<PAGE>
Financial Statements
(Statutory Basis)
National Integrity Life
Insurance Company
YEARS ENDED DECEMBER 31, 1999 AND 1998
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
National Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1999 and 1998
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 (Statutory Basis)........................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, 1999 and 1998, 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 auditing standards generally accepted
in the United States. 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
accounting principles generally accepted in the United States. The variances
between such practices and accounting principles generally accepted in the
United States 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 accounting principles generally accepted in the United States,
the financial position of National Integrity Life Insurance Company at December
31, 1999 and 1998, 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, 1999 and 1998, 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
March 31, 2000
1
<PAGE>
National Integrity Life Insurance Company
Balance sheets (Statutory Basis)
<TABLE>
<CAPTION>
DECEMBER 31,
1999 1998
-------------------------------
(IN THOUSANDS)
<S> <C> <C>
ADMITTED ASSETS
Cash and invested assets:
Bonds $ 345,374 $ 360,012
Preferred stocks 9,740 9,740
Mortgage loans 2,350 2,835
Policy loans 29,246 26,695
Cash and short-term investments 110,583 78,883
Receivable for securities 1,826 -
Federal income tax recoverable 2,769 -
Other invested assets 3,776 3,786
-------------------------------
Total cash and invested assets 505,664 481,951
Separate account assets 841,835 771,953
Accrued investment income 9,618 5,062
Other admitted assets 71 718
-------------------------------
Total admitted assets $ 1,357,188 $ 1,259,684
===============================
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
1999 1998
-----------------------------------
(IN THOUSANDS)
<S> <C> <C>
LIABILITIES AND CAPITAL AND SURPLUS
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $ 460,159 $ 437,286
Unpaid claims 50 50
Deposits on policies to be issued 1,067 1,243
-----------------------------------
Total policy and contract liabilities 461,276 438,579
Separate account liabilities 841,835 771,953
Accounts payable and accrued expenses 339 13
Transfers to separate accounts due or (accrued), net (14,732) (27,297)
Reinsurance balances payable 334 207
Federal income taxes - 1,005
Asset valuation reserve 3,526 3,204
Interest maintenance reserve 7,884 8,443
Other liabilities 1,547 4,074
-----------------------------------
Total liabilities 1,302,009 1,200,181
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
Unassigned surplus (deficit) (6,065) (2,491)
-----------------------------------
Total capital and surplus 55,179 59,503
-----------------------------------
Total liabilities and capital and surplus $ 1,357,188 $ 1,259,684
===================================
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
National Integrity Life Insurance Company
Statements of Income (Statutory Basis)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998
(IN THOUSANDS)
-----------------------------------
<S> <C> <C>
Premiums and other revenues:
Premiums and annuity considerations $ 13,615 $ 13,496
Deposit-type funds 137,690 196,927
Net investment income 39,019 36,077
Amortization of the interest maintenance reserve 1,127 1,478
Income from Separate Account Seed Money Investment 14,800 -
Reserve adjustments on reinsurance ceded 78,722 -
Other revenues 16,400 8,331
-----------------------------------
Total premiums and other revenues 301,373 256,309
Benefits paid or provided:
Death benefits 961 4,098
Annuity benefits 20,560 16,475
Surrender benefits 221,211 142,420
Payments on supplementary contracts 1,812 1,637
Increase (decrease) in insurance and annuity reserves 22,961 (9,247)
Other benefits 93 101
-----------------------------------
Total benefits paid or provided 267,598 155,484
Insurance and other expenses:
Commissions 17,791 8,904
General expenses 7,393 14,876
Taxes, licenses and fees 795 228
Net transfers to separate accounts 213 63,171
Other expenses 643 3,871
-----------------------------------
Total insurance and other expenses 26,835 91,050
-----------------------------------
Gain from operations before federal income taxes
and net realized capital gains (losses) 6,940 9,775
Federal income tax expense (benefit) (5,113) 31
Gain from operations before net realized -----------------------------------
capital gains (losses) 12,053 9,744
Net realized capital gains (losses), excluding realized
capital gains (losses) net of tax transferred to the
interest maintenance reserve (1999-$567; 1998-$2,681) (1,255) 147
-----------------------------------
Net income $ 10,798 $ 9,891
===================================
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
National Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years Ended December 31, 1999 and 1998
<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, 1998 $ 2,000 $ 59,244 $ 750 $ (7,977) $ 54,017
Net income 9,891 9,891
Increase in asse
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
