<PAGE>
Financial Statements
Separate Account I
of
Integrity Life Insurance Company
December 31, 1995
With Report of Independent Auditors
<PAGE>
Separate Account I
of
Integrity Life Insurance Company
Financial Statements
December 31, 1995
CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors............................................... 1
Audited Financial Statements
Statement of Assets and Liabilities......................................... 2
Statement of Operations..................................................... 4
Statements of Changes in Net Assets......................................... 6
Notes to Financial Statements.............................................. 10
</TABLE>
<PAGE>
Report of Independent Auditors
Contract Holders
Separate Account I of Integrity Life Insurance Company
We have audited the accompanying statement of assets and liabilities of Separate
Account I of Integrity Life Insurance Company (comprising, respectively, the
Money Market, High Income, Equity-Income, Growth, Overseas, Investment Grade
Bond, Asset Manager, Index 500, Asset Manager: Growth, and Contrafund Divisions)
as of December 31, 1995, and the related statements of operations and 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 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 securities owned in Variable Insurance Products Fund and
Variable Insurance Products Fund II (Fidelity VIP Funds) as of December 31,
1995, by correspondence with the transfer agent of the Funds. 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 the Integrity Life Insurance Company Separate Account I
at December 31, 1995, and the results of their operations and changes in their
net assets for each of the periods indicated herein in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
April 19, 1996
1
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1995
<TABLE>
<CAPTION>
MONEY HIGH EQUITY -
MARKET INCOME INCOME GROWTH OVERSEAS
DIVISION DIVISION DIVISION DIVISION DIVISION
-----------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
Investments in Fidelity VIP Funds at value (cost of
$247,769,093 in the aggregate) $26,369,295 $29,616,280 $55,440,447 $50,061,266 $21,011,796
LIABILITIES
Payable to (receivable from) the general account of
Integrity 6,604 1,586 41,066 35,580 (54,088)
------------------------------------------------------------------
NET ASSETS $26,362,691 $29,614,694 $55,399,381 $50,025,686 $21,065,884
==================================================================
Unit value $ 14.46 $ 13.23 $ 24.46 $ 30.03 $ 16.10
==================================================================
Units outstanding 1,823,146 2,238,450 2,264,897 1,665,857 1,308,440
==================================================================
</TABLE>
See accompanying notes.
2
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Assets and Liabilities (continued)
December 31, 1995
<TABLE>
<CAPTION>
ASSET
INVESTMENT ASSET INDEX MANAGER: CONTRA-
GRADE BOND MANAGER 500 GROWTH FUND
DIVISION DIVISION DIVISION DIVISION DIVISION TOTAL
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Investments in Fidelity VIP Funds at value
(cost of $247,769,093 in the aggregate) $11,413,982 $56,983,663 $ 6,740,850 $ 2,107,966 $14,427,205 $274,172,750
LIABILITIES
Payable to (receivable from) the general
account of Integrity 2,218 42,287 (1,793) 1,056 (3,040) 71,476
--------------------------------------------------------------------------------
NET ASSETS $11,411,764 $56,941,376 $ 6,742,643 $ 2,106,910 $14,430,245 $274,101,274
================================================================================
Unit value $ 18.20 $ 19.15 $ 14.20 $ 12.03 $ 13.50
==================================================================
Units outstanding 627,020 2,973,440 474,834 175,138 1,068,907
==================================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1995
<TABLE>
<CAPTION>
MONEY HIGH EQUITY -
MARKET INCOME INCOME GROWTH OVERSEAS
DIVISION DIVISION DIVISION DIVISION DIVISION
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Dividends from Fidelity VIP Funds $1,190,708 $ 847,477 $ 2,090,573 $ 133,546 $ 141,460
EXPENSES
Mortality and expense risk and administrative
charges 284,297 245,316 501,726 490,747 252,603
--------------------------------------------------------------
NET INVESTMENT INCOME (LOSS) 906,411 602,161 1,588,847 (357,201) (111,143)
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain (loss) on sales of investments - 421,460 398,434 1,747,660 74,370
Net unrealized appreciation (depreciation) of
investments:
Beginning of period 227 (36,180) 307,294 150,087 (388,476)
End of period (1,163) 1,820,824 8,678,431 7,671,018 1,015,935
--------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (1,390) 1,857,004 8,371,137 7,520,931 1,404,411
--------------------------------------------------------------
NET REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS (1,390) 2,278,464 8,769,571 9,268,591 1,478,781
--------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS $ 905,021 $2,880,625 $10,358,418 $8,911,390 $1,367,638
==============================================================
</TABLE>
See accompanying notes.
4
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Operations (continued)
Year Ended December 31, 1995
<TABLE>
<CAPTION>
INVESTMENT ASSET
GRADE ASSET INDEX MANAGER: CONTRA-
BOND MANAGER 500 GROWTH FUND
DIVISION DIVISION DIVISION DIVISION* DIVISION* TOTAL
------------------------------------------------------------------------
<C> <C> <C> <C> <C> <C> <C>
INVESTMENT INCOME
Dividends from Fidelity VIP Funds $ 248,975 $ 1,222,443 $ 44,262 $ 82,736 $ 181,181 $ 6,183,361
EXPENSES
Mortality and expense risk and
administrative charges 122,798 769,768 50,285 9,315 79,833 2,806,688
------------------------------------------------------------------------
NET INVESTMENT INCOME (LOSS) 126,177 452,675 (6,023) 73,421 101,348 3,376,673
REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS
Net realized gain (loss) on sales of
investments (41,212) 773,658 135,255 20,837 306,555 3,837,017
Net unrealized appreciation (depreciation)
of investments:
Beginning of period (342,585) (2,242,077) 18,176 - - (2,533,534)
End of period 889,374 4,628,621 966,863 7,420 726,334 26,403,657
------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period 1,231,959 6,870,698 948,687 7,420 726,334 28,937,191
------------------------------------------------------------------------
NET REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS 1,190,747 7,644,356 1,083,942 28,257 1,032,889 32,774,208
------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS $1,316,924 $ 8,097,031 $1,077,919 $101,678 $1,134,237 $36,150,881
========================================================================
</TABLE>
* For the period February 6, 1995 (commencement of operations) to
December 31, 1995.
See accompanying notes.
