<PAGE>
May 5, 1997
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Separate Account I of Integrity Life Insurance Company ("Registrant")
Rule 497(e) Filing of Financial Statements
Registration No. 33-8903
Pursuant to Rule 497(e) under the Securities Act of 1933, we are filing updated
financial statements which have been provided to policyholders of the
Registrant's GrandMaster product. Registrant is no longer issuing the product,
and in accordance with a no-action position of the Securities and Exchange
Commission, the prospectus has been "evergreened."
Sincerely,
/s/ Sheri L. Bean
Paralegal
<PAGE>
Financial Statements
Separate Account I
of
Integrity Life Insurance Company
December 31, 1996
With Report of Independent Auditors
<PAGE>
Separate Account I
of
Integrity Life Insurance Company
Financial Statements
December 31, 1996
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, 1996, 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,
1996, 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, 1996, and the results of their operations and changes in their
net assets for each of the periods indicated therein, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
April 18, 1997
1
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Assets and Liabilities
December 31, 1996
<TABLE>
<CAPTION>
Money Equity-
Market High 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 $364,279,014 in the aggregate) $27,668,954 $24,732,893 $82,088,400 $78,547,595 $32,238,102
Liabilities
Payable to (receivable from) the general
account of Integrity 14,686 5,226 8,540 (6,384) 609
--------------------------------------------------------------------------
Net assets $27,654,268 $42,727,667 $82,079,860 $78,553,979 $32,237,493
===========================================================================
Unit value $ 15.03 $ 14.88 $ 27.57 $ 33.98 $ 17.98
===========================================================================
Units outstanding 1,839,938 2,871,483 2,977,144 2,311,771 1,792,964
===========================================================================
</TABLE>
See accompanying notes.
2
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Assets and Liabilities (continued)
December 31, 1996
<TABLE>
<CAPTION>
Asset
Investment Asset Manager:
Grade Bond Manager Index 500 Growth Contrafund
Division Division Division Division Division Total
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Assets
Investments in Fidelity VIP Funds at value
(cost of $364,279,014 in the aggregate) $14,955,631 $58,647,566 $20,774,010 $ 6,832,743 $38,479,268 $402,965,162
Liabilities
Payable to (receivable from) the general
account of Integrity (1,915) 2,154 (1,560) 2,912 472 24,740
-----------------------------------------------------------------------------------
Net assets $14,957,546 $58,645,412 $20,775,570 $ 6,829,831 $38,478,796 $402,940,422
===================================================================================
Unit value $ 18.53 $ 21.65 $ 17.20 $ 14.23 $ 16.15
===================================================================
Units outstanding 807,207 2,708,795 1,207,882 479,960 2,382,588
===================================================================
</TABLE>
See accompanying notes.
3
<PAGE>
<TABLE>
<CAPTION>
Separate Account I of Integrity Life Insurance Company
Statement of Operations
Year Ended December 31, 1996
Money Equity-
Market High Income Income Growth Overseas
Division Division Division Division Division
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Investment income
Reinvested dividends from Fidelity VIP Funds $2,077,792 $2,788,700 $ 2,695,924 $ 3,656,936 $ 569,919
Expenses
Mortality and expense risk and
administrative charges 543,822 454,923 967,411 861,617 378,399
--------------------------------------------------------------------------
Net investment income (loss) 1,533,970 2,333,777 1,728,513 2,795,319 191,520
Realized and unrealized gain (loss)
on investments
Net realized gain on sales
of investments - 1,751,094 2,121,848 6,441,843 648,251
Net unrealized appreciation (depreciation)
of investments:
Beginning of period (1,163) 1,820,824 8,678,431 7,671,018 1,015,935
End of period 17 1,712,483 13,214,606 5,155,205 3,176,319
--------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period 1,180 (108,341) 4,536,175 (2,515,813) 2,160,384
--------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investment 1,180 1,642,753 6,658,023 3,926,030 2,808,635
--------------------------------------------------------------------------
Net increase in net assets resulting from operations $1,535,150 $3,976,530 $ 8,386,536 $ 6,721,349 $3,000,155
==========================================================================
</TABLE>
See accompanying notes.
4
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Operations (continued)
Year Ended December 31, 1996
<TABLE>
<CAPTION>
Investment Asset
Grade Asset Manager:
Bond Manager Index 500 Growth Contrafund
Division Division Division Division Division Total
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Investment income
Reinvested dividends from Fidelity VIP Funds $ 580,069 $3,679,957 $ 321,571 $341,274 $ 148,076 $16,860,218
Expenses
Mortality and expense risk and
administrative charges 171,455 784,805 180,553 58,740 358,537 4,760,262
--------------------------------------------------------------------------
Net investment income (loss) 408,614 2,895,152 141,018 282,534 (210,461) 12,099,956
Realized and unrealized gain (loss)
on investments
Net realized gain on sales
of investments 240,589 586,105 895,378 83,953 1,902,313 14,671,374
Net unrealized appreciation (depreciation)
of investments:
Beginning of period 889,374 4,628,621 966,863 7,420 726,334 26,403,657
End of period 508,186 8,077,051 2,528,584 365,540 3,948,157 38,686,148
--------------------------------------------------------------------------
Change in net unrealized appreciation/
depreciation during the period (381,188) 3,448,430 1,561,721 358,120 3,221,823 12,282,491
--------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments (140,599) 4,034,535 2,457,099 442,073 5,124,136 26,953,865
--------------------------------------------------------------------------
Net increase in net assets resulting from operations $ 268,015 $6,929,687 $2,598,117 $724,607 $4,913,675 $39,053,821
==========================================================================
</TABLE>
See accompanying notes.
