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KEMPER SELECT
PROSPECTUS
May 1, 1995
This prospectus does not constitute an offer to
sell or a solicitation of an offer to buy securities
in any state, to any person, to whom it is not lawful
to make such an offer in such state.
A Variable Life Product Offered by
Kemper Investors Life Insurance Company
[KEMPER LOGO]
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PROSPECTUS--MAY 1, 1995
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VARIABLE LIFE INSURANCE POLICY
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ISSUED BY
KEMPER INVESTORS LIFE INSURANCE COMPANY
THROUGH ITS KILICO VARIABLE SEPARATE ACCOUNT
HOME OFFICE: 1 KEMPER DRIVE, LONG GROVE, ILLINOIS 60049 (708) 320-4500
This Prospectus describes a variable life insurance policy (the "Policy")
issued by Kemper Investors Life Insurance Company ("KILICO"). The Policy
provides for life insurance and for the accumulation of Cash Value on a variable
basis. The Death Benefit and Cash Value of the Policy may vary to reflect the
investment experience of the KILICO Variable Separate Account (the "Separate
Account").
The Policy is designed to permit the payment of a large initial premium
and, subject to certain restrictions, additional premiums. As designed, the
Policy operates substantially as a single premium policy, providing for an
initial premium payment of at least eighty percent of guideline single premiums,
as defined under Section 7702 of the Internal Revenue Code. This Policy, as
currently offered, is classified as a modified endowment contract for tax
purposes and, as such, distributions during the life of the Insured would be
taxed in a manner similar to an annuity. The minimum initial premium KILICO will
accept is $5,000. An Owner may allocate premiums and Separate Account Value
under a Policy to one or more of the Subaccounts of the Separate Account. Each
Subaccount invests in one of the following portfolios of the Kemper Investors
Fund (the "Fund"): Money Market, Total Return, High Yield, Equity and Government
Securities. The International and Small Capitalization Equity Portfolios of the
Fund are not currently available for investment through the Separate Account.
The Fund is managed by Kemper Financial Services, Inc. The accompanying
Prospectus for the Fund describes the investment objectives and the attendant
risks of the portfolios of the Fund.
Until the Trade Date, the initial premium is held in KILICO's General
Account. The initial premium will be credited with interest equivalent to the
investment experience, less additional applicable charges, of the KILICO Money
Market Subaccount, from the later of the day following the date of receipt or
the Policy Date. On the Trade Date, the initial premium and any credited
investment return will be allocated to the KILICO Money Market Subaccount, and
15 days after the Trade Date, to one or more of the Subaccounts as specified in
the Owner's application.
KILICO guarantees that the Death Benefit payable for a Policy will never be
less than the Death Benefit stated on the Policy Schedule page, less Debt, as
long as the Policy is in force. There is no guaranteed Cash Value. If the
Surrender Value is insufficient to cover the charges under the Policy, the
Policy will lapse.
See "Federal Tax Matters", page 17 for a discussion of laws that affect the
tax treatment of the Policy.
The Owner may examine the Policy and return it to KILICO for a refund
during the Free-Look Period.
It may not be advantageous to purchase a Policy as a replacement for
another type of life insurance policy, or to obtain additional insurance
protection if a flexible premium variable life insurance policy is already
owned.
THIS PROSPECTUS IS VALID ONLY IF ACCOMPANIED OR PRECEDED
BY A CURRENT PROSPECTUS FOR THE KEMPER INVESTORS FUND. ALL
PROSPECTUSES SHOULD BE READ AND RETAINED FOR FUTURE
REFERENCE.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION, NOR HAS THE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
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TABLE OF CONTENTS
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DEFINITIONS................................................................................. 1
SUMMARY..................................................................................... 2
KILICO AND THE SEPARATE ACCOUNT............................................................. 4
THE FUND.................................................................................... 5
THE POLICY.................................................................................. 7
POLICY BENEFITS AND RIGHTS.................................................................. 9
CHARGES AND DEDUCTIONS...................................................................... 13
GENERAL PROVISIONS.......................................................................... 14
DISTRIBUTION OF POLICIES.................................................................... 17
FEDERAL TAX MATTERS......................................................................... 17
LEGAL CONSIDERATIONS........................................................................ 19
SAFEKEEPING OF THE SEPARATE ACCOUNT'S ASSETS................................................ 19
VOTING RIGHTS............................................................................... 19
STATE REGULATION OF KILICO.................................................................. 19
DIRECTORS AND OFFICERS OF KILICO............................................................ 20
LEGAL MATTERS............................................................................... 21
LEGAL PROCEEDINGS........................................................................... 21
EXPERTS..................................................................................... 22
REGISTRATION STATEMENT...................................................................... 22
FINANCIAL STATEMENTS........................................................................ 22
APPENDIX.................................................................................... 55
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DEFINITIONS
ACCUMULATION UNIT--An accounting unit of measure used to calculate the
value of each Subaccount.
AGE--The Insured's age on his or her last birthday.
BENEFICIARY--The person to whom the proceeds due on the Insured's death are
paid.
CASH VALUE--The sum of the value of Policy assets in the Separate Account
and any associated value in the General Account.
DATE OF RECEIPT--Date of receipt means the valuation date during which a
request, form or payment is received at KILICO's Home Office. KILICO is deemed
to have received any request, form or payment on the date it is actually
received at the Home Office, provided that it is received before the close of
the New York Stock Exchange (which is normally 3:00 p.m. Long Grove time) on any
date when the New York Stock Exchange is open. Otherwise, it will be deemed to
be received on the next such day.
DEBT--Debt means (1) the principal of any outstanding loan, plus (2) any
loan interest due or accrued to KILICO.
FREE-LOOK PERIOD--The period of time in which an Owner may cancel the
Policy and receive a refund. In most states, an Owner may cancel the Policy
within 10 days of the date it is received by the Owner. The applicable period of
time will depend on the state in which the Policy is issued; however, it will be
at least 10 days from the date the Policy is received by the Owner.
FUND--The Kemper Investors Fund, an open-end diversified investment company
in which the Subaccounts of the Separate Account invest.
GENERAL ACCOUNT--The assets of KILICO other than those allocated to the
Separate Account or any other separate account.
GUIDELINE SINGLE PREMIUM--Guideline Single Premium is the maximum initial
amount of premium that can be paid while retaining qualification as a life
insurance policy under the Internal Revenue Code.
INSURANCE AGE--The Insurance Age is the Age of the Insured on the first day
of any Policy Year. If the first day of a Policy Year falls on the Insured's
birthday, the Age attained on such date is the Insurance Age.
INSURED--The person whose life is covered by the Policy and who is named on
the Policy Schedule.
MATURITY DATE--The Policy Date anniversary coinciding with or next
following the Insured's 95th birthday.
MONTHLY PROCESSING DATE--The same day in each month as the Policy Date.
MORTALITY AND EXPENSE RISK CHARGE--The mortality and expense risk charge is
a charge deducted in the calculation of the Accumulation Unit Value for the
assumption of mortality risks and expense guarantees.
POLICY DATE--The date shown in the Policy Schedule. The Policy Date is the
date used to determine Policy Years and Monthly Processing Dates. The Policy
Date will be the date following receipt of the application, except that if such
date is the 29th, 30th, or 31st of a month, the Policy Date will be the first of
the following month.
POLICY YEAR--Each year commencing with the Policy Date and each Policy Date
anniversary thereafter.
SEPARATE ACCOUNT VALUE--The portion of the Cash Value in the Subaccount(s)
of the Separate Account.
SUBACCOUNT--The subdivisions of the Separate Account.
SURRENDER VALUE--The surrender value of a Policy is (1) the Cash Value
minus (2) any applicable Surrender Charge; minus (3) any Debt.
TRADE DATE--The Trade Date is stated in the Policy Schedule. It is the date
on which the initial premium and any credited investment experience, less
additional applicable charges, are allocated to the KILICO Money Market
Subaccount. The Trade Date is the date when KILICO accepts the risk of providing
insurance coverage to the Insured.
VALUATION DATE--Each business day on which valuation of the assets of the
Separate Account is required by applicable law, which currently is each day that
the New York Stock Exchange is open for trading.
VALUATION PERIOD--The period that starts at the close of a Valuation Date
and ends at the close of the next succeeding Valuation Date.
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SUMMARY
The following summary should be read in conjunction with the detailed
information in this prospectus. You should refer to the heading "Definitions"
for the meaning of certain terms. A Policy entered into on or after June 21,
1988 is considered a modified endowment contract. Further, a Policy entered into
before June 21, 1988 may, in certain circumstances, be considered a modified
endowment contract. For a Policy treated as a modified endowment contract,
certain assignments, loans and surrenders will be considered received by the
Owner and are included in the Owner's Federal gross income to the extent that
the Cash Value exceeds the Owner's investment in the Policy. Subject to
specified exceptions, the portion of any amount considered received by the Owner
that is includible in gross income is subject to an additional 10 percent tax.
(See "Federal Tax Matters," at page 17.) Variations from the information
appearing in this prospectus due to individual state requirements are described
in supplements which are attached to this Prospectus, or in endorsements to the
Policy, as appropriate. Unless otherwise indicated the description of the Policy
contained in this prospectus assumes that the Policy is in force, that there is
no indebtedness, that the current Death Benefit is required to be adjusted
through multiplication of the Cash Value by the Death Benefit Factor, and that
current Federal tax laws apply.
The Owner of a Policy pays a premium for life insurance coverage on the
person insured. The Policy provides for a Surrender Value which is payable if
the Policy is terminated during an Insured's lifetime. The Death Benefit and
Cash Value of the Policy may increase or decrease to reflect the investment
experience of the Subaccounts of the Separate Account to which premiums are
allocated. There is no guaranteed Cash Value. If the Surrender Value is
insufficient to pay charges under the Policy, the Policy will lapse unless an
additional premium payment or loan repayment is made. (See "The Policy--Premiums
and Allocation of Premiums and Separate Account Value," pages 7 and 8, "Charges
and Deductions," page 13, and "Policy Benefits and Rights," page 9.)
The purpose of the Policy is to provide insurance protection for the
beneficiary named therein. No claim is made that the Policy is in any way
similar or comparable to a systematic investment plan of a mutual fund.
POLICY BENEFITS
Cash Value. The Policy provides for a Cash Value. The Cash Value will
reflect the amount and frequency of premium payments, the investment experience
of the selected Subaccounts of the Separate Account, any values in the General
Account, and charges imposed in connection with the Policy. The entire
investment risk is borne by the Owner. KILICO does not guarantee a minimum
Separate Account Value. (See "Policy Benefits and Rights--Cash Value," page 10.)
The Owner may surrender a Policy at any time and receive the Surrender
Value, which equals the Cash Value less any applicable surrender charge and
outstanding Debt. (See "Policy Benefits and Rights--Surrender Privilege," page
13.)
Policy Loans. The Owner may borrow up to 90% of the Policy's Cash Value
minus applicable surrender charges, subject to the requirements of the Internal
Revenue Code. The minimum amount of a loan is $500. Interest at an effective
annual rate of 6.00% will be charged on outstanding loan amounts. (See "Federal
Tax Matters," page 17.)