5
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1995
<TABLE>
<CAPTION>
MONEY HIGH EQUITY -
MARKET INCOME INCOME GROWTH OVERSEAS
DIVISION DIVISION DIVISION DIVISION DIVISION
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM
OPERATIONS
Net investment income (loss) $ 906,411 $ 602,161 $ 1,588,847 $ (357,201) $ (111,143)
Net realized gain (loss) on sales of
investments -- 421,460 398,434 1,747,660 74,370
Change in net unrealized appreciation/
depreciation during the period (1,390) 1,857,004 8,371,137 7,520,931 1,404,411
-----------------------------------------------------------------------
Net increase in net assets resulting from
operations 905,021 2,880,625 10,358,418 8,911,390 1,367,638
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 20,334,306 11,774,062 15,978,463 14,692,149 5,584,300
Contract terminations and benefits (3,262,823) (651,621) (2,258,085) (2,305,745) (1,398,897)
Net transfers among investment options (10,489,510) 4,609,207 9,173,422 6,493,844 (3,417,808)
-----------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions 6,581,973 15,731,648 22,893,800 18,880,248 767,595
-----------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS 7,486,994 18,612,273 33,252,218 27,791,638 2,135,233
Net assets, beginning of year 18,875,697 11,002,421 22,147,163 22,234,048 18,930,651
-----------------------------------------------------------------------
NET ASSETS, END OF YEAR $26,362,691 $29,614,694 $55,399,381 $50,025,686 $21,065,884
=======================================================================
UNIT TRANSACTIONS
Contributions 1,439,814 920,318 733,711 553,520 364,819
Terminations and benefits (239,468) (50,330) (109,024) (84,599) (92,992)
Net transfers (740,572) 379,055 433,527 208,262 (235,605)
-----------------------------------------------------------------------
Increase (decrease) in units 459,774 1,249,043 1,058,214 677,183 36,222
=======================================================================
</TABLE>
See accompanying notes.
6
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Changes in Net Assets (continued)
Year Ended December 31, 1995
<TABLE>
<CAPTION>
INVESTMENT ASSET
GRADE ASSET INDEX MANAGER: CONTRA-
BOND MANAGER 500 GROWTH FUND
DIVISION DIVISION DIVISION DIVISION* DIVISION* TOTAL
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS
Net investment income (loss) $ 126,177 $ 452,675 $ (6,023) $ 73,421 $ 101,348 $ 3,376,673
Net realized gain (loss) on sales of
investments (41,212) 773,658 135,255 20,837 306,555 3,837,017
Changes in net unrealized appreciation/
depreciation during the period 1,231,959 6,870,698 948,687 7,420 726,334 28,937,191
-----------------------------------------------------------------------------------
Net increase in net assets resulting from
operations 1,316,924 8,097,031 1,077,919 101,678 1,134,237 36,150,881
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 2,732,767 7,813,632 2,590,878 1,618,000 9,189,750 92,308,307
Contract terminations and benefits (598,195) (4,780,955) (211,930) (7,244) (78,792) (15,554,287)
Net transfers among investment options 814,239 (12,437,415) 997,890 394,476 4,185,050 323,395
-----------------------------------------------------------------------------------
Net increase (decrease) in net assets
derived from contract related transactions 2,948,811 (9,404,738) 3,376,838 2,005,232 13,296,008 77,077,415
-----------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS 4,265,735 (1,307,707) 4,454,757 2,106,910 14,430,245 113,228,296
Net assets, beginning of year 7,146,029 58,249,083 2,287,886 -- -- 160,872,978
-----------------------------------------------------------------------------------
NET ASSETS, END OF YEAR $11,411,764 $56,941,376 $6,742,643 $2,106,910 $14,430,245 $274,101,274
===================================================================================
UNIT TRANSACTIONS
Contributions 159,543 453,078 200,180 141,402 734,758
Terminations and benefits (35,875) (283,950) (18,438) (616) (9,811)
Net transfers 48,994 (704,833) 74,973 34,352 343,960
--------------------------------------------------------------------
Increase (decrease) in units 172,662 (535,705) 256,715 175,138 1,068,907
====================================================================
</TABLE>
*For the period February 6, 1995 (commencement of operations) to
December 31, 1995.
See accompanying notes.
7
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1994
<TABLE>
<CAPTION>
MONEY HIGH EQUITY
MARKET INCOME INCOME GROWTH
DIVISION DIVISION DIVISION DIVISION
------------------------------------------------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS
Net investment income (loss) $ 520,326 $ 683,901 $ 897,356 $ 446,029
Net realized gain (loss) on sales of
investments -- (516,635) 304,256 143,796
Change in net unrealized appreciation/
depreciation during the period 213 (321,640) (256,264) (504,945)
------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations 520,539 (154,374) 945,348 84,880
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 21,643,360 4,311,125 9,460,972 9,955,775
Contract terminations and benefits (1,085,525) (255,523) (3,155,579) (962,825)
Net transfers among investment options (6,869,228) 56,577 1,890,970 3,030,967
------------------------------------------------------
Net increase in net assets derived from
contract related transactions 13,688,607 4,112,179 8,196,363 12,023,917
------------------------------------------------------
INCREASE IN NET ASSETS 14,209,146 3,957,805 9,141,711 12,108,797
Net assets, beginning of year 4,666,551 7,044,616 13,005,452 10,125,251
------------------------------------------------------
NET ASSETS, END OF YEAR $18,875,697 $11,002,421 $22,147,163 $22,234,048
======================================================
UNIT TRANSACTIONS
Contributions 1,587,152 375,895 529,463 470,116
Terminations and benefits (79,139) (21,769) (171,313) (43,374)
Net transfers (491,285) 19,992 100,097 117,855
------------------------------------------------------
Increase in units 1,016,728 374,118 458,247 544,597
======================================================
</TABLE>
See accompanying notes.
8
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Changes in Net Assets (continued)
Year Ended December 31, 1994
<TABLE>
<CAPTION>
INVESTMENT ASSET
OVERSEAS GRADE BOND MANAGER INDEX 500
DIVISION DIVISION DIVISION DIVISION TOTAL
------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS FROM
OPERATIONS
Net investment income (loss) $ (151,157) $ (74,339) $ 1,077,535 $ (20,045) $ 3,379,606
Net realized gain (loss) on sales of
investments 373,451 (44,973) 219,467 214 479,576
Change in net unrealized appreciation/
depreciation during the period (710,584) (224,172) (5,059,060) 15,663 (7,060,789)
------------------------------------------------------------------------------
Net increase (decrease) in net assets
resulting from operations (488,290) (343,484) (3,762,058) (4,168) (3,201,607)
INCREASE (DECREASE) IN NET ASSETS FROM
CONTRACT RELATED TRANSACTIONS
Contributions from contract holders 10,337,826 3,188,701 36,175,287 985,715 96,058,761
Contract terminations and benefits (867,716) (295,106) (2,770,158) (106,875) (9,499,307)
Net transfers among investment options 2,825,487 (876,555) (2,718,283) 378,924 (2,281,141)
------------------------------------------------------------------------------
Net increase in net assets derived from
contract related transactions 12,295,597 2,017,040 30,686,846 1,257,764 84,278,313
------------------------------------------------------------------------------
INCREASE IN NET ASSETS 11,807,307 1,673,556 26,924,788 1,253,596 81,076,706
Net assets, beginning of year 7,123,344 5,472,473 31,324,295 1,034,290 79,796,272
------------------------------------------------------------------------------
NET ASSETS, END OF YEAR $18,930,651 $7,146,029 $58,249,083 $2,287,886 $160,872,978
==============================================================================
UNIT TRANSACTIONS
Contributions 669,465 196,883 2,075,458 94,413
Terminations and benefits (52,718) (18,546) (149,420) (10,092)
Net transfers 175,065 (54,339) (165,139) 35,510
-------------------------------------------------------------
Increase in units 791,812 123,998 1,760,899 119,831
=============================================================
</TABLE>
See accompanying notes.
