November 26, 1996
SUPPLEMENT TO
STATEMENT OF ADDITIONAL INFORMATION DATED MAY 1, 1996
FOR GROUP TAX-DEFERRED VARIABLE ANNUITY CONTRACTS
ISSUED THROUGH
THE PRUDENTIAL VARIABLE CONTRACT ACCOUNT-2 ("VCA-2")
On November 22, 1996, persons having voting rights in respect of VCA-2
("Participants") approved two proposals to revise VCA-2's fundamental investment
policies and restrictions. First, Participants approved a proposal to make only
VCA-2's investment objective fundamental, permitting the VCA-2 Committee to make
changes to the policies designed to achieve that objective without Participant
approval. Second, Participants approved a proposal to revise VCA-2's fundamental
investment restrictions (1) to permit VCA-2 to make certain investments and
utilize certain investment techniques designed to meet VCA-2's objective, and
(2) to make the restrictions more consistent with other accounts and funds
managed by Prudential and its affiliates.
These approved changes will be effective on the date of the next revision
of the VCA-2 prospectus and its associated statement of additional information
("SAI"), which is currently expected to be May 1, 1997. This supplement to the
SAI, along with the supplement dated November 26, 1996 to the prospectus ("the
prospectus supplement"), is designed to advise current investors of changes that
will become effective as of that date.
1. Revised Fundamental Investment Restrictions
-------------------------------------------
Effective May 1, 1997, the fundamental investment restrictions set forth on
pages 2-3 will be changed to the following:
In addition to the investment objective described in the prospectus
supplement, the following investment restrictions are fundamental
investment policies of VCA-2 and may not be changed without the approval of
a majority vote of persons having voting rights in respect of the Account.
Concentration in Particular Industries. VCA-2 will not purchase any
security (other than obligations of the U.S. Government, its agencies or
instrumentalities) if as a result: (i) with respect to 75% of VCA-2's total
assets, more than 5% of VCA-2's total assets (determined at the time
<PAGE>
2
of investment) would then be invested in securities of a single issuer, or
(ii) 25% or more of VCA-2's total assets (determined at the time of the
investment) would be invested in a single industry.
Investments in Real Estate-Related Securities. No purchase of or investment
in real estate will be made for the account of VCA-2 except that VCA-2 may
buy and sell securities that are secured by real estate or shares of real
estate investment trusts listed on stock exchanges or reported on the
National Association of Securities Dealers, Inc. automated quotation system
("NASDAQ").
Investments in Financial Futures. No commodities or commodity contracts
will be purchased or sold for the account of VCA-2 except that VCA-2 may
purchase and sell financial futures contracts and related options.
Loans. VCA-2 will not lend money, except that loans of up to 10% of the
value of VCA-2's total assets may be made through the purchase of privately
placed bonds, debentures, notes, and other evidences of indebtedness of a
character customarily acquired by institutional investors that may or may
not be convertible into stock or accompanied by warrants or rights to
acquire stock. Repurchase agreements and the purchase of publicly traded
debt obligations are not considered to be "loans" for this purpose and may
be entered into or purchased by VCA-2 in accordance with its investment
objectives and policies.
Borrowing. VCA-2 will not issue senior securities, borrow money or pledge
its assets, except that VCA-2 may borrow from banks up to 33-1/3 percent of
the value of its total assets (calculated when the loan is made) for
temporary, extraordinary or emergency purposes, for the clearance of
transactions or for investment purposes. VCA-2 may pledge up to 33-1/3
percent of the value of its total assets to secure such borrowing. For
purposes of this restriction, the purchase or sale of securities on a
when-issued or delayed delivery basis, forward foreign currency exchange
contracts and collateral arrangements relating thereto, and collateral
arrangements with resect to interest rate swap transactions, reverse
repurchase agreements, dollar roll transactions, options, futures
contracts, and options thereon are not deemed to be a pledge of assets or
the issuance of a senior security.
Margin. VCA-2 will not purchase securities on margin (but VCA-2 may obtain
such short-term credits as may be necessary for the clearance of
transactions); provided that the deposit or payment by VCA-2 of initial or
maintenance margin
<PAGE>
3
in connection with futures or options is not considered the purchase of a
security on margin.
Underwriting of Securities. VCA-2 will not underwrite the securities of
other issuers, except where VCA-2 may be deemed to be an underwriter for
purposes of certain federal securities laws in connection with the
disposition of portfolio securities and with loans that VCA-2 is permitted
to make.
Control or Management of Other Companies. No securities of any company will
be acquired for VCA-2 for the purpose of exercising control or management
thereof.