5
<PAGE>
Separate Account I of Integrity Life Insurance Company
Statement of Changes in Net Assets
Year Ended December 31, 1996
<TABLE>
<CAPTION>
Equity-
Money Market High 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) $ 1,533,970 $ 2,333,777 $ 1,728,513 $ 2,795,319 $ 191,520
Net realized gain on sales of investments - 1,751,094 2,121,848 6,441,843 648,251
Change in net unrealized appreciation/
depreciation during the period 1,180 (108,341) 4,536,175 (2,515,813) 2,160,384
--------------------------------------------------------------------
Net increase in net assets resulting from operations 1,535,150 3,976,530 8,386,536 6,721,349 3,000,155
Increase (decrease) in net assets from contract
related transactions
Contributions from contract holders 34,330,875 5,779,865 22,514,540 14,358,955 6,261,045
Contract terminations and benefits (6,208,045) (1,524,016) (4,704,707) (3,893,678) (1,526,278)
Net transfers among investment options (28,366,403) 4,880,594 484,110 11,341,667 3,436,687
--------------------------------------------------------------------
Net increase (decrease) in net assets derived from
contract related transactions (243,573) 9,136,443 18,293,943 21,806,944 8,171,454
--------------------------------------------------------------------
Increase in net assets 1,291,577 13,112,973 26,680,479 28,528,293 11,171,609
Net assets, beginning of year 26,362,691 29,614,694 55,399,381 50,025,686 21,065,884
--------------------------------------------------------------------
Net assets, end of year $ 27,654,268 $42,727,667 $82,079,860 $78,553,979 $32,237,493
====================================================================
Unit transactions
Contributions 2,336,691 407,773 878,376 442,061 363,533
Terminations and benefits (431,061) (118,461) (182,775) (140,423) (89,813)
Net transfers (1,888,838) 343,721 16,646 344,276 210,804
--------------------------------------------------------------------
Net increase (decrease) in units 16,792 633,033 712,247 645,914 484,524
====================================================================
</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, 1996
<TABLE>
<CAPTION>
Asset
Investment Asset Manager:
Grade Bond Manager Index 500 Growth Contrafund
Division Division Division Division Division Total
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Increase (decrease) in net assets from
operations
Net investment income (loss) $ 408,614 $ 2,895,152 $ 141,018 $ 282,534 $ (210,461) $ 12,099,956
Net realized gain on sales of investments 240,589 586,105 895,378 83,953 1,902,313 14,671,374
Change in net unrealized appreciation/
depreciation during the period (381,188) 3,448,430 1,561,721 358,120 3,221,823 12,282,491
---------------------------------------------------------------------------------
Net increase in net assets resulting from
operations 268,015 6,929,687 2,598,117 724,607 4,913,675 39,053,821
Increase (decrease) in net assets from
contract related transactions
Contributions from contract holders 3,378,025 6,136,455 7,410,209 2,833,347 11,316,760 114,320,076
Contract terminations and benefits (838,675) (5,296,646) (418,288) (248,404) (1,179,766) (25,838,503)
Net transfers among investment options 738,417 (6,065,460) 4,442,889 1,413,371 8,997,882 1,303,754
---------------------------------------------------------------------------------
Net increase (decrease) in net assets derived
from contract related transactions 3,277,767 (5,225,651) 11,434,810 3,998,314 19,134,876 89,785,327
---------------------------------------------------------------------------------
Increase in net assets 3,545,782 1,704,036 14,032,927 4,722,921 24,048,551 128,839,148
Net assets, beginning of year 11,411,764 56,941,376 6,742,643 2,106,910 14,430,245 274,101,274
---------------------------------------------------------------------------------
Net assets, end of year $14,957,546 $58,645,412 $20,775,570 $6,829,831 $38,478,796 $402,940,422
=================================================================================
Unit transactions
Contributions 186,436 309,032 466,833 218,521 802,193
Terminations and benefits (47,054) (261,549) (26,888) (18,720) (84,387)
Net transfers 40,805 (312,128) 293,103 105,021 595,875
------------------------------------------------------------------
Net increase (decrease) in units 180,187 (264,645) 733,048 304,822 1,313,681
==================================================================
</TABLE>
See accompanying notes.
7
<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 investment 0 421,460 398,434 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)
--------------------------------------------------------------------
Net increase (decrease) in units 459,774 1,249,043 1,058,214 677,183 36,222
====================================================================
</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, 1995
<TABLE>
<CAPTION>
Asset
Investment Asset Manager:
Grade Bond Manager Index 500 Growth Contrafund
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
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 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 0 0 160,872,978
----------------------------------------------------------------------------
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
--------------------------------------------------------------
Net 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.