When a loan is made, a portion of the Policy's Cash Value equal to the
amount of the loan will be transferred from the Separate Account
(proportionately from the Subaccounts, unless the Owner requests otherwise) to
KILICO's General Account. Cash Values within the General Account attributable to
premium will earn no less than 4.00% annual interest. That portion of the Cash
Values within the General Account attributable to amounts in excess of premium
will earn 6.00% annual interest. Such earnings will be allocated to the General
Account. (See "Policy Benefits and Rights--Policy Loans," page 12.)
Death Benefits. As long as the Policy remains in force, the Policy provides
a death benefit payment upon the death of the Insured. The death benefit is the
greater of the Death Benefit stated on the Policy Schedule, or a specified
multiple of the Cash Value. The Death Benefit stated on the Policy Schedule may
not be increased unless Cash Value times the Death Benefit Factor is at least
equal to the Death Benefit stated on the Policy Schedule. The death benefit
payable will be reduced by any Debt. (See "Policy
Benefits and Rights--Death Benefits," page 9.)
PREMIUMS
The minimum initial premium that may be paid under the Policy is $5,000.
The application for the Policy must accompany or precede the full minimum
initial premium. Subject to premium guidelines
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established under Federal tax law, additional premiums may be paid while the
Policy is in force, including when necessary to prevent lapse. (See "The
Policy--Premiums," page 7 and "Federal Tax Matters," page 17.)
THE SEPARATE ACCOUNT
Allocation of Premiums. The portion of the premium available for allocation
equals the premium paid. An Owner indicates in the application for the Policy
the percentages of premium to be allocated among the Subaccounts of the Separate
Account. The Separate Account currently consists of five Subaccounts, each of
which invests in shares of a designated portfolio of the Fund. The Fund is
managed by Kemper Financial Services, Inc., an affiliate of KILICO.
On the day following the date of receipt, the initial premium will be
allocated to the KILICO General Account. It will be credited with interest
equivalent to the investment experience of the Money Market Subaccount from the
later of the day following the date of receipt or the Policy Date. On the Trade
Date, such amount in the KILICO General Account will be allocated to the Money
Market Subaccount. Additional applicable charges which are currently the charge
for the cost of insurance will be deducted as of the Policy Date. On the Trade
Date, the Policy's Cash Value will thus be the same as if the initial premium
had been allocated to the Money Market Subaccount on the Policy Date. Fifteen
days from the Trade Date, the Separate Account Value in the Money Market
Subaccount will be allocated among the Subaccounts in accordance with the
Owner's instructions in the application. (See "Policy Issue," page 7.)
Transfers. An Owner may transfer Separate Account Value among the
Subaccounts. One transfer of all or part of the Separate Account Value may be
made within a fifteen day period. (See "Allocation of Premiums and Separate
Account Value--Transfers," page 8.)
THE FUND
The following portfolios of the Kemper Investors Fund are currently
available for investment by the Separate Account:
Money Market Portfolio, which seeks to provide maximum current income to
the extent consistent with stability of principal by investing exclusively in
debt securities maturing in 12 months or less.
Total Return Portfolio, which seeks to obtain a high total return, a
combination of income and capital appreciation, by investing in a combination of
debt securities and common stocks.
High Yield Portfolio, which seeks to provide a high level of current income
by investing in fixed-income securities.
Equity Portfolio, which seeks to provide maximum appreciation of capital
through diversification of investment securities having potential for capital
appreciation.
Government Securities Portfolio, which seeks high current return consistent
with preservation of capital from a portfolio composed primarily of U.S.
Government securities.
For a more detailed description of the Fund, see "KILICO and the Separate
Account--the Fund," page 5, the Fund prospectus, and Statement of Additional
Information available upon request.
CHARGES
Deductions will be made from the Policy's value in each Subaccount on the
Policy Date and on each Monthly Processing Date for the cost of insurance
charge. In addition, deductions will be imposed on the Policy's value in each
Subaccount on a daily basis for the assumption by KILICO of certain mortality
and expense risks incurred in connection with the Policy, at an annual rate of
.90%. (See "Charges and Deductions--Mortality and Expense Risk Charge," page
14.)
No sales charge is deducted from any premium payment. However, if the
Policy is surrendered or if the Cash Value is applied under a Settlement Option,
a Surrender Charge on the lesser of premium paid in the first Policy Year or
Cash Value under the Policy will be deducted from the amount payable. The
Surrender Charge starts at 9% in the first Policy Year and reduces by 1% each
Policy Year so that there is no charge in the tenth and later Policy Years.
Subject to other considerations, the Owner may decide to reduce the potential
Surrender Charge by paying less initial premium. (See "Policy Benefits and
Rights--Surrender Privilege," page 13.)
No charges are currently made from the Separate Account for Federal, state
or other taxes. Should KILICO determine that such taxes may be imposed, it may
make deductions from the Separate Account to pay those taxes. (See "Federal Tax
Matters," page 17.)
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In addition, the Subaccounts of the Separate Account purchase shares of the
Fund. For fees and expenses of the Fund, see the prospectus for the Fund.
TAX TREATMENT UNDER CURRENT FEDERAL TAX LAW
The Cash Value, while it remains in the Policy, and the Death Benefit
should be subject to the same Federal income tax treatment as the cash value
under a conventional fixed benefit life insurance policy. Under existing tax
law, the Owner is generally not deemed to be in constructive receipt of the Cash
Value under a Policy until a distribution occurs through a loan or surrender. A
change of Owners, an assignment, a loan or a surrender of the Policy generally
will have tax consequences.
Death Benefits payable under the Policy should be completely excludable
from the gross income of the Beneficiary. As a result, the Beneficiary generally
will not be subject to income tax on the Death Benefit. (See "Federal Tax
Matters," page 17.)
FREE-LOOK PERIOD AND EXCHANGE RIGHTS
The Owner is granted a period of time to examine a Policy and return it for
a refund. The applicable period of time will depend on the state in which the
Policy is issued; however, it will be at least 10 days from the date the Policy
is received by the Owner. (See "Policy Benefits and Rights--Free-Look Period and
Exchange Rights," page 13.)
The Owner may, while the Policy is in force, exchange it at any time after
its issue, for a non-variable permanent fixed benefit life insurance policy then
currently being offered by KILICO on the life of the Insured. Such policy would
be treated and taxed as a modified endowment contract. No evidence of
insurability will be required. During the first two years after the Policy Trade
Date, the amount of the new policy may be, at the election of the Owner, either
the initial Death Benefit or the same net amount at risk as the Policy on the
exchange date. After two years from the Policy Trade Date, the amount of the new
policy will be for the same net amount at risk as the Policy on the exchange
data. All Debt under the Policy must be repaid and the surrender of the Policy
is required before the exchange is made. The policy date and issue age will be
the same as existed under the Policy.
ILLUSTRATIONS OF SEPARATE ACCOUNT VALUES
SURRENDER VALUES AND DEATH BENEFITS
Tables in the Appendix illustrate the Separate Account Values, Surrender
Values and Death Benefits based upon certain hypothetical assumed rates of
return for the Separate Account and the charges deducted under the Policy.
KILICO AND THE SEPARATE ACCOUNT
KEMPER INVESTORS LIFE INSURANCE COMPANY
Kemper Investors Life Insurance Company ("KILICO") is a stock life
insurance company organized under the laws of the State of Illinois. KILICO was
originally organized in 1947. KILICO is a wholly-owned subsidiary of Kemper
Financial Companies, Inc. ("KFC"), a nonoperating holding company. KFC is a
subsidiary of Kemper Corporation ("Kemper"), another public financial services
holding company. KILICO offers life insurance and annuity products and is
admitted to do business in the District of Columbia and in all states except New
York.
On April 11, 1995, Kemper and an investor group comprised of Zurich
Insurance Company ("Zurich") and Insurance Partners, L.P. and Insurance Partners
Offshore (Bermuda), L.P. announced that they reached an agreement in principle
pursuant to which Kemper, including KILICO, would be acquired in a merger
transaction. Following the transaction, Zurich, or an affiliate, indirectly
would be the majority owner of Kemper, including KILICO. A definitive agreement
is expected in early May, subject to the completion of the investor group's due
diligence. Consummation of the transaction is subject to, among other things,
stockholder and regulatory approvals. The transaction is expected to close early
in the fourth quarter of 1995.
KILICO Variable Separate Account (the "Separate Account") was established
by KILICO as a separate investment account on January 22, 1987. The Separate
Account will receive and invest the premiums under the Policy. In addition, the
Separate Account may receive and invest premiums for other variable life
insurance policies issued by KILICO.
The Separate Account is administered and accounted for as part of the
general business of KILICO, but the income, capital gains or capital losses of
the Separate Account are credited to or charged against the assets held in the
Separate Account, without regard to any other income, capital gains or capital
losses of
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any other separate account or arising out of any other business which KILICO may
conduct. The benefits provided under the Policy are obligations of KILICO.
The Separate Account is currently divided into five Subaccounts. Each
Subaccount invests exclusively in shares of one of the portfolios of the Fund.
Income and both realized and unrealized gains or losses from the assets of each
Subaccount generally are credited to or charged against that Subaccount without
regard to income, gains or losses from any other Subaccount of the Separate
Account or arising out of any business KILICO may conduct.
The Separate Account has been registered with the Securities and Exchange
Commission ("Commission") as a unit investment trust under the Investment
Company Act of 1940 (the "1940 Act"). Such registration does not involve
supervision by the Commission of the management, investment practices or
policies of the Separate Account or KILICO.
THE FUND
The Separate Account invests in shares of the Kemper Investors Fund, a
series type mutual fund registered with the Commission as an open-end,
diversified management investment company. Registration of the Fund does not
involve supervision of its management, investment practices or policies by the
Commission. The Fund is designed to provide an investment vehicle for variable
life insurance and variable annuity contracts. Shares of the Fund are sold only
to insurance company separate accounts. In addition to the Separate Account,
shares of the Fund may be sold to variable life insurance and variable annuity
separate accounts of insurance companies not affiliated with KILICO. It is
conceivable that in the future it may be disadvantageous for variable life
insurance separate accounts of companies unaffiliated with KILICO, or for both
variable life insurance separate accounts and variable annuity separate
accounts, to invest simultaneously in the Fund. Currently neither KILICO nor the
Fund foresees any such disadvantages to either variable life insurance or
variable annuity owners. Management of the Fund has an obligation to monitor
events to identify material conflicts between such owners and determine what
action, if any, should be taken. In addition, if KILICO believes that the Fund's
response to any of those events or conflicts insufficiently protects the Owners,
it will take appropriate action on its own.
The Separate Account invests in the following Portfolios of the Fund: Money
Market Portfolio, Total Return Portfolio, High Yield Portfolio, Equity Portfolio
and Government Securities Portfolio. The International and Small Capitalization
Equity Portfolios of the Fund are not currently available for investment through
the Separate Account. The assets of each Portfolio are held separate from the
assets of the other Portfolios, and each Portfolio has its own distinct
investment objective and policies. Each Portfolio operates as a separate
investment fund, and the income or losses of one Portfolio generally have no
effect on the investment performance of any other Portfolio.