2. Non-Fundamental Investment Restrictions
---------------------------------------
Effective May 1, 1997, the following non-fundamental investment
restrictions, which the VCA-2 Committee can change without Participant approval,
will be applicable to VCA-2:
Investments in Other Investment Companies. Except as part of a merger,
consolidation, acquisition or reorganization, VCA-2 will not invest in the
securities of other investment companies in excess of the limits stipulated
by the Investment Company Act of 1940 as amended, and the rules and
regulations thereunder.
Short Sales. VCA-2 will not make short sales of securities or maintain a
short position, except that VCA-2 may make short sales against the box.
Collateral arrangements entered into with respect to options, futures
contracts and forward contracts are not deemed to be short sales.
Collateral arrangements entered into with respect to interest rate swap
agreements are not deemed to be short sales.
Restricted Securities. No more than 15% of the value of the net assets held
in VCA-2 will be invested in securities (including repurchase agreements
and non-negotiable time deposits maturing in more than seven days) that are
subject to legal or contractual restrictions on resale or for which no
readily available market exists, or in the securities of issuers (other
than U.S. Government agencies or instrumentalities) having a record,
together with predecessors, of less than three years' continuous operation.
3. Descriptions of New Investment Instruments and Techniques
---------------------------------------------------------
Effective May 1, 1997, the revisions to VCA-2's investment policies and
restrictions will permit the Account to make certain investments and use certain
investment techniques designed to
<PAGE>
4
meet VCA-2's objective. The following describes these investments and techniques
or expands upon the descriptions provided in the prospectus supplement.
Additional information about financial futures contracts. As described in
the prospectus supplement, effective May 1, 1997, VCA-2 may engage in certain
transactions involving financial futures contracts. This supplement provides
additional information on those instruments and should be read in conjunction
with the prospectus supplement.
A stock index futures contract is an agreement in which the seller of the
contract agrees to deliver to the buyer an amount of cash equal to a specific
dollar amount times the difference between the value of a specific stock index
at the close of the last trading day of the contract and the price at which the
agreement is made. No physical delivery of the underlying stocks in the index is
made. When the futures contract is entered into, each party deposits with a
broker or in a segregated custodial account approximately 5% of the contract
amount, called the "initial margin." Subsequent payments to and from the broker,
called the "variation margin," are made on a daily basis as the underlying
security, index, or rate fluctuates, making the long and short positions in the
futures contracts more or less valuable, a process known as "marking to the
market."
VCA-2's successful use of financial futures contracts will depend upon the
investment adviser's ability to predict the direction of the relevant market.
The correlation between movement in the price of the futures contract and the
price of the securities or currencies being hedged is imperfect. The ability to
close out a futures position depends on a liquid secondary market. There is no
assurance that liquid secondary markets will exist for any particular futures
contract at any particular time.
Additional information about options. As described in the prospectus
supplement, effective May 1, 1997, VCA-2 may engage in certain transactions
involving options. This supplement provides additional information on those
instruments and should be read in conjunction with the prospectus supplement.
Options have other risks, primarily related to liquidity. A position in an
exchange-traded option may be closed out only on an exchange, board of trade or
other trading facility which provides a secondary market for an option of the
same series. Although VCA-2 will generally purchase or write only those
exchange-traded options for which there appears to be an active secondary
market, there is no assurance that a liquid secondary market on an exchange will
exist for any particular option, or at any particular time, and for some options
no secondary market on an exchange or otherwise may exist. In such event it
might not
<PAGE>
5
be possible to effect closing transactions in particular options, with the
result that VCA-2 would have to exercise its options in order to realize any
profit and would incur brokerage commissions upon the exercise of such options
and upon the subsequent disposition of underlying securities acquired through
the exercise of call options or upon the purchase of underlying securities for
the exercise of put options. If VCA-2, as a covered call option writer, were
unable to effect a closing purchase transaction in a secondary market, it would
not be able to sell the underlying security until the option expired or it
delivered the underlying security upon exercise.
Reasons for the absence of a liquid secondary market on an exchange include
the following: (i) there may be insufficient trading interest in options;
(ii) an exchange may impose restrictions on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other restrictions may
be imposed with respect to particular classes or series of options or underlying
securities; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the facilities of an exchange or a clearing
corporation may not at all times be adequate to handle current trading volume;
or (vi) one or more exchanges could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of options (or a
particular class or series of options), in which event the secondary market on
that exchange (or in the class or series of options) would cease to exist,
although outstanding options on that exchange that had been issued by a clearing
corporation as a result of trades on that exchange would continue to be
exercisable in accordance with their terms. There is no assurance that higher
than anticipated trading activity or other unforeseen events might not, at
times, render certain of the facilities of any of the clearing corporations
inadequate, and thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of customers' orders.
The purchase and sale of over-the-counter ("OTC") options will also be
subject to certain liquidity and credit risks. Unlike exchange-traded options,
OTC options generally do not have a continuous liquid market. Consequently,
VCA-2 will generally be able to realize the value of an OTC option it has
purchased only by exercising it or reselling it to the dealer who issued it.