9
<PAGE>
Separate Account I
of
Integrity Life Insurance Company
Notes to Financial Statements
December 31, 1996
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
premium 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, as amended. The operations of the Separate
Account are part of Integrity.
Integrity is an indirect wholly owned subsidiary of ARM Financial Group, Inc.
("ARM"). ARM specializes in the asset accumulation business, providing retail
and institutional customers with products and services designed to serve the
growing long-term savings and retirement markets.
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
GRO. Certain contract holders may also allocate new contributions to a
Systematic Transfer Option ("STO") which accumulates interest at a fixed rate.
All STO contributions must be transferred to other investment divisions or to a
guaranteed rate option within one year of the contribution.
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"). The contract holder's account
value in a Separate Account division will vary depending on the performance of
the corresponding portfolio. The Separate Account currently has ten investment
divisions available. The Separate Account introduced three new investment
divisions to contract holders on December 31, 1996 which include the Balanced
Portfolio, the Growth and Income Portfolio, and the Growth Opportunities
Portfolio from the Fidelity VIP Funds. The investment objective of each division
and its corresponding portfolio are the same. Set forth below is a summary of
the
10
<PAGE>
Separate Account I
of
Integrity Life Insurance Company
Notes to Financial Statements (continued)
1. Organization and Significant Accounting Policies (continued)
investment objectives of the operative portfolios of the Fidelity VIP Funds at
December 31, 1996 for this Separate Account.
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 I
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 50% in equities, 40% in intermediate
to long-term bonds and 10% 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 70%,
25% 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 I
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 and distributions from the Fidelity VIP Fund portfolios
are reinvested in the respective portfolios and are reflected in the unit value
of the divisions of the Separate Account.
Unit Value
Unit values for the Separate Account divisions are computed at the end of each
business day. The unit value is equal to the unit value for the preceding
business day multiplied by a net investment factor. This net investment factor
is determined based on the value of the underlying mutual fund portfolios of the
Separate Account, reinvested dividends and capital gains, new premium deposits
or withdrawals, and the daily asset charge for the mortality and expense risk
and administrative charges. Unit values are adjusted daily for all activity in
the Separate Account.
Taxes
Operations of the Separate Account are included in the income tax return of
Integrity, which is taxed as a life insurance company under the Internal Revenue
Code. The Separate Account will not be taxed as a regulated investment company
under Subchapter
13
<PAGE>
Separate Account I
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.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
2. Investments
The aggregate cost of portfolio shares purchased and proceeds from portfolio
shares sold during the year ended December 31, 1996 and the cost of shares held
at December 31, 1996 for each division were as follows:
<TABLE>
<CAPTION>
Division Purchases Sales Cost
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Money Market $107,208,446 $105,909,966 $ 27,668,937
High Income 51,321,014 39,847,156 41,020,410
Equity-Income 30,450,353 10,460,425 68,873,794
Growth 48,195,522 23,635,224 73,392,390
Overseas 17,273,367 8,855,696 29,061,783
Investment Grade Bond 7,574,318 3,892,069 14,447,445
Asset Manager 9,362,435 11,733,066 50,570,515
Index 500 14,321,355 2,745,294 18,245,426
Asset Manager: Growth 5,170,383 887,677 6,467,203
Contrafund 30,676,620 11,748,693 34,531,111
</TABLE>
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 account 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, 1996 and 1995
with Report of Independent Auditors
<PAGE>
Integrity Life Insurance Company
Financial Statements
(Statutory Basis)
Years Ended December 31, 1996 and 1995
Contents
<TABLE>
<CAPTION>
<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 (Statutory Basis)........................... 9
</TABLE>
<PAGE>
Report of Independent Auditors
Board of Directors
Integrity Life Insurance Company
We have audited the accompanying statutory basis balance sheets of Integrity
Life Insurance Company as of December 31, 1996 and 1995, and the related
statutory basis statements of operations, changes in capital and surplus, and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As described in Note 1 to the financial statements, the Company presents its
financial statements in conformity with accounting practices prescribed or
permitted by the Ohio Department of Insurance, which practices differ from
generally accepted accounting principles. The variances between such practices
and generally accepted accounting principles and the effects on the accompanying
financial statements are described in Note 1.
In our opinion, because of the effects of the matter described in the preceding
paragraph, the financial statements referred to above do not present fairly, in
conformity with generally accepted accounting principles, the financial position
of Integrity Life Insurance Company at December 31, 1996 and 1995, or the
results of its operations or its cash flows for the years then ended.
