-----------
</TABLE>
3. EXPENSES
Integrity assumes mortality and expense risks related to the operations of the
Separate Account and deducts a charge from the assets of the Separate Account at
an annual rate of 0.60% of policyholders' net assets to cover these risks.
Integrity makes deductions for administrative expenses and state premium taxes
from premiums before amounts are allocated to the Separate Account.
9
<PAGE>
Financial Statements
(Statutory Basis)
Integrity Life Insurance Company
YEARS ENDED DECEMBER 31, 1997 AND 1996
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1997 and 1996
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . .1
Audited Financial Statements
Balance Sheets (Statutory Basis) . . . . . . . . . . . . . . . . . . . . .3
Statements of Income (Statutory Basis) . . . . . . . . . . . . . . . . . .5
Statements of Changes in Capital and Surplus (Statutory Basis) . . . . . .6
Statements of Cash Flows (Statutory Basis) . . . . . . . . . . . . . . . .7
Notes to Financial Statements (Statutory Basis). . . . . . . . . . . . . .9
</TABLE>
<PAGE>
Report of Independent Auditors
Board of Directors
Integrity Life Insurance Company
We have audited the accompanying statutory basis balance sheets of Integrity
Life Insurance Company as of December 31, 1997 and 1996, and the related
statutory basis statements of income, changes in capital and surplus, and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As described in Note 1 to the financial statements, the Company presents its
financial statements in conformity with accounting practices prescribed or
permitted by the Ohio Department of Insurance, which practices differ from
generally accepted accounting principles. The variances between such practices
and generally accepted accounting principles and the effects on the accompanying
financial statements are described in Note 1.
In our opinion, because of the effects of the matter described in the preceding
paragraph, the financial statements referred to above do not present fairly, in
conformity with generally accepted accounting principles, the financial position
of Integrity Life Insurance Company at December 31, 1997 and 1996, or the
results of its operations or its cash flows for the years then ended.
1
<PAGE>
However, in our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Integrity Life
Insurance Company at December 31, 1997 and 1996, and the results of its
operations and its cash flows for the years then ended in conformity with
accounting practices prescribed or permitted by the Ohio Department of
Insurance.
Louisville, Kentucky
February 10, 1998
2
<PAGE>
Integrity Life Insurance Company
Balance Sheets (Statutory Basis)
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
--------------------------
(IN THOUSANDS)
<S> <C> <C>
ADMITTED ASSETS
Cash and invested assets:
Bonds $3,444,659 $2,482,392
Preferred stocks 58,369 42,234
Subsidiaries 54,028 48,272
Mortgage loans 13,186 32,946
Policy loans 99,531 98,212
Cash and short-term investments 201,242 87,009
Other invested assets 27,591 6,807
--------------------------
Total cash and invested assets 3,898,606 2,797,872
Separate account assets 1,822,557 764,060
Accrued investment income 38,247 29,182
Reinsurance balances receivable 4,837 1,702
Other admitted assets 207 1,400
--------------------------
Total admitted assets $5,764,454 $3,594,216
--------------------------
--------------------------
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
-------------------------
(IN THOUSANDS)
<S> <C> <C>
LIABILITIES AND CAPITAL AND SURPLUS
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $1,603,893 $1,722,182
Funding agreement and GIC deposit
fund liabilities 2,039,202 891,936
Unpaid claims 207 232
Deposits on policies to be issued, net (1,715) 348
-------------------------
Total policy and contract liabilities 3,641,587 2,614,698
Separate account liabilities 1,798,069 759,170
Accounts payable and accrued expenses 2,538 3,187
Transfers to separate accounts due or
accrued, net (42,028) (37,533)
Reinsurance balances payable 14,602 13,473
Federal income taxes 763 -
Asset valuation reserve 23,368 13,805
Interest maintenance reserve 42,272 38,594
Other liabilities 71,523 24,988
-------------------------
Total liabilities 5,552,694 3,430,382
Capital and surplus:
Common stock, $2 par value, 1,500,000 shares
authorized, issued and outstanding 3,000 3,000
Paid-in surplus 113,109 87,535
Unassigned surplus 95,651 73,299
-------------------------
Total capital and surplus 211,760 163,834
-------------------------
Total liabilities and capital and surplus $5,764,454 $3,594,216
-------------------------
-------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
Integrity Life Insurance Company
Statements of Income (Statutory Basis)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
-------------------------
(IN THOUSANDS)
<S> <C> <C>
Premiums and other revenues:
Premiums and annuity considerations $ 13,386 $ 7,803
Deposit-type funds 2,191,350 737,791
Net investment income 239,514 171,811
Amortization of the interest maintenance
reserve 2,561 3,090
Income from separate account seed money
investment 469 347
Other revenues 16,988 13,085
-------------------------
Total premiums and other revenues 2,464,268 933,927
Benefits paid or provided:
Death benefits 5,136 3,196
Annuity benefits 136,630 78,058
Surrender benefits 408,615 248,282