The investment objectives and policies of the Fund's portfolios in which
the Separate Account invests are summarized below:
Money Market Portfolio: This Portfolio seeks to provide maximum current
income to the extent consistent with stability of principal. It will maintain a
dollar weighted average portfolio maturity of 90 days or less. This Portfolio
pursues its objective of maximum income and stability of principal by investing
in money market securities such as U.S. Treasury obligations, commercial paper,
and certificates of deposit and bankers' acceptances of domestic and foreign
banks, including foreign branches of domestic banks, and will enter into
repurchase agreements.
Total Return Portfolio: This Portfolio seeks a high total return, a
combination of income and capital appreciation, by investing in a combination of
debt securities and common stocks. The Portfolio's investments will normally
consist of fixed-income and equity securities. Fixed-income securities will
include bonds and other debt securities and preferred stocks, some of which may
have a call on common stocks through attached warrants or a conversion
privilege. Equity investments normally will consist of common stocks and
securities convertible into or exchangeable for common stocks; however the
Portfolio may also make private placement investments (which are normally
restricted securities).
High Yield Portfolio: This Portfolio seeks to provide a high level of
current income by investing in fixed-income securities. It invests in U.S.
Government, corporate, and other notes and bonds paying high current income.
Equity Portfolio: This Portfolio seeks maximum appreciation of capital
through diversification of investment securities having potential for capital
appreciation. Current income will not be a significant factor. This Portfolio's
investments normally will consist of common stocks and securities convertible
into or
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exchangeable for common stocks; however, it may also make private placement
investments (which are normally restricted securities).
Government Securities Portfolio: This Portfolio seeks high current return
consistent with preservation of capital from a portfolio composed primarily of
U.S. Government securities. The Portfolio will also invest in fixed-income
securities other than U.S. Government securities, and will engage in options and
financial futures transactions. The Portfolio may purchase or sell portfolio
securities on a when-issued or delayed delivery basis. The Portfolio's current
return is sought from interest income and net short-term gains on securities and
options and futures transactions. There are two broad categories of U.S.
Government securities: (1) direct obligations of the U.S. Treasury and (2)
obligations issued or guaranteed by agencies and instrumentalities of the United
States. Some obligations issued or guaranteed by agencies or instrumentalities
are backed by the full faith and credit of the United States (such as Government
National Mortgage Association "GNMA" Certificates) and others are backed
exclusively by an agency or instrumentality with limited rights of the issuer to
borrow from the U.S. Treasury (such as Federal National Mortgage Association
Bonds). U.S. Government securities may include "zero coupon" securities that
have been stripped by the U.S. Government of their unmatured interest coupons
and collateralized obligations issued or guaranteed by a U.S. Government agency.
There is no assurance that any of the Portfolios of the Fund will achieve
its stated objective. More detailed information, including a description of
risks involved in investing in each of the Portfolios, may be found in the
prospectus for the Fund, which must accompany or precede this Prospectus, and
the Fund's Statement of Additional Information available upon request from
Kemper Investors Life Insurance Company, 1 Kemper Drive, Long Grove, Illinois
60049.
Kemper Financial Services, Inc., an affiliate of KILICO, ("KFS" or the
"Adviser") is the investment adviser to the Fund and manages its daily
investments and business affairs, subject to the policies established by the
trustees of the Fund. For its advisory services to the Portfolios, the Adviser
receives compensation monthly at annual rates equal to .50 of 1%, .55 of 1%, .60
of 1%, .60 of 1% and .55 of 1% of the average daily net asset values of the
Money Market Portfolio, the Total Return Portfolio, the High Yield Portfolio,
the Equity Portfolio, and the Government Securities Portfolio, respectively.
CHANGE OF INVESTMENTS
KILICO reserves the right, subject to applicable law, to make additions to,
deletions from, or substitutions for the shares held by the Separate Account or
that the Separate Account may purchase. KILICO reserves the right to eliminate
the shares of any of the portfolios of the Fund and to substitute shares of
another portfolio of the Fund or of another investment company, if the shares of
a portfolio are no longer available for investment, or if in its judgment
further investment in any portfolio becomes inappropriate in view of the
purposes of the Separate Account. KILICO will not substitute any shares
attributable to an Owner's interest in a Subaccount of the Separate Account
without notice to the Owner and prior approval of the Commission, to the extent
required by the 1940 Act or other applicable law. Nothing contained in this
Prospectus shall prevent the Separate Account from purchasing other securities
for other series or classes of policies, or from permitting a conversion between
series or classes of policies on the basis of requests made by Owners.
KILICO also reserves the right to establish additional subaccounts of the
Separate Account, each of which would invest in a new portfolio of the Fund, or
in shares of another investment company, with a specified investment objective.
New subaccounts may be established when, in the sole discretion of KILICO,
marketing needs or investment conditions warrant, and any new subaccounts may be
made available to existing Owners as determined by KILICO. KILICO may also
eliminate or combine one or more subaccounts, transfer assets, or it may
substitute one subaccount for another subaccount, if, in its sole discretion,
marketing, tax or investment conditions warrant. KILICO will notify all Owners
of any such changes.
If deemed by KILICO to be in the best interests of persons having voting
rights under the Policy, the Separate Account may be: (a) operated as a
management company under the 1940 Act; (b) deregistered under that Act in the
event such registration is no longer required; or (c) combined with other KILICO
separate accounts. To the extent permitted by law, KILICO may also transfer the
assets of the Separate Account associated with the Policy to another separate
account, or to the General Account.
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THE POLICY
POLICY ISSUE
Before KILICO will issue a Policy, it must receive a completed application
and a full initial premium at its Home Office. A Policy ordinarily will be
issued only for Insureds Age 0 through 75 who supply satisfactory evidence of
insurability to KILICO. Acceptance of an application is subject to underwriting
by KILICO. KILICO reserves the right to decline an application for any reason.
After underwriting is complete and the Policy is delivered to the Owner,
insurance coverage under the Policy will be deemed to have begun as of the day
following the date of receipt of a completed application and the full initial
premium. (See "Premiums," below.) This date is the Policy Date.
PREMIUMS
Premiums are to be paid to KILICO at its Home Office. (See "Distribution of
Policies.") Checks ordinarily must be made payable to KILICO.
Initial Premium. The minimum initial premium that KILICO will accept under
a Policy is $5,000. KILICO reserves the right to increase or decrease this
amount for a class of Policies issued after some future date.
For a given initial premium, the minimum death benefit will depend upon the
Insurance Age, sex, and rate class of the Insured. The minimum death benefit for
a given initial premium will be consistent with the assumptions for the
Guideline Single Premium calculated under section 7702 of the Internal Revenue
Code (the "Code"). (See "Federal Tax Matters.")
The initial premium will be allocated to the KILICO General Account. It
will be credited with interest equivalent to the investment experience of the
Money Market Subaccount. This premium will remain in the KILICO General Account
until the Trade Date. On the Trade Date, the initial premium, plus interest,
will be allocated to the Money Market Subaccount. Additional applicable charges,
including the charge for the cost of insurance, will be deducted as of the
Policy Date. On the Trade Date, the Policy Cash Value will thus be the same as
if the initial premium had been allocated to the Money Market Subaccount on the
Policy Date. The Separate Account Value will remain in the Money Market
Subaccount until 15 days from the Trade Date of the Policy. At the end of the 15
day period, the Separate Account Value in the Money Market Subaccount will be
allocated to the Subaccounts elected by the Owner in the application for the
Policy.
The Policy Date is the date used to determine Policy Years and Monthly
Processing Dates. The Policy Date will be the date following receipt of the
application, except that if such date is the 29th, 30th, or 31st of a month, the
Policy Date will be the first of the following month. Acceptance is subject to
KILICO's underwriting rules, and KILICO reserves the right to reject an
application for any reason. The contestability period and suicide exclusion
period are measured from the Policy Date.
The Trade Date is the date when KILICO accepts the risk of providing
insurance coverage to the Insured. Insurance coverage will be limited to a
maximum of $200,000 net amount at risk by the temporary insurance provisions of
the application until the Trade Date. Monthly deductions and the crediting of
investment experience begin as of the Policy Date, even if the Trade Date of the
Policy is delayed due to underwriting requirements.
In the event an application is declined by KILICO, the initial premium will
be refunded, together with the earnings credited based on the investment
experience of the KILICO Money Market Subaccount.
The full initial premium is the only premium required to be paid under a
Policy. However, additional premiums may be necessary to keep the Policy in
force. (See "The Policy--Policy Lapse and Reinstatement.")
Additional Premiums. Subject to the premium guidelines established under
Federal tax law, additional premiums may be contributed while this Policy is in
force, including when necessary to prevent lapse. Upon request, KILICO will tell
the Owner whether an additional premium payment can be made and what its maximum
amount is. These premium payments will not increase the maximum possible
Surrender Charge. Except to prevent lapse, such an additional premium payment
must be at least $1,000. KILICO reserves the right to limit the ability to make
more than one additional premium payment in each Policy Year. Evidence of
insurability may be required if an additional premium payment would result in an
increase in the Death Benefit.
Several factors affect when additional premium payments may be made. For
example, assuming the maximum initial premium payment, the Policy Years in which
an Owner issue age 45 may make additional payments depend upon investment
experience. Based upon a hypothetical gross annual rate of return of 6% in the
selected Kemper Investors Fund Portfolio(s), an additional payment may first be
made in year
7
<PAGE> 11
13, and additional payments may be made each year thereafter subject to any
applicable underwriting requirements. A higher annual rate of return may cause
the Death Benefit to exceed the minimum guaranteed death benefit. (See "Policy
Rights and Benefits.") When this occurs additional payments are subject to
underwriting requirements.
Effect of Additional Premiums on Death Benefit. Any additional premiums
paid under a Policy may cause the Death Benefit to increase. (See "Policy
Benefits and Rights--Death Benefits.") An increase in the Death Benefit may
cause the cost of insurance charge to increase. (See "Charges and
Deductions--Cost of Insurance.")
ALLOCATION OF PREMIUMS AND SEPARATE ACCOUNT VALUE
Allocation of Premiums. The Owner allocates premiums to Subaccounts of the
Separate Account. The Owner must indicate the initial allocation in the Policy
application.
Fifteen days after the Trade Date (see "Policy Benefits and
Rights--Free-Look Period."), the Policy's Separate Account Value in the Money
Market Subaccount will be allocated to the Subaccounts of the Separate Account
in accordance with the Owner's allocation instructions in the application.
Additional premiums received will continue to be allocated in accordance with
the Owner's instructions in the application unless contrary written instructions
are received. Once a change in allocation is made, all future premiums will be
allocated in accordance with the new allocation, unless contrary written
instructions are received.
The Separate Account Value will vary with the investment experience of the
chosen Subaccounts. The Owner bears the entire investment risk.