Net income 10,798 10,798
Increase in asset
valuation reserve (322) (322)
Release of Special Surplus Funds (750) 750
Change in surplus in
separate accounts (14,800) (14,800)
-------------------------------------------------------------------------
Balance, December 31, 1999 $ 2,000 $ 59,244 $ - $ (6,065) $ 55,179
==========================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998
-------------------------------------
(IN THOUSANDS)
<S> <C> <C>
OPERATIONS:
Premiums, policy proceeds, and other
considerations received $ 151,305 $ 210,424
Net investment income received 33,836 36,344
Commission and expense allowances received on
reinsurance ceded 83,164 8
Benefits paid (244,637) (164,730)
Insurance expenses paid (25,653) (24,148)
Other income received net of other expenses paid 11,458 4,368
Net transfers from (to) separate accounts 12,352 (66,100)
Federal income taxes recovered (paid) 2,441 (4,670)
-------------------------------------
Net cash used in operations 24,266 (8,504)
INVESTMENT ACTIVITIES:
Proceeds from sales, maturities, or repayments
of investments:
Bonds 95,849 291,759
Preferred stocks - 38,672
Mortgage loans 485 407
Other invested assets - 8
Net gains on cash and short-term investments 8 64
Total investment proceeds 96,342 330,910
Taxes paid on capital gains (1,407) (1,407)
-------------------------------------
Net proceeds from sales, maturities, or repayments
of investments 94,935 329,503
Cost of investments acquired:
Bonds 80,974 232,584
Preferred stocks - 26,322
-------------------------------------
Total cost of investments acquired 80,974 258,906
Net increase in policy loans and premium notes 2,551 299
-------------------------------------
Net cash provided by investment activities 11,410 70,298
</TABLE>
6
<PAGE>
National Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998
----------------------------------
(IN THOUSANDS)
<S> <C> <C>
FINANCING AND MISCELLANEOUS ACTIVITIES:
Other cash provided:
Other sources 2,311 8,644
------------------------------
Total other cash provided 2,311 8,644
------------------------------
Other cash applied:
Dividends to shareholder - 2,771
Other applications, net 6,286 862
------------------------------
Total other cash applied 6,286 3,633
------------------------------
Net cash provided by (used in) financing and
miscellaneous activities (3,975) 5,011
------------------------------
Net increase in cash and short-term investments 31,701 66,805
Cash and short-term investments at beginning of year 78,883 12,078
------------------------------
Cash and short-term investments at end of year $ 110,584 $ 78,883
==============================
</TABLE>
SEE ACCOMPANYING NOTES.
7
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
December 31, 1999
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"). 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 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 accounting principles generally
accepted in the United States ("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 prescribed
8
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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 (Statuatory 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,
1999 1998
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Net income as reported in the accompanying statutory
basis financial statements $ 10,798 $ 9,891
Deferred policy acquisition costs, net of amortization 4,073 9,940
Adjustments to customer deposits (2,613) (4,560)
Adjustments to invested asset carrying values at
acquisition date 19 (32)
Amortization of value of insurance in force (831) (539)
Amortization of interest maintenance reserve (1,127) (1,478)
Adjustments for realized investment gains (losses) (1,106) 3,646
Adjustments for federal income tax expense (8,084) (5,200)
Other (2,629) (107)
------------------------------------
Net income (loss), GAAP basis $ (1,500) $ 11,561
====================================
</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,
1999 1998
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Capital and surplus as reported in the accompanying statutory basis
financial statements $ 55,179 $ 59,503
Adjustments to customer deposits (28,245) (37,356)
Adjustments to invested asset carrying values at
acquisition date (1,231) 77
Asset valuation reserve and interest maintenance reserve 11,410 11,646
Value of insurance in force 3,702 4,159
Deferred policy acquisition costs 48,063 43,497
Net unrealized gains (losses) on available-for-sale securities
(48,105) (7,076)
Other (5,378) 3,474
------------------------------------
Shareholder's equity, GAAP basis $ 35,395 $ 77,924
====================================
</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.
Preferred stocks are reported at cost.
Short-term investments include investments with maturities of less than one
year at the date of acquisition.
11
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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.
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
12
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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 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.
