<PAGE>
[NATIONAL 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 National Integrity Life Insurance Company
("Registrant")
Rule 497(e) Filing of Financial Statements
Registration No. 33-41384
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
National Integrity Life Insurance Company
DECEMBER 31, 1997
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
Separate Account VUL
of
National 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 National Integrity Life Insurance Company
We have audited the accompanying statement of assets and liabilities of Separate
Account VUL of National 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 National 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>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1997
<TABLE>
<CAPTION>
COMMON MONEY AGGRESSIVE HIGH
STOCK MARKET BALANCED STOCK 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 $132,396 in the aggregate) $ 5,627 $ - $ 6,784 $117,881 $ 1,266 $ 588 $132,146
LIABILITIES
Payable to the general account
of National Integrity 10 - 5 205 - 1 221
-------------------------------------------------------------------------------------
NET ASSETS $ 5,617 $ - $ 6,779 $117,676 $ 1,266 $ 587 $131,925
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
Unit value $ 328.34 $ - $ 218.03 $373.41 $ 282.51 $ 249.91
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Units outstanding 17.108 - 31.093 315.139 4.482 2.350
--------------------------------------------------------------------------
--------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
2
<PAGE>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Operations
Year ended December 31, 1997
<TABLE>
<CAPTION>
COMMON MONEY AGGRESSIVE HIGH
STOCK MARKET BALANCED STOCK 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 $ 453 $ - $ 518 $ 10,037 $ 160 $ 105 $ 11,273
EXPENSES
Mortality and expense risk and administrative
charges 31 - 34 667 7 3 742
---------------------------------------------------------------------------
NET INVESTMENT INCOME 422 - 484 9,370 153 102 10,531
REALIZED AND UNREALIZED GAIN ON
INVESTMENTS
Net realized gain on sales of investments 194 - 36 520 15 - 765
Net unrealized appreciation (depreciation)
of investments:
Beginning of period 688 - (86) (2,543) 27 43 (1,871)
End of period 1,376 - 62 (1,802) 58 56 (250)
---------------------------------------------------------------------------
Change in net unrealized appreciation
during the period 688 - 148 741 31 13 1,621
---------------------------------------------------------------------------
NET REALIZED AND UNREALIZED GAIN ON
INVESTMENTS 882 - 184 1,261 46 13 2,386
---------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS $ 1,304 $ - $ 668 $ 10,631 $ 199 $ 115 $ 12,917
---------------------------------------------------------------------------
---------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year ended December 31, 1997
<TABLE>
<CAPTION>
COMMON MONEY AGGRESSIVE HIGH
STOCK MARKET BALANCED STOCK 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 $ 422 $ - $ 484 $ 9,370 $ 153 $ 102 $ 10,531
Net realized gain on sales of investments 194 - 36 520 15 - 765
Change in net unrealized appreciation/depreciation
during the period 688 - 148 741 31 13 1,621
--------------------------------------------------------------------------
Net increase in net assets resulting from operations 1,304 - 668 10,631 199 115 12,917
INCREASE (DECREASE) IN NET ASSETS FROM POLICY
RELATED TRANSACTIONS
Contributions from policyholders - - 2,002 10,502 - - 12,504
Policy terminations and benefits (556) - (571) (1,957) (149) (64) (3,297)
Net increase (decrease) in net assets from
policy related transactions (556) - 1,431 8,545 (149) (64) 9,207
--------------------------------------------------------------------------
INCREASE IN NET ASSETS 748 - 2,099 19,176 50 51 22,124
Net assets, beginning of period 4,869 - 4,680 98,500 1,216 536 109,801
--------------------------------------------------------------------------
NET ASSETS, END OF PERIOD $ 5,617 $ - $ 6,779 $117,676 $ 1,266 $ 587 $131,925
--------------------------------------------------------------------------
--------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions - - 9.465 29.652 - -
Terminations and benefits (1.937) - (2.906) (5.055) (0.587) (0.027)
----------------------------------------------------------------
Net increase (decrease) in units (1.937) - 6.559 24.597 (0.587) (0.027)
----------------------------------------------------------------
----------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year ended December 31, 1996