Transfers. Separate Account Value may be transferred among the Subaccounts
of the Separate Account. One transfer of all or a part of the Separate Account
Value may be made within a fifteen day period. All transfers made during a
business day will be treated as one request.
Transfer requests must be in writing in a form acceptable to KILICO, or by
telephone authorization under forms authorized by KILICO. (See "General
Provisions--Written Notices and Requests.") The minimum transfer amount is $500.
No partial transfer may be made if the value of the Owner's remaining interest
in a Subaccount, from which amounts are to be transferred, would be less than
$500 after such transfer. Transfers will be based on the Accumulation Unit
Values next determined following receipt of valid, complete transfer
instructions by KILICO. The transfer provision may be suspended, modified or
terminated at any time by KILICO. KILICO disclaims all liability for acting in
good faith in following instructions which are given in accordance with
procedures established by KILICO, including requests for personal identifying
information, that are designed to limit unauthorized use of the privilege.
Therefore, the Owner would bear the risk of loss in the event of a fraudulent
telephone transfer.
POLICY LAPSE AND REINSTATEMENT
Lapse. Lapse will occur when the Surrender Value of a Policy is
insufficient to cover the monthly deduction for the cost of insurance, and a
grace period expires without a sufficient payment being made. (See "Charges and
Deductions.")
A grace period of 61 days will be given to the Owner. It begins when notice
is sent that the Surrender Value of the Policy is insufficient to cover the
monthly deduction for the cost of insurance. Failure to make a premium payment
or loan repayment during the grace period sufficient to keep the Policy in force
for three months will cause the Policy to lapse and terminate without value.
If payment is received within the grace period, the premium or loan
repayment will be allocated to the Subaccounts in accordance with the most
current allocation instructions, unless otherwise requested. Amounts over and
above the amounts necessary to prevent lapse may be paid as additional premiums,
however, to the extent otherwise permitted. (See "The Policy--Additional
Premiums.")
KILICO will not accept any payment that would cause the total premium
payment to exceed the maximum payment permitted by the Code for life insurance
under the guideline premium limits. However, the Owner may voluntarily repay a
portion of Debt to avoid lapse. (See "Federal Tax Matters.")
If premium payments have not exceeded the maximum payment permitted by the
Code, the Owner may choose to make a larger payment than the minimum required
payment to avoid the recurrence of the potential lapse of coverage. The Owner
may also combine premium payments with Debt repayments.
The death benefit payable during the grace period will be the Death Benefit
in effect immediately prior to the grace period, less any Debt.
8
<PAGE> 12
Reinstatement. If a Policy lapses because of insufficient Cash Value to
cover the monthly cost of insurance deduction, and it has not been surrendered
for its Surrender Value, it may be reinstated at any time within five years
after the date of lapse. Tax consequences may affect the decision to reinstate.
Reinstatement is subject to:
(1) receipt of evidence of insurability satisfactory to KILICO;
(2) payment of a minimum premium sufficient to keep the Policy in force
three months; and
(3) payment or reinstatement of any Debt against the Policy which existed
at the date of termination of coverage.
The effective date of reinstatement of a Policy will be the Monthly
Processing Date that coincides with or next follows the date the application for
reinstatement is approved by KILICO. Suicide and incontestability provisions
will apply from the effective date of reinstatement. If the Policy has been in
force for two years during the lifetime of the Insured, it will be contestable
only as to statements made in the reinstatement application.
POLICY BENEFITS AND RIGHTS
DEATH BENEFITS
While the Policy is in force (see "Policy Lapse and Reinstatement--Lapse,"
above), the Death Benefit can never be less than the Death Benefit stated on the
Policy Schedule page ("guaranteed minimum death benefit").
The Death Benefit may vary with the Cash Value of the Policy, which depends
on the investment experience of the Separate Account Subaccounts to which a
Policy's Separate Account Value is allocated. An increase in the Cash Value may
increase the Death Benefit. However, while the Policy is in force, because the
Death Benefit will never be less than the guaranteed minimum death benefit, a
decrease in Cash Value may decrease the Death Benefit but never below the
guaranteed minimum death benefit.
The Death Benefit will be the greater of the guaranteed minimum death
benefit or the applicable multiple of the Cash Value. If investment experience
is sufficiently favorable, the Death Benefit may increase. Increases in the
Death Benefit are calculated by KILICO by multiplying the Cash Value by the
Death Benefit Factor. If the Cash Value were to drop because of unfavorable
investment experience, the Death Benefit would drop, but not below the Death
Benefit stated on the Policy Schedule page.
The guaranteed minimum death benefit is based on the 1980 Commissioner's
Standard Ordinary Smoker and Non-Smoker Mortality Tables [age last birthday]
(called the "1980 CSO Tables"), the Insured's sex, rate class and insurance age
at issue, and an assumed interest rate of 5.10 percent. The guaranteed minimum
death benefit is calculated by KILICO based on the applicable 1980 CSO Table and
the initial premium paid.
Representative guaranteed minimum death benefits are shown below:
<TABLE>
<CAPTION>
GUARANTEED MINIMUM DEATH BENEFIT
PER $1 SINGLE PREMIUM
-----------------------------------------------
MALE FEMALE
INSURANCE -------------------- --------------------
AGE NON-SMOKER SMOKER NON-SMOKER SMOKER
--- ------- ------ ------- ------
<S> <C> <C> <C> <C>
5 ........................................ 18.196 N/A 21.735 N/A
15 ........................................ 12.510 N/A 14.975 N/A
25 ........................................ 8.852 6.854 10.186 8.652
35 ........................................ 5.915 4.614 6.785 5.783
45 ........................................ 3.929 3.138 4.537 3.939
55 ........................................ 2.671 2.236 3.098 2.787
65 ........................................ 1.905 1.696 2.164 2.203
75 ........................................ 1.461 1.379 1.582 1.530
</TABLE>
9
<PAGE> 13
Representative multiples, each of which is referred to as a Death Benefit
Factor, are shown in the table below:
<TABLE>
<CAPTION>
DEATH BENEFIT IS NO LESS THAN THE
CASH VALUE TIMES THE FOLLOWING
MULTIPLE (DEATH BENEFIT FACTOR)
ASSUMING NO DEBT
------------------------------
INSURANCE AGE MALE FEMALE
------------- ---- -------
<S> <C> <C>
5 .................................... 2.50 2.50
15 .................................... 2.50 2.50
25 .................................... 2.50 2.50
35 .................................... 2.50 2.50
45 .................................... 2.15 2.15
55 .................................... 1.50 1.50
65 .................................... 1.20 1.20
75 .................................... 1.05 1.05
85 .................................... 1.05 1.05
95 .................................... 1.00 1.00
</TABLE>
EXAMPLES:
<TABLE>
<CAPTION>
A B
-------- --------
<S> <C> <C>
Initial Premium: $ 25,000 $ 25,000
Death Benefit on Policy Schedule (guaranteed minimum death benefit): 98,225 98,225
Insurance Age at Issue: 45 45
Insurance Age at Death: 55 55
Cash Value on Date of Death: 75,000 50,000
Death Benefit Factor: 1.5 1.5
</TABLE>
In Example A, the Death Benefit equals $112,500, i.e., the greater of
$98,225 or $112,500 (the Cash Value at the date of death of $75,000,
multiplied by the Death Benefit Factor of 1.5). This amount less any
outstanding Debt constitutes the Death Benefit which we would pay to
the Beneficiary.
In Example B, the Death Benefit is $98,225, i.e., the greater of
$98,225 or $75,000 (the Cash Value of $50,000 multiplied by the Death
Benefit Factor of 1.5).
The difference in the Cash Value assumed is based upon different assumed
investment experience.
For a Policy, male age 45, non-smoker, under the above assumptions the
Death Benefit payable would exceed the guaranteed minimum death benefit in the
tenth Policy Year, assuming a 12% gross annual investment rate of return. (See
Appendix at pages 58 and 59.) With a lesser gross annual investment rate of
return, the Death Benefit would not exceed the guaranteed minimum death benefit
until a later Policy Year.
All or part of the Death Benefit may be paid in cash or applied under a
settlement option. (See "General Provisions--Settlement Options.")
Effect on Cost of Insurance Charge. Any change in the Death Benefit will
affect the net amount at risk, which would, in turn, affect the Owner's cost of
insurance charge. (See "Charges and Deductions--Cost of Insurance Charge".)
Payment of Death Benefit. Death Benefits under the Policy will ordinarily
be paid within seven days after KILICO receives all documentation required for
such a payment. Payments may be postponed in certain circumstances. (See
"General Provisions--Postponement of Payments.")
BENEFITS AT MATURITY
If the Insured is living on the Policy anniversary following the Insured's
Age 95, KILICO will pay the Owner the Surrender Value of the Policy, on
surrender of the Policy to KILICO. On the Maturity Date, the Policy will
terminate and KILICO will have no further obligations under the Policy.
CASH VALUE
The Policy's Cash Value will reflect the investment experience of the
selected Subaccounts of the Separate Account, the frequency and amount of
premiums paid, transfers between Subaccounts, any General Account values, and
any charges assessed in connection with the Policy. An Owner may at any time
surrender the Policy and receive the Policy's Surrender Value, which equals the
Cash Value less surrender charges and Debt. (See "Surrender Privilege.") There
is no minimum guaranteed Cash Value.
10
<PAGE> 14
Calculation of Cash Value. The Cash Value of the Policy is the total of the
Policy's Separate Account Value and the Cash Value in the General Account. The
Cash Value is determined on each Valuation Date. It will first be calculated on
the Policy Date. On that date, the Cash Value equals the initial premium, less
the cost of insurance charge for the first Policy Month. (See "Charges and
Deductions.")
On any Valuation Date during the Policy Year, the Policy's Separate Account
Value in any Subaccount will equal:
(1) The Policy's Separate Account Value in the Subaccount at the end
of the preceding Valuation Period, multiplied by the Investment Experience
Factor (defined below) for the current Valuation Period; plus
(2) Any premium payments received during the current Valuation Period
which are allocated to the Subaccount; plus
(3) All amounts transferred to the Subaccount, either from another
Subaccount or from the General Account in connection with the repayment of
a Policy loan (see "Policy Benefits and Rights--Policy Loans," page 12)
during the current Valuation Period; minus
(4) All amounts transferred from the Subaccount during the current
Valuation Period; minus
(5) The pro rata portion of the monthly cost of insurance charge
attributable to the Subaccount if a Policy Month began during the Valuation
Period. (See "Charges and Deductions--Cost of Insurance Charge.")
There will also be Cash Value in the General Account if there is a Policy
loan outstanding. The General Account is credited with amounts transferred from
Subaccounts in connection with Policy loans. The General Account balance accrues
daily interest at an effective annual rate of 4.00% for values attributable to
premium and 6.00% for values attributable to amounts in excess of premium. (See
"Policy Benefits and Rights--Policy Loans.")