Interest on funds left on deposit 84,652 25,204
Payments on supplementary contracts 10,659 10,261
Increase in reserves and deposit fund
liabilities 945,161 372,699
-------------------------
Total benefits paid or provided 1,590,853 737,700
Insurance and other expenses:
Commissions 29,189 20,270
General expenses 15,869 8,955
Taxes, licenses and fees 1,111 549
Net transfers to separate accounts 785,374 137,570
Other expenses 3,354 1,085
-------------------------
Total insurance and other expenses 834,897 168,429
-------------------------
Gain from operations before federal income
taxes and net realized capital gains (losses) 38,518 27,798
Federal income tax expense (benefit) 2,871 (3,259)
-------------------------
Gain from operations before net realized
capital gains (losses) 35,647 31,057
Net realized capital gains (losses), excluding
realized capital gains, net of tax,
transferred to the interest maintenance
reserve (1997-$6,239; 1996-$6,467) 2,512 (5,015)
-------------------------
Net income $ 38,159 $ 26,042
-------------------------
-------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years Ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
TOTAL
COMMON PAID-IN UNASSIGNED CAPITAL AND
STOCK SURPLUS SURPLUS SURPLUS
------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance, January 1, 1996 $ 3,000 $ 87,535 $ 55,492 $146,027
Net income 26,042 26,042
Net change in unrealized gain
of subsidiary 9,133 9,133
Decrease in nonadmitted assets 27 27
Increase in asset valuation reserve (1,395) (1,395)
Dividends to shareholder (16,000) (16,000)
------------------------------------------------------
Balance, December 31, 1996 3,000 87,535 73,299 163,834
Net income 38,159 38,159
Net change in unrealized gain
of subsidiary 5,756 5,756
Increase in asset valuation reserve (9,563) (9,563)
Capital contribution, net 25,574 25,574
Dividends to shareholder (12,000) (12,000)
------------------------------------------------------
Balance, December 31, 1997 $ 3,000 $113,109 $ 95,651 $211,760
------------------------------------------------------
------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
6
<PAGE>
Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
--------------------------
(IN THOUSANDS)
<S> <C> <C>
OPERATIONS:
Premiums, policy proceeds, and other
considerations received $2,204,736 $ 745,594
Net investment income received 230,747 171,376
Commission and expense allowances
received on reinsurance ceded 3,838 1,905
Benefits paid (561,208) (341,767)
Insurance expenses paid (46,819) (30,246)
Other income received net of other
expenses paid 9,092 10,100
Net transfers to separate accounts (789,869) (144,958)
Federal income taxes paid (5,501) (3,702)
--------------------------
Net cash provided by operations 1,045,016 408,302
INVESTMENT ACTIVITIES:
Proceeds from sales, maturities, or
repayments of investments:
Bonds 3,407,120 1,604,304
Preferred stocks 87,435 57,895
Mortgage loans 19,760 5,668
Real estate 359 -
Other invested assets 10,216 7,233
Net gains (losses) on cash and
short-term investments (24) 9
Miscellaneous proceeds 3,436 211
--------------------------
Total investment proceeds 3,528,302 1,675,320
Benefits recovered (taxes paid) on
capital gains 175 (2,312)
--------------------------
Net proceeds from sales, maturities,
or repayments of investments 3,528,477 1,673,008
</TABLE>
7
<PAGE>
Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
-------------------------
(IN THOUSANDS)
<S> <C> <C>
Cost of investments acquired:
Bonds 4,376,185 1,960,794
Preferred and common stocks 101,175 92,077
Other invested assets 31,931 -
-------------------------
Total cost of investments acquired 4,509,291 2,052,871
Net increase in policy loans and premium notes 1,320 3,569
-------------------------
Net cash used in investment activities (982,134) (383,432)
FINANCING AND MISCELLANEOUS ACTIVITIES:
Other cash provided:
Capital and surplus paid-in 40,000 -
Other sources 52,548 40,403
-------------------------
Total other cash provided 92,548 40,403
Other cash applied:
Dividends to shareholder 12,000 16,000
Other applications, net 29,197 16,740
-------------------------
Total other cash applied 41,197 32,740
-------------------------
Net cash provided by financing and
miscellaneous activities 51,351 7,663
-------------------------
Net increase in cash and short-term investments 114,233 32,533
Cash and short-term investments at beginning
of year 87,009 54,476
-------------------------
Cash and short-term investments at end of year $ 201,242 $ 87,009
-------------------------
-------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
8
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
December 31, 1997
1. ORGANIZATION AND ACCOUNTING POLICIES
ORGANIZATION
Integrity Life Insurance Company ("Integrity" or the "Company") is an indirect
wholly owned subsidiary of ARM Financial Group, Inc. ("ARM"). ARM acquired the
Company and its wholly owned insurance subsidiary, National Integrity Life
Insurance Company ("National Integrity"), on November 26, 1993 from The National
Mutual Life Association of Australasia Limited ("National Mutual"). The Company
is domiciled in the state of Ohio. The Company, currently licensed in 45 states
and the District of Columbia, and National Integrity specialize in the growing
asset accumulation business with particular emphasis on retirement savings and
investment products.