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, 1996 and 1995, and the results of its operations and its
cash flows for the years then ended in conformity with accounting practices
prescribed or permitted by the Ohio Department of Insurance.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 12, 1997
<PAGE>
Integrity Life Insurance Company
Balance Sheets (Statutory Basis)
<TABLE>
<CAPTION>
December 31,
1996 1995
------------------------
(In Thousands)
<S> <C> <C>
Admitted assets
Cash and invested assets:
Bonds $2,482,392 $1,755,236
Preferred stocks 42,234 7,604
Subsidiary 48,272 39,139
Mortgage loans 32,946 38,612
Real estate 497 512
Policy loans 98,212 94,642
Cash and short-term investments 87,009 54,476
Other invested assets 6,310 13,754
------------------------
Total cash and invested assets 2,797,872 2,003,975
Separate accounts assets 764,060 544,664
Accrued investment income 29,182 27,806
Receivable for investments sold - 6,636
Reinsurance balances receivable 1,702 6,795
Other admitted assets 1,400 2,892
------------------------
Total admitted assets $3,594,216 $2,592,768
========================
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
December 31,
1996 1995
------------------------
(In Thousands)
<S> <C> <C>
Liabilities and capital and surplus
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $2,614,118 $1,858,672
Unpaid claims 232 2,121
Deposits on policies to be issued 348 702
------------------------
Total policy and contract liabilities 2,614,698 1,861,495
Separate accounts liabilities 759,170 543,081
Accounts payable and accrued expenses 3,187 3,659
Transfers to separate accounts due or accrued, net (37,533) (30,146)
Reinsurance balances payable 13,473 2,472
Federal income taxes - 2,986
Asset valuation reserve 13,805 12,410
Interest maintenance reserve 38,594 35,217
Other liabilities 24,988 15,567
------------------------
Total liabilities 3,430,382 2,446,741
Capital and surplus:
Common stock, $2 par value, 1,500,000 shares
authorized, issued and outstanding 3,000 3,000
Paid-in surplus 87,535 87,535
Unassigned surplus 73,299 55,492
------------------------
Total capital and surplus 163,834 146,027
------------------------
Total liabilities and capital and surplus $3,594,216 $2,592,768
========================
</TABLE>
See accompanying notes.
4
<PAGE>
Integrity Life Insurance Company
Statements of Operations (Statutory Basis)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Premiums and other revenues:
Premiums and annuity considerations $ 7,803 $ 14,010
Deposit-type funds 737,791 232,682
Net investment income 171,811 152,365
Amortization of the interest maintenance reserve 3,090 2,947
Net gain from operations from Separate Accounts Statement 347 297
Other revenues 13,085 11,654
---------------------
Total premiums and other revenues 933,927 413,955
Benefits paid or provided:
Death benefits 20,012 24,688
Annuity benefits 61,242 39,092
Surrender benefits 248,282 322,569
Interest on funds left on deposit 25,204 1,059
Payments on supplementary contracts 10,261 9,423
Increase (decrease) in insurance and annuity reserves 372,699 (125,970)
---------------------
Total benefits paid or provided 737,700 270,861
Insurance and other expenses:
Commissions 20,270 16,215
General expenses 8,955 11,927
Taxes, licenses and fees 549 794
Net transfers to separate accounts 137,570 92,817
Other expenses 1,085 1,184
---------------------
Total insurance and other expenses 168,429 122,937
---------------------
Gain from operations before federal income taxes and
net realized capital losses 27,798 20,157
Federal income tax expense (benefit) (3,259) 1,370
---------------------
Gain from operations before net realized capital losses 31,057 18,787
Net realized capital losses, less capital gains tax
expense (1996-$5,738; 1995-$1,543) and excluding net
gains transferred to the interest maintenance reserve
(1996-$6,467; 1995-$8,061) (5,015) (918)
---------------------
Net income $ 26,042 $17,869
=====================
</TABLE>
See accompanying notes.
5
<PAGE>
Integrity Life Insurance Company
Statements of Changes in Capital and Surplus (Statutory Basis)
Years Ended December 31, 1996 and 1995
<TABLE>
<CAPTION>
Total
Common Paid-In Unassigned Capital and
Stock Surplus Surplus Surplus
------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Balances, January 1, 1995 $3,000 $82,941 $57,600 $143,541
Net income 17,869 17,869
Net change in unrealized gain
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 (1,113) (1,113)
Transfer from separate accounts 1,114 1,114
------------------------------------------------------
Balances, December 31, 1995 3,000 87,535 55,492 146,027
Net income 26,042 26,042
Net change in unrealized gain of subsidiary 9,133 9,133
Decrease in nonadmitted assets 27 27
Increase in asset valuation reserve (1,395) (1,395)
Dividends to shareholder (16,000) (16,000)
Other changes in surplus in separate accounts 2,960 2,960
Transfer to separate accounts, net (2,960) (2,960)
------------------------------------------------------
Balances, December 31, 1996 $3,000 $87,535 $73,299 $163,834
======================================================
</TABLE>
See accompanying notes.