Similarly, when VCA-2 writes an OTC option, it generally will be able to close
out the OTC option prior to its expiration only by entering into a closing
purchase transaction with the dealer to which VCA-2 originally wrote the OTC
option. There can be no assurance that VCA-2 will be able to liquidate an OTC
option at a favorable price at any time prior to expiration. In the event of
insolvency of the other party, VCA-2 may be unable to liquidate an OTC option.
<PAGE>
6
The distinctive characteristics of options on stock indices create certain
risks that are not present with stock options. Index prices may be distorted if
trading of certain stocks included in the index is interrupted. Trading in the
index options also may be interrupted in certain circumstances, such as if
trading were halted in a substantial number of stocks included in the index. If
this occurred, VCA-2 would not be able to close out options which it had
purchased or written and, if restrictions on exercise were imposed, might be
unable to exercise an option it holds, which could result in substantial losses
to the Account. Price movements in VCA-2's equity security holdings probably
will not correlate precisely with movements in the level of the index and,
therefore, in writing a call on a stock index VCA-2 will bear the risk that the
price of the securities held by the Account may not increase as much as the
index. In such event, VCA-2 would bear a loss on the call which is not
completely offset by movement in the price of the Account's equity securities.
It is also possible that the index may rise when VCA-2's securities do not rise
in value. If this occurred, VCA-2 would experience a loss on the call which is
not offset by an increase in the value of its securities holdings and might also
experience a loss in its securities holdings.
VCA-2's successful use of options on foreign currencies will depend upon
the manager's ability to predict the direction of the currency exchange markets
and political conditions, which requires different skills and techniques than
predicting changes in the securities markets generally. In addition, the
correlation between movements in the price of options and the price of
currencies being hedged is imperfect.
Options on futures contracts are subject to additional risks. The writer of
the option is required upon exercise to assume an offsetting futures position (a
short position if the option is a call and long position if the option is a
put). Upon exercise of the option, the assumption of offsetting futures
positions by the writer and holder of the option will be accomplished by
delivery of the accumulated balance in the writer's futures margin account,
which represents the amount by which the market price of the futures contract,
at exercise, exceeds, in the case of a call, or is less than, in the case of a
put, the exercise price of the option on the futures contract. As an alternative
to exercise, the holder or writer of an option may terminate a position by
selling or purchasing an option of the same series. There is no guarantee that
such closing transactions can be effected. There is also a risk of imperfect
correlation between the option and the underlying futures contract. If there
were no liquid secondary market for a particular option on a futures contract,
VCA-2 might have to exercise an option it held in order to realize any profit
and might continue to be obligated under an option it had written until the
option expired or was exercised. If VCA-2 were unable
<PAGE>
7
to close out an option it had written on a futures contract, it would continue
to be required to maintain initial margin and make variation margin payments
with respect to the option position until the option expired or was exercised
against the Account.
Forward foreign currency exchange contracts. A forward foreign currency
exchange contract is a contract obligating one party to purchase and the other
party to sell one currency for another currency at a future date and price.
Effective May 1, 1997, VCA-2 may enter into such contracts in anticipation of or
to protect itself against fluctuations in currency exchange rates.
VCA-2 generally will not enter into a forward contract with a term of
greater than 1 year. At the maturity of a forward contract, VCA-2 may either
sell the security and make delivery of the foreign currency or it may retain the
security and terminate its contractual obligation to deliver the foreign
currency by purchasing an "offsetting" contract with the same currency trader
obligating it to purchase, on the same maturity date, the same amount of the
foreign currency.
VCA-2's successful use of forward contracts will depend upon the manager's
ability to predict the direction of currency exchange markets and political
conditions, which requires different skills and techniques than predicting
changes in markets generally.
Interest rate swap transactions. Effective May 1, 1997, VCA-2 may enter
into interest rate swap transactions. Interest rate swaps, in their most basic
form, involve the exchange by one party with another party of their respective
commitments to pay or receive interest. For example, VCA-2 might exchange its
right to receive certain floating rate payments in exchange for another party's
right to receive fixed rate payments. Interest rate swaps can take a variety of
other forms, such as agreements to pay the net differences between two different
indices or rates, even if the parties do not own the underlying instruments.
Despite their differences in form, the function of interest rate swaps is
generally the same -- to increase or decrease exposure to long- or short-term
interest rates. For example, VCA-2 may enter into a swap transaction to preserve
a return or spread on a particular investment or a portion of its portfolio or
to protect against any increase in the price of securities the Account
anticipates purchasing at a later date. VCA-2 will maintain appropriate liquid
assets in a segregated custodial account to cover its obligations under swap
agreements.