In June 1997, ARM completed an initial public offering of 9.2 million shares
of its common stock of which 5.75 million shares were sold by ARM for net
proceeds of $78.8 million. The remaining 3.45 million shares were sold by
certain private equity funds sponsored by Morgan Stanley Dean Witter & Co.
("Morgan Stanley Stockholders"). On June 30, 1997, ARM used a portion of such
net proceeds to make a $40 million capital contribution to the Company,
thereby strengthening the Company's capital base to provide for future
growth. Simultaneously, the Company paid a $14.4 million dividend of bonds
held by the Company to ARM for a net capital contribution of $25.6 million.
The Morgan Stanley Stockholders owned approximately 91% of the outstanding
shares of ARM's common stock prior to the offering and, as a result of the
offering, owned approximately 53% at December 31, 1997.
BASIS OF PRESENTATION
The accompanying financial statements of the Company have been prepared in
conformity with accounting practices prescribed or permitted by the Ohio
Department of Insurance. Such practices vary from generally accepted accounting
principles ("GAAP"). The more significant variances from GAAP are as follows:
INVESTMENTS
Investments in bonds and preferred stocks are reported at amortized cost or fair
value based on the National Association of Insurance Commissioners' ("NAIC")
rating; for GAAP, such fixed maturity investments are designated at purchase as
held-to-maturity, trading or available-for-sale. Held-to-maturity fixed
investments are reported at amortized
9
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
cost, and the remaining fixed maturity investments are reported at fair value
with unrealized holding gains and losses reported in operations for those
designated as trading and as a separate component of shareholder's equity for
those designated as available-for-sale. In addition, fair values of certain
investments in bonds and stocks are based on values specified by the NAIC,
rather than on actual or estimated fair values used for GAAP.
Realized gains and losses are reported in income net of income tax and transfers
to the interest maintenance reserve. Changes between cost and admitted
investment asset amounts are credited or charged directly to unassigned surplus
rather than to a separate surplus account. The Asset Valuation Reserve is
determined by an NAIC prescribed formula and is reported as a liability rather
than unassigned surplus. Under a formula prescribed by the NAIC, the Company
defers the portion of realized gains and losses on sales of fixed income
investments, principally bonds and mortgage loans, attributable to changes in
the general level of interest rates and amortizes those deferrals over the
remaining period to maturity of the individual security sold using the seriatim
method. The net deferral is reported as the Interest Maintenance Reserve in the
accompanying balance sheets. Under GAAP, realized gains and losses are reported
in the income statement on a pretax basis in the period that the asset giving
rise to the gain or loss is sold and include provisions when there has been a
decline in asset values deemed other than temporary.
SUBSIDIARY
The accounts and operations of the Company's subsidiary are not consolidated
with the accounts and operations of the Company as would be required under GAAP.
POLICY ACQUISITION COSTS
Costs of acquiring and renewing business are expensed when incurred. Under GAAP,
acquisition costs related to investment-type products, to the extent recoverable
from future gross profits, are amortized generally in proportion to the
emergence of future gross profits over the estimated term of the underlying
policies.
10
<PAGE>
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
NONADMITTED ASSETS
Certain assets designated as "nonadmitted," principally receivables greater than
90 days past due, are excluded from the accompanying balance sheets and are
charged directly to unassigned surplus.
PREMIUMS AND BENEFITS
Revenues include premiums and deposits received and benefits include death
benefits paid and the change in policy reserves. Under GAAP, such premiums and
deposits received are accounted for as a deposit liability and therefore not
recognized as premium revenue; benefits paid equal to the policy account value
are accounted for as a return of deposit instead of benefit expense.
BENEFIT RESERVES
Certain policy reserves are calculated using statutorily prescribed interest and
mortality assumptions rather than on expected experience or actual account
balances as would be required under GAAP.