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 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
13
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
2. PERMITTED STATUTORY ACCOUNTING PRACTICES (CONTINUED)
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, 1999:
Mortgage-backed securities $ 120,317 $ 8 $ 4 $ 120,321
Corporate securities 182,138 15 11,959 170,194
Asset-backed securities 22,877 - - 22,877
U.S. Treasury securities and
obligations of U.S. government
agencies 3,229 1 199 3,031
Foreign governments 16,813 94 1,886 15,021
-----------------------------------------------------------------------
Total bonds $ 345,374 118 14,048 331,444
=======================================================================
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
=======================================================================
</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, 1999 and 1998, the fair
value of investments in bonds includes $242.4 million and $256.2 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, 1999, by contractual maturity, is as
follows:
<TABLE>
COST OR
AMORTIZED COST FAIR VALUE
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Years to maturity:
One or less $ 1,068 $ 1,062
After one through five 37,355 37,161
After five through ten 24,019 22,460
After ten 139,738 127,563
Asset-backed securities 22,877 22,877
Mortgage-backed securities 120,317 120,321
------------------------------------
Total $ 345,374 $ 331,444
====================================
</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 1999 and 1998 were $40.7
million and $262.0 million; gross gains of $1.4 million and $5.6 million, and
gross losses of $2.8 million and $1.4 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, 1999 and 1998, bonds with an admitted asset value of $1,220,000
and $1,218,000, 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, 1999,
the Company held no mortgages with interest more than one year past due. During
1999, 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,
1999 1998
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Income:
Bonds $ 29,956 $ 31,054
Preferred stocks 796 1,328
Mortgage loans 219 245
Policy loans 2,238 2,014
Cash and short-term investments 6,218 2,147
Other 320 279
------------------------------------
Total investment income 39,747 37,067
Investment expenses (725) (656)
Interest expense on repurchase agreements (3) (334)
------------------------------------
Net investment income $ 39,019 $ 36,077
====================================
</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.
The effect of reinsurance on premiums, annuity considerations and deposit-type
funds is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998
-------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Direct premiums and amounts assessed against
policyholders $229,228 $ 199,389
Reinsurance assumed 10,640 11,757
Reinsurance ceded (88,563) (723)
-------------------------------------
Net premiums, annuity considerations and deposit-
type funds $151,305 $ 210,423
=====================================
</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, 1999 and 1998, the adjusted capital
and surplus of the Company is 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, 1999 and 1998, 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, 1999:
Subject of discretionary withdrawal (with adjustment):
With market value adjustment $ 209,485 17.3%
At book value less surrender charge of 5% or more 156,431 12.9%
----------------
At market value 617,377 50.9%
-----------------
Total with adjustment or at market value 983,293 81.1%
Subject to discretionary withdrawal (without adjustment)
at book value less surrender charge of 5% or more 166,356 13.7%
Not subject to discretionary withdrawal 62,646 5.2%
---------------------------------
Total annuity reserves and deposit fund liabilities
(before reinsurance) 1,212,295
Less reinsurance ceded 3,772
-----------------
Net annuity reserves and deposit fund liabilities $ 1,208,523 100.0%
=================================
At December 31, 1998:
Subject of 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 less surrender charge of 5% or more 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
=================
</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, 1999 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 $ 10,627 $ 60,894 $ 71,521
========================================================
Reserves for separate accounts with assets at
fair value $ 209,485 $ 617,562 $ 827,047
========================================================
Reserves for separate accounts by withdrawal characteristics:
Subject to discretionary withdrawal (with adjustment):
With market value adjustment $ 209,485 $ - $ 209,485
At book value without market value
adjustment and with current surrender
charge of 5% or more - - -
At market value - 617,562 617,562
--------------------------------------------------------
Total with adjustment or at market value 209,485 617,562 827,047
Not subject to discretionary withdrawal - - -
--------------------------------------------------------
Total separate accounts reserves $ 209,485 $ 617,562 $ 827,047
========================================================
</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, 1999 and 1998 is presented below:
<TABLE>
<CAPTION>
1999 1998
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Transfers as reported in the Summary of Operations of the Separate Accounts
Statement:
Transfers to separate accounts $ 71,521 $ 119,350
Transfers from separate accounts (71,472) (56,316)
------------------------------------
Net transfers to separate accounts 49 63,034
Reconciling adjustments:
Other revenues 164 137
------------------------------------
Transfers as reported in the Summary of Operations of the Life,
Accident and Health Annual Statement $ 213 $ 63,171
====================================
</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, 1999 DECEMBER 31, 1998
----------------------------------- --------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------------------------------- --------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Bonds $345,374 $290,545 $360,012 $348,766
Preferred stocks 9,740 7,680 9,740 7,981
Mortgage loans 2,350 2,350 2,835 2,835
Cash and short-term investments 110,583 110,583 78,883 78,883
Liabilities:
Life and annuity reserves for
investment-type contracts $382,394 $378,233 $360,606 $359,972
Separate accounts annuity
reserves 826,862 826,164 744,349 733,365
</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 AND CASH AND SHORT-TERM INVESTMENTS
The carrying amount of mortgage loans and cash and short-term investments
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
1999 and 1998, the Company was charged $7.6 million and $8.6 million,
respectively, for these services in accordance with the requirements of
applicable insurance law and regulations.