Accumulation Unit Value. Each Subaccount has a distinct Accumulation Unit
Value. When premiums or other amounts are allocated to a Subaccount, a number of
units are purchased based on the Accumulation Unit Value of the Subaccount at
the end of the Valuation Period during which the allocation is made. When
amounts are transferred out of, or deducted from, a Subaccount, units are
redeemed in a similar manner.
For each Subaccount, the Accumulation Unit Value was initially set at
$1.00. The Accumulation Unit Value for each subsequent Valuation Period is the
Investment Experience Factor for that Valuation Period multiplied by the
Accumulation Unit Value for the immediately preceding period. Each Valuation
Period has a single Accumulation Unit Value which applies for each day in the
period. The number of Accumulation Units will not change as a result of
investment experience. The Investment Experience Factor may be greater or less
than one; therefore, the Accumulation Unit Value may increase or decrease.
Investment Experience Factor. The investment experience of the Separate
Account is calculated by applying the Investment Experience Factor to the
Separate Account Value in each Subaccount during a Valuation Period. Each
Subaccount has its own distinct Investment Experience Factor. The Investment
Experience Factor of a Subaccount for any Valuation Period is determined by
dividing (1) by (2) and subtracting (3) from the result, where:
(1) is the net result of:
a. The net asset value per share of the investment held in the
Subaccount determined at the end of the current Valuation Period; plus
b. the per share amount of any dividend or capital gain distributions
made by the investment held in the Subaccount division, if the
"ex-dividend" date occurs during the current Valuation Period; plus or
minus
c. a charge or credit for any taxes reserved for the current valuation
period which we determine to have resulted from the investment
operations of the Subaccount;
(2) is the net asset value per share of the investment held in the
Subaccount, determined at the end of the last prior Valuation Period;
11
<PAGE> 15
(3) is the factor representing the Mortality and Expense Risk Charge at an
annual rate of 0.90% of the assets of the Subaccount and compensates
KILICO for certain mortality and expense risks assumed. (See "Charges
and Deductions--Mortality and Expense Risk Charge.")
POLICY LOANS
On and after the first Monthly Processing Date after the Policy Date of the
Policy, the Owner may by written request to KILICO borrow all or part of the
Maximum Loan Amount of the Policy. The Maximum Loan Amount is 90% of the
Policy's Cash Value minus applicable surrender charges, subject to the
requirements of the Internal Revenue Code. The amount of any new loan may not
exceed the Maximum Loan Amount less Debt on the date a loan is granted. The
minimum amount of a loan is $500. Any amount due an Owner under a Policy Loan
ordinarily will be paid within 7 days after KILICO receives a loan request at
its Home Office, although payments may be postponed under certain circumstances.
(See "Postponement of Payments," and "Federal Tax Matters.")
On the date a loan is made, Separate Account Value equal to the loan amount
will be transferred from the Separate Account to the loan account in the General
Account. Unless the Owner directs otherwise, the loaned amount will be deducted
from the Subaccounts in proportion to the values that each Subaccount bears to
the Separate Account Value of the Policy in all of the Subaccounts at the end of
the Valuation Period during which the request is received.
The loan interest will be assessed at an effective annual rate of 6.00%.
Interest not paid when due will be added to the loan amount due and bear
interest at the same rate.
Cash Value in the loan account within the General Account attributable to
the premium will earn no less than 4.00% annual interest. Cash Value in the loan
account within the General Account attributable to amounts in excess of premium
will earn no less than 6.00% annual interest. Such earnings will be allocated to
the General Account.
Loan Repayment. While the Policy is in force, policy loans may be repaid
at any time, in whole or in part. Payments will be treated as payment of
outstanding Debt unless the Owner indicates that the payments should be treated
otherwise. If otherwise permitted by the guideline premium limits of the Code
where there is no indication made, the portion of a payment that exceeds the
amount of any Debt will be treated as a premium payment. If not permitted by the
Code, the amount that exceeds any Debt will be refunded to the Owner.
At the time of repayment, Cash Value in the loan account of the General
Account equal to the amount of the repayment which exceeds the difference
between interest due and interest earned will be allocated to the Subaccounts
according to the Owner's current allocation instructions, unless otherwise
requested by the Owner. Loan repayments will be applied first to reduce that
portion of the loan account attributable to interest due on loaned premium;
second, to that portion of the loan account attributable to premium; third, to
that portion of the loan account attributable to interest due on loaned amounts
in excess of premium; and fourth to that portion of the loan account
attributable to loaned amounts in excess of premium. Transfers from the General
Account to the Separate Account as a result of the repayment of Debt will be
allocated at the end of the Valuation Period during which the repayment is
received. Such transfers will not be counted in determining the transfers made
within a 15 day period.
Effects of Policy Loan. Policy loans decrease Surrender Value and,
therefore, the amount available to pay the charges necessary to keep the Policy
in force. If Surrender Value on the day immediately preceding a Monthly
Processing Date is less than the monthly cost of insurance deduction for the
next month, KILICO will notify the Owner and any assignee of record. (See
"General Provisions--Written Notices and Requests.") This Policy will lapse and
terminate without value, unless a sufficient payment is made to KILICO within 61
days of the date such notice is sent to the Owner. (See "The Policy--Policy
Lapse and Reinstatement".)
Effect on Investment Experience. A Policy Loan will have an effect on the
Cash Value of a Policy. The collateral for the loan (the amount held in the
General Account) does not participate in the experience of the Subaccounts while
the loan is outstanding. If the amount credited to the General Account is more
than the amount that would have been earned in the Subaccounts, the Cash Value
will, and the Death Benefit may, be higher as a result of the loan. Conversely,
if the amount credited to the General Account is less than would have been
earned in the Subaccounts, the Cash Value, as well as the Death Benefit, may be
less.
12
<PAGE> 16
SURRENDER PRIVILEGE
While the Insured is living and the Policy is in force, the Owner may
surrender the Policy for its Surrender Value. To surrender the Policy, the Owner
must make written request to KILICO at its Home Office and return the Policy to
KILICO. The Surrender Value is equal to the Cash Value less any applicable
Surrender Charge and any Debt. (See "Surrender Charge," below.) Partial
surrenders are not permitted.
Surrender Charge. No sales charge is deducted from any premium payment.
However, a contingent deferred sales charge ("Surrender Charge") will be used to
cover expenses relating to the sale of the Policy including commissions paid to
sales personnel, and other promotion and acquisition expenses. If this Policy is
surrendered or if the Cash Value is applied under a Settlement Option (see
"General Provisions--Settlement Options"), the amount payable may reflect a
deduction for applicable Surrender Charges. A Surrender Charge will not be
assessed against Cash Values applied under a settlement option if the Policy has
been in force for five or more years and the settlement option elected provides
for benefit payments of at least five years. The amount of the Surrender Charge
will be calculated as a percentage of the lesser of premium paid in the first
Policy Year or Cash Value under the Policy. The charge decreases from 9% to 0%
depending on the length of time between the Policy Date and the date of
surrender or application under a settlement option, provided, however, that the
Surrender Charge will never exceed $60 per $1,000 of initial Death Benefit.
During the period from the Policy Date to the first Policy Anniversary, the rate
is 9%; on the first Policy Anniversary, the rate decreases to 8%, and on each of
the next eight Policy Anniversaries it will decrease an additional 1%. Thus,
there will be no Surrender Charge with respect to the premium paid in the first
Policy Year beginning on the ninth Policy Anniversary.
The applicable Surrender Charge will be determined based upon the date of
receipt of the written request for surrender.
FREE-LOOK PERIOD AND EXCHANGE RIGHTS
The Owner may, until the end of the period of time specified in the Policy,
examine the Policy and return it for a refund. The applicable period of time
will depend on the state in which the Policy is issued; however, it will be at
least 10 days from the date the Policy is received by the Owner. The amount of
the refund will be the premium paid. An Owner seeking a refund should return the
Policy to KILICO at its Home Office or to the agent who sold the Policy.
The Owner may, while the Policy is in force, exchange it at any time after
its issue, for a non-variable permanent fixed benefit life insurance policy then
currently being offered by KILICO on the life of the Insured. Such policy would
be treated and taxed as a modified endowment contract. No evidence of
insurability will be required. During the first two years after the Policy Trade
Date, the amount of the new policy may be, at the election of the Owner, either
the initial Death Benefit or the same net amount at risk as the Policy on the
exchange date. After two years from the Policy Trade Date, the amount of the new
policy will be for the same net amount at risk as the Policy on the exchange
date. All Debt under the Policy must be repaid and the surrender of the Policy
is required before the exchange is made. The Policy Date and issue age will be
the same as existed under the Policy.
CHARGES AND DEDUCTIONS
COST OF INSURANCE CHARGE
A monthly deduction is made from the Subaccounts for the cost of insurance
to cover KILICO's anticipated mortality costs. The cost of insurance charge is
deducted monthly in advance and is allocated among the Subaccounts in proportion
to the value of each Subaccount to the Separate Account Value.
The cost of insurance will be deducted on the Policy Date and on each
Monthly Processing Date thereafter. If the Monthly Processing Date falls on a
day other than a Valuation Date, the charge will be determined on the next
Valuation Date. The cost of insurance charge is determined by multiplying the
applicable cost of insurance rate (see below) by the "net amount at risk" for
each policy month. The net amount at risk is equal to the Death Benefit minus
the Cash Value on the Monthly Processing Date.
Cost of Insurance Rate. The monthly cost of insurance rates are based on
the sex, Insurance Age and rate class of the Insured. The monthly cost of
insurance rates will be determined by KILICO based on its expectations as to
future mortality experience. Any change in the schedule of rates will apply to
all individuals of the same class as the Insured. The cost of insurance rate may
never exceed those shown in the table of guaranteed maximum cost of insurance
rates in the Policy. The guaranteed maximum cost of
13
<PAGE> 17
insurance rates are based on the 1980 Commissioner's Standard Ordinary Smoker
and Non-Smoker Mortality Tables, published by the National Association of
Insurance Commissioners.
Rate Class. The rate class of an Insured will affect the cost of insurance
rate. KILICO currently places Insureds in standard rate classes and rate classes
involving a higher mortality risk. The cost of insurance rates for rate classes
involving a higher mortality risk are multiples of the standard rates. (See
"Charges and Deductions--Cost of Insurance Rate," above.)
MORTALITY AND EXPENSE RISK CHARGE
A daily charge is deducted from the Subaccounts of the Separate Account for
mortality and expense risks assumed by KILICO. This charge will be at an annual
rate of 0.90%. This rate is guaranteed not to increase for the duration of the
Policy. If these charges are insufficient to cover the risks and costs, any loss
or deficiency will fall on KILICO. Conversely, if the charges are more than
sufficient, the gain will accrue to KILICO, creating a profit which would be
available for any proper corporate purpose including, among other things,
payment of distribution expenses.
The mortality and expense risk assumed is that KILICO's estimates of
longevity and of the expenses incurred over the lengthy period the Policy may be
in effect--which estimates are the basis for the level of other charges KILICO
makes under the Policy--will not be correct.