FEDERAL INCOME TAXES
Deferred federal income taxes are not provided for differences between the
financial statement amounts and tax bases of assets and liabilities.
STATEMENT OF CASH FLOWS
Cash and short-term investments in the statement of cash flows represent cash
balances and investments with initial maturities of one year or less. Under
GAAP, the corresponding captions of cash and cash equivalents include cash
balances and investments with initial maturities of three months or less.
11
<PAGE>
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
The effects of the foregoing variances from GAAP on the accompanying statutory
basis financial statements are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
------------------------
(IN THOUSANDS)
<S> <C> <C>
Net income as reported in the accompanying
statutory basis financial statements $ 38,159 $ 26,042
Deferred policy acquisition costs,
net of amortization 19,174 11,036
Adjustments to customer deposits (10,224) (1,883)
Adjustments to invested asset carrying values
at acquisition date (69) (412)
Amortization of value of insurance in force (8,423) (5,850)
Amortization of interest maintenance reserve (2,561) (3,090)
Adjustments for realized investment gains 217 3,373
Adjustments for federal income tax expense (4,419) (6,516)
Investment in subsidiary 6,009 9,498
Other 3,300 (2,108)
------------------------
Net income, GAAP basis $ 41,163 $ 30,090
------------------------
------------------------
</TABLE>
12
<PAGE>
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
-------------------------
(IN THOUSANDS)
<S> <C> <C>
Capital and surplus as reported in the
accompanying statutory basis
financial statements $ 211,760 $ 163,834
Adjustments to customer deposits (179,265) (169,041)
Adjustments to invested asset carrying
values at acquisition date (15,432) (15,580)
Asset valuation reserve and interest
maintenance reserve 88,089 81,246
Value of insurance in force 76,929 85,352
Goodwill 6,571 6,826
Deferred policy acquisition costs 73,528 54,354
Net unrealized gains on available-for-sale
securities 2,912 (9,211)
Other 25,035 8,238
-------------------------
Shareholder's equity, GAAP basis $ 290,127 $ 206,018
-------------------------
-------------------------
</TABLE>
Other significant accounting practices are as follows:
INVESTMENTS
Bonds, preferred stocks, common stocks, and short-term investments are stated at
values prescribed by the NAIC, as follows:
Bonds and short-term investments are reported at cost or amortized cost. The
discount or premium on bonds is amortized using the interest method. For
loan-backed bonds and structured securities, anticipated prepayments are
considered when determining the amortization of discount or premium. Prepayment
assumptions for loan-backed bonds and structured securities are obtained from
broker-dealer survey values or internal estimates. These assumptions are
consistent with the current interest rate and economic environment. The
retrospective adjustment method is used to value all such securities.
13
<PAGE>
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
Preferred stocks are reported at cost.
The Company's investment in its insurance subsidiary is reported at the equity
in the underlying statutory basis of National Integrity's net assets. Changes in
the admitted asset carrying amount of the investment are credited or charged
directly to unassigned surplus.
Short-term investments includes investments with maturities of less than one
year at the date of acquisition.
Mortgage loans and policy loans are reported at unpaid principal balances.
Realized capital gains and losses are determined using the specific
identification method.
BENEFITS
Life and annuity reserves are developed by actuarial methods and are determined
based on published tables using statutorily specified interest rates and
valuation methods that will provide, in the aggregate, reserves that are greater
than or equal to the minimum or guaranteed policy cash values or the amounts
required by the Ohio Department of Insurance. The Company waives deduction of
deferred fractional premiums upon the death of life and annuity policy insureds
and does not return any premium beyond the date of death. Surrender values on
policies do not exceed the corresponding benefit reserve. Policies issued
subject to multiple table substandard extra premiums are valued on the standard
reserve basis which recognizes the non-level incidence of the excess mortality
costs. Additional reserves are established when the results of cash flow testing
under various interest rate scenarios indicate the need for such reserves.
Tabular interest, tabular less actual reserve released, and tabular cost have
been determined by formula as prescribed by the NAIC.
REINSURANCE
Reinsurance premiums, benefits and expenses are accounted for on bases
consistent with those used in accounting for the original policies issued and
the terms of the reinsurance contracts. Premiums, benefits and expenses, and the
reserves for policy and contract liabilities are reported net, rather than
gross, of reinsured amounts.
14
<PAGE>
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
SEPARATE ACCOUNTS
Separate account assets and liabilities reported in the accompanying financial
statements represent funds that are separately administered, principally for
variable annuity contracts and institutional funding agreements. Separate
account assets are reported at fair value. Surrender charges collectible by the
general account in the event of variable annuity contract surrenders are
reported as a negative liability rather than an asset pursuant to prescribed
NAIC accounting practices. Investment income and interest credited on deposits
held in guaranteed separate accounts are included in the accompanying statements
of income. The Company receives administratives fees for managing the
non-guaranteed separate accounts and other fees for assuming mortality and
certain expense risks. Such fees are included in other revenues.