<TABLE>
<CAPTION>
COMMON MONEY AGGRESSIVE HIGH
STOCK MARKET BALANCED STOCK 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 $ 742 $ - $ 651 $ 24,476 $ 220 $ 42 $ 26,131
Net realized gain on sales of investments 123 - 5 465 12 2 607
Change in net unrealized appreciation/depreciation
during the period 144 - (103) (9,573) 29 22 (9,481)
--------------------------------------------------------------------------
Net increase in net assets resulting from operations 1,009 - 553 15,368 261 66 17,257
INCREASE (DECREASE) in net assets from policy
RELATED TRANSACTIONS
Contributions from policyholders 533 - 516 14,670 - - 15,719
Policy terminations and benefits (616) - (639) (1,993) (182) (7) (3,437)
--------------------------------------------------------------------------
Net increase (decrease) in net assets from
policy related transactions (83) - (123) 12,677 (182) (7) 12,282
--------------------------------------------------------------------------
INCREASE IN NET ASSETS 926 - 430 28,045 79 59 29,539
Net assets, beginning of period 3,943 - 4,250 70,455 1,137 477 80,262
--------------------------------------------------------------------------
NET ASSETS, END OF PERIOD $ 4,869 $ - $ 4,680 $ 98,500 $ 1,216 $ 536 $109,801
--------------------------------------------------------------------------
--------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions 2.347 - 2.861 43.564 - -
Terminations and benefits (2.355) - (3.059) (5.449) (0.720) (0.034)
----------------------------------------------------------------
Net increase (decrease) in units (0.008) - (0.198) 38.115 (0.720) (0.034)
----------------------------------------------------------------
----------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1997
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF OPERATIONS
National Integrity Life Insurance Company ("National Integrity") established
Separate Account VUL (the "Separate Account") on February 26, 1986 under the
insurance laws of the state of New York 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 National 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 National Integrity.
National Integrity is a wholly owned subsidiary of Integrity Life Insurance
Company and their ultimate parent is 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 National 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
National 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 National 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 National 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
National 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
National 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, National 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, National Integrity pays no tax on investment income and capital
gains reflected in variable life insurance policy reserves. However, National
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
National 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 $ 453 $ 577 $ 4,251
Money Market - - -
Balanced 2,546 626 6,722
Aggressive Stock 20,509 2,389 119,683
High Yield 162 158 1,208
Global 49 10 532
--------------
$ 132,396
--------------
--------------
</TABLE>
3. EXPENSES
National 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.
National 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)
National Integrity Life
Insurance Company
YEARS ENDED DECEMBER 31, 1997 AND 1996
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
National Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1997 and 1996
CONTENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . 1
Audited Financial Statements
Balance Sheets (Statutory Basis) . . . . . . . . . . . . . . . . . . . . . 2
Statements of Income (Statutory Basis) . . . . . . . . . . . . . . . . . . 4
Statements of Changes in Capital and Surplus (Statutory Basis) . . . . . . 5
Statements of Cash Flows (Statutory Basis) . . . . . . . . . . . . . . . . 6
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . 8
<PAGE>
Report of Independent Auditors
Board of Directors
National Integrity Life Insurance Company
We have audited the accompanying statutory basis balance sheets of National
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 New York Insurance Department, 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 National 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.
However, in our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of National 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 New York Insurance
Department.