11. OTHER ITEMS
On July 29, 1999, ARM announced that it was restructuring its institutional
business and positioning its retail business and technology operations for the
sale of ARM or its businesses or its assets. Following the July 29, 1999
announcement, the ratings of ARM and its insurance subsidiaries were
significantly lowered several times by four major rating agencies, materially
and adversely affecting the Company's ability to market retail products and
adversely affecting the persistency of its existing business.
In order to preserve and maximize value for policyholders as well as for ARM's
creditors and/or stockholders, ARM requested supervision with respect to it's
insurance subsidiary Integrity from the Ohio Department of Insurance, its
domiciliary regulator. On August 20, 1999, the Ohio Department of Insurance
issued a Supervision Order. Under the terms of the Supervision Order, Integrity
continued payments of death benefits, previously scheduled systematic
withdrawals, previously scheduled immediate annuity payments, and agent
commissions, but could not make other payments without approval from the Ohio
Department of Insurance. The Supervision Order also suspended the processing of
surrenders of policies except in cases of approved hardship. On August 31, 1999,
the Supervision Order was amended to allow Integrity Life Insurance Company to
resume processing surrender requests from its variable life and annuity
policyholders.
On December 17, 1999, ARM entered into a Purchase Agreement (the "Purchase
Agreement") with The Western and Southern Life Insurance Company ("W&S") whereby
W&S agreed to acquire ARM's insurance subsidiaries, Integrity and National
Integrity Insurance Company, the ("Insurance Subsidiaries").
23
<PAGE>
National Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
11. OTHER ITEMS (CONTINUED)
On March 3, 2000, ARM closed the transaction contemplated by the Purchase
Agreement (the "Closing"). Under the terms of the Purchase Agreement, the
purchase price of $119.3 million is subject to a number of downward price
adjustments (see below) and was placed in an escrow account. The Company does
not expect any remaining proceeds in the escrow (after any such downward
adjustments) to be distributed from the escrow prior to the 12 month anniversary
of the Closing.
The $119.3 million purchase price may be decreased to the extent that the sum of
the Insurance Subsidiaries' statutory surplus and asset valuation reserves set
forth on the Insurance Subsidiaries' final February 29, 2000 balance sheet (less
certain enumerated items) is more than $1 million less than the sum of the
Insurance Subsidiaries' statutory surplus and asset valuation reserves set forth
in the Insurance Subsidiaries September 30, 1999 statutory financial statements
plus $2.2 million. The purchase price may be increased to the extent that the
sum of the Insurance Subsidiaries' statutory surplus and asset valuation
reserves set forth on the Insurance Subsidiaries' final February 29, 2000
balance sheet (less certain enumerated items) is more than $1 million greater
than the sum of the Insurance Subsidiaries' statutory surplus and asset
valuation reserves set forth on the Insurance Subsidiaries' September 30, 1999
statutory financial statements plus $2.2 million.
Subject to certain specified limitations, the purchase price may also be
decreased to the extent of any losses by W&S arising out of any inaccuracy in or
breach of any of ARM's representations, warranties or covenants.
The purchase price may be further decreased to the extent of any "losses" from
the sales or deemed sales of certain securities owned by the Insurance
Subsidiaries (the "Securities"). The Securities, which the parties have agreed
are to be sold, are set forth on a confidential list. "Losses" are calculated as
the aggregate amount by which the "carrying value" of the Securities exceeds the
aggregate net sale proceeds from the sales or deemed sales of the Securities.
The aggregate "carrying value" of the Securities as of February 29, 2000 was
$453.5 million. Losses of $4.7 million have been recognized on securities sold
subsequent to entering into the sale transaction.
24
<PAGE>
Financial Statements
Separate Account VUL
of
National Integrity Life Insurance Company
DECEMBER 31, 1999
WITH REPORT OF INDEPENDENT AUDITORS
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Financial Statements
December 31, 1999
CONTENTS
<TABLE>
<S> <C>
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
</TABLE>
<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 Company (comprising, respectively, the
Hudson River Trust Common Stock, Hudson River Trust Balanced, Hudson River Trust
Aggressive Stock, Hudson River Trust High Yield, Hudson River Trust Global, EQAT
Common Stock, EQAT Balanced, EQAT Aggressive Stock, EQAT High Yield and EQAT
Global Divisions) as of December 31, 1999, and the related statement of
operations for the year then ended and statements of changes in net assets for
the periods indicated therein. 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 auditing standards generally accepted
in the United States. 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 EQ Advisors
Trust (the "Trust") as of December 31, 1999, 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, 1999, the results of their operations, and changes in
their net assets for each of the periods indicated therein in conformity with
accounting principles generally accepted in the United States.