USE OF ESTIMATES
The preparation of financial statements in compliance with statutory accounting
practices requires management to make estimates and assumptions that affect
amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
presentation of the 1997 financial statements. These reclassifications had no
effect on previously reported net income or surplus.
2. PERMITTED STATUTORY ACCOUNTING PRACTICES
The Company's statutory basis financial statements are prepared in accordance
with accounting practices prescribed or permitted by the Ohio Department of
Insurance. "Prescribed" statutory accounting practices include state laws,
regulations, and general administrative rules, as well as a variety of
publications of the NAIC. "Permitted" statutory accounting practices encompass
all accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. The NAIC is in the process of codifying statutory
accounting practices ("Codification"). Codification will likely change, to some
extent, prescribed statutory accounting practices and may result in changes to
the accounting practices that the
15
<PAGE>
2. PERMITTED STATUTORY ACCOUNTING PRACTICES (CONTINUED)
Company uses to prepare its statutory basis financial statements. Codification
has been approved by the NAIC in March 1998, but it will require adoption by the
various states before it becomes the prescribed statutory basis of accounting
for insurance companies domesticated within those states. Accordingly, before
Codification becomes effective for the Company, Ohio must adopt Codification as
the prescribed basis of accounting on which domestic insurers must report their
statutory basis results to the Department of Insurance. At this time it is
unclear whether Ohio will adopt Codification. The Company is monitoring
developments related to codification and assessing the potential effects any
changes would have on the Company's statutory basis financial statements.
3. INVESTMENTS
The cost or amortized cost and the fair value of investments in bonds are
summarized as follows:
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
---------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
At December 31, 1997:
Mortgage-backed securities $ 1,606,968 $ - $ - $1,606,968
Corporate securities 1,132,531 13,329 7,533 1,138,327
Asset-backed securities 374,841 - - 374,841
U.S. Treasury securities and
obligations of U.S. government
agencies 276,801 714 7 277,508
Foreign governments 49,513 121 437 49,197
States and political subdivisions 4,005 160 - 4,165
---------------------------------------------------------
Total bonds $ 3,444,659 $14,324 $7,977 $3,451,006
---------------------------------------------------------
---------------------------------------------------------
</TABLE>
16
<PAGE>
3. INVESTMENTS (CONTINUED)
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
---------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
At December 31, 1996:
Mortgage-backed securities $ 1,182,448 $ - $ 170 $1,182,278
Corporate securities 746,732 5,315 19,741 732,306
Asset-backed securities 282,903 - - 282,903
U.S. Treasury securities and
obligations of U.S. government
agencies 226,928 778 1,343 226,363
Foreign governments 39,336 160 296 39,200
States and political subdivisions 4,045 121 - 4,166
---------------------------------------------------------
Total bonds $ 2,482,392 $6,374 $21,550 $2,467,216
---------------------------------------------------------
---------------------------------------------------------
</TABLE>
Fair values are based on published quotations of the Securities Valuation
Office of the NAIC. Fair values generally represent quoted market value
prices for securities traded in the public marketplace, or analytically
determined values using bid or closing prices for securities not traded in
the public marketplace. However, for certain investments for which the NAIC
does not provide a value, the Company uses the amortized cost amount as a
substitute for fair value in accordance with prescribed guidance. As of
December 31, 1997 and 1996, the fair value of investments in bonds includes
$2.9 billion and $1.9 billion, respectively, of bonds that were valued at
amortized cost.
17
<PAGE>
3. INVESTMENTS (CONTINUED)
A summary of the cost or amortized cost and fair value of the Company's
investments in bonds at December 31, 1997, by contractual maturity, is as
follows:
<TABLE>
<CAPTION>
COST OR
AMORTIZED
COST FAIR VALUE
-------------------------
(IN THOUSANDS)
<S> <C> <C>
Years to maturity:
One or less $ 3,455 $ 3,458
After one through five 115,951 116,123
After five through ten 283,999 282,881
After ten 1,059,445 1,066,735
Asset-backed securities 374,841 374,841
Mortgage-backed securities 1,606,968 1,606,968
-------------------------
Total $3,444,659 $3,451,006
-------------------------
-------------------------
</TABLE>
The expected maturities in the foregoing table may differ from the
contractual maturities because certain borrowers have the right to call or
prepay obligations with or without call or prepayment penalties and because
asset-backed and mortgage-backed securities (including floating-rate
securities) provide for periodic payments throughout their life.