9
<PAGE>
Separate Account 1
of
Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1995
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF OPERATIONS
Integrity Life Insurance Company ("Integrity") established Separate Account I
(the "Separate Account") on May 19, 1986, for the purpose of issuing flexible
payment variable annuity contracts ("contracts"). The Separate Account is a unit
investment trust registered with the Securities and Exchange Commission under
the Investment Company Act of 1940. The operations of the Separate Account are
part of Integrity.
Integrity is an indirect wholly owned subsidiary of ARM Financial Group, Inc.
("ARM"). ARM is a financial services company focusing on the long-term savings
and retirement marketplace by providing retail and institutional products and
services throughout the United States.
Contract holders may allocate or transfer their account values to one or more of
the Separate Account's investment divisions or, for certain contract holders, to
a guaranteed interest division provided by Integrity, or both. Certain contract
holders may also allocate or transfer a portion or all of their account values
to one or more fixed guaranteed rate options of Integrity's Separate Account
GPO. The Separate Account investment divisions are invested in shares of
corresponding investment portfolios of the Variable Insurance Products Fund and
Variable Insurance Products Fund II (collectively the "Fidelity VIP Funds"). The
Fidelity VIP Funds are "series" type mutual funds managed by Fidelity Management
and Research Company ("Fidelity Management"). Prior to September 3, 1991, the
Separate Account investment divisions then offered were invested in shares of
corresponding portfolios of Prism Investment Trust. The contract holder's
account value allocated to the investment divisions of the Separate Account
reflect the investment performance of the Fidelity VIP Funds' corresponding
portfolios. The Separate Account currently has ten 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 Fidelity VIP Funds.
10
<PAGE>
Separate Account 1
of
Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Money Market Portfolio seeks to obtain as high a level of current income as
is consistent with preserving capital and providing liquidity. It invests
only in high-quality, U.S. dollar denominated money market securities of
domestic and foreign issuers, such as certificates of deposit, obligations
of governments and their agencies, and commercial paper and notes.
High Income Portfolio seeks to obtain a high level of current income by
investing primarily in high-yielding, lower rated, fixed-income securities,
while also considering growth of capital. It normally invests at least 65%
of its total assets in income-producing debt securities and preferred
stocks, including convertible securities, and up to 20% in common stocks and
other equity securities.
Equity-Income Portfolio seeks reasonable income by investing primarily in
income producing equity securities, with the potential for capital
appreciation as a consideration. It normally invests at least 65% of its
assets in income-producing common or preferred stock and the remainder in
debt securities.
Growth Portfolio seeks to achieve capital appreciation, normally by purchase
of common stocks, although investments are not restricted to any one type of
security. Capital appreciation may also be found in other types of
securities, including bonds and preferred stocks.
Overseas Portfolio seeks long-term growth of capital primarily through
investments in foreign securities. It normally invests 65% of its assets in
securities from at least three countries outside North America.
Investment Grade Bond Portfolio seeks as high a level of current income as
is consistent with the preservation of capital by investing in a broad range
of investment-grade fixed-income securities. It will maintain a dollar-
weighted average portfolio maturity of ten years or less. For 80% of its
assets, the portfolio purchases only securities rated A or better by Moody's
Investors Service, Inc. or Standard & Poor's Corporation or unrated
securities judged by Fidelity Management to be of equivalent quality.
11
<PAGE>
Separate Account 1
of
Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Asset Manager Portfolio seeks high total return with reduced risk over the
long-term by allocating its assets among stocks, bonds and short-term fixed-
income instruments. The expected "neutral" mix of assets, which will occur
when the investment adviser concludes there is minimal relative difference
in value between the three asset classes, is 40% in equities, 40% in
intermediate to long-term bonds and 20% in short-term fixed-income
instruments. The portfolio's relatively large investment in countries with
limited or developing capital markets may involve greater risks than
investments in more developed markets and the prices of such investments may
be volatile.
Index 500 Portfolio seeks to provide investment results that correspond to
the total return (i.e., the combination of capital changes and income) of
common stocks publicly traded in the United States. In seeking this
objective, the portfolio attempts to duplicate the composition and total
return of the Standard & Poor's 500 Composite Stock Price Index while
keeping transaction costs and other expenses low.
Asset Manager: Growth Portfolio is an asset allocation fund which seeks to
maximize total return over the long term through investments in stocks,
bonds, and short-term instruments. The fund has a neutral mix which
represents the general allocation of the fund's investments over the long
term. The approximate neutral mix for stocks, bonds and short-term
instruments is 65%, 30% and 5%, respectively.
Contrafund Portfolio is a growth fund which seeks to increase the value of
the investment over the long-term by investing in equity securities of
companies that are undervalued or out of favor. This approach focuses on
companies that are currently out of public favor but show potential for
capital appreciation. Contrafund Portfolio invests primarily in common stock
and securities convertible into common stock, but it has the flexibility to
invest in any type of security that may produce capital appreciation.
The assets of the Separate Account are owned by Integrity. The portion of the
Separate Account's assets supporting the contracts may not be used to satisfy
liabilities arising out of any other business of Integrity.
12
<PAGE>
Separate Account 1
of
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
generally accepted accounting principles for unit investment trusts.
INVESTMENTS
Investments in shares of the Fidelity VIP Funds 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 instruments.
Share transactions are recorded on the trade date. Realized gains and losses on
sales of shares of the Fidelity VIP Funds are determined based on the identified
cost basis.
Dividends from income and capital gain distributions are recorded on the ex-
dividend date. Dividends from the portfolios are reinvested in the portfolios
and are reflected in the unit value of the divisions of the Separate Account.
UNIT VALUE
Unit values for the Separate Accounts 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 of the Separate Account,
reinvested dividends and capital gains, new premium deposits or withdrawals, and
the daily asset charge for the mortality and expense risk and administrative
charges. Unit values are adjusted daily for all activity in the Separate
Account.
TAXES
Operations of the Separate Account are included in the income tax return of
Integrity, which is taxed as a life insurance company under the Internal Revenue
Code. The Separate Account will not be taxed as a regulated investment company
under Subchapter
13
<PAGE>
Separate Account 1
of
Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
M of the Internal Revenue Code. Under existing federal income tax law, no taxes
are payable on the investment income or on the capital gains of the Separate
Account.
2. INVESTMENTS
The aggregate cost of portfolio shares purchased and proceeds from portfolio
shares sold during the year ended December 31, 1995 and the cost of shares held
at December 31, 1995 for each division were as follows:
PURCHASES SALES COST
--------------------------------------
Money Market Division $36,955,580 $29,467,519 $26,370,458
High Income Division 22,662,187 6,327,217 27,795,456
Equity-Income Division 27,164,221 2,641,872 46,762,016
Growth Division 28,325,626 9,767,409 42,390,248
Overseas Division 11,956,061 11,354,340 19,995,861
Investment Grade Bond Division 7,521,709 4,444,627 10,524,608
Asset Manager Division 6,068,190 14,980,616 52,355,042
Index 500 Division 4,478,275 1,109,335 5,773,987
Asset Manager: Growth Division 2,269,262 189,553 2,100,546
Contrafund Division 14,822,694 1,428,378 13,700,871
3. EXPENSES
Integrity assumes mortality and expense risks and incurs certain administrative
expenses related to the operations of the Separate Account and deducts a charge
from the assets of the Separate Account at an annual rate of 1.20% and 0.15% of
net assets, respectively, to cover these risks and expenses. In addition, an
annual charge of $30 per contract is assessed if the participant's contract
value is less than $50,000 at the end of any participation year prior to the
participant's retirement date (as defined by the participant's contract).
