<PAGE>
Financial Statements
Separate Account VUL
of
National Integrity Life Insurance Company
DECEMBER 31, 1998
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Financial Statements
December 31, 1998
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, 1998, the related statement of
operations for the year then ended and statements of changes in net assets for
the years ended December 31, 1998 and 1997. 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, 1998, 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, 1998, the results of their operations for the year then
ended, and changes in their net assets for the years ended December 31, 1998 and
1997, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Louisville, Kentucky
April 9, 1999
1
<PAGE>
<TABLE>
<CAPTION>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1998
COMMON MONEY BALANCED AGGRESSIVE HIGH YIELD GLOBAL TOTAL
STOCK MARKET DIVISION STOCK DIVISION DIVISION
DIVISION DIVISION DIVISION
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Investments in The Hudson River Trust
at value (aggregate cost of $149,558) $ 6,587 $ - $ 9,208 $124,897 $ 1,071 $ 703 $142,466
LIABILITIES
Payable to the general account
of National Integrity 2 - - 142 - - 144
---------------------------------------------------------------------------------
NET ASSETS $ 6,585 $ - $ 9,208 $124,755 $ 1,071 $ 703 $142,322
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Unit value $ 422.28 $ - $ 255.97 $ 372.23 $ 266.35 $ 302.56
----------------------------------------------------------------------
----------------------------------------------------------------------
Units outstanding 15.593 - 35.973 335.156 4.022 2.323
----------------------------------------------------------------------
----------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
2
<PAGE>
<TABLE>
<CAPTION>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1998
COMMON MONEY BALANCED AGGRESSIVE HIGH YIELD GLOBAL TOTAL
STOCK MARKET DIVISION STOCK DIVISION DIVISION
DIVISION DIVISION DIVISION
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Reinvested dividends from The Hudson
River Trust $ 836 $ - $ 977 $ 6,539 $ 142 $ 52 $ 8,546
EXPENSES
Mortality and expense risk and
administrative charges 30 - 39 612 6 3 690
-------------------------------------------------------------------------------
NET INVESTMENT INCOME 806 - 938 5,927 136 49 7,856
REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS
Net realized gain on sales of investments 252 - 50 464 9 1 776
Net unrealized appreciation (depreciation)
of investments:
Beginning of period 1,376 - 62 (1,802) 58 56 (250)
End of period 1,821 - 253 (9,087) (152) 73 (7,092)
-------------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period 445 - 191 (7,285) (210) 17 (6,842)
-------------------------------------------------------------------------------
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS 697 - 241 (6,821) (201) 18 (6,066)
-------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS $ 1,503 $ - $ 1,179 $ (894) $ (65) $ 67 $ 1,790
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
<TABLE>
<CAPTION>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1998
COMMON MONEY BALANCED AGGRESSIVE HIGH GLOBAL TOTAL
STOCK MARKET DIVISION STOCK YIELD DIVISION
DIVISION DIVISION DIVISION DIVISION
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
FROM OPERATIONS
Net investment income $ 806 $ - $ 938 $ 5,927 $ 136 $ 49 $ 7,856
Net realized gain on sales of 252 - 50 464 9 1 776
investments
Change in net unrealized appreciation/
depreciation during the period 445 - 191 (7,285) (210) 17 (6,842)
-------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting
from operations 1,503 - 1,179 (894) (65) 67 1,790
INCREASE (DECREASE) IN NET ASSETS
FROM POLICY RELATED TRANSACTIONS
Contributions from policyholders - - 2,002 9,652 - - 11,654
Policy terminations and benefits (535) - (752) (1,679) (130) 49 (3,047)
-------------------------------------------------------------------------------
Net increase (decrease) in net assets from
policy related transactions (535) - 1,250 7,973 (130) 49 8,607
-------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS 968 - 2,429 7,079 (195) 116 10,397
Net assets, beginning of period 5,617 - 6,779 117,676 1,266 587 131,925
-------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD $ 6,585 $ - $ 9,208 $124,755 $ 1,071 $ 703 $142,322
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
UNIT TRANSACTIONS
Contributions - - 8.150 25.460 - -
Terminations and benefits (1.515) - (3.270) (5.443) (0.460) (0.027)
--------------------------------------------------------------------
Net increase (decrease) in units (1.515) - 4.880 20.017 (0.460) (0.027)
--------------------------------------------------------------------
--------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
<TABLE>
<CAPTION>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1997
COMMON MONEY BALANCED AGGRESSIVE HIGH GLOBAL TOTAL
STOCK MARKET DIVISION STOCK YIELD DIVISION
DIVISION DIVISION DIVISION DIVISION
-----------------------------------------------------------------------------------
<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.