6
<PAGE>
Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Operations:
Premiums, policy proceeds, and other
considerations received $ 745,594 $ 246,692
Net investment income received 171,376 153,357
Commission and expense allowances received
on reinsurance ceded 1,905 2,111
Benefits paid (341,767) (395,810)
Insurance expenses paid (30,246) (30,624)
Other income received net of other expenses paid 10,100 8,914
Net transfers to separate accounts (144,958) (99,721)
Federal income taxes paid (3,702) -
-----------------------
Net cash provided by (used in) operations 408,302 (115,081)
Investment activities:
Proceeds from sales, maturities, or repayments
of investments:
Bonds 1,604,304 1,075,864
Preferred stocks 57,895 7,604
Common stocks - 3,300
Mortgage loans 5,668 50,528
Real estate - 638
Other invested assets 7,233 3,360
Net gains on cash and short-term investments 9 -
Miscellaneous proceeds 211 -
-----------------------
Total investment proceeds 1,675,320 1,141,294
Taxes paid on capital gains (2,312) -
-----------------------
Net proceeds from sales, maturities, or repayments
of investments 1,673,008 1,141,294
</TABLE>
7
<PAGE>
Integrity Life Insurance Company
Statements of Cash Flows (Statutory Basis) (continued)
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
---------------------------
(In Thousands)
<S> <C> <C>
Cost of investments acquired:
Bonds 1,960,794 1,036,258
Preferred and common stocks 92,077 13,340
Other invested assets - 10,472
---------------------------
Total cost of investments acquired 2,052,871 1,060,070
Net increase in policy loans and premium notes 3,569 4,071
---------------------------
Net cash provided by (used in) investment activities (383,432) 77,153
Financing and miscellaneous activities:
Other cash provided:
Capital and surplus paid-in - 19,850
Other sources 40,403 16,930
---------------------------
Total other cash provided 40,403 36,780
Other cash applied:
Dividends to shareholders 16,000 12,800
Other applications, net 16,740 12,132
---------------------------
Total other cash applied 32,740 24,932
---------------------------
Net cash provided by financing and
miscellaneous activities 7,663 11,848
---------------------------
Net increase (decrease) in cash and short-term
investments 32,533 (26,080)
Cash and short-term investments at beginning of year 54,476 80,556
---------------------------
Cash and short-term investments at end of year $ 87,009 $ 54,476
===========================
</TABLE>
See accompanying notes.
8
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
December 31, 1996
1. Organization and Accounting Policies
Organization
Integrity Life Insurance Company ("Integrity" or the "Company") is an indirect
wholly owned subsidiary of ARM Financial Group, Inc. ("ARM"). ARM acquired the
Company and its wholly owned insurance subsidiary, National Integrity Life
Insurance Company ("National Integrity"), on November 26, 1993 from The National
Mutual Life Association of Australasia Limited ("National Mutual"). The Company
is domiciled in the state of Ohio. The Company, currently licensed in 45 states
and the District of Columbia, and National Integrity provide retail and
institutional products throughout the United States to the long-term savings and
retirement marketplace.
On June 14, 1995, ARM completed the acquisition of substantially all of the
assets and business operations of SBM Company (the "Acquisition"), including all
of the issued and outstanding capital stock of SBM Company's subsidiaries, State
Bond and Mortgage Life Insurance Company ("SBM Life") and SBM Financial
Services, Inc. (which subsequently changed its name to ARM Securities
Corporation). 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 SBM Life, (ii) acquire SBM Certificate Company from SBM Life for
$3.3 million, and (iii) provide for fees and expenses related to the
Acquisition.
In connection with the Acquisition, on May 31, 1995, SBM Life was permitted to
record a direct charge to paid-in surplus of $15.3 million from marking-to-
market its entire bond portfolio. ARM's $19.9 million capital contribution to
SBM Life was primarily intended
9
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)
December 31, 1996
1. Organization and Accounting Policies (continued)
to replace surplus depleted by the $15.3 million charge. Following the
Acquisition, ARM restructured SBM Life's investment portfolio to reduce SBM
Life's concentration of investments in collateralized mortgage obligations.
On December 31, 1995, SBM Life was merged with and into the Company. In
accordance with the National Association of Insurance Commissioners' (the
"NAIC") Annual Statement Instructions, the 1996 and 1995 Annual Statements were
prepared as if the merger had occurred on January 1, 1994. The capital stock and
paid-in surplus reported at December 31, 1995 represent balances for the Company
(adjusted for the aforementioned charge to paid-in surplus and offsetting
capital contribution). All remaining SBM Life capital and surplus at that date
was included as unassigned surplus.
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 the 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 used for GAAP.
10
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
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. The net deferral is
reported as the Interest Maintenance Reserve in the accompanying balance
sheets. Under GAAP, realized gains and losses are reported in the income
statement on a pretax basis in the period that the asset giving rise to the
gain or loss is sold and include provisions when there has been a decline in
asset values deemed other than temporary.
Subsidiary
The accounts and operations of the Company's subsidiary are not consolidated
with the accounts and operations of the Company as would be required under
GAAP.
Policy Acquisition Costs
Costs of acquiring and renewing business are expensed when incurred. Under
GAAP, acquisition costs related to investment-type products, to the extent
recoverable from future gross profits, are amortized generally in proportion
to the emergence of future gross profits over the estimated term of the
underlying policies.
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.
11
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Premiums
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.
Federal Income Taxes
Deferred federal income taxes are not provided for differences between the
financial statement amounts and tax bases of assets and liabilities.