14
<PAGE>
Financial Statements
(Statutory Basis)
Integrity Life Insurance Company
Years Ended December 31, 1995 and 1994
with Report of Independent Auditors
<PAGE>
Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1995 and 1994
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
Report of Independent Auditors............................................... 1
Audited Financial Statements
Balance Sheets (Statutory Basis)............................................. 3
Statements of Operations (Statutory Basis)................................... 5
Statements of Changes in Capital and Surplus (Statutory Basis)............... 6
Statements of Cash Flows (Statutory Basis)................................... 7
Notes to Financial Statements................................................ 9
</TABLE>
<PAGE>
Report of Independent Auditors
Board of Directors
Integrity Life Insurance Company
We have audited the accompanying statutory basis balance sheet of Integrity Life
Insurance Company as of December 31, 1995, and the related statutory basis
statements of operations, changes in capital and surplus, and cash flows for the
year 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 audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
The Company presents its financial statements in conformity with accounting
practices prescribed or permitted by the Ohio Department of Insurance. 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 materiality of the effects of the variances
between generally accepted accounting principles and the accounting practices
referred to in the preceding paragraph, the financial statements referred to
above are not intended to and do not present fairly, in conformity with
generally accepted accounting principles, the financial position of Integrity
Life Insurance Company at December 31, 1995, or the results of its operations or
its cash flows for the year then ended. However, in our opinion, the
supplementary information included in Note 1 presents fairly, in all material
respects, shareholder's equity at December 31, 1995, and net income for the year
then ended in conformity with generally accepted accounting principles.
1
<PAGE>
Also, in our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Integrity Life Insurance
Company at December 31, 1995, and the results of its operations and its cash
flows for the year then ended in conformity with accounting practices prescribed
or permitted by the Ohio Department of Insurance.
We previously audited and reported on the statutory basis balance sheet and the
statutory basis statements of operations, changes in capital and surplus, and
cash flows of Integrity Life Insurance Company for the year ended December 31,
1994, prior to their restatement for the 1995 statutory merger as described in
Note 2. The contribution of Integrity Life Insurance Company to total admitted
assets, capital and surplus, and net income represented 68%, 75%, and 87% of the
respective restated totals. Statutory basis financial statements of the other
merged company included in the 1994 restated statutory basis statements were
audited and reported on separately by other auditors. We also have audited, as
to combination only, the accompanying statutory basis balance sheet and the
related statutory basis statements of operations, changes in capital and
surplus, and cash flows for the year ended December 31, 1994, after restatement
for the 1995 statutory merger; in our opinion, such statutory basis financial
statements have been properly combined on the basis described in Note 2 to the
statutory basis financial statements.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 23, 1996
2
<PAGE>
Integrity Life Insurance Company
Balance Sheets (Statutory Basis)
DECEMBER 31,
1995 1994*
------------------------
(In Thousands)
Admitted assets
Cash and invested assets:
Bonds $1,755,236 $1,799,778
Preferred stocks 7,604 3,367
Subsidiaries 39,139 35,744
Real estate 512 1,705
Mortgage loans 38,612 91,130
Policy loans 94,642 90,571
Cash and short-term investments 54,476 80,556
Other invested assets 13,754 6,834
------------------------
Total cash and invested assets 2,003,975 2,109,685
Separate account assets 544,664 363,008
Accrued investment income 27,806 28,273
Broker balances receivable 6,636 1,132
Reinsurance balances receivable 6,795 2,518
Other admitted assets 2,892 5,264
------------------------
Total admitted assets $2,592,768 $2,509,880
========================
3
<PAGE>
DECEMBER 31,
1995 1994*
-------------------------
(In Thousands)
Liabilities and capital and surplus
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $1,858,672 $1,975,872
Unpaid claims 2,121 1,921
Deposits on policies to be issued 702 1,239
-------------------------
Total policy and contract liabilities 1,861,495 1,979,032
Separate account liabilities 543,081 360,609
Accounts payable and accrued expenses 3,659 5,346
Transfers to Separate Accounts due or accrued, net (30,146) (23,242)
Reinsurance balances payable 2,472 1,739
Federal income taxes 2,986 744
Asset valuation reserve 12,410 8,526
Interest maintenance reserve 35,217 30,104
Other liabilities 15,567 3,481
-------------------------
Total liabilities 2,446,741 2,366,339
Capital and surplus:
Common stock, $2 par value, 1,500,000
shares authorized, issued and outstanding 3,000 3,000
Paid-in capital 87,535 82,941
Unassigned surplus 55,492 57,600
-------------------------
Total capital and surplus 146,027 143,541
-------------------------
Total liabilities and capital and surplus $2,592,768 $2,509,880
=========================
See accompanying notes.
* Restated to include the balances of State Bond and Mortgage Life Insurance
Company (see note 2).
4
<PAGE>
Integrity Life Insurance Company
Statements of Operations (Statutory Basis)
YEAR ENDED DECEMBER 31,
1995 1994*
-----------------------
(In Thousands)
Premiums and other revenues:
Premiums and annuity considerations $ 14,010 $ 39,422
Deposit-type funds 232,682 278,408
Net investment income 152,365 158,847
Amortization of the interest maintenance reserve 2,947 4,240
Other income 11,654 8,399
---------------------
Total premiums and other revenues 413,658 489,316
Benefits paid or provided:
Death benefits 24,688 24,060
Annuity benefits 39,092 38,692
Surrender benefits 322,569 264,613
Interest on funds left on deposit 1,059 165
Payments on supplementary contracts 9,423 10,252
Decrease in insurance and annuity reserves (125,970) (79,091)
Other, principally reinsurance transactions - (4,138)
---------------------
Total benefits paid or provided 270,861 254,553
Insurance and other expenses:
Commissions 16,215 23,314
General expenses 11,927 13,012
Taxes, licenses and fees 794 2,648
Net transfers to separate account 92,817 167,407
Other expenses 1,184 836
---------------------
Total insurance and other expenses 122,937 207,217
---------------------
Gain from operations before federal income taxes and net
realized capital losses 19,860 27,546
Federal income taxes 1,370 3,215
---------------------
Gain from operations before net realized capital losses 18,490 24,331
Net realized capital gains (losses), less capital gains
tax expense (benefit) (1995-$1,543,000;
1994-($3,303,000)) and excluding net gains (losses)
transferred to the interest maintenance reserve
(1995-$8,061,000; 1994-($31,520,000)) (918) (458)
---------------------
Net income $ 17,572 $ 23,873
=====================
See accompanying notes.