Louisville, Kentucky /s/ Ernst & Young LLP
April 12, 2000
1
<PAGE>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1999
<TABLE>
<CAPTION>
HUDSON HUDSON HUDSON
RIVER TRUST HUDSON RIVER TRUST RIVER
COMMON RIVER TRUST AGGRESSIVE TRUST
STOCK BALANCED STOCK HIGH YIELD
DIVISION(1) DIVISION(1) DIVISION(1) DIVISION(1)
---------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets
Investments in EQ Advisors Trust
at value (aggregate cost of $171,080) $ - $ - $ - $ -
Receivable from (payable to) the general account
of National Integrity - - - -
---------------------------------------------------------------------
Net assets $ - $ - $ - $ -
---------------------------------------------------------------------
---------------------------------------------------------------------
Unit value $ - $ - $ - $ -
---------------------------------------------------------------------
---------------------------------------------------------------------
Units outstanding - - - -
---------------------------------------------------------------------
---------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
HUDSON
RIVER EQAT EQAT
TRUST COMMON EQAT AGGRESSIVE
GLOBAL STOCK BALANCED STOCK
DIVISION(1) DIVISION DIVISION DIVISION
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Assets
Investments in EQ Advisors Trust
at value (aggregate cost of $171,080) $ - $ 70,656 $ 11,341 $ 70,716
Receivable from (payable to) the general account
of National Integrity - (240) 48 77
-----------------------------------------------------------------
Net assets $ - $ 70,416 $ 11,389 $ 70,793
-----------------------------------------------------------------
-----------------------------------------------------------------
Unit value $ - $ 525.49 $ 299.71 $ 439.71
-----------------------------------------------------------------
-----------------------------------------------------------------
Units outstanding - 134 38 161
-----------------------------------------------------------------
-----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
EQAT
HIGH EQAT
YIELD GLOBAL
DIVISION DIVISION TOTAL
--------------------------------------------------
<S> <C> <C> <C>
Assets
Investments in EQ Advisors Trust
at value (aggregate cost of $171,080) $ 923 $ 35,385 $ 189,021
Receivable from (payable to) the general account
of National Integrity 101 28 14
--------------------------------------------------
Net assets $ 1,024 $ 35,413 $ 189,035
--------------------------------------------------
--------------------------------------------------
Unit value $ 255.88 $ 416.62
--------------------------------------------------
--------------------------------------------------
Units outstanding 4 85
--------------------------------------------------
--------------------------------------------------
</TABLE>
(1) Effective October 18, 1999, the net assets of the division were transferred
to a new division through a substitution.
SEE ACCOMPANYING NOTES.
2
<PAGE>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1999
<TABLE>
<CAPTION>
HUDSON HUDSON HUDSON
RIVER TRUST HUDSON RIVER TRUST RIVER
COMMON RIVER TRUST AGGRESSIVE TRUST
STOCK BALANCED STOCK HIGH YIELD
DIVISION(1) DIVISION(1) DIVISION(1) DIVISION(1)
------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment income
Reinvested dividends from
EQ Advisors Trust $ - $ - $ - $ -
Expenses
Mortality and expense risk and
administrative charges 229 39 247 7
------------------------------------------------------------------
Net investment income (loss) (229) (39) (247) (7)
Realized and unrealized gain (loss)
on investments
Net realized gain (loss) on sales of investments 5,079 (9,049) 7,708 (132)
Net unrealized appreciation (depreciation)
of investments:
Beginning of period 1,821 253 (9,087) (152)
End of period - - - -
------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (1,821) (253) 9,087 152
------------------------------------------------------------------
Net realized and unrealized gain (loss)
on investments 3,258 (9,302) 16,795 20
------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations $ 3,029 $ (9,341) $ 16,548 $ 13
-------------------------------------------------------------------
-------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
HUDSON
RIVER EQAT EQAT
TRUST COMMON EQAT AGGRESSIVE
GLOBAL STOCK BALANCED STOCK
DIVISION(1) DIVISION(2) DIVISION(2) DIVISION(2)
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Investment income
Reinvested dividends from
EQ Advisors Trust $ - $ 9,701 $ 1,219 $ 4,109
Expenses
Mortality and expense risk and
administrative charges 120 70 11 67
-----------------------------------------------------------------
Net investment income (loss) (120) 9,631 1,208 4,042
Realized and unrealized gain (loss)
on investments
Net realized gain (loss) on sales of investments (1,378) 25 39 -
Net unrealized appreciation (depreciation)
of investments:
Beginning of period 73 - - -
End of period - 2,121 208 10,130