Proceeds from the sales of investments in bonds during 1997 and 1996 were
$2.9 billion and $1.4 billion; gross gains of $34.9 million and $26.2
million, and gross losses of $26.9 million and $14.4 million were realized on
those sales, respectively.
At December 31, 1997 and 1996, bonds with an admitted asset value of
$7,664,000 and $7,693,000, respectively, were on deposit with state insurance
departments to satisfy regulatory requirements.
At December 31, 1997 and 1996, the fair value of future contracts, call and
put options and interest rate swaps held by the Company was, in its separate
accounts, $11.3 million and $3.9
18
<PAGE>
3. INVESTMENTS (CONTINUED)
million, respectively. These derivative financial instruments are used to
hedge specific market value risks associated with the Company's
equity-indexed annuity products and separate account seed money investments
and interest rate risks associated with certain institutional spread
deposits. The derivative financial instruments are not held for trading
purposes and are classified on the Company's balance sheet as separate
account assets. The derivative financial instruments hedge items carried at
fair value and are therefore marked to market with unrealized gains and
losses recognized through the separate account statements of operations. The
Company is exposed to credit-related losses in the event of nonperformance by
counter parties to the derivative financial instruments, but does not expect
any counter parties to fail to meet their obligations given their high credit
ratings.
Unrealized gains and losses on investment in subsidiary are reported directly
in surplus and do not affect operations. The gross unrealized gains and
losses on, and the cost and fair value of, the investment are summarized as
follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
At December 31, 1997:
Subsidiary $ 17,823 $ 36,205 $ - $ 54,028
------------------------------------------------------
------------------------------------------------------
At December 31, 1996:
Subsidiary $ 17,823 $ 30,449 $ - $ 48,272
------------------------------------------------------
------------------------------------------------------
</TABLE>
The Company's mortgage loan portfolio is primarily comprised of agricultural
loans. The Company has made no new investments in mortgage loans during 1997.
The maximum percentage of any one loan to the value of the security at the
time of the loan exclusive of and purchase money mortgages is 75%. Fire
insurance is required on all properties covered by mortgage loans. As of
December 31, 1997, the Company held no mortgages with interest more than one
year past due. During 1997, no interest rates of outstanding mortgage loans
were reduced. No amounts have been advanced by the Company.
19
<PAGE>
3. INVESTMENTS (CONTINUED)
Major categories of the Company's net investment income are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
-----------------------
(IN THOUSANDS)
<S> <C> <C>
Income:
Bonds $216,166 $158,724
Preferred stocks 6,042 3,626
Mortgage loans 5,619 3,703
Real estate 158 218
Policy loans 6,842 6,729
Cash and short-term investments 7,072 3,849
Other investment income 880 168
-----------------------
Total investment income 242,779 177,017
Investment expenses (3,265) (5,206)
-----------------------
Net investment income $239,514 $171,811
-----------------------
-----------------------
</TABLE>
4. REINSURANCE
Consistent with prudent business practices and the general practice of the
insurance industry, the Company reinsures risks under certain of its
insurance products with other insurance companies through reinsurance
agreements. Through these reinsurance agreements, substantially all mortality
risks associated with single premium endowment and variable annuity deposits
and substantially all risks associated with variable life business have been
reinsured with non-affiliated insurance companies. A contingent liability
exists with respect to insurance ceded which would become a liability should
the reinsurer be unable to meet the obligations assumed under these
reinsurance agreements.
20
<PAGE>
4. REINSURANCE (CONTINUED)
The effect of reinsurance on premiums, annuity considerations and
deposit-type funds is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
-------------------------
(IN THOUSANDS)
<S> <C> <C>
Direct premiums and amounts assessed
against policyholders $1,005,583 $241,442
Reinsurance assumed 1,217,681 521,067
Reinsurance ceded (18,528) (16,915)
-------------------------
Net premiums, annuity considerations and
deposit-type funds $2,204,736 $745,594
-------------------------
-------------------------
</TABLE>
In 1997 and 1996, the Company assumed $1.1 billion and $0.5 billion,
respectively, in GIC deposits through a 50% coinsurance agreement with General
American Life Insurance Company.
5. FEDERAL INCOME TAXES
The Company files a consolidated return with National Integrity. The method
of allocation between the companies is based on separate return calculations
after consolidated losses and credits.
Income before income taxes differs from taxable income principally due to
value of insurance in force, interest maintenance reserves, and differences
in policy and contract liabilities and investment income for tax and
financial reporting purposes.