* Restated to include the combined results of Integrity Life Insurance Company
and State Bond and Mortgage Life Insurance Company (see note 2).
5
<PAGE>
Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years ended December 31, 1995 and 1994
TOTAL
COMMON PAID-IN UNASSIGNED CAPITAL AND
STOCK SURPLUS SURPLUS SURPLUS
------------------------------------------
(In Thousands)
Balances, January 1, 1994* $2,000 $ 83,941 $ 41,864 $127,805
Net income 23,873 23,873
Net change in unrealized gains
(losses) of subsidiaries (532) (532)
Increase in nonadmitted assets (70) (70)
Decrease from change in
valuation basis (4,107) (4,107)
Increase in asset valuation
reserve (2,861) (2,861)
Dividends to shareholder (650) (650)
Change in surplus in separate
accounts (695) (695)
Change in par value 1,000 (1,000)
Transfers from separate account 778 778
------------------------------------------
Balances, December 31, 1994* 3,000 82,941 57,600 143,541
Net income 17,572 17,572
Net change in unrealized gain
(losses) of subsidiary 5,174 5,174
Decrease in nonadmitted assets 125 125
Decrease from change in
valuation basis (8,593) (8,593)
Increase in asset valuation
reserve (3,884) (3,884)
Capital contributions 19,850 19,850
Mark to market adjustment for
SBM Life (15,256) (15,256)
Dividends to shareholder (12,800) (12,800)
Change in surplus in separate
accounts (816) (816)
Transfer from separate account 1,114 1,114
------------------------------------------
Balances, December 31, 1995 $3,000 $ 87,535 $ 55,492 $146,027
==========================================
See accompanying notes.
* Restated to include the balances and combined results of Integrity Life
Insurance Company and State Bond and Mortgage Life Insurance Company (see
note 2).
6
<PAGE>
Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis)
Year Ended December 31,
1995 1994*
----------------------
(In Thousands)
Operations:
Premiums, policy proceeds, and other considerations
received $ 246,692 $ 317,842
Net investment income received 153,357 155,582
Commission and expense allowances received (returned)
on reinsurance ceded 3,155 (2,787)
Benefits paid (395,810) (337,631)
Insurance expenses paid (31,313) (36,475)
Other income received net of other expenses paid 4,488 6,642
Net transfers to separate account (99,721) (177,042)
Federal income taxes paid - (2,101)
---------------------
Net cash used in operations (119,152) (75,970)
Proceeds from sales, maturities, or repayments of
investments:
Bonds 1,075,864 787,130
Preferred stocks 7,604 3,478
Common stocks 3,300 -
Mortgage loans 50,528 86,213
Real estate 638 150
Other invested assets 3,360 -
Miscellaneous proceeds - 533
---------------------
Total investment proceeds 1,141,294 877,504
---------------------
Net proceeds from sales, maturities, or repayments of
investments 1,141,294 877,504
Other cash provided:
Capital and surplus paid-in 19,850 -
Other sources 16,930 8,161
---------------------
Total other cash provided 36,780 8,161
---------------------
Total cash provided 1,058,922 809,695
---------------------
7
<PAGE>
Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
Year Ended December 31,
1995 1994*
----------------------
(In Thousands)
Cost of investments acquired:
Bonds $1,036,258 $840,254
Preferred and common stocks 13,340 6,734
Other invested assets 10,472 6,000
Miscellaneous applications - 1,219
--------------------
Total investments acquired 1,060,070 854,207
Other cash applied:
Dividends to stockholders 12,800 650
Other applications, net 12,132 19,920
--------------------
Total other cash applied 24,932 20,570
--------------------
Total cash used 1,085,002 874,777
--------------------
Net decrease in cash and short-term investments (26,080) (65,082)
Cash and short-term investments at beginning of year 80,556 145,638
--------------------
Cash and short-term investments at end of year $ 54,476 $ 80,556
====================
See accompanying notes.
* Restated to include the combined results of Integrity Life Insurance Company
and State Bond and Mortgage Life Insurance Company (see note 2).
8
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
December 31, 1995
1. ORGANIZATION AND ACCOUNTING POLICIES
ORGANIZATION
Integrity Life Insurance Company ("Integrity" or the "Company") is an indirect
wholly owned subsidiary of ARM Financial Group, Inc. ("ARM"). ARM acquired the
Company and its wholly owned insurance subsidiary, National Integrity Life
Insurance Company ("National Integrity"), on November 26, 1993 from The National
Mutual Life Association of Australasia Limited ("National Mutual"). The Company
is domiciled in the state of Ohio. Integrity, currently licensed in 44 states
and the District of Columbia, and National Integrity Life Insurance company
provide retail and institutional products throughout the United States to the
long-term savings and retirement marketplace.
On June 14, 1995, the Company's indirect parent, ARM, completed the acquisition
of substantially all of the assets and business operations of SBM Company
("SBM"), including all of the issued and outstanding capital stock of SBM's
subsidiaries, State Bond and Mortgage Life Insurance Company ("SBM Life"),
domiciled in Minnesota, and SBM Financial Services, Inc. ("SBM Financial
Services"), and SBM's management contracts with the State Bond group of mutual
funds (the "Acquisition"). By virtue of the Acquisition, ARM acquired control of
SBM Certificate Company, a wholly owned subsidiary of SBM Life. Concurrent with
the Acquisition, ARM acquired all outstanding shares of the authorized capital
stock of SBM certificate Company from SBM Life for a purchase price of $3.3
million. The designated effective date of the Acquisition was May 31, 1995.
The aggregate purchase price for the Acquisition was $38.8 million. ARM financed
the Acquisition by issuing a total of 9,770 shares of ARM's Class A common stock
to certain private equity funds managed by a subsidiary of Morgan Stanley Group
Inc. and certain private investors for an aggregate sale price of $63.5 million.
ARM used proceeds from issuance of the new common equity in excess of the
adjusted purchase price for the Acquisition to (i) make a $19.9 million capital
contribution to SMB Life, (ii) acquire SBM Certificate Company from SBM Life for
$3.3 million, and (iii) provide for fees and expenses related to the
Acquisition.
ARM's $19.9 million capital contribution to SBM Life was used to strengthen SBM
Life's financial position and allowed for a significant investment portfolio
restructuring immediately following the acquisition with no adverse effect on
statutory adjusted capital
9
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
and surplus. In connection with the Acquisition, on May 31, 1995, SBM Life was
permitted by the Insurance Division of the State of Minnesota Department of
Commerce to record a direct charge to paid-in capital of $15.3 million which
represented the effect of marking to market its entire bond portfolio on that
date.