5
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1998
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, 1998 and the cost of shares held
at December 31, 1998 for each division were as follows:
<TABLE>
<CAPTION>
DIVISION PURCHASES SALES COST
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Common Stock $ 842 $ 579 $ 4,766
Money Market - - -
Balanced 2,989 806 8,955
Aggressive Stock 16,541 2,703 133,984
High Yield 144 138 1,223
Global 108 11 630
----------
$ 149,558
----------
----------
</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>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
4. YEAR 2000 (UNAUDITED)
ARM has undertaken a Year 2000 project that includes all of its subsidiaries,
including the Company. ARM's Year 2000 compliance project, as it relates to the
Company, is provided for under the Investment Services Agreement and
Administrative Services Agreement between ARM and the Company. The cost of ARM's
Year 2000 initiatives is not expected to be material to ARM's results of
operations or financial condition. Likewise, any cost to the Company related to
Year 2000 compliance is not expected to be material to the Company's results of
operations or financial condition.
ARM has completed the assessment phase of the project for all production
applications, hardware (personal computers and servers), system software,
vendors, and business partners. Although ARM is still receiving information from
a few vendors and business partners and assessing various logistic concerns with
its facilities, ARM's major production systems are substantially Year 2000
compliant. Where Year 2000 problems were found, the necessary upgrades and
repairs have begun and are scheduled for completion no later than May 31, 1999.
As well as assessing its facilities, ARM is also in the repair and certification
testing phase of its project. The testing phase will serve to verify the results
of repairs and assessments. Steps needed to correct any problems uncovered
during testing will begin immediately at that time. ARM's Year 2000 project is
well underway and because management believes that it will be Year 2000
compliant by May 31, 1999, it currently has no contingency plans for system
issues in place beyond its normal disaster recovery procedures. As a precaution,
ARM is developing a contingency and business resumption plan to address various
logistic concerns with its facilities. The contingency and business resumption
plan is scheduled for completion no later than September 30, 1999.
Although ARM anticipates no major interruption of business activities, that will
depend, in part, upon the activity of third parties. Even though ARM has
assessed and continues to assess third party issues, it has no direct ability to
influence the compliance actions of such parties. Accordingly, while ARM
believes its actions in this regard should have the effect of reducing Year 2000
risks, it is unable to eliminate them or to estimate the ultimate effect Year
2000 risks will have on the Company's operations.
10
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
4. YEAR 2000 (UNAUDITED) (CONTINUED)
The estimated date on which ARM believes it will complete its Year 2000
compliance efforts, and the expenses related to ARM's Year 2000 compliance
efforts are based upon management's best estimates, which were based on
assumptions of future events, including the availability of certain resources,
third party modification plans and other factors. There can be no assurance that
these results and estimates will be achieved, and the actual results could
materially differ from those anticipated.