Louisville, Kentucky
February 10, 1998
1
<PAGE>
National 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 $ 414,907 $ 451,439
Preferred stocks 21,792 50,715
Mortgage loans 3,242 3,929
Policy loans 26,396 24,981
Cash and short-term investments 12,078 14,570
Receivable for securities 1,941 4,522
Other invested assets 3,794 36
--------------------------------
Total cash and invested assets 484,150 550,192
Separate account assets 617,327 370,988
Accrued investment income 5,735 6,513
Federal income tax recoverable - 438
Other admitted assets 2,143 1,794
--------------------------------
Total admitted assets $ 1,109,355 $ 929,925
--------------------------------
--------------------------------
</TABLE>
2
<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 $ 446,610 $ 513,639
Unpaid claims 50 124
Deposits on policies to be issued 564 645
---------------------------------
Total policy and contract liabilities 447,224 514,408
Separate account liabilities 617,327 370,988
Accounts payable and accrued expenses 151 213
Transfers to separate accounts due or accrued, net (24,362) (21,247)
Reinsurance balances payable 511 589
Federal income taxes 5,645 -
Asset valuation reserve 1,570 1,773
Interest maintenance reserve 7,240 8,914
Other liabilities 32 6,016
---------------------------------
Total liabilities 1,055,338 881,654
Capital and surplus:
Common stock, $10 par value, 200,000 shares
authorized, issued, and outstanding 2,000 2,000
Paid-in surplus 59,244 59,244
Special surplus funds 750 750
Unassigned surplus (deficit) (7,977) (13,723)
---------------------------------
Total capital and surplus 54,017 48,271
---------------------------------
Total liabilities and capital and surplus $ 1,109,355 $ 929,925
---------------------------------
---------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
National 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 $ 11,533 $ 8,640
Deposit-type funds 211,637 352,899
Net investment income 42,464 53,553
Amortization of the interest maintenance reserve 1,359 1,001
Other revenues 5,961 5,653
-------------------------------
Total premiums and other revenues 272,954 421,746
Benefits paid or provided:
Death benefits 1,268 921
Annuity benefits 12,687 19,445
Surrender benefits 123,520 101,241
Payments on supplementary contracts 1,648 1,879
Increase (decrease) in insurance and annuity reserves (66,954) 192,985
Other benefits 119 7,818
-------------------------------
Total benefits paid or provided 72,288 324,289
Insurance and other expenses:
Commissions 10,088 5,817
General expenses 11,146 8,051
Taxes, licenses and fees 794 349
Net transfers to separate accounts 163,896 69,158
Other expenses 3,542 3,110
-------------------------------
Total insurance and other expenses 189,466 86,485
-------------------------------
Gain from operations before federal income taxes
and net realized capital losses 11,200 10,972
Federal income tax expense (benefit) 3,621 (444)
-------------------------------
Gain from operations before net realized capital losses 7,579 11,416
Net realized capital losses, excluding realized
capital gains (losses) net of tax transferred to the
interest maintenance reserve (1997-($314); 1996-$2,923) (2,036) (2,500)
-------------------------------
Net income $ 5,543 $ 8,916
-------------------------------
-------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
National Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years Ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
SPECIAL UNASSIGNED TOTAL
COMMON PAID-IN SURPLUS SURPLUS CAPITAL AND
STOCK SURPLUS FUNDS (DEFICIT) SURPLUS
-------------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1996 $ 2,000 $ 59,244 $ 750 $ (22,855) $ 39,139
Net income 8,916 8,916
Decrease in nonadmitted assets 19 19
Decrease in asset valuation reserve 197 197
-------------------------------------------------------------------------
Balance, December 31, 1996 2,000 59,244 750 (13,723) 48,271
Net income 5,543 5,543
Decrease in asset valuation reserve 203 203
-------------------------------------------------------------------------
Balance, December 31, 1997 $ 2,000 $ 59,244 $ 750 $ (7,977) $ 54,017
-------------------------------------------------------------------------
-------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
National 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 $ 223,170 $ 361,539
Net investment income received 42,944 53,492
Commission and expense allowances received on
reinsurance ceded 8 644
Benefits paid (139,316) (125,238)
Insurance expenses paid (22,090) (14,170)
Other income received net of other expenses paid 2,335 5,009
Net transfers to separate accounts (167,010) (74,076)
Federal income taxes (4,479) -
---------------------------------
Net cash provided by (used in) operations (64,438) 207,200
<CAPTION>
<S> <C> <C>
INVESTMENT ACTIVITIES:
Proceeds from sales, maturities, or repayments of investments:
Bonds 368,167 455,716