OTHER CHARGES
Surrender Charge. If the Policy is surrendered or if the Cash Value is
applied under a Settlement Option, a Surrender Charge equal to the lesser of the
premium paid in the first Policy Year or the Cash Value under the Policy may be
imposed. The charge decreases from 9% to 0%, depending on the length of time
between the payment and the date of surrender or application under a Settlement
Option. Subject to other considerations, the Owner may decide to reduce the
potential Surrender Charge by paying less initial premium. The Surrender Charges
are intended to compensate KILICO for expenses in connection with the
distribution of the Policy. Under current assumptions KILICO anticipates
Surrender Charges will not fully cover distribution expenses. To the extent that
distribution expenses are not recovered from Surrender Charges, those expenses
may be recovered from other sources, including the cost of insurance and the
mortality and expense risk charges described above. Surrender Charges are
described in more detail under "Policy Benefits--Surrender Privilege."
Taxes. Currently, no charges are made against the Separate Account for
Federal, state or other taxes that may be attributable to the Separate Account.
KILICO may, however, in the future impose charges for Federal income taxes
attributable to the Separate Account. Charges for other taxes, if any,
attributable to the Policy may also be made. (See "Federal Tax Matters.")
Charges Against the Fund. Under the investment advisory agreement between
the Fund, on behalf of the Portfolios, and the Adviser, the Adviser provides
investment advisory services for the Portfolios. The Fund is responsible for the
advisory fee and all its other expenses. The investment advisory fee differs
with respect to each of the Portfolios of the Fund and is described beginning on
page 6 of this Prospectus. For more information concerning the investment
advisory fee and other charges against the Portfolios of the Fund, see the
prospectus for the Fund and the Statement of Additional Information available
upon request.
Reduction of Charges. KILICO may reduce certain charges and the minimum
initial premium in special circumstances that result in lower sales,
administrative, or mortality expenses. For example, special circumstances may
exist in connection with group or sponsored arrangements, sales to KILICO
policyowners, or sales to employees or clients of members of the Kemper group of
companies. The amounts of any reductions will reflect the reduced sales effort
and administrative costs resulting from, or the different mortality experience
expected as a result of, the special circumstances. Reductions will not be
unfairly discriminatory against any person, including the affected Owners and
owners of all other policies funded by the Separate Account.
GENERAL PROVISIONS
SETTLEMENT OPTIONS
The Owner, or Beneficiary at the death of the Insured, may elect to have
all of the Death Benefit or Surrender Value of this Policy paid in a lump sum or
have the amount applied to one of the Settlement Options. The minimum amount
that may be placed under a Settlement Option is $4,000 unless KILICO consents to
a lesser amount. Payments under these options will not be affected by the
investment
14
<PAGE> 18
experience of the Separate Account after proceeds are applied under a Settlement
Option. Payment will be made as elected by the payee on a monthly, quarterly,
semi-annual or annual basis. If the amount of any payment under a Settlement
Option is less than $100, KILICO may increase the interval between payments to a
quarterly, semi-annual or annual payment to make the payment at least $100.
The Cash Value on the day immediately preceding the date on which the first
benefit payment is due shall first be reduced by any applicable Surrender Charge
and Debt. The Surrender Value shall be used to determine the benefit payment.
For Settlement Options 1 through 5, the payment shall be based upon the
settlement option elected in accordance with the appropriate settlement option
table.
Option 1--Income For Specified Period. KILICO will pay income for the
period and payment mode elected but not less than 3 years nor more than 30
years.
Option 2--Life Income. KILICO will pay a monthly income to the payee during
the payee's lifetime. If this Option is elected, annuity payments terminate
automatically and immediately on the death of the annuitant without regard to
the number or total amount of payments made. Thus, it is possible for an
individual to receive only one payment if death occurred prior to the date the
second payment was due.
Option 3--Life Income with Installments Guaranteed. KILICO will pay a
monthly income for the guaranteed period elected and thereafter for the
remaining lifetime of the payee. The period elected may only be 5, 10, 15 or 20
years.
Option 4--Joint and Survivor Annuity. KILICO will pay the full monthly
income while both payees are living. Upon the death of either payee, the income
will continue during the lifetime of the surviving payee. The surviving payee's
income shall be the percentage of such full amount chosen at the time of
election of this option. Annuity payments terminate automatically and
immediately upon the death of the surviving payee without regard to the number
or total amount of payments received.
Option 5--Pension and Survivor Annuity. KILICO will pay the full monthly
income during the lifetime of the primary payee. Such payments will continue
whether or not the secondary payee is living. If the primary payee dies before
the secondary payee dies, the benefits will continue during the lifetime of the
secondary payee. However, such benefits will be for the percentage chosen for
such continuation at the time this option is elected. Annuity payments terminate
automatically and immediately upon the death of the surviving payee without
regard to the number or total amount of payments received.
Option 6--Income of Specified Amount. KILICO will pay the amount elected
for as long as the amount applied and interest will last. The minimum income
which may be elected is $10.00 per month for each $1,000 applied.
Option 7--Proceeds Left At Interest. KILICO will hold the amount applied on
deposit, subject to any withdrawal limits stated in the supplementary contract.
Interest will be paid on the amount deposited.
KILICO consent is necessary for any other payment methods.
Interest on funds held by KILICO under Options 1, 6 and 7 shall be at the
rate of 4% per year. The sums payable under Options 2, 3, 4 and 5 are based on
the 1971 Individual Annuity Mortality Tables, male and female, at 4% interest
per year, unless otherwise required by law. Interest shall be compounded
annually. Additional interest, if any, will be paid as determined by KILICO, in
its sole discretion.
POSTPONEMENT OF PAYMENTS
General. Payment of any amount due upon: (a) Policy termination at the
Maturity Date, (b) surrender of the Policy, (c) payment of any Policy loan, or
(d) death of the Insured, may be postponed whenever:
(1) The New York Stock Exchange is closed other than customary weekend
and holiday closings, or trading on the New York Stock Exchange is
restricted as determined by the SEC;
(2) The SEC by order permits postponement for the protection of
Owners; or
(3) An emergency exists, as determined by the SEC, as a result of
which disposal of securities of the Fund is not reasonably practicable or
it is not reasonably practicable to determine the value of the net assets
of the Separate Account.
Transfers may also be postponed under these circumstances.
15
<PAGE> 19
Payment Not Honored by Bank. The portion of any payment due under the
Policy which is derived from any amount paid to KILICO by check or draft may be
postponed until such time as KILICO determines that such instrument has been
honored by the bank upon which it was drawn.
THE CONTRACT
The Policy, any endorsements, and the application constitute the entire
contract between KILICO and the Owner. All statements made by the Insured or
contained in the application will, in the absence of fraud or misrepresentation,
be deemed representations and not warranties.
Only the President, the Secretary, or an Assistant Secretary of KILICO is
authorized to change or waive the terms of a Policy. Any change or waiver must
be in writing and signed by one of those persons.
MISSTATEMENT OF AGE OR SEX
If the age or sex of the Insured is misstated, the Cash Value and Death
Benefit will be recalculated from the Policy Date based on the correct sex and
age.
SUICIDE
Suicide by the Insured, while sane or insane, within two years from the
Policy Date of the Policy is a risk not assumed under the Policy. KILICO's
liability for such suicide is limited to the Cash Value less any Debt. When the
laws of the state in which a Policy is delivered require less than a two year
period, or return of premium paid, the period or amount paid will be as stated
in such laws.
ASSIGNMENT
No assignment of a Policy is binding on KILICO until it is received by
KILICO at its Home Office. KILICO assumes no responsibility for the validity of
the assignment. Any claim under an assignment is subject to proof of the extent
of the interest of the assignee. If this Policy is assigned, the rights of the
Owner and Beneficiary are subject to the rights of the assignee of record.
NONPARTICIPATING
This Policy will not pay dividends. It will not participate in any of
KILICO's surplus or earnings.
OWNER AND BENEFICIARY
The Owner may, at any time during the life of the Insured and while the
Policy is in force, designate a new Owner.
Primary and secondary Beneficiaries may be designated by the Owner in the
application. If changed, the primary or secondary Beneficiary is as shown in the
latest change filed with KILICO. If no Beneficiary survives the Insured, the
Insured's estate will be the Beneficiary. The interest of any Beneficiary may be
subject to that of an assignee.
Any change of Owner or Beneficiary must be made in writing in a form
acceptable to KILICO. The change will take effect as of the date the request is
signed. KILICO will not be liable for any payment made or other action taken
before the notice has been received at KILICO's Home Office.
RECORDS AND REPORTS
KILICO will maintain all records relating to the Separate Account. KILICO
will send Owners, at their last known address of record, an annual report
stating the Death Benefit, the Accumulation Unit Value, the Cash Value and
Surrender Value under the Policy, and indicating any additional premium
payments, transfers, Policy loans and repayments and charges made during the
Policy Year. Owners will also be sent annual and semi-annual reports for the
Fund to the extent required by the 1940 Act.
WRITTEN NOTICES AND REQUESTS
Any written notice or request to be sent to KILICO should be sent to its
Home Office, 1 Kemper Drive, Long Grove, Illinois 60049. The notice or request
should include the Policy number and the Insured's full name. Any notice sent by
KILICO to an Owner will be sent to the address shown in the application unless
an address change has been filed with KILICO.
16
<PAGE> 20
DISTRIBUTION OF POLICIES
The Policy is sold by licensed insurance representatives who represent
KILICO and who are registered representatives of broker-dealers which are
registered under the Securities Exchange Act of 1934 and are members of the
National Association of Securities Dealers, Inc. The Policy is distributed
through the principal underwriter, Investors Brokerage Services, Inc. ("IBS"), a
wholly owned subsidiary of KILICO.
Gross commissions paid by KILICO on the sale of the Policy plus fees for
marketing services provided by affiliates of KILICO are not more than 6.75%. In
lieu of part of the 6.75%, a service fee at an annual rate of .25 of 1% on
assets which have been maintained and serviced may also be paid to the principal
underwriter or the licensed broker-dealers. Firms to which service fees and
commissions may be paid include affiliated broker-dealers. In addition to the
commissions described above, KILICO may, from time to time, pay or allow
additional promotional incentives, in the form of cash or other compensation, to
licensed broker-dealers that sell the Policies. In some instances, such other
incentives may be offered only to certain licensed broker-dealers that sell or
are expected to sell during specified time periods certain minimum amounts of
the Policy or other contracts issued by KILICO. The aggregate amount of gross
commissions paid by KILICO on the sale of the Policy in 1992 was $137,640, in
1993 was $12,700, and in 1994 was $25,764.
FEDERAL TAX MATTERS
The ultimate effect of Federal income taxes on the Policy, on settlement
options and on the economic benefit to the Owner, Beneficiary or payee depends
on KILICO's tax status, and upon the tax status of the individual concerned.