-----------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (73) 2,121 208 10,130
-----------------------------------------------------------------
Net realized and unrealized gain (loss)
on investments (1,451) 2,146 247 10,130
-----------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations $ (1,571) $ 11,777 $ 1,455 $ 14,172
-----------------------------------------------------------------
-----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
EQAT
HIGH EQAT
YIELD GLOBAL
DIVISION(2) DIVISION(2) TOTAL
---------------------------------------
<S> <C> <C> <C>
Investment income
Reinvested dividends from
EQ Advisors Trust $ 107 $ 1,595 $ 16,731
Expenses
Mortality and expense risk and
administrative charges 1 34 825
----------------------------------------
Net investment income (loss) 106 1,561 15,906
Realized and unrealized gain (loss)
on investments
Net realized gain (loss) on sales of investments (2) 30 2,320
Net unrealized appreciation (depreciation)
of investments:
Beginning of period - - (7,092)
End of period (94) 5,576 17,941
----------------------------------------
Change in net unrealized appreciation/
depreciation during the period (94) 5,576 25,033
----------------------------------------
Net realized and unrealized gain (loss)
on investments (96) 5,606 27,353
----------------------------------------
Net increase (decrease) in net assets
resulting from operations $ 10 $ 7,167 $ 43,259
----------------------------------------
----------------------------------------
</TABLE>
(1) For the period January 1, 1999 to October 17, 1999 (date of substitution)
(2) For the period October 18, 1999 (commencement of operations) to December 31,
1999
SEE ACCOMPANYING NOTES.
3
<PAGE>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1999
<TABLE>
<CAPTION>
HUDSON HUDSON HUDSON
RIVER TRUST HUDSON RIVER TRUST RIVER
COMMON RIVER TRUST AGGRESSIVE TRUST
STOCK BALANCED STOCK HIGH YIELD
DIVISION(1) DIVISION(1) DIVISION(1) DIVISION(1)
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Increase (decrease) in net assets from
operations
Net investment income (loss) $ (229) $ (39) $ (247) $ (7)
Net realized gain (loss) on sales of investments 5,079 (9,049) 7,708 (132)
Change in net unrealized appreciation/
depreciation during the period (1,821) (253) 9,087 152
----------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations 3,029 (9,341) 16,548 13
Increase (decrease) in net assets from policy
related transactions
Contributions from policyholders 2,865 2,002 4,867 -
Policy terminations and benefits (12,479) (1,869) (146,170) (1,084)
----------------------------------------------------------------
Net increase (decrease) in net assets from
policy related transactions (9,614) 133 (141,303) (1,084)
----------------------------------------------------------------
Increase (decrease) in net assets (6,585) (9,208) (124,755) (1,071)
Net assets, beginning of year 6,585 9,208 124,755 1,071
----------------------------------------------------------------
Net assets, end of year $ - $ - $ - $ -
----------------------------------------------------------------
----------------------------------------------------------------
Unit transactions
Contributions 6 6 12 4
Terminations, benefits and transfers (22) (42) (347) (8)
----------------------------------------------------------------
Net increase (decrease) in units (16) (36) (335) (4)
----------------------------------------------------------------
----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
HUDSON
RIVER EQAT EQAT
TRUST COMMON EQAT AGGRESSIVE
GLOBAL STOCK BALANCED STOCK
DIVISION(1) DIVISION(2) DIVISION(2) DIVISION(2)
---------------------------------------------------------
<S> <C> <C> <C> <C>
Increase (decrease) in net assets from
operations
Net investment income (loss) $ (120) $ 9,631 $ 1,208 $ 4,042
Net realized gain (loss) on sales of investments (1,378) 25 39 -
Change in net unrealized appreciation/
depreciation during the period (73) 2,121 208 10,130
----------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations (1,571) 11,777 1,455 14,172
Increase (decrease) in net assets from policy
related transactions
Contributions from policyholders 1,220 2,400 - 2,400
Policy terminations and benefits (352) 56,239 9,934 54,221
----------------------------------------------------------
Net increase (decrease) in net assets from
policy related transactions 868 58,639 9,934 56,621
----------------------------------------------------------
Increase (decrease) in net assets (703) 70,416 11,389 70,793
Net assets, beginning of year 703 - - -
----------------------------------------------------------
Net assets, end of year $ - $ 70,416 $ 11,389 $ 70,793
---------------------------------------------------------
---------------------------------------------------------
Unit transactions
Contributions 4 5 - 6
Terminations, benefits and transfers (6) 129 38 155
----------------------------------------------------------
Net increase (decrease) in units (2) 134 38 161