Preferred stocks 55,948 19,067
Mortgage loans 687 1,389
Other invested assets - 8,826
Miscellaneous proceeds 4,254 -
---------------------------------
Total investment proceeds 429,056 484,998
Benefits received (taxes paid) on capital gains 6,921 (1,212)
---------------------------------
Net proceeds from sales, maturities, or repayments
of investments 435,977 483,786
<CAPTION>
<S> <C> <C>
Cost of investments acquired:
Bonds 337,887 626,879
Preferred stocks 26,621 55,045
Other invested assets 3,794 -
Miscellaneous applications 405 36
---------------------------------
Total cost of investments acquired 368,707 681,960
Net increase in policy loans and premium notes 1,415 2,375
---------------------------------
Net cash provided by (used in) investment activities 65,855 (200,549)
</TABLE>
6
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
------------------------
(IN THOUSANDS)
<S> <C> <C>
FINANCING AND MISCELLANEOUS ACTIVITIES:
Other cash provided:
Other sources 2,588 3,826
------------------------
Total other cash provided 2,588 3,826
------------------------
Other cash applied:
Other applications, net 6,497 16,175
------------------------
Total other cash applied 6,497 16,175
------------------------
Net cash used in financing and miscellaneous activities (3,909) (12,349)
------------------------
Net decrease in cash and short-term investments (2,492) (5,698)
Cash and short-term investments at beginning of year 14,570 20,268
------------------------
Cash and short-term investments at end of year $ 12,078 $ 14,570
------------------------
------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
7
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
December 31, 1997
1. ORGANIZATION AND ACCOUNTING POLICIES
ORGANIZATION
National Integrity Life Insurance Company ("National Integrity" or the
"Company") is a wholly owned subsidiary of Integrity Life Insurance Company
("Integrity") which is an indirect wholly owned subsidiary of ARM Financial
Group, Inc. ("ARM"). ARM acquired Integrity and the Company from The National
Mutual Life Association of Australasia Limited ("National Mutual"). The Company
is domiciled in the state of New York. The Company, currently licensed in eight
states and the District of Columbia, specializes in the growing asset
accumulation business with particular emphasis on retirement savings and
investment products.
BASIS OF PRESENTATION
The accompanying financial statements of the Company have been prepared in
conformity with accounting practices prescribed or permitted by the New York
Insurance Department. 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 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
8
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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.
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.
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 estimated expected
experience or actual account balances as would be required under GAAP.
9
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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.
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 $ 5,543 $ 8,916
Deferred policy acquisition costs, net of amortization 10,157 5,187
Adjustments to customer deposits (5,781) (441)
Adjustments to invested asset carrying values
at acquisition date (38) (160)
Amortization of value of insurance in force (870) (1,470)
Amortization of interest maintenance reserve (1,359) (1,001)
Adjustments for realized investment gains 1,511 852
Adjustments for federal income tax expense (3,320) (2,185)
Other 166 (200)
------------------------
Net income, GAAP basis $ 6,009 $ 9,498
------------------------
------------------------
</TABLE>
10
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
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 $ 54,017 $ 48,271
Adjustments to customer deposits (33,014) (27,233)
Adjustments to invested asset carrying values at
acquisition date (3,724) (5,197)
Asset valuation reserve and interest maintenance reserve 17,796 19,369
Value of insurance in force 13,043 13,913
Deferred policy acquisition costs 33,885 23,728
Net unrealized gains on available-for-sale securities 5,849 1,416
Other (5,793) (2,650)
------------------------
Shareholder's equity, GAAP basis $ 82,059 $ 71,617
------------------------
------------------------
</TABLE>
Other significant accounting practices are as follows:
INVESTMENTS
Bonds, preferred 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.
11
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
Preferred stocks are reported at cost.
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 New York Insurance Department. 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.
12
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
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. Separate account assets are reported at fair value.