12
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
The effects of the foregoing variances from GAAP on the accompanying statutory
basis financial statements are as follows:
<TABLE>
<CAPTION>
December 31,
1996 1995
-------------------------
(In Thousands)
<S> <C> <C>
Net income as reported in the accompanying statutory
basis financial statements $ 26,042 $ 17,869
Deferred policy acquisition costs, net of amortization 11,036 16,651
Adjustments to customer deposits (1,883) (5,994)
Adjustments to invested asset carrying values at acquisition date (412) (769)
Amortization of value of insurance in force (5,850) (7,104)
Amortization of interest maintenance reserve (3,090) (3,906)
Adjustments for realized investment gains 3,373 5,313
Adjustments for federal income tax expense (6,516) (4,719)
Investment in subsidiary 9,498 4,833
Adjustment for SBM Life operating results prior to the Acquisition (see Note 1) - 4,604
Other (2,108) 1,274
-------------------------
Net income, GAAP basis $ 30,090 $ 28,052
=========================
</TABLE>
<TABLE>
<CAPTION>
December 31,
1996 1995
-------------------------
(In Thousands)
<S> <C> <C>
Capital and surplus as reported in the accompanying
statutory basis financial statements $ 163,834 $ 146,027
Adjustments to customer deposits (169,041) (167,158)
Adjustments to invested asset carrying values at acquisition date (15,580) (18,541)
Asset valuation reserve and interest maintenance reserve 81,246 82,941
Value of insurance in force 85,352 91,202
Goodwill 6,826 7,090
Deferred policy acquisition costs 54,354 43,318
Net unrealized gains (losses) on available-for-sale securities (9,211) 24,127
Other 8,238 7,127
-------------------------
Shareholder's equity, GAAP basis $ 206,018 $ 216,133
=========================
</TABLE>
13
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
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.
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.
The Company's investment in its insurance subsidiary is reported at the equity
in the underlying statutory basis of National Integrity's net assets. Changes
in the admitted asset carrying amount of the investment are credited or
charged directly to unassigned surplus.
Short-term investments include investments with maturities of less than one
year at the date of acquisition.
Mortgage loans and policy loans are reported at unpaid principal balances.
Realized capital gains and losses are determined using the specific
identification method.
Benefits
Life and annuity reserves are developed by actuarial methods and are determined
based on published tables using statutorily specified interest rates and
valuation methods that will provide, in the aggregate, reserves that are greater
than or equal to the minimum or guaranteed policy cash values or the amounts
required by the Ohio Department of
14
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Insurance. The Company waives deduction of deferred fractional premiums upon the
death of life and annuity policy insureds and does not return any premium beyond
the date of death. Surrender values on policies do not exceed the corresponding
benefit reserve. Policies issued subject to multiple table substandard extra
premiums are valued on the standard reserve basis which recognizes the non-level
incidence of the excess mortality costs. Additional reserves are established
when the results of cash flow testing under various interest rate scenarios
indicate the need for such reserves.
Tabular interest, tabular less actual reserve released, and tabular cost have
been determined by formula as prescribed by the NAIC.
Reinsurance
Reinsurance premiums, benefits and expenses are accounted for on bases
consistent with those used in accounting for the original policies issued and
the terms of the reinsurance contracts. Premiums, benefits and expenses, and the
reserves for policy and contract liabilities are reported net, rather than
gross, of reinsured amounts.
Separate Accounts
Separate accounts assets and liabilities reported in the accompanying balance
sheets represent funds that are separately administered, principally for
variable annuity contracts. Separate accounts 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. Fees charged on separate accounts
policyholder deposits are included in other revenues.
Use of Estimates
The preparation of financial statements in compliance with statutory accounting
practices requires management to make estimates and assumptions that affect
amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.
15
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
1. Organization and Accounting Policies (continued)
Reclassifications
Certain prior year amounts have been reclassified to conform with the
presentation of the 1996 financial statements. These reclassifications resulted
in an immaterial increase in prior year net income and had no effect on
previously reported surplus.
2. Permitted Statutory Accounting Practices
The Company's statutory basis financial statements are prepared in accordance
with accounting practices prescribed or permitted by the Ohio Department of
Insurance. "Prescribed" statutory accounting practices include state laws,
regulations, and general administrative rules, as well as a variety of
publications of the NAIC. "Permitted" statutory accounting practices encompass
all accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. The NAIC 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 effective for 1999, 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. 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, 1996:
U.S. Treasury securities and obligations
of U.S. government agencies $ 226,928 $ 778 $ 1,343 $ 226,363
States and political subdivisions 4,045 121 - 4,166
Foreign governments 39,336 160 296 39,200
Public utilities 120,513 1,204 1,084 120,633
Other corporate securities 626,219 4,111 18,657 611,673
Asset-backed securities 282,903 - - 282,903
Mortgage-backed securities 1,182,448 - 170 1,182,278
-------------------------------------------------------------
Total bonds $2,482,392 $6,374 $21,550 $2,467,216
=============================================================
</TABLE>
<TABLE>
<CAPTION>
Cost or Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair 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
=============================================================
</TABLE>
Fair values are based on published quotations of the Securities Valuation Office
of the NAIC. Fair values generally represent quoted market value prices for
securities traded in
17
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
3. Investments (continued)
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, 1996 and 1995, the fair value of
investments in bonds includes $1,853,618,000 and $646,393,000, 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, 1996, by contractual maturity, is as
follows:
<TABLE>
<CAPTION>
Cost or
Amortized Fair
Cost Value
--------------------------
(In Thousands)
<S> <C> <C>
Years to maturity:
One or less $ 24,891 $ 24,783
After one through five 164,212 160,461
After five through ten 209,202 203,861
After ten 618,737 612,931
Asset-backed securities 282,902 282,902
Mortgage-backed securities 1,182,448 1,182,278
--------------------------
Total $2,482,392 $2,467,216
==========================
</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 1996 and 1995 were
$1,435,801,000 and $912,298,000; gross gains of $26,178,000 and $21,015,000, and
gross losses of $14,430,000 and $10,561,000 were realized on those sales,
respectively.