11
<PAGE>
Financial Statements
(Statutory Basis)
National Integrity Life
Insurance Company
YEARS ENDED DECEMBER 31, 1998 AND 1997
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
National Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1998 and 1997
CONTENTS
<TABLE>
<S> <C>
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 (Statutory Basis)............................ 8
</TABLE>
<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, 1998 and 1997, 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, 1998 and 1997, 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, 1998 and 1997, 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.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 9, 1999
1
<PAGE>
National Integrity Life Insurance Company
Balance Sheets (Statutory Basis)
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
-------------------------------------
(IN THOUSANDS)
<S> <C> <C>
ADMITTED ASSETS
Cash and invested assets:
Bonds $ 360,012 $ 414,907
Preferred stocks 9,740 21,792
Mortgage loans 2,835 3,242
Policy loans 26,695 26,396
Cash and short-term investments 78,883 12,078
Receivable for securities - 1,941
Other invested assets 3,786 3,794
-------------------------------------
Total cash and invested assets 481,951 484,150
Separate account assets 771,953 617,327
Accrued investment income 5,062 5,735
Other admitted assets 718 2,143
-------------------------------------
Total admitted assets $ 1,259,684 $ 1,109,355
-------------------------------------
-------------------------------------
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
1998 1997
-------------------------------------
(IN THOUSANDS)
<S> <C> <C>
LIABILITIES AND CAPITAL AND SURPLUS
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $ 437,286 $ 446,610
Unpaid claims 50 50
Deposits on policies to be issued 1,243 564
-------------------------------------
Total policy and contract liabilities 438,579 447,224
Separate account liabilities 771,953 617,327
Accounts payable and accrued expenses 13 151
Transfers to separate accounts due or accrued, net (27,297) (24,362)
Reinsurance balances payable 207 511
Federal income taxes 1,005 5,645
Asset valuation reserve 3,204 1,570
Interest maintenance reserve 8,443 7,240
Other liabilities 4,074 32
-------------------------------------
Total liabilities 1,200,181 1,055,338
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) (2,491) (7,977)
-------------------------------------
Total capital and surplus 54,017 59,503
-------------------------------------
Total liabilities and capital and surplus $ 1,259,684 $ 1,109,355
-------------------------------------
-------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
National Integrity Life Insurance Company
Statements of Income (Statutory Basis)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997
-------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Premiums and other revenues:
Premiums and annuity considerations $ 13,496 $ 11,533
Deposit-type funds 196,927 211,637
Net investment income 36,077 42,464
Amortization of the interest maintenance reserve 1,478 1,359
Other revenues 8,331 5,961
-------------------------------------
Total premiums and other revenues 256,309 272,954
Benefits paid or provided:
Death benefits 4,098 1,268
Annuity benefits 16,475 12,687
Surrender benefits 142,420 123,520
Payments on supplementary contracts 1,637 1,648
Decrease in insurance and annuity reserves (9,247) (66,954)
Other benefits 101 119
-------------------------------------
Total benefits paid or provided 155,484 72,288
Insurance and other expenses:
Commissions 8,904 10,088
General expenses 14,876 11,146
Taxes, licenses and fees 228 794
Net transfers to separate accounts 63,171 163,896
Other expenses 3,871 3,542
-------------------------------------
Total insurance and other expenses 91,050 189,466
-------------------------------------
Gain from operations before federal income taxes
and net realized capital gains (losses) 9,775 11,200
Federal income tax expense 31 3,621
-------------------------------------
Gain from operations before net realized
capital gains (losses) 9,744 7,579
Net realized capital gains (losses), excluding realized
capital gains (losses) net of tax transferred to the
interest maintenance reserve (1998-$2,681; 1997-$(314)) 147 (2,036)
-------------------------------------
Net income $ 9,891 $ 5,543
-------------------------------------
-------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
National Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years Ended December 31, 1998 and 1997
<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, 1997 $ 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
Net income 9,891 9,891
Increase in asset
valuation reserve (1,634) (1,634)
Dividend to shareholder (2,771) (2,771)
-----------------------------------------------------------------------
Balance, December 31,
1998 $ 2,000 $ 59,244 $ 750 $ (2,491) $ 59,503
-----------------------------------------------------------------------
-----------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997
-------------------------------------
(IN THOUSANDS)
<S> <C> <C>
OPERATIONS:
Premiums, policy proceeds, and other
considerations received $ 210,424 $ 223,170
Net investment income received 36,344 42,944
Commission and expense allowances received on
reinsurance ceded 8 8
Benefits paid (164,730) (139,316)
Insurance expenses paid (24,148) (22,090)
Other income received net of other expenses paid 4,368 2,335
Net transfers to separate accounts (66,100) (167,010)
Federal income taxes (4,670) (4,479)
-------------------------------------
Net cash used in operations (8,504) (64,438)
INVESTMENT ACTIVITIES:
Proceeds from sales, maturities, or repayments of investments:
Bonds 291,759 368,167
Preferred stocks 38,672 55,948
Mortgage loans 407 687
Other invested assets 8 -
Net gains on cash and short-term investments 64 -
Miscellaneous proceeds - 4,254
-------------------------------------
Total investment proceeds 330,910 429,056
Benefits received (taxes paid) on capital gains (1,407) 6,921
-------------------------------------
Net proceeds from sales, maturities, or repayments
of investments 329,503 435,977
Cost of investments acquired:
Bonds 232,584 337,887
Preferred stocks 26,322 26,621
Other invested assets - 3,794
Miscellaneous applications - 405
-------------------------------------
Total cost of investments acquired 258,906 368,707
Net increase in policy loans and premium notes 299 1,415
-------------------------------------
Net cash provided by investment activities 70,298 65,855
</TABLE>
6
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997
-------------------------------------
(IN THOUSANDS)
<S> <C> <C>
FINANCING AND MISCELLANEOUS ACTIVITIES:
Other cash provided:
Other sources 8,644 2,588
-------------------------------------
Total other cash provided 8,644 2,588
-------------------------------------
Other cash applied:
Dividends to shareholder 2,771 -
Other applications, net 861 6,497
-------------------------------------
Total other cash applied 3,632 6,497
-------------------------------------
Net cash provided by (used in) financing and
miscellaneous activities 5,012 (3,909)
-------------------------------------
Net increase (decrease) in cash and short-term investments 66,805 (2,492)
Cash and short-term investments at beginning of year 12,078 14,570
-------------------------------------
Cash and short-term investments at end of year $ 78,883 $ 12,078
-------------------------------------
-------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
7
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
December 31, 1998
1. ORGANIZATION AND ACCOUNTING POLICIES
ORGANIZATION
National Integrity Life Insurance Company (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. 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 formula and is
reported as a liability rather than unassigned surplus. Under a formula
8
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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 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,
1998 1997
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Net income as reported in the accompanying statutory
basis financial statements $ 9,891 $ 5,543
Deferred policy acquisition costs, net of amortization 9,940 10,157
Adjustments to customer deposits (4,560) (5,781)
Adjustments to invested asset carrying values at acquisition date
(32) (38)
Amortization of value of insurance in force (539) (870)
Amortization of interest maintenance reserve (1,478) (1,359)
Adjustments for realized investment gains 3,646 1,511
Adjustments for federal income tax expense (5,200) (3,320)
Other (107) 166
------------------------------------
Net income, GAAP basis $ 11,561 $ 6,009
------------------------------------
------------------------------------
</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,
1998 1997
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Capital and surplus as reported in the accompanying
statutory basis financial statements $ 59,503 $ 54,017
Adjustments to customer deposits (37,356) (32,825)
Adjustments to invested asset carrying values at acquisition date
77 94
Asset valuation reserve and interest maintenance reserve 11,646 8,799
Value of insurance in force 4,159 4,810
Deferred policy acquisition costs 43,497 33,902
Net unrealized gains (losses) on available-for-sale securities
(7,076) 5,849
Other 3,474 7,413
------------------------------------
Shareholder's equity, GAAP basis $ 77,924 $ 82,059
------------------------------------
------------------------------------
</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 average cost 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
annuity contract surrenders are reported as a negative liability rather than an
asset pursuant to prescribed NAIC accounting practices. Policy related activity
involving cashflows, such as premiums and benefits, are reported in the
accompanying financial statements of income in separate line items combined with
related general account amounts. Investment income and interest credited on
deposits held in guaranteed separate accounts are included in the accompanying
statements of income as a net amount included in net transfers to (from)