Surrender charges collectible by the general account in the event of variable
policy surrenders are reported as a negative liability rather than an asset
pursuant to prescribed NAIC accounting practices. Investments income and
interest credited on deposits held in guaranteed separate accounts are included
in the accompanying statements of income. The Company receives administrative
fees for managing the nonguaranteed 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 these 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 New York Insurance
Department. "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
13
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
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, New York must adopt Codification
as the prescribed basis of accounting on which domestic insurers must report
their statutory basis results to the Insurance Department. At this time it is
unclear whether New York 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 $ 193,688 $ - $ - $ 193,688
Corporate securities 159,208 4,074 34 163,248
Asset-backed securities 27,370 - - 27,370
U.S. Treasury securities and
obligations of U.S. government
agencies 24,361 1,083 2 25,442
Foreign governments 10,280 - 437 9,843
-------------------------------------------------------
Total bonds $ 414,907 $ 5,157 $ 473 $ 419,591
-------------------------------------------------------
-------------------------------------------------------
<CAPTION>
<S> <C> <C> <C> <C>
At December 31, 1996:
Mortgage-backed securities $ 244,376 $ - $ - $ 244,376
Corporate securities 168,146 775 7,178 161,743
Asset-backed securities 10,311 - - 10,311
U.S. Treasury securities and
obligations of U.S. government
agencies 16,243 415 110 16,548
Foreign governments 12,363 643 - 13,006
-------------------------------------------------------
Total bonds $ 451,439 $ 1,833 $ 7,288 $ 445,984
-------------------------------------------------------
-------------------------------------------------------
</TABLE>
14
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. INVESTMENTS (CONTINUED)
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 $306.8 million and $312.7 million,
respectively, of bonds that were valued at amortized cost.
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 $ 1,304 $ 1,314
After one through five 13,493 13,513
After five through ten 39,042 39,192
After ten 140,010 144,514
Asset-backed securities 27,370 27,370
Mortgage-backed securities 193,688 193,688
------------------------------
Total $ 414,907 $ 419,591
------------------------------
------------------------------
</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 $375.5
million and $755.7 million; gross gains of $8.6 million and $7.9 million, and
gross losses of $8.3 million and $4.5 million were realized on those sales,
respectively.
15
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. INVESTMENTS (CONTINUED)
At December 31, 1997 and 1996, bonds with an admitted asset value of $1,235,000
and $1,234,000, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
The Company's mortgage loan portfolio is primarily comprised of agricultural
loans. The Company has made no new investments in mortgage loans since 1988. The
maximum percentage of any one loan to the value of the security at the time of
the loan exclusive of any purchase money mortgages was 75%. Fire insurance is
required on all properties covered by mortgage loans. As of year-end, 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.
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 $ 34,854 $ 47,487
Preferred stocks 4,205 4,150
Mortgage loans 291 610
Policy loans 2,072 1,886
Cash and short-term investments 1,506 1,277
Other (3) 3
---------------------------
Total investment income 42,925 55,413
Investment expenses (461) (1,860)
---------------------------
Net investment income $ 42,464 $ 53,553
---------------------------
---------------------------
</TABLE>
16
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
4. REINSURANCE
Consistent with prudent business practices and the general practice of the
insurance industry, National Integrity 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. Reinsurance is not significant to the Company's premiums, benefits
or policy and contract liabilities.
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 $ 210,910 $ 115,547
Reinsurance assumed 12,770 246,571
Reinsurance ceded (510) (580)
----------------------------
Net premiums, annuity considerations and
deposit-type funds $ 223,170 $ 361,538
----------------------------
----------------------------
</TABLE>
The Company sold guaranteed investment contract ("GIC") deposits totaling $358.3
million to Integrity as of June 30, 1996.
5. FEDERAL INCOME TAXES
The Company files a consolidated return with 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.
17
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
6. SURPLUS
The ability of the Company to pay dividends is limited by state insurance laws.
Under New York insurance laws, the Company may pay dividends 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 the Company
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.