At December 31, 1996 and 1995, bonds with an admitted asset value of $7,693,000
and $24,192,000, 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)
3. Investments (continued)
Unrealized gains and losses on investment in subsidiary are reported directly in
surplus and do not affect operations. The gross unrealized gains and losses on,
and the cost and fair value of, the investment are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
At December 31, 1996:
Subsidiary $17,823 $30,449 $ - $48,272
=====================================================
At December 31, 1995:
Subsidiary $17,823 $21,316 $ - $39,139
=====================================================
</TABLE>
The Company has made no new investments in mortgage loans during 1996. 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 1996, 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)
3. Investments (continued)
Major categories of the Company's net investment income are summarized as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Income:
Bonds $158,724 $138,791
Preferred stocks 3,626 680
Mortgage loans 3,703 7,140
Real estate 218 118
Policy loans 6,729 6,150
Short-term investments and cash 3,849 3,696
Other investment income 168 911
--------------------
Total investment income 177,017 157,486
Investment expenses (5,206) (5,121)
--------------------
Net investment income $171,811 $152,365
====================
</TABLE>
4. Reinsurance
Consistent with prudent business practices and the general practice of the
insurance industry, the Company reinsures risks under certain of its insurance
products with other insurance companies through reinsurance agreements. Through
these reinsurance agreements, substantially all mortality risks associated with
single premium endowment and variable annuity deposits and substantially all
risks associated with variable life business have been reinsured with non-
affiliated insurance companies. A contingent liability exists with respect to
insurance ceded which would become a liability should the reinsurer be unable to
meet the obligations assumed under these reinsurance agreements.
The Company purchased guaranteed investment contract ("GIC") deposits totaling
$358,339,000 from National Integrity as of June 30, 1996. Beginning April 1,
1996 and
20
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
4. Reinsurance (continued)
through December 31, 1996, the Company assumed $507,934,000 in GIC deposits
through a 50% coinsurance agreement with General American Life Insurance
Company.
The effect of reinsurance on premiums and amounts earned is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Direct premiums and amounts
assessed against policyholders $241,442 $248,906
Reinsurance assumed 521,067 7,497
Reinsurance ceded (16,915) (9,713)
---------------------
Net premiums and amounts earned $745,594 $246,690
=====================
</TABLE>
5. Federal Income Taxes
The Company files a consolidated return with National Integrity. The method of
allocation between the companies is based on separate return calculations after
consolidated losses and credits.
Income before income taxes differs from taxable income principally due to value
of insurance in force, interest maintenance reserves, and differences in policy
and contract liabilities and investment income for tax and financial reporting
purposes.
The current year and prior year tax provisions were calculated including
consolidated net operating loss carryover benefits of $14,164,000 and
$14,084,000, respectively.
The Company had a net operating loss carryforward of approximately $7.0 million
at December 31, 1995 expiring in the years 2005 to 2007. The filing of amended
1993 and 1994 consolidated federal returns generated additional consolidated net
operating losses of $7.2 million, which were fully utilized in the current year
provision.
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
21
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
5. Federal Income Taxes (continued)
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, 1996, the Company's accumulated separate policyholders'
surplus account balance was approximately $1,739,000, which the Company obtained
as a result of the SBM Life merger at December 31, 1995. 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.
6. Surplus
Dividends that ARM may receive from the Company in any year without prior
approval of the Ohio Insurance Director are limited by statute to the greater of
(i) 10% of the Company's statutory capital and surplus as of the preceding
December 31, and (ii) the Company's statutory net income for the preceding year.
The maximum dividend payments that may be made by the Company to ARM during 1997
are $26,042,000.