separate accounts. 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 those estimates.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
presentation of the 1998 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. In 1998, the NAIC adopted codified 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
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, 1998:
Mortgage-backed securities $ 184,619 $ - $ - $ 184,619
Corporate securities 129,725 3,426 7,681 125,470
Asset-backed securities 26,483 - - 26,483
U.S. Treasury securities and
obligations of U.S. government
agencies 2,489 112 - 2,601
Foreign governments 16,696 - 2,471 14,225
--------------------------------------------------------------------
Total bonds $ 360,012 $ 3,538 $ 10,152 $ 353,398
--------------------------------------------------------------------
--------------------------------------------------------------------
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
--------------------------------------------------------------------
--------------------------------------------------------------------
</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, 1998 and 1997, the fair
value of investments in bonds includes $256.2 million and $306.8 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, 1998, by contractual maturity, is as
follows:
<TABLE>
<CAPTION>
COST OR FAIR VALUE
AMORTIZED COST
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Years to maturity:
One or less $ 200 $ 200
After one through five 27,253 26,920
After five through ten 20,769 19,437
After ten 100,689 95,740
Asset-backed securities 26,483 26,483
Mortgage-backed securities 184,618 184,618
------------------------------------
Total $ 360,012 $ 353,398
------------------------------------
------------------------------------
</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 1998 and 1997 were $262.0
million and $375.5 million; gross gains of $5.6 million and $8.6 million, and
gross losses of $1.4 million and $8.3 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, 1998 and 1997, bonds with an admitted asset value of $1,218,000
and $1,235,000, 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 December 31, 1998,
the Company held no mortgages with interest more than one year past due. During
1998, 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,
1998 1997
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Income:
Bonds $ 31,054 $ 34,854
Preferred stocks 1,328 4,205
Mortgage loans 245 291
Policy loans 2,014 2,072
Cash and short-term investments 2,147 1,506
Other 279 (3)
------------------------------------
Total investment income 37,067 42,925
Investment expenses (656) (461)
Interest expense on repurchase agreements (334) -
------------------------------------
Net investment income $ 36,077 $ 42,464
------------------------------------
------------------------------------
</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, 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. 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,
1998 1997
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Direct premiums and amounts assessed against
policyholders $ 199,389 $ 210,910
Reinsurance assumed 11,757 12,770
Reinsurance ceded (723) (510)
------------------------------------
Net premiums, annuity considerations and deposit-type funds
$ 210,423 $ 223,170
------------------------------------
------------------------------------
</TABLE>
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 with current
benefit taken for the use of the Company's losses and credits in the
consolidated return.
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, 1998 and 1997, 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, 1998 and 1997, 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, 1998:
Subject to discretionary withdrawal (with adjustment):
With market value adjustment $ 221,118 20.0%
At book value less surrender charge of 5% or more 71,502 6.5
At market value 523,230 47.4
-------------------------------------
Total with adjustment or at market value 815,850 73.9
Subject to discretionary withdrawal (without adjustment)
at book value with minimal or no charge or adjustment 228,629 20.7
Not subject to discretionary withdrawal 60,076 5.4
-------------------------------------
Total annuity reserves and deposit fund liabilities (before
reinsurance) 1,104,555 100.0%
-----------------
-----------------
Less reinsurance ceded -
-------------------
Net annuity reserves and deposit fund liabilities $ 1,104,555
-------------------
-------------------
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
-------------------
-------------------
</TABLE>
19
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. SEPARATE ACCOUNTS
The Company's guaranteed separate accounts include non-indexed products and
options (i.e., guaranteed rate options). The guaranteed rate options are sold as
a fixed annuity product or as an investment option within the Company's variable
annuity products.
The Company's nonguaranteed separate accounts primarily include variable
annuities. The net investment experience of variable annuities is credited
directly to the policyholder and can be positive or negative.