The current year and prior year tax provisions were calculated including
consolidated net operating loss carryover benefits of $12.4 million and $14.2
million, respectively.
21
<PAGE>
6. SURPLUS
Dividends that ARM may receive from the Company in any year without prior
approval of the Ohio Insurance Director are limited by statute to the greater
of (i) 10% of the Company's statutory capital and surplus as of the preceding
December 31, and (ii) the Company's statutory net income for the preceding
year. The maximum dividend payments that may be made by the Company to ARM
during 1998 are $38.2 million.
Under New York insurance laws, National Integrity may pay dividends to
Integrity only out of its earnings and surplus, subject to at least thirty
days' prior notice to the New York Insurance Superintendent and no
disapproval from the Superintendent prior to the date of such dividend. The
Superintendent may disapprove a proposed dividend if the Superintendent finds
that the financial condition of National Integrity does not warrant such
distribution.
The NAIC's Risk-Based Capital ("RBC") requirements attempt to evaluate the
adequacy of a life insurance company's adjusted statutory capital and surplus
in relation to investment, insurance and other business risks. The RBC
formula is used by the states as an early warning tool to identify possible
under-capitalized companies for the purpose of initiating regulatory action
and is not designed to be a basis for ranking the financial strength of
insurance companies. In addition, the formula defines a new minimum capital
standard which supplements the previous system of low fixed minimum capital
and surplus requirements. The RBC requirements provide for four different
levels of regulatory attention depending on the ratio of the company's
adjusted capital and surplus to its RBC. As of December 31, 1997 and 1996,
the adjusted capital and surplus of the Company is substantially in excess of
the minimum level of RBC that would require regulatory response.
22
<PAGE>
7. ANNUITY RESERVES
At December 31, 1997 and 1996, the Company's general and separate account
annuity reserves and deposit fund liabilities that are subject to
discretionary withdrawal (with adjustment), subject to discretionary
withdrawal without adjustment, and not subject to discretionary withdrawal
provisions are summarized as follows:
<TABLE>
<CAPTION>
AMOUNT PERCENT
-------------------------
(IN THOUSANDS)
<S> <C> <C>
At December 31, 1997:
Subject to discretionary withdrawal (with adjustment):
With market value adjustment $ 348,451 7.0%
At book value less surrender charge of 5% or more 235,360 4.7
At market value 711,105 14.3
-------------------------
Total with adjustment or at market value 1,294,916 26.0
Subject to discretionary withdrawal (without adjustment)
at book value with minimal or no charge or adjustment 3,095,701 62.1
Not subject to discretionary withdrawal 594,781 11.9
-------------------------
Total annuity reserves and deposit fund liabilities (before
reinsurance) 4,985,398 100.0%
Less reinsurance ceded (34,721) ----------
---------- ----------
Net annuity reserves and deposit fund liabilities $4,950,677
----------
----------
At December 31, 1996:
Subject to discretionary withdrawal (with adjustment):
With market value adjustment $ 121,549 4.0%
At book value less surrender charge of 5% or more 263,726 8.7
At market value 543,906 18.1
-------------------------
Total with adjustment or at market value 929,181 30.8
Subject to discretionary withdrawal (without adjustment)
at book value with minimal or no charge or adjustment 1,520,259 50.5
Not subject to discretionary withdrawal 561,616 18.7
-------------------------
Total annuity reserves and deposit fund liabilities (before
reinsurance) 3,011,056 100.0%
Less reinsurance ceded (44,653) ----------
---------- ----------
Net annuity reserves and deposit fund liabilities $2,966,403
----------
----------
</TABLE>
23
<PAGE>
8. SEPARATE ACCOUNTS
Separate accounts assets and liabilities represent funds segregated for the
benefit of variable annuity, certain fixed annuity and variable life
policyholders who generally bear the investment risk (mutual fund options),
or for certain policyholders who are guaranteed a fixed rate of return
(guaranteed rate options). In addition, the Company has begun marketing
institutional products (fixed rate guaranteed investment contracts and
funding agreements) through its separate accounts. Assets held in separate
accounts are carried at estimated fair values. Information regarding the
separate accounts of the Company as of and for the year ended December 31,
1997 is as follows:
<TABLE>
<CAPTION>
SEPARATE ACCOUNTS WITH
GUARANTEES
------------------------
NONINDEXED
GUARANTEED NONGUARANTEED
INDEXED MORE THAN 4% SEPARATE ACCOUNTS TOTAL
-----------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Premiums, deposits and other
considerations $521,179 $231,429 $ 121,977 $ 874,585
-----------------------------------------------------------
-----------------------------------------------------------
Reserves for separate accounts
with assets at fair value $546,379 $373,303 $ 742,203 $1,661,885
-----------------------------------------------------------
-----------------------------------------------------------
Reserves for separate accounts
by withdrawal characteristics:
Subject to discretionary withdrawal
(with adjustment):