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, 1996 and 1995, 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)
7. Annuity Reserves
At December 31, 1996 and 1995, the Company's annuity reserves, including
separate accounts, 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, 1996:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $ 121,549 4.0%
At book value less current surrender
charge of 5% or more 263,726 8.7
At market value 543,906 18.1
Total with adjustment or at market --------------------
value 929,181 30.8
Subject to discretionary withdrawal
(without adjustment) at book value
with minimal or no charge or
adjustment 1,520,259 50.5
Not subject to discretionary withdrawal 561,616 18.7
--------------------
Total annuity reserves and deposit
fund liabilities-before reinsurance 3,011,056 100.0%
======
Less reinsurance ceded 44,653
----------
Net annuity reserves and deposit fund
liabilities $2,966,403
==========
</TABLE>
23
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis)(continued)
7. Annuity Reserves (continued)
<TABLE>
<CAPTION>
Amount Percent
--------------------
(In Thousands)
<S> <C> <C>
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
==========
</TABLE>
The Company's insurance and annuity reserves (net of reinsurance) increased in
1996 by 48.2%, from $2,001,550,000 at December 31, 1995 to $2,966,403,000 at
December 31, 1996. Beginning April 1, 1996 and through December 31, 1996, the
Company assumed $507,934,000 in GIC deposits through a 50% coinsurance agreement
and purchased $358,339,000 in GIC deposits from National Integrity as of
June 30, 1996.
8. Separate Accounts
Separate accounts assets and liabilities represent funds segregated for the
benefit of variable annuity, certain fixed annuity and variable life
policyholders who generally bear the investment risk (mutual fund options), or
for certain policyholders who are
24
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
8. Separate Accounts (continued)
guaranteed a fixed rate of return (guaranteed rate options). Assets held in
separate accounts are carried at estimated fair values.
Information regarding the separate accounts of the Company as of and for the
year ended December 31, 1996 is as follows:
<TABLE>
<CAPTION>
Separate Accounts
with Guarantees
-------------------------
Nonindexed Nonguaranteed
Guaranteed Separate
Indexed More than 4% Accounts Total
----------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Premiums, deposits and other
considerations $15,499 $ 57,823 $126,770 $200,092
==========================================================
Reserves for separate accounts with
assets at fair value $13,776 $129,793 $571,880 $715,449
==========================================================
Reserves for separate accounts by
withdrawal characteristics:
Subject to discretionary withdrawal
(with adjustment):
With market value adjustment $ - $121,549 $ - $121,549
At book value without market value
adjustment and with current
surrender charge of 5% or more - 8,244 - 8,244
At market value 183 - 571,880 572,063
----------------------------------------------------------
183 129,793 571,880 701,856
Not subject to discretionary
withdrawal 13,593 - - 13,593
----------------------------------------------------------
Total separate accounts reserves $13,776 $129,793 $571,880 $715,449
==========================================================
</TABLE>
25
<PAGE>
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, 1996 and 1995 is presented below:
<TABLE>
<CAPTION>
1996 1995
-----------------------
(In Thousands)
<S> <C> <C>
Transfers as reported in the Summary of
Operations of the Separate Accounts
Statement:
Transfers to separate accounts $200,092 $129,830
Transfers from separate accounts (71,356) (43,344)
-----------------------
Net transfers to separate accounts 128,736 86,486
Reconciling adjustments:
Mortality and expense charges reported
as other revenues 6,977 4,726
Policy deductions reported as other
revenues 1,857 1,605
-----------------------
Transfers as reported in the Summary of
Operations of the Life, Accident and
Health Annual Statement $137,570 $ 92,817
=======================
</TABLE>
9. Fair Values of Financial Instruments
Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About
Fair Value of Financial Instruments," requires disclosure of fair value
information about all financial instruments, including insurance liabilities
classified as investment contracts, unless specifically exempted. The fair value
of a financial instrument is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced or liquidation sale. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. Accordingly, the aggregate
26
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. 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, 1996 December 31, 1995
-----------------------------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
-----------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Assets:
Bonds $2,482,392 $2,552,022 $1,755,236 $1,797,097
Preferred stocks 42,234 43,550 7,604 8,623
Mortgage loans 32,946 32,946 38,612 38,612
Liabilities:
Life and annuity reserves for
investment-type contracts $2,279,832 $2,297,739 $1,490,606 $1,571,032
Separate accounts annuity reserves 687,292 686,518 485,951 484,406
</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
Pursuant to the terms of ARM's acquisition of the Company, payments of principal
and interest on mortgage loans acquired on November 26, 1993 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.
27
<PAGE>
Integrity Life Insurance Company
Notes to Financial Statements (Statutory Basis) (continued)
9. Fair Values of Financial Instruments (continued)
Life and Annuity Reserves for Investment-Type Contracts
The fair value of single premium immediate annuities is based on discounted
cash flow calculations using a market yield rate for assets with similar
durations. The fair value of the remaining annuities is primarily based on the
cash surrender values of the underlying policies.
Separate Accounts Annuity Reserves
The fair value of separate accounts annuity reserves for investment-type
products equals the cash surrender values.
10. Related Party Transactions
Effective January 1, 1994, the Company entered into an Administrative Services
Agreement with ARM. ARM performs certain administrative and special services for
the Company to assist with its business operations. The services include
policyholder services; accounting, tax and auditing; underwriting; marketing and
product development; functional support services; payroll functions; personnel
functions; administrative support services; and investment functions. During
1996 and 1995, the Company was charged $13,823,000 and $9,691,000, respectively,
for these services in accordance with the requirements of applicable insurance
law and regulations.
In connection with ARM's acquisition of the Company 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