18
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
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 $ 219,464 22.9%
At book value less surrender charge of 5% or more 5,760 0.6
At market value 372,550 38.9
-------------------------
Total with adjustment or at market value 597,774 62.4
Subject to discretionary withdrawal (without adjustment)
at book value with minimal or no charge or adjustment 299,314 31.2
Not subject to discretionary withdrawal 61,448 6.4
-------------------------
Total annuity reserves and deposit fund liabilities (before
reinsurance) 958,536 100.0%
---------
---------
Less reinsurance ceded -
----------
Net annuity reserves and deposit fund liabilities $ 958,536
----------
----------
<CAPTION>
<S> <C> <C>
At December 31, 1996:
Subject to discretionary withdrawal (with adjustment):
With market value adjustment $ 89,668 11.5%
At book value less surrender charge of 5% or more 23,208 3.0
At market value 257,419 33.0
-------------------------
Total with adjustment or at market value 370,295 47.5
Subject to discretionary withdrawal (without adjustment)
at book value with minimal or no charge or adjustment 347,883 44.7
Not subject to discretionary withdrawal 60,995 7.8
-------------------------
Total annuity reserves and deposit fund liabilities (before
reinsurance) 779,173 100.0%
---------
---------
Less reinsurance ceded -
----------
Net annuity reserves and deposit fund liabilities $ 779,173
----------
----------
</TABLE>
19
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. SEPARATE ACCOUNTS
Separate accounts assets and liabilities represent funds segregated for the
benefit of variable 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). 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>
*NONINDEXED NONGUARANTEED
GUARANTEED SEPARATE
MORE THAN 4% ACCOUNTS TOTAL
--------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Premiums, deposits and other considerations $ 122,664 $ 89,078 $ 211,742
--------------------------------------------------
--------------------------------------------------
Reserves for separate accounts with assets
at fair value $ 219,469 $ 372,669 $ 592,138
--------------------------------------------------
--------------------------------------------------
Reserves for separate accounts by
withdrawal characteristics:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $ 219,464 $ - $ 219,464
At book value without market value
adjustment and with current
surrender charge of 5% or more 5 - 5
At market value - 372,669 372,669
--------------------------------------------------
Total with adjustment or at market value 219,469 372,669 592,138
Not subject to discretionary withdrawal - - -
--------------------------------------------------
Total separate accounts reserves $ 219,469 $ 372,669 $ 592,138
--------------------------------------------------
--------------------------------------------------
</TABLE>
* Separate accounts with guarantees.
20
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
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 $ 211,743 $ 102,901
Transfers from separate accounts (52,365) (37,150)
-------------------------
Net transfers to separate accounts 159,378 65,751
Reconciling adjustments:
Mortality and expense charges reported as other revenues 4,417 3,194
Other revenues 101 213
-------------------------
Transfers as reported in the Summary of Operations
of the Life, Accident and Health Annual Statement $ 163,896 $ 69,158
-------------------------
-------------------------
</TABLE>
9. FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About
Fair Value of Financial Instruments," requires disclosures 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.
21
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. FAIR VALUES 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 $ 414,907 $ 424,642 $ 451,439 $ 457,875
Preferred stocks 21,792 22,252 50,715 50,454
Mortgage loans 3,242 3,242 3,929 3,929
Liabilities:
Life and annuity reserves for
investment-type contracts $ 367,124 $ 367,374 $ 432,013 $ 426,516
Separate accounts annuity reserves 592,018 576,877 347,503 347,072
</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 ON REAL ESTATE
The carrying amount of mortgage loans approximates their fair value.
LIFE AND ANNUITY RESERVES FOR INVESTMENT-TYPE CONTRACTS
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 of deposit fund liabilities and the remaining
annuity reserves are based on the cash surrender value of the underlying
contracts.
SEPARATE ACCOUNTS ANNUITY RESERVES
The fair value of separate accounts annuity reserves for investment-type
products equals the cash surrender values.
22
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
10. RELATED PARTY TRANSACTIONS
Effective January 1, 1994, the Company entered into an Administrative Services
Agreement and an Investment Advisory Agreement with ARM. Under these agreements,
ARM performs certain administrative investment advisory 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 $5.9 million and $6.1 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.
23