The use of swap agreements is subject to certain risks. As with options and
futures, if the investment adviser's prediction of interest rate movements is
incorrect, VCA-2's total return will be less than if the Account had not used
swaps. In
<PAGE>
8
addition, if the counterparty's creditworthiness declines, the value of the swap
would likely decline. Moreover, there is no guarantee that VCA-2 could eliminate
its exposure under an outstanding swap agreement by entering into an offsetting
swap agreement with the same or another party.
Real estate-related securities. Effective May 1, 1997, VCA-2 may invest in
securities secured by real estate or shares of real estate investment trusts
that are listed on a stock exchange or reported on the National Association of
Securities Dealers, Inc. automated quotation system ("NASDAQ"). Such securities
may be sensitive to factors such as real estate values and property taxes,
interest rates, cash flow of underlying real estate assets, overbuilding, and
the management skill and creditworthiness of the issuer. They may also be
affected by tax and regulatory requirements, such as those relating to the
environment.
When-issued and delayed delivery securities. Effective May 1, 1997, VCA-2
may, from time to time and in the ordinary course of business, purchase or sell
securities on a when-issued or delayed delivery basis, that is, delivery and
payment can take place a month or more after the date of the transaction. If
VCA-2 were to dispose of the right to acquire a security it could, as with the
disposition of any security, incur a gain or loss due to market fluctuations.
Reverse repurchase agreements and dollar roll transactions. Effective May
1, 1997, VCA-2 may enter into reverse repurchase agreements and dollar roll
transactions. Reverse repurchase agreements involve the sale of securities held
by VCA-2 with an agreement by the Account to repurchase the same securities at
an agreed upon price and date. During the reverse repurchase period, VCA-2 often
will continue to receive principal and interest payments on the sold securities.
The terms of each agreement reflect a rate of interest for use of the funds for
the period, and thus these agreements have some of the characteristics of
borrowing by VCA-2.
Dollar rolls involve sales of securities for delivery in the current month
with a simultaneous contract to repurchase substantially similar securities
(same type and coupon) from the same party at an agreed upon price and date.
During the roll period, the seller forgoes principal and interest paid on the
securities. The seller is compensated by the difference between the current
sales price and the forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale. A "covered roll" is a specific type of dollar roll for which there
is an offsetting cash position or a cash equivalent security position which
matures on or before the forward settlement date
<PAGE>
9
of the dollar roll transaction. VCA-2 will establish a segregated account with
its custodian in which it will maintain cash, U.S. Government securities or
other liquid high-grade debt obligations equal in value to its obligations in
respect of reverse repurchase agreements and dollar rolls.
Reverse repurchase agreements and dollar rolls involve the risk that the
market value of the securities retained by VCA-2 may decline below the price of
the securities the Account has sold but is obligated to repurchase under the
agreement. In the event the buyer of securities under a reverse repurchase
agreement or dollar roll files for bankruptcy or becomes insolvent, VCA-2's use
of the proceeds of the agreement may be restricted pending a determination by
the other party, or its trustee or receiver, whether to enforce the Account's
obligation to repurchase the securities.
Short sales against the box. Effective May 1, 1997, VCA-2 may make short
sales of securities or maintain a short position, provided that at all times
when a short position is open, the Account owns an equal amount of the
securities sold short or securities convertible into or exchangeable, with or
without payment of any further consideration, for securities of the same issue
as, and equal in amount to, the securities sold short (a "short sale against the
box"); provided, that if further consideration is required in connection with
the conversion or exchange, cash or U.S. Government securities in an amount
equal to such consideration will be put in a segregated account.
4. Members of the Committee
------------------------
The following supplements the list of Members of the VCA-2 Committee on
page 6.
On November 22, 1996, VCA-2 Participants elected Mendel A. Melzer and
Jonathan M. Greene to serve as Members of the Committee. Mark Fetting, who was
Chairman and a Member of the Committee, and James Scott, who was a Member of the
Committee, resigned. The VCA-2 Committee has elected Mr. Melzer as Chairman and
appointed Mr. Greene as President.
Mr. Melzer served as Chief Financial Officer of Prudential's Money
Management Group since 1995, and currently is the Chief Investment Officer of
Prudential Mutual Funds. From 1993 to 1995, he served as Senior Vice President
and Chief Financial Officer of Prudential Preferred Financial Services. Prior to
1993, he served as Managing Director of Prudential Investment Corporation.
Mr. Greene has served as President of Investment Management of Prudential
Investments since March 1996. Prior
<PAGE>
10
thereto, he served as a Vice President and Portfolio Manager for T. Rowe Price
Associates, Inc.
Mr. Melzer and Mr. Greene are interested persons of Prudential, its
affiliates, or VCA-2, as defined in the 1940 Act and described on page 6 of
the SAI.