KILICO'S TAX STATUS
Under current interpretations of Federal income tax law, KILICO is taxed as
a life insurance company and the operations of the Separate Account are treated
as part of the total operations of KILICO. The operations of the Separate
Account do not materially affect KILICO's Federal income tax liability because
KILICO is allowed a deduction to the extent that net investment income of the
Separate Account is applied to increase Owners' equity. KILICO may incur state
and local taxes attributable to the Separate Account. At present, these taxes
are not significant. Accordingly, KILICO does not charge or credit the Separate
Account for Federal, state or local taxes. Thus, the Separate Account may
realize net investment income, such as interest, dividends or capital gains, and
reinvest such income all without tax consequences to the Separate Account.
If there is a material change in applicable Federal, state or local law,
however, charges or credits may be made to the Separate Account for Federal,
state or local taxes, or reserves for such taxes, if any, attributable to the
Separate Account. Such charges or credits will be determined independent of the
taxes actually paid by KILICO.
TAX STATUS OF THE POLICY
The Technical and Miscellaneous Revenue Act of 1988 altered the Federal
income tax treatment of loans and predeath distributions under life insurance
policies classified as "modified endowment contracts."
A Policy entered into on or after June 21, 1988 is considered a modified
endowment contract. Further, a Policy entered into before June 21, 1988 is
considered a modified endowment contract if the Death Benefit payable under the
Policy is increased on or after June 21, 1988 as a result of the payment of
additional premium and the Owner did not have a unilateral right before June 21,
1988 to obtain such increase without providing additional evidence of
insurability. Finally, a Policy is considered a modified endowment contract if
the Death Benefit increases by more than $150,000 over the Death Benefit on
October 20, 1988 and, on or after the date of such increase, there is a
"material change" to the Policy. A material change does not include an increase
in the Death Benefit, if the increase is attributable to (1) premiums necessary
to fund the Death Benefit as of October 20, 1988 increased by $150,000, or (2)
the crediting of earnings with respect to such premiums. An exchange of a policy
entered into before June 21, 1988 under section 1035 of the Internal Revenue
Code is considered a material change, but does not cause the new policy to be
treated as a modified endowment contract so long as no additional premiums are
paid.
A Policy treated as a modified endowment contract is subject to the
following rules:
17
<PAGE> 21
First, the amount of a Policy loan (or, if a Policy is assigned or pledged,
the amount of Cash Value assigned or pledged) is considered received by the
Owner and is included in the Owner's Federal gross income to the extent that the
Cash Value exceeds the Owner's investment in the Policy. The Owner's investment
in the Policy is the initial premium (or, if a Policy is issued in exchange for
another policy under section 1035 of the Internal Revenue Code, the Owner's
investment in the other policy), increased by additional premiums and by amounts
included in the Owner's gross income.
Second, all modified endowment contracts issued by KILICO (or an affiliate)
to the same Owner during a calendar year are to be aggregated and considered a
single contract for purposes of determining the amount includible in gross
income. Under this rule, amounts received by the Owner are includible in gross
income to the extent that total cash value exceeds total investment in such
aggregated contracts.
Third, the portion of any amount considered received by the Owner that is
includible in gross income is subject to an additional 10-percent tax. The
additional tax does not apply to any amount that is (1) received on or after the
date the Owner attains age 59 1/2; (2) distributed as a result of the Owner
becoming disabled; or (3) one of a series of substantially equal periodic
payments (not less frequently than annually) made for the life (of life
expectancy) of the Owner or the joint lives (or life expectancies) of the Owner
and the Owner's beneficiary.
The United States Congress may in the future consider additional
legislation that, if enacted, could adversely affect the tax treatment of life
insurance policies, including loans and other distributions and undistributed
appreciation. There is no way of predicting whether, when or in what form
Congress will enact any such proposal or any other legislation affecting life
insurance policies. Any such legislation could have retroactive effect
regardless of the date of enactment.
The Policy is a life insurance contract for Federal income tax purposes
under current Section 7702 of the Internal Revenue Code. As such, the Death
Benefit is excludable from the gross income of the Beneficiary. Also, the Owner
is not deemed to be in constructive receipt of the Cash Value, including
increments thereon, until a distribution occurs through a loan or actual
surrender. Interest paid on a loan under the Policy is not deductible by the
individual Owner. Section 7702 of the Internal Revenue Code imposes certain
conditions with respect to premiums received under the Policy. KILICO intends to
monitor the premiums to assure compliance.
If there is a surrender or exchange of a Policy, KILICO may be required to
withhold Federal income tax from the portion of the money received that is
includable in the Owner's Federal gross income. An Owner may, however, make an
election not to have such tax withheld but the election must be made before
KILICO makes payment.
Federal estate and state and local estate, inheritance and other tax
consequences of ownership or receipt of Policy proceeds depend on the
circumstances of each Owner and Beneficiary.
The Secretary of the Treasury has issued final regulations establishing
diversification provisions for variable life insurance contracts. Failure to
meet the diversification requirements could result in taxation of KILICO and
immediate taxation of the Owner of the Policy to the extent of appreciation on
the Owner's investment. KILICO will monitor compliance with these tests. A
special test exists for variable life insurance contracts that invest in United
States Treasury obligations. A separate account that issues variable life
insurance contracts need not meet the diversification test to the extent that it
invests in securities issued by the United States Treasury.
OTHER CONSIDERATIONS
Because of the complexity of the law in its application to a specific
individual, tax advice may be needed by a person contemplating purchase of a
Policy or the exercise of elections under a Policy. The above comments
concerning the Federal income tax consequences are not exhaustive and are not
intended as tax advice. Counsel and other competent advisers should be consulted
for more complete information. This discussion is based on KILICO's
understanding of Federal income tax laws as they are currently interpreted by
the Internal Revenue Service. No representation is made as to the likelihood of
continuation of these current laws and interpretations. KILICO also believes the
Policy meets other requirements concerning Owner control over investments.
However, the Secretary of Treasury has not issued regulations on this subject.
Such regulations, if adopted, could include requirements not included in the
Policy. We believe that such regulations if adopted would apply prospectively.
KILICO will make modifications to the Policy to comply with such regulations.
18
<PAGE> 22
LEGAL CONSIDERATIONS
On July 6, 1983, the Supreme Court held in Arizona Governing Committee v.
Norris that certain annuity benefits provided by employers' retirement and
fringe benefit programs may not vary between men and women on the basis of sex.
The Policy described in this Prospectus contains cost of insurance rates that
distinguish between men and women. Accordingly, employers and employee
organizations should consider, in consultation with legal counsel, the impact of
federal, state and local laws, including Title VII of the Civil Rights Act, the
Equal Pay Act, and Norris and subsequent cases on any employment-related
insurance or fringe benefit program before purchasing this Policy.
SAFEKEEPING OF THE SEPARATE ACCOUNT'S ASSETS
KILICO holds the assets of the Separate Account. The assets are kept
segregated and held separate and apart from the general funds of KILICO. KILICO
maintains records of all purchases and redemptions of the shares of each
portfolio of the Fund by each of the Subaccounts.
VOTING RIGHTS
To the extent required by law, KILICO will vote the Fund's shares held in
the Separate Account at regular and special shareholder meetings of the Fund in
accordance with instructions received from persons having voting interests in
the corresponding Subaccounts of the Separate Account. If, however, the 1940 Act
or any regulation thereunder should be amended or if the present interpretation
thereof should change, and as a result KILICO determines that it is permitted to
vote the Fund's shares in its own right, it may elect to do so.
Owners of all Policies participating in each Subaccount shall have voting
rights with respect to that Subaccount, based upon each Owner's proportionate
interest in that Subaccount as measured by units.
Each person having a voting interest in a Subaccount will receive proxy
material, reports, and other materials relating to the appropriate Portfolio of
the Fund.
KILICO will vote shares of the Fund for which it has not received timely
instructions in proportion to the voting instructions that KILICO has received
with respect to all variable policies participating in a portfolio. KILICO will
also vote any Fund shares attributed to amounts it has accumulated in the
Subaccounts in the same proportions that Owners vote.
KILICO may, when required by state insurance regulatory authorities,
disregard voting instructions if the instructions require that the shares be
voted so as to cause a change in the subclassification or investment objective
of the Fund or of one or more of its portfolios or to approve or disapprove an
investment advisory contract for a Portfolio of the Fund. In addition, KILICO
itself may disregard voting instructions in favor of changes initiated by an
Owner in the investment policy or the investment adviser of a Portfolio of the
Fund if KILICO reasonably disapproves of such changes. A proposed change would
be disapproved only if the change is contrary to state law or prohibited by
state regulatory authorities, or if KILICO determines that the change would have
an adverse effect on its General Account in that the proposed investment policy
for a Portfolio may result in overly speculative or unsound investments. In the
event KILICO does disregard voting instructions, a summary of that action and
the reasons for such action will be included in the next annual report to
Owners.
STATE REGULATION OF KILICO
KILICO, a stock life insurance company organized under the laws of
Illinois, is subject to regulation by the Illinois Department of Insurance. An
annual statement is filed with the Director of Insurance on or before March 1st
of each year covering the operations and reporting on the financial condition of
KILICO as of December 31st of the preceding year. Periodically, the Director of
Insurance examines the liabilities and reserves of KILICO and the Separate
Account and certifies to their adequacy, and a full examination of KILICO's
operations is conducted by the National Association of Insurance Commissioners
at least once every three years.
In addition, KILICO is subject to the insurance laws and regulations of
other states within which it is licensed to operate. Generally, the insurance
department of any other state applies the laws of the state of domicile in
determining permissible investments.
19
<PAGE> 23
DIRECTORS AND OFFICERS OF KILICO
The directors and principal officers of KILICO are listed below together
with their current positions and their other business experience during the past
five years. The address of each officer and director is 1 Kemper Drive, Long
Grove, Illinois 60049.
<TABLE>
<CAPTION>
POSITION WITH KILICO OTHER BUSINESS EXPERIENCE DURING
NAME AND AGE YEAR OF ELECTION PAST 5 YEARS OR MORE
----------------------------- ----------------------- -------------------------------------
<S> <C> <C>
John B. Scott (50)........... Chairman of the Board, Executive Vice President of Kemper
Director and Chief Corporation from January 1994,
Executive Officer 1992 Director, Chairman of the Board,
and President 1993 Chief Executive Officer and President
of Federal Kemper Life Assurance
Company and Fidelity Life Association
since 1988. Executive Vice President
of Kemper Financial Companies, Inc.
since January 1994 and Director since
1992.
John H. Fitzpatrick (38)..... Senior Vice President Executive Vice President and Chief
and Chief Financial Financial Officer of Kemper
Officer 1994 and Corporation since May 1993; prior
Director 1992 thereto, Senior Vice President and
Chief Financial Officer until May
1993 from May 1990; prior thereto,
Vice President of Kemper Corporation,
also Executive Vice President and
Chief Financial Officer of Kemper
Financial Companies, Inc. since
January 1994.
James R. Boris (50).......... Director 1993 Executive Vice President of Kemper
Corporation from January 1994.
Director of Federal Kemper Life
Assurance Company since January 1993.
Executive Vice President of Kemper
Financial Companies, Inc. since March
1990. Chairman of the Board and Chief
Executive Officer of both Kemper
Securities Holdings, Inc. and Kemper
Securities, Inc. since August 1990.