BASIS OF PRESENTATION
The accompanying financial statements of the Company have been prepared in
conformity with accounting practices prescribed or permitted by the Ohio
Department of Insurance. Such practices vary from generally accepted accounting
principles ("GAAP"). The more significant variances from GAAP are as follows:
INVESTMENTS
Investments in bonds and preferred stocks are reported at amortized cost or
market value based on their 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 market values. Mortgage loans on real
estate in good standing are reported at unpaid principal balances. Realized
gains and losses are reported in income net of income tax and transfers to
the interest maintenance reserve. Changes between cost and admitted
investment asset amounts are credited or charged directly to unassigned
surplus rather than to a separate surplus account. The Asset Valuation
Reserve is determined by an NAIC prescribed formula and is reported as a
liability rather than unassigned surplus. Under a formula prescribed by the
NAIC, the Company defers the portion of realized gains and losses on sales
of fixed income investments, principally bonds and mortgage loans,
attributable to changes in the general level of interest rates and amortizes
those deferrals over the remaining period to maturity based on the
individual security sold using the seriatim method.
10
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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 valuation allowances are
provided when there has been a decline in value deemed other than temporary,
in which case, the provision for such declines would be charged to income.
SUBSIDIARIES
The accounts and operations of the Company's subsidiaries are not
consolidated with the accounts and operations of the Company as would be
required under GAAP.
POLICY ACQUISITION COSTS
Costs of acquiring and renewing business are expensed when incurred. Under
GAAP, acquisition costs related to investment-type products, to the extent
recoverable from future gross profits, are amortized generally in proportion
to the present value of expected gross profits from surrender charges and
investment, mortality, and expense margins.
NONADMITTED ASSETS
Certain assets designated as "nonadmitted," principally agents' debit
balances, are excluded from the accompanying balance sheets and are charged
directly to unassigned surplus.
PREMIUMS
Revenues for investment-type products consist of the entire premium received
and benefits represent the death benefits paid and the change in policy
reserves. Under GAAP, such premiums received are accounted for as deposits
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.
11
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
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.
FEDERAL INCOME TAXES
Deferred federal income taxes are not provided for differences between the
financial statement amounts and tax bases of assets and liabilities.
The effects of the foregoing variances from GAAP on the accompanying statutory
basis financial statements are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1995 1994
------------------------
(In Thousands)
<S> <C> <C>
Net income as reported in the accompanying
statutory basis financial statements $17,572 $ 23,873
Deferred policy acquisition costs, net of
amortization 16,651 23,976
Adjustments to policyholder deposits (5,994) (15,773)
Adjustments to invested asset carrying values at
acquisition date (769) (3,727)
Amortization of value of insurance in force (7,104) (3,830)
Amortization of interest maintenance reserve (3,906) (5,795)
Adjustments for realized investment gains (losses) 5,313 (35,510)
Adjustments for federal income tax benefit (expense) (4,719) 5,341
Investment in subsidiary 4,833 3,953
Adjustment for SBM Life operating results prior to
the acquisition (see Note 1) 4,604 (3,062)
Other 1,274 (1,204)
-------------------------
Net income (loss), GAAP basis $27,755 $ (11,758)
=========================
</TABLE>
12
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
1995 1994
---------------------
(In Thousands)
<S> <C> <C>
Capital and surplus as reported in the accompanying
statutory basis financial statements $ 146,027 $ 143,541
Adjustments to policyholder deposits (167,158) (118,036)
Adjustments to invested asset carrying values at
acquisition date (18,541) (23,085)
Asset valuation reserve and interest
maintenance reserve 82,941 83,189
Value of insurance in force 91,202 37,175
Goodwill 7,090 -
Deferred policy acquisition costs 43,318 26,667
Net unrealized gains (losses) on available-for-sale
investments 24,127 (104,905)
Adjustment for restatement of capital and surplus due
to the Merger (see Note 2) - (35,675)
Other 7,127 2,002
---------------------
Shareholder's equity, GAAP basis $ 216,133 $ 10,873
=====================
</TABLE>
Other significant accounting practices are as follows:
INVESTMENTS
Bonds, preferred stocks, common stocks, and short-term investments, are stated
at values prescribed by the NAIC, as follows:
Bonds and short-term investments are reported at cost or amortized cost; the
discount or premium on bonds is amortized using the interest method. For
loan-backed bonds, anticipated prepayments are considered when determining
the amortization of discount or premium.
13
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. ORGANIZATION AND ACCOUNTING POLICIES (CONTINUED)
Prepayment assumptions for loan-backed bonds and structured securities were
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 or amortized cost.
The Company's insurance subsidiary is reported at equity in the underlying
statutory basis of its net assets. Changes in admitted asset carrying amounts
of investments in subsidiaries are credited or charged directly to unassigned
surplus.
Mortgage loans and policy loans are reported at unpaid principal balances.
Short-term investments includes investments with maturities of less than one
year at the date of acquisition.
Realized capital gains and losses are determined using the specific
identification method.
BENEFITS
Insurance and annuity reserves are developed by actuarial methods and are
determined based on published tables using statutorily specified interest rates
and valuation methods that will provide, in the aggregate, reserves that are
greater than or equal to the minimum or guaranteed policy cash values or the
amounts required by the Ohio Department of Insurance. The Company waives
deduction of deferred fractional premiums on 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.
14
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
POLICY AND CONTRACT CLAIMS
Unpaid benefits and related expenses are established for estimates of payments
to be made on individual insurance claims that have been incurred and reported,
and estimates of losses which have occurred but have not been reported.
Management believes that its reserve estimate for policy and contract claims is
adequate.
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 balance
sheets represent funds that are separately administered, principally for
variable annuity contracts. Separate account assets are reported at market
value. Surrender charges collectible by the general account in the event of
variable policy surrenders are reported as a negative liability rather than an
asset pursuant to prescribed NAIC accounting practices. The operations of the
separate accounts are not included in the accompanying financial statements,
except for separate accounts with guarantees.
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.
2. MERGER
On December 31, 1995 and pursuant to approvals received from the applicable
regulatory authorities, including the Ohio Department of Insurance, SBM Life was
merged with and into the Company (the "Merger"). In accordance with prescribed
statutory accounting practices, the statutory basis financial statements
retroactively give effect to the merger.
15
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
2. MERGER (CONTINUED)
Accordingly, the accompanying 1994 financial statements and notes to financial
statements of the Company have been restated to include the accounts of SBM
Life. The capital stock and paid-in capital reported at December 31, 1995 and
1994 represent balances for the Company (adjusted for the aforementioned charge
to paid-in-capital and offsetting capital contribution). All remaining SBM Life
capital and surplus is included as unassigned surplus. Selected financial
information of the separate entities prior to the Merger is as follows:
<TABLE>
<CAPTION>
INTEGRITY SBM LIFE ADJUSTMENTS MERGED
---------------------------------------------------
<S> <C> <C> <C> <C>
(In Thousands)
1995:
Admitted assets $1,835,147 $757,621 - $2,592,768
Capital and surplus 112,096 33,931 - 146,027
Net income 15,816 1,756 - 17,572
1994:
Admitted assets $1,714,643 $798,243 $(3,006) $2,509,880
Capital and surplus 107,866 32,627 3,048 143,541
Net income 20,811 3,062 - 23,873
</TABLE>
3. PERMITTED STATUTORY ACCOUNTING PRACTICES
The Company's statutory basis financial statements are prepared in accordance
with accounting practices prescribed or permitted by the Ohio Department of
Insurance. "Prescribed" statutory accounting practices include state laws,
regulations, and general administrative rules, as well as a variety of
publications of the NAIC. "Permitted" statutory accounting practices encompass
all accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. The NAIC currently is in the process of recodifying
statutory accounting practices, the result of which is expected to constitute
the only source of "prescribed" statutory accounting practices. Accordingly,
that project, which is expected to be completed in 1997, 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 financial statements. Although the recodification project is meant to
be surplus neutral, there is not enough available information for the industry
to assess the impact of such project.