---------------------------------------------------------
---------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
EQAT
HIGH EQAT
YIELD GLOBAL
DIVISION(2) DIVISION(2) TOTAL
-----------------------------------------------
<S> <C> <C> <C>
Increase (decrease) in net assets from
operations
Net investment income (loss) $ 106 $ 1,561 $ 15,906
Net realized gain (loss) on sales of investments (2) 30 2,320
Change in net unrealized appreciation/
depreciation during the period (94) 5,576 25,033
-----------------------------------------------
Net increase (decrease) in net assets
resulting from operations 10 7,167 43,259
Increase (decrease) in net assets from policy
related transactions
Contributions from policyholders - 1,200 16,954
Policy terminations and benefits 1,014 27,046 (13,500)
-----------------------------------------------
Net increase (decrease) in net assets from
policy related transactions 1,014 28,246 3,454
-----------------------------------------------
Increase (decrease) in net assets 1,024 35,413 46,713
Net assets, beginning of year - - 142,322
-----------------------------------------------
Net assets, end of year $ 1,024 $ 35,413 $ 189,035
-----------------------------------------------
-----------------------------------------------
Unit transactions
Contributions - 3
Terminations, benefits and transfers 4 82
-----------------------------
Net increase (decrease) in units 4 85
-----------------------------
-----------------------------
</TABLE>
(1) For the period January 1, 1999 to October 17, 1999 (date of substitution)
(2) For the period October 18, 1999 (commencement of operations) to
December 31, 1999
SEE ACCOMPANYING NOTES.
4
<PAGE>
Separate Account VUL of National Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1998
<TABLE>
<CAPTION>
HUDSON HUDSON
RIVER TRUST HUDSON RIVER TRUST
COMMON RIVER TRUST AGGRESSIVE
STOCK BALANCED STOCK
DIVISION DIVISION DIVISION
-----------------------------------------------
<S> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income $ 806 $ 938 $ 5,927
Net realized gain on sales of investments 252 50 464
Change in net unrealized appreciation/depreciation
during the period 445 191 (7,285)
---------------------------------------------
Net increase (decrease) in net assets resulting from operations 1,503 1,179 (894)
Increase (decrease) in net assets from policy
related transactions
Contributions from policyholders - 2,002 9,652
Policy terminations and benefits (535) (752) (1,679)
---------------------------------------------
Net increase (decrease) in net assets from
policy related transactions (535) 1,250 7,973
---------------------------------------------
Increase (decrease) in net assets 968 2,429 7,079
Net assets, beginning of period 5,617 6,779 117,676
---------------------------------------------
Net assets, end of period $ 6,585 $ 9,208 $ 124,755
---------------------------------------------
---------------------------------------------
Unit transactions
Contributions - 8.150 25.460
Terminations and benefits (1.515) (3.270) (5.443)
-----------------------------------------------
Net increase (decrease) in units (1.515) 4.880 20.017
---------------------------------------------
---------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
HUDSON HUDSON
RIVER RIVER
TRUST TRUST
HIGH YIELD GLOBAL
DIVISION DIVISION TOTAL
----------------------------------------
<S> <C> <C> <C>
Increase (decrease) in net assets from operations
Net investment income $ 136 $ 49 $ 7,856
Net realized gain on sales of investments 9 1 776
Change in net unrealized appreciation/depreciation
during the period (210) 17 (6,842)
----------------------------------------
Net increase (decrease) in net assets resulting from operations (65) 67 1,790
Increase (decrease) in net assets from policy
related transactions
Contributions from policyholders - - 11,654
Policy terminations and benefits (130) 49 (3,047)
----------------------------------------
Net increase (decrease) in net assets from
policy related transactions (130) 49 8,607
----------------------------------------
Increase (decrease) in net assets (195) 116 10,397
Net assets, beginning of period 1,266 587 131,925
----------------------------------------
Net assets, end of period $ 1,071 $ 703 $ 142,322
----------------------------------------
----------------------------------------
Unit transactions
Contributions - -
Terminations and benefits (0.460) (0.027)
--------------------------
Net increase (decrease) in units (0.460) (0.027)
--------------------------
--------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1999
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 ("SEC") 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 ("Integrity") which, prior to March 3, 2000, was an indirect wholly
owned subsidiary of ARM Financial Group, Inc. ("ARM"). Effective March 3, 2000,
Integrity and National Integrity were acquired by the Western and Southern Life
Insurance Company ("W&S.") (See Note 4 of Notes to Financial Statements.)