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, 1998 is as follows:
<TABLE>
<CAPTION>
*NONINDEXED NONGUARANTEED
GUARANTEED MORE SEPARATE
THAN 4% ACCOUNTS TOTAL
--------------------------------------------------------
--------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Premiums, deposits and other considerations $ 9,330 $ 110,020 $ 119,350
--------------------------------------------------------
--------------------------------------------------------
Reserves for separate accounts with assets at
fair value $ 221,118 $ 523,363 $ 744,481
--------------------------------------------------------
--------------------------------------------------------
Reserves for separate accounts by withdrawal
characteristics:
Subject to discretionary withdrawal(with
adjustment):
With market value adjustment $ 221,118 $ - $ 221,118
At book value without market value
adjustment and with current surrender
charge of 5% or more - - -
At market value - 523,363 523,363
--------------------------------------------------------
Total with adjustment or at market value 221,118 523,363 744,481
Not subject to discretionary withdrawal - - -
--------------------------------------------------------
Total separate accounts reserves $ 221,118 $ 523,363 $ 744,481
--------------------------------------------------------
--------------------------------------------------------
</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, 1998 and 1997 is presented below:
<TABLE>
<CAPTION>
1998 1997
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Transfers as reported in the Summary of Operations of
the Separate Accounts Statement:
Transfers to separate accounts $ 119,350 $ 211,743
Transfers from separate accounts (56,316) (47,948)
------------------------------------
Net transfers to separate accounts 63,034 163,795
Reconciling adjustments:
Other revenues 137 101
------------------------------------
Transfers as reported in the Summary of Operations of the Life,
Accident and Health Annual Statement $ 63,171 $ 163,896
------------------------------------
------------------------------------
</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, 1998 DECEMBER 31, 1997
-------------------------------------------------------------------------
CARRYING AMOUNT FAIR VALUE CARRYING AMOUNT FAIR VALUE
-------------------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Bonds $ 360,012 $ 348,766 $ 414,907 $ 424,642
Preferred stocks 9,740 7,981 21,792 22,252
Mortgage loans 2,835 2,835 3,242 3,242
Liabilities:
Life and annuity reserves for
investment-type contracts $ 360,606 $ 359,972 $ 367,124 $ 367,374
Separate accounts annuity
reserves 744,349 733,365 592,018 576,877
</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
estimates or quoted market prices of comparable investments.
MORTGAGE LOANS
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
1998 and 1997, the Company was charged $8.6 million and $5.9 million,
respectively, for these services in accordance with the requirements of
applicable insurance law and regulations.
11. YEAR 2000 (UNAUDITED)
ARM has undertaken a Year 2000 project that includes all of its subsidiaries,
including the Company. ARM's Year 2000 compliance project, as it relates to the
Company, is provided for under the Investment Services Agreement and
Administrative Services Agreement between ARM and the Company. The cost of ARM's
Year 2000 initiatives is not expected to be material to ARM's results of
operations or financial condition. Likewise, any cost to the Company related to
Year 2000 compliance is not expected to be material to the Company's results of
operations or financial condition.
ARM has completed the assessment phase of the project for all production
applications, hardware (personal computers and servers), system software,
vendors and business partners. Although ARM is still receiving information from
a few vendors and business partners and assessing various logistic concerns with
its facilities, ARM's major production systems are substantially Year 2000
compliant. Where Year 2000 problems were found, the necessary upgrades and
repairs have begun and are scheduled for completion no later than May 31, 1999.
23
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
11. YEAR 2000 (UNAUDITED) (CONTINUED)
As well as assessing its facilities, ARM is also in the repair and certification
testing phase of its project. The testing phase will serve to verify the results
of repairs and assessments. Steps needed to correct any problems uncovered
during testing will begin immediately at that time. ARM's Year 2000 project is
well underway and because management believes that it will be Year 2000
compliant by May 31, 1999, it currently has no contingency plans for system
issues in place beyond its normal disaster recovery procedures. As a precaution,
ARM is developing a contingency and business resumption plan to address various
logistic concerns with its facilities. The contingency and business resumption
plan is scheduled for completion no later than September 30, 1999.
Although ARM anticipates no major interruption of business activities, that will
depend, in part, upon the activity of third parties. Even though ARM has
assessed and continues to assess third party issues, it has no direct ability to
influence the compliance actions of such parties. Accordingly, while ARM
believes its actions in this regard should have the effect of reducing Year 2000
risks, it is unable to eliminate them or to estimate the ultimate effect Year
2000 risks will have on the Company's operations.
The estimated date on which ARM believes it will complete its Year 2000
compliance efforts, and the expenses related to ARM's Year 2000 compliance
efforts are based upon management's best estimates, which were based on
assumptions of future events, including the availability of certain resources,
third party modification plans and other factors. There can be no assurance that
these results and estimates will be achieved, and the actual results could
materially differ from those anticipated.
24