16
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. PERMITTED STATUTORY ACCOUNTING PRACTICES (CONTINUED)
On December 30, 1994, the Company redomesticated from Arizona to Ohio. In
conjunction with the redomestication, written approval was received from the
Ohio Department of Insurance to offset the reported deficit in the Company's
unassigned funds account against its gross paid-in and contributed surplus
account as of December 31, 1993. The Company requested permission for that
accounting because prescribed statutory accounting practices did not address
that subject. The change did not affect the total capital and surplus of the
Company as of December 31, 1994.
4. INVESTMENTS
The cost or amortized cost and the fair, or comparable, value of investments in
bonds are summarized as follows:
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
At December 31, 1995:
U.S. treasury securities and obligations of U.S.
government agencies $187,867 $ 3,089 $ 71 $ 190,885
States and political subdivisions 9,193 495 - 9,688
Foreign governments 60,881 433 577 60,737
Public utilities 76,388 3,822 2 80,208
Other corporate securities 577,088 15,845 8,103 584,830
Asset-backed securities 109,480 - - 109,480
Mortgage-backed securities 734,339 52 1 734,390
-----------------------------------------------
Total bonds $1,755,236 $23,736 $ 8,754 $1,770,218
===============================================
At December 31, 1994:
U.S. treasury securities and obligations of U.S.
government agencies $114,749 $ 5 $ 4,035 $ 110,719
States and political subdivisions 50,964 47 5,255 45,756
Foreign governments 44,383 - 5,101 39,282
Public utilities 130,134 - 12,946 117,188
Other corporate securities 539,613 634 43,574 496,673
Asset-backed securities 15,299 - - 15,299
Mortgage-backed securities 904,636 253 69,964 834,925
-----------------------------------------------
Total bonds $1,799,778 $ 939 $140,875 $1,659,842
===============================================
</TABLE>
17
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
4. 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, 1995 and 1994, the fair
value of investments in bonds includes $646,393,000 and $560,877,000,
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, 1995, by contractual maturity, is as
follows:
<TABLE>
<CAPTION>
COST OR
AMORTIZED FAIR
COST VALUE
-----------------------------
(In Thousands)
<S> <C> <C>
Maturity:
One or less $ 19,580 $ 19,578
After one through five 239,562 240,306
After five through ten 169,588 170,211
After ten 482,687 496,253
Asset-backed securities 109,480 109,480
Mortgage-backed securities 734,339 734,390
-----------------------------
Total $1,755,236 $1,770,218
=============================
</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 1995 and 1994 were
$912,298,000 and $633,723,000; gross gains of $21,015,000 and $2,746,000, and
gross losses of $10,561,000 and $37,209,000 were realized on those sales,
respectively.
At December 31, 1995 and 1994, bonds with an admitted asset value of $24,192,000
and $22,699,000, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
18
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
4. INVESTMENTS (CONTINUED)
Unrealized gains and losses on investments in subsidiaries are reported directly
in surplus and do not affect operations. The gross unrealized gains and losses
on, and the cost and fair value of, those investments are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
At December 31, 1995:
Subsidiary $17,823 $21,316 $ - $39,139
===================================================
At December 31, 1994:
Subsidiaries $21,704 $17,734 $3,694 $35,744
===================================================
</TABLE>
The Company has made no new investments in mortgage loans during 1995. 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 is 75%. Fire insurance at
least equal to the excess of the loan over the maximum loan which would be
permitted by law on the land without the buildings is required on all properties
covered by mortgage loans. As of year-end the Company held no mortgages with
interest more than one year past due. During 1995, no interest rates of
outstanding mortgage loans were reduced. No amounts have been advanced by the
Company.
In connection with the change in control of the Company during 1993, National
Mutual agreed to indemnify the Company pursuant to a Guaranty Agreement dated
November 26, 1993, with respect to (i) principal (up to 100%) of the Company's
mortgage loans' statutory book value as of December 31, 1992 and (ii)
contractual interest payments (based on the original principal amount) of all
acquired commercial and agricultural mortgage loans. In support of its
indemnification obligations, National Mutual has placed $23.0 million into
escrow in favor of the Company and National Integrity until the mortgage loans
have been repaid in full.
19
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
4. INVESTMENTS (CONTINUED)
Major categories of the Company's net investment income are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1995 1994
-------------------------
(In Thousands)
<S> <C> <C>
Income:
Bonds $138,791 $139,953
Preferred stocks 680 205
Mortgage loans 7,140 12,770
Real estate 118 92
Policy loans 6,150 6,070
Short-term investments and cash 3,696 3,861
Other investment income (loss) 911 (39)
-------------------------
Total investment income 157,486 162,912
Investment expenses (5,121) (4,065)
--------------------------
Net investment income $152,365 $158,847
==========================
</TABLE>
5. REINSURANCE
Consistent with prudent business practices and the general practice of the
insurance industry, the Company reinsures mortality risks under certain of its
insurance products with other insurance companies through reinsurance
agreements. These reinsurance agreements primarily cover single premium
endowment contracts and variable life insurance policies. Through these
reinsurance agreements, substantially all mortality risks associated with SPE
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 ceded has reduced premiums by $9,644,000 in 1995 and $4,005,000 in
1994, benefits paid or provided by $422,000 in 1995 and $628,000 in 1994 and
policy and contract liabilities by $67,447,000 at December 31, 1995 and
$104,216,000 at December 31, 1994. Reinsurance assumed is not significant to
the Company's premiums, benefits or policy and contract liabilities.
20
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
6. FEDERAL INCOME TAXES
The Company files a consolidated return with National Integrity. The method of
allocation between the companies is based on separate return calculations. For
1995, SBM Life will file a separate return.
Income before income taxes differs from taxable income principally due to value
of insurance in force, policy acquisition costs, and differences in policy and
contract liabilities and investment income for tax and financial reporting
purposes.
The current year tax provision and prior year tax provision were calculated
including net operating loss carryover benefits of $14,084,000 and $1,757,000,
respectively.
The Company had a net operating loss carryforward of approximately $7.0 million
and $25.4 million at December 31, 1995 and December 31, 1994, respectively,
expiring in the years 2005 to 2007.
Federal income tax regulations allowed certain special deductions for 1983 and
prior years which are accumulated in a memorandum tax account designated as
"policyholders' surplus". Generally, this policyholders' surplus account will
become subject to tax at the then-current rates only if the accumulated balance
exceeds certain maximum limitations or if certain cash distributions are deemed
to be paid out of the account. At December 31, 1995, SBM Life had accumulated
approximately $1,738,000 in its separate policyholders' surplus account. The
Company has no plans to distribute amounts from the policyholders' surplus
account, and no further additions to the account are allowed by the Tax Reform
Act of 1984.