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 EQ Advisors Trust ("EQAT" or the
"Trust"), a mutual fund managed by EQ Financial Consultants, Inc.
On July 1, 1999, National Integrity filed an application with the SEC to approve
the substitution of newly created portfolios of EQAT for each of the Hudson
River Trust portfolios (the "Substitution"). The Substitution involved the
transfer of assets to EQAT Portfolios (the "New Divisions") that have
substantially identical investment objectives, strategies, and policies to those
of the Hudson River Trust Portfolios. The Substitution was approved by the SEC
on September 22, 1999, and was effective on October 18, 1999. The divisions of
the Separate Account affected by the Substitution and the New Divisions that
received the respective assets of each of the Hudson River Trust Portfolios are
as follows:
6
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ORIGINAL DIVISION NEW DIVISION
Hudson River Common Stock EQAT Common Stock
Hudson River Balanced EQAT Balanced
Hudson River Aggressive Stock EQAT Aggressive Stock
Hudson River High Yield EQAT High Yield
Hudson River Global EQAT Global
Units of each division of the Separate Account affected by the Substitution were
redeemed in-kind and the redemption proceeds were used to purchase units of the
New Division. The costs of the Substitution were borne by National Integrity,
and no fees, transfer charges or sales charges to effect the Substitution were
imposed on the Separate Account or the policyholders. Prior to and immediately
following the Substitution, the account values of policyholders were the same.
In addition, the Substitution did not alter the tax or insurance benefits to
policyholders or the contractual obligation of National Integrity.
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.
7
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
8
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
BASIS OF PRESENTATION
The accompanying financial statements have been prepared in accordance with
accounting principles generally accepted in the United States 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.
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
9
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
USE OF ESTIMATES
The preparation of financial statements 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, 1999 and the cost of shares held
at December 31, 1999 for each division were as follows:
<TABLE>
<CAPTION>
DIVISION PURCHASES SALES COST
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Hudson River Trust Common Stock $ 61,746 $ 71,591 $ -
Hudson River Trust Balanced 1,638 1,544 -
Hudson River Trust Aggressive Stock 5,047 146,739 -
Hudson River Trust High Yield 1 1,092 -
Hudson River Trust Global 25,426 24,678 -
EQAT Common Stock 68,752 242 68,535
EQAT Balanced 11,278 184 11,133
EQAT Aggressive Stock 60,869 283 60,586
EQAT High Yield 1,036 17 1,017
EQAT Global 29,851 72 29,809
-----------------
$ 171,080
=================
</TABLE>
10
<PAGE>
Separate Account VUL
of
National Integrity Life Insurance Company
Notes to Financial Statements (continued)
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.
4. EVENTS RELATING TO NATIONAL INTEGRITY, INTEGRITY AND ARM
On July 29, 1999, ARM announced that it was restructuring its institutional
business and positioning its retail business and technology operations for the
sale of ARM or its businesses or its assets. Following the July 29, 1999
announcement, the ratings of ARM and its insurance subsidiaries, including
National Integrity, were significantly lowered several times by four major
rating agencies, materially and adversely affecting National Integrity's ability
to market retail products and adversely affecting the persistency of its
existing business during the remainder of 1999.
On December 17, 1999 ARM entered into a Purchase Agreement (the "Purchase
Agreement") with W&S whereby W&S agreed to acquire Integrity and National
Integrity. On March 3, 2000, W&S and ARM closed the transaction contemplated by
the Purchase Agreement. The Company has been assigned a AAA (Extremely Strong)
rating for financial strength by Standard & Poor's, AAA (Highest) for claims
paying ability from Duff & Phelps' and A (Excellent) for financial strength from
A.M. Best. It is expected that Moody's will assign similar ratings to National
Integrity.
W&S is part of the Western-Southern Enterprise, a financial services group which
also includes Western-Southern Life Assurance Company, Columbus Life Insurance
Company, Touchstone Advisors, Inc., Fort Washington Investment Advisors, Inc.,
Todd Investment Advisors, Inc., Countrywide Financial Services, Capital Analysts
Incorporated and Eagle Realty Group, Inc. Assets owned or under management by
the group exceed $20 billion. Western and Southern is rated A++ (Superior) by
A.M. Best, AAA (Highest) by Duff & Phelps, AAA (Extremely Strong) by Standard &
Poor's, and Aa2 (Excellent) by Moody's.
11