With market adjustment $ - $343,032 $ - $ 343,032
At book value without
market value adjustment
and with current surrender
charge of 5% 5,420 30,271 - 35,691
At market value - - 742,203 742,203
-----------------------------------------------------------
Total with adjustment or
at market value 5,420 373,303 742,203 1,120,926
Not subject to discretionary
withdrawal 540,959 - - 540,959
-----------------------------------------------------------
Total separate accounts reserves $546,379 $373,303 $ 742,203 $1,661,885
-----------------------------------------------------------
-----------------------------------------------------------
</TABLE>
24
<PAGE>
8. SEPARATE ACCOUNTS (CONTINUED)
A reconciliation of the amounts transferred to and from the separate accounts
for the years ended December 31, 1997 and 1996 is presented below:
<TABLE>
<CAPTION>
1997 1996
-----------------------
(IN THOUSANDS)
<S> <C> <C>
Transfers as reported in the Summary of Operations
of the Separate Accounts Statement:
Transfers to separate accounts $874,585 $200,092
Transfers from separate accounts (99,876) (71,356)
-----------------------
Net transfers to separate accounts 774,709 128,736
Reconciling adjustments:
Mortality and expense charges reported as other revenues 8,838 6,977
Policy deductions and other expense reported as
other revenues 1,827 1,857
-----------------------
Transfers as reported in the Summary of Operations
of the Life, Accident and Health Annual Statement $785,374 $137,570
-----------------------
-----------------------
</TABLE>
9. FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures
About Fair Value of Financial Instruments," requires disclosure of fair value
information about all financial instruments, including insurance liabilities
classified as investment contracts, unless specifically exempted. The fair
value of a financial instrument is the amount at which the instrument could
be exchanged in a current transaction between willing parties, other than in
a forced or liquidation sale. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. Accordingly, the aggregate fair value amounts presented do not
necessarily represent the underlying value of such instruments. For financial
instruments not separately disclosed below, the carrying amount is a
reasonable estimate of fair value.
25
<PAGE>
9. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
-------------------------------------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Bonds $3,444,659 $3,643,009 $2,482,392 $2,552,022
Preferred stocks 58,369 59,964 42,234 43,550
Mortgage loans 13,186 13,186 32,946 32,946
Liabilities:
Life and annuity reserves for
investment-type contracts $3,320,869 $3,379,388 $2,279,832 $2,297,739
Separate accounts annuity reserves 1,630,787 1,607,081 687,292 686,518
</TABLE>
BONDS AND PREFERRED STOCKS
Fair values for bonds and preferred stocks are based on quoted market prices
where available. For bonds and preferred stocks for which a quoted market
price is not available, fair values are estimated using internally calculated
estimate or quoted market price of comparable investments.
MORTGAGE LOANS
The carrying amount of mortgage loans approximates their fair value.
LIFE AND ANNUITY RESERVES AND DEPOSIT FUND LIABILITIES
The fair value of single premium immediate annuity reserves are based on
discounted cash flow calculations using a market yield rate for assets with
similar durations. The fair value amounts of deposit fund liabilities and the
remaining annuity reserves are primarily based on the cash surrender values
of the underlying contracts.
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9. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
SEPARATE ACCOUNTS ANNUITY RESERVES
The fair value of separate accounts annuity reserves for investment-type
products equals the cash surrender values.
10. RELATED PARTY TRANSACTIONS
Effective January 1, 1994, the Company entered into an Administrative
Services Agreement with ARM. ARM performs certain administrative and special
services for the Company to assist with its business operations. The services
include policyholder services; accounting, tax and auditing; underwriting;
marketing and product development; functional support services; payroll
functions; personnel functions; administrative support services; and
investment functions. During 1997 and 1996, the Company was charged $19.3
million and $13.8 million, respectively, for these services in accordance
with the requirements of applicable insurance law and regulations.
11. YEAR 2000 (UNAUDITED)
The Company is currently evaluating on an ongoing basis, its computer systems
and the systems of other companies on which the Company's operations rely to
determine if they will function properly with respect to dates in the year
2000 and beyond. These activities are designed to ensure that there is no
adverse effect on the Company's core business operations. While the Company
believes its planning efforts are adequate to address its Year 2000 concerns,
there can be no guarantee that the systems of other companies on which the
Company's operations rely will be converted on a timely basis and will not
have a material effect on the Company. The cost of the Company's Year 2000
initiatives is not expected to be material to the Company's results of
operations or financial condition.
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