7. SURPLUS
Dividends that ARM may receive from the Company in any year without prior
approval of the Ohio Insurance Commissioner are limited by statute to the
greater of (i) 10% of the Company's statutory capital and surplus as of the
preceding December 31, or (ii) the Company's statutory net income for the
preceding year. The maximum dividend payments that may be made by the Company to
ARM during 1996 are $17,572,000.
21
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
7. SURPLUS (CONTINUED)
Under New York insurance laws, National Integrity may pay dividends to Integrity
only out of its earnings and surplus, subject to at least thirty days' prior
notice to the New York Insurance Superintendent and no disapproval from the
Superintendent prior to the date of such dividend, the Superintendent may
disapprove a proposed dividend if the Superintendent finds that the financial
condition of National Integrity does not warrant such distribution.
The NAIC adopted Risk-Based Capital ("RBC") requirements which became effective
December 31, 1993, that 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 will be 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, 1995 and 1994, the adjusted capital and surplus of the
Company is substantially in excess of the minimum level of RBC that would
require regulatory response.
22
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. ANNUITY RESERVES
At December 31, 1995 and 1994, the Company's 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:
AMOUNT PERCENT
-------------------------
(In Thousands)
At December 31, 1995:
Subject to discretionary withdrawal (with
adjustment):
With market value adjustment $ 81,678 4.0%
At book value less current surrender charge of
5% or more 371,396 18.0
At market value 404,273 19.5
-------------------------
Total with adjustment or at market value 857,347 41.5
Subject to discretionary withdrawal (without
adjustment) at book value with minimal or no
charge or adjustment 664,997 32.2
Not subject to discretionary withdrawal 542,014 26.3
-------------------------
Total annuity reserves and deposit fund
liabilities--before reinsurance 2,064,358 100.0%
============
Less reinsurance ceded 62,808
----------
Net annuity reserves and deposit fund liabilities $2,001,550
==========
23
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. ANNUITY RESERVES (CONTINUED)
AMOUNT PERCENT
-------------------------
(In Thousands)
At December 31, 1994:
Subject to discretionary withdrawal (with
adjustment):
With market value adjustment $ 49,122 2.4%
At book value less current surrender charge of
5% or more 418,712 20.6
At market value 268,099 13.1
-------------------------
Total with adjustment or at market value 753,933 36.1
Subject to discretionary withdrawal (without
adjustment) at book value with minimal or no
charge or adjustment 776,196 38.1
Not subject to discretionary withdrawal 526,708 25.8
-------------------------
Total annuity reserves and deposit fund
liabilities--before reinsurance 2,038,837 100.0%
============
Less reinsurance ceded 104,629
----------
Net annuity reserves and deposit fund liabilities $1,934,208
==========
9. SEPARATE ACCOUNTS
Separate accounts assets and liabilities represent funds segregated for the
benefit of variable annuity and variable life policyholders who generally bear
the investment risk (mutual fund options), or for certain policyholders who are
guaranteed a fixed rate of return (guaranteed rate options). Assets held in
separate accounts are carried at estimated fair values.
24
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. SEPARATE ACCOUNTS (CONTINUED)
Information regarding the separate accounts of the Company as of and for the
year ended December 31, 1995 is as follows:
<TABLE>
<CAPTION>
*NONINDEXED NON-
GUARANTEE GUARANTEED
LESS THAN OR SEPARATE
EQUAL TO 4% ACCOUNTS TOTAL
----------------------------------------
<S> <C> <C> <C>
(In Thousands)
Premiums, deposits and other considerations $21,240 $108,590 $129,830
=======================================
Reserves for separate accounts with assets at
fair value $81,678 $429,907 $511,585
=======================================
Reserves for separate accounts by
withdrawal characteristics:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $81,678 $ - $81,678
At market value - 429,907 429,907
---------------------------------------
Total separate account reserves $81,678 $429,907 $511,585
=======================================
*Separate accounts with guarantees.
</TABLE>
25
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. SEPARATE ACCOUNTS (CONTINUED)
A reconciliation of the amounts transferred to and from the separate accounts
for the years ended December 31, 1995 and 1994 is presented below:
<TABLE>
<CAPTION>
1995 1994
-------------------------
(In Thousands)
<S> <C> <C>
Transfers as reported in the Summary of
Operations of the Separate Accounts
Statement:
Transfers to Separate Accounts $129,830 $195,591
Transfers from Separate Accounts (43,344) (33,003)
---------------------
Net transfers to Separate Accounts 86,486 162,588
Reconciling adjustments:
Mortality and expense charges reported as
other income 4,726 3,432
Policy deductions reported as other income 1,605 1,387
---------------------
Transfers as reported in the Summary of
Operations of the Life, Accident and
Health Annual Statement $92,817 $167,407
=====================
</TABLE>
10. FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About
Fair Value of Financial Instruments," requires disclosure of fair value
information about all financial instruments, including insurance liabilities
classified as investment contracts, unless specifically exempted. The fair value
of a financial instrument is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced or liquidation sale. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. Accordingly, the aggregate
26
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
10. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
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.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1994
-------------------------------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Assets:
Bonds $1,755,236 $1,797,097 $1,799,778 $1,632,221
Preferred stocks 7,604 8,623 3,367 3,331
Mortgage loans 38,612 38,612 91,130 91,130
Liabilities:
Life and annuity reserves
for investment-type contracts $1,490,606 $1,571,032 $1,609,997 $1,634,330
Separate account reserves 485,951 484,406 316,178 315,177
</TABLE>
Mortgage Loans
Pursuant to the terms of the acquisition of the Company, payments of principal
and interest on mortgage loans are guaranteed by National Mutual. Principal
received in excess of statutory book value is to be returned to National Mutual.
Accordingly, book value is deemed to be fair value.
Life and Annuity Reserves for Investment-type Contracts
The fair value of structured settlements and immediate annuities are based on
discounted cash flow calculations using a market yield rate for assets with
similar durations. The fair value of structured settlements and immediate
annuities represents the fair values of those insurance policies as a whole. The
fair value amounts of the remaining annuities are primarily based on the cash
surrender values of the underlying policies.
Separate Account Reserves
The fair value of separate account reserves for investment-type products equals
the cash surrender values.
27
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
11. RELATED PARTY TRANSACTIONS
Effective January 1, 1994, the Company entered into an Administrative Services
Agreement with ARM. ARM performs certain administrative and special services for
the Company to assist with its business operations. The services include
policyholder services; accounting, tax and auditing; underwriting; marketing and
product development; functional support services; payroll functions; personnel
functions; administrative support services; and investment functions. During
1995 and 1994, the Company was charged $9,691,000 and $11,261,000, respectively
for these services in accordance with the requirements of applicable insurance
law and regulations.
In connection with the acquisition of the Company and its subsidiaries in 1993,
ARM obtained a Term Loan Facility Agreement in the principal amount of $40.0
million. The loan amount is secured by a pledge of the shares of common stock of
Integrity.
28