Chairman of the Board and Chief
Executive Officer of INVEST Financial
Corporation from May 1989 to July
1991.
David B. Mathis (57)......... Director 1990 Chairman of the Board and Chief
Executive Officer of Kemper
Corporation from February 1992; prior
thereto, President from May 1990 to
September 1992, Chief Operating
Officer from May 1990 to February
1992; prior thereto, Executive Vice
President from May 1989 of Kemper
Corporation. Chairman of the Board
and Chief Executive Officer of Kemper
Reinsurance Company until March 1990;
Vice President of Lumbermens until
May 1989.
</TABLE>
20
<PAGE> 24
<TABLE>
<CAPTION>
POSITION WITH KILICO OTHER BUSINESS EXPERIENCE DURING
NAME AND AGE YEAR OF ELECTION PAST 5 YEARS OR MORE
----------------------------- ----------------------- -------------------------------------
<S> <C> <C>
</TABLE>
<TABLE>
<S> <C> <C>
Stephen B. Timbers (50)...... Director 1989 President and Chief Operating Officer
of Kemper Corporation since September
1992; prior thereto, Chief Investment
Officer until May 1993 from May 1991
of Kemper Corporation; also Chairman,
Chief Executive Officer and Chief
Investment Officer of Kemper
Financial Services, Inc. from
February 1995; prior thereto, Senior
Executive Vice President from March
1990 to February 1995; Chief
Investment Officer from May 1990 to
May 1993; prior thereto, Executive
Vice President and Chief Investment
Officer of Kemper Financial Services,
Inc.
Debra P. Rezabek (39)........ Vice President 1995 and Vice President since 1995, General
General Counsel, Direc- Counsel, Director of Government
tor of Government Affairs since 1992, prior thereto
Affairs and Assistant Assistant General Counsel from
Secretary 1992 September 1988, Federal Kemper Life
Assurance Company and Fidelity Life
Association.
Jerome J. Cwiok (47)......... Executive Vice Senior Vice President of KILICO 1993-
President 1995 1995; Senior Vice President from
November 1993; prior thereto, Vice
President of Federal Kemper Life
Assurance Company and Fidelity Life
Association from March 1993.
Executive Vice President from
1986-1993 of Academy Insurance Group,
Atlanta, Georgia.
Eliane C. Frye (46).......... Executive Vice Senior Vice President of KILICO 1992-
President 1995 1995; Executive Vice President since
1995, Senior Vice President
1993-1995, Vice President 1988-1993
Federal Kemper Life Assurance Company
and Fidelity Life Association.
</TABLE>
LEGAL MATTERS
All matters of Illinois law pertaining to the Policy, including the
validity of the Policy and KILICO's right to issue the Policy under Illinois
Insurance Law, have been passed upon by Debra P. Rezabek, Vice President,
General Counsel and Director of Government Affairs of KILICO. Katten Muchin &
Zavis, Washington, D.C., has advised KILICO on certain legal matters concerning
federal securities laws applicable to the issue and sale of Policies.
LEGAL PROCEEDINGS
There are no legal proceedings to which the Separate Account is a party or
to which the assets of the Separate Account are subject. KILICO is not a party
in any litigation that is of material importance in relation to its total assets
or that relates to the Separate Account. With respect to KILICO, in 1992 the
Staff of the Securities and Exchange Commission commenced an investigation into
certain of Kemper Corporation's ("Kemper's") real estate-related accounting
practices and related disclosures. KILICO's accounting and disclosure practices
are consistent with those of Kemper. Kemper fully cooperated throughout the
Staff's investigation which has now concluded. Kemper and the Staff have had
settlement discussions respecting this matter, and KILICO anticipates that this
matter will be resolved with respect to Kemper in 1995 with the filing of an
administrative proceeding.
21
<PAGE> 25
EXPERTS
The financial statements of KILICO and the Separate Account have been
included in the Prospectus in reliance upon the reports of KPMG Peat Marwick
LLP, independent certified public accountants, appearing elsewhere herein, and
upon the authority of said firm as experts in accounting and auditing. As
discussed in the notes to KILICO's consolidated financial statements, effective
January 1, 1994, KILICO changed its method of accounting for investment
securities to adopt the provisions of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards ("SFAS") 115, Accounting for Certain
Investments in Debt and Equity Securities. Also, as discussed in the notes
effective January 1, 1993, KILICO changed its method of accounting for
impairment of loans receivable to adopt the provisions of SFAS 114, Accounting
by Creditors for Impairment of a Loan, and changed its method of accounting for
income taxes to adopt the provisions of SFAS 109, Accounting for Income Taxes.
Further, as discussed in the notes, KILICO adopted the provisions of SFAS 106,
Employers' Accounting for Postretirement Benefits Other than Pensions in 1992.
Actuarial matters included in this prospectus have been examined by Steven
D. Powell, FSA as stated in the opinion filed as an exhibit to Post-Effective
Amendment No. 3 to the Registration Statement.
REGISTRATION STATEMENT
A registration statement has been filed with the Securities and Exchange
Commission under the Securities Act of 1933, as amended, with respect to the
Policies. For further information concerning the Separate Account, KILICO and
the Policy, reference is made to the Registration Statement as amended with
exhibits. Copies of the Registration Statement are available from the
Commission.
FINANCIAL STATEMENTS
The financial statements of KILICO that are included should be considered
only as bearing upon KILICO's ability to meet its contractual obligations under
the Policy. KILICO's financial statements do not bear on the investment
experience of the assets held in the Separate Account.
22
<PAGE> 26
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS
KEMPER INVESTORS LIFE INSURANCE COMPANY:
We have audited the accompanying combined statement of assets and
liabilities and policy owners' equity of the KILICO Variable Separate Account as
of December 31, 1994, and the related combined statement of operations for the
year then ended, and the combined statements of changes in policy owners' equity
for the years ended December 31, 1994 and 1993. 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.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the combined financial position of the KILICO
Variable Separate Account as of December 31, 1994, and the combined results of
its operations for the year then ended, and the combined changes in its policy
owners' equity for the years ended December 31, 1994 and 1993, in conformity
with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Chicago, Illinois
February 13, 1995
23
<PAGE> 27
KILICO VARIABLE SEPARATE ACCOUNT
COMBINED STATEMENT OF ASSETS AND LIABILITIES AND POLICY OWNERS' EQUITY
DECEMBER 31, 1994 (IN THOUSANDS)
<TABLE>
<CAPTION>
Money Total High Government
Market Return Yield Equity Securities
Combined Subaccount Subaccount Subaccount Subaccount Subaccount
-------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Investments, at current value............... $ 10,448 1,308 2,125 1,716 1,121 4,178
Dividends and other receivables............. 3 3 -- -- -- --
-------- ------ ------ ------ ------ ------
Total assets.......................... 10,451 1,311 2,125 1,716 1,121 4,178
LIABILITIES AND POLICY OWNERS' EQUITY
Liabilities:
Mortality and expense risk................ 7 1 1 2 -- 3
-------- ------ ------ ------ ------ ------
Policy owners' equity....................... $ 10,444 1,310 2,124 1,714 1,121 4,175
======== ====== ====== ====== ====== ======
ANALYSIS OF POLICY OWNERS' EQUITY
Excess of proceeds from units sold over
payments for units redeemed............... $ 7,124 906 1,239 1,307 702 2,970
Accumulated net investment income........... 2,553 404 630 516 116 887
Accumulated net realized gain (loss) on
sales of investments...................... 666 -- 315 (51) 189 213
Unrealized appreciation (depreciation) of
investments............................... 101 -- (60) (58) 114 105
-------- ------ ------ ------ ------ ------
Policy owners' equity....................... $ 10,444 1,310 2,124 1,714 1,121 4,175
======== ====== ====== ====== ====== ======
</TABLE>
See accompanying notes to combined financial statements.
24
<PAGE> 28
KILICO VARIABLE SEPARATE ACCOUNT
COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1994 (IN THOUSANDS)
<TABLE>
<CAPTION>
Money Total High Government
Market Return Yield Equity Securities
Combined Subaccount Subaccount Subaccount Subaccount Subaccount
-------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Dividends and capital gains
distributions........................... $ 710 56 208 104 69 273
Mortality and expense risk charges........ 95 13 20 16 12 34
-------- --- ----- ----- ----- -----
Net investment income..................... 615 43 188 88 57 239
-------- --- ----- ----- ----- -----
Net realized and unrealized gain (loss) on
investments:
Net realized gain (loss) on sales of
investments........................... 55 -- 20 28 (1) 8
Change in unrealized depreciation of
investments........................... (1,154) -- (458) (171) (143) (382)
-------- --- ----- ----- ----- -----
Net realized and unrealized loss on
investments............................. (1,099) -- (438) (143) (144) (374)
-------- --- ----- ----- ----- -----
Net increase (decrease) in policy owners'
equity resulting from operations........ $ (484) 43 (250) (55) (87) (135)
======== === ===== ===== ===== =====
</TABLE>
See accompanying notes to combined financial statements.
25
<PAGE> 29
KILICO VARIABLE SEPARATE ACCOUNT
COMBINED STATEMENTS OF CHANGES IN POLICY OWNERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1993 (IN THOUSANDS)
<TABLE>
<CAPTION>
Money Market
Combined Subaccount
-------------------------- ------------------------
1994 1993 1994 1993
-------- ------- ------ -------
<S> <C> <C> <C> <C>
Operations:
Net investment income......................................... $ 615 556 43 28
Net realized gain (loss) on sales of investments.............. 55 270 -- --
Change in unrealized appreciation (depreciation)
of investments.............................................. (1,154) 110 -- --
-------- ------- ------ -------
Net increase (decrease) in policy owners' equity
resulting from operations................................. (484) 936 43 28
-------- ------- ------ -------
Account unit transactions:
Proceeds from units sold...................................... 514 268 507 250
Net transfers (to) from subaccounts........................... -- -- 14 (1,792)
Payments for units redeemed................................... (563) (412) (96) (46)
-------- ------- ------ -------
Net increase (decrease) in policy owners' equity
from account unit transactions............................ (49) (144) 425 (1,588)
-------- ------- ------ -------
Total increase (decrease) in policy owners' equity.............. (533) 792 468 (1,560)
Policy owners' equity:
Beginning of year............................................. 10,977 10,185 842 2,402
-------- ------- ------ -------
End of year................................................... $ 10,444 10,977 1,310 842
======== ====== ===== ======
</TABLE>
See accompanying notes to combined financial statements.
26
<PAGE> 30
<TABLE>
<CAPTION>
Government
Total Return High Yield Equity Securities
Subaccount Subaccount Subaccount Subaccount
- --------------- --------------- --------------- ---------------
1994 1993 1994 1993 1994 1993 1994 1993
- ----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
188 161 88 113 57 15 239 239
20 60 28 60 (1) 94 8 56
(458) 30 (171) 97 (143) 62 (382) (79)
- ----- ----- ----- ----- ----- ----- ----- -----
(250) 251 (55) 270 (87) 171 (135) 216
- ----- ----- ----- ----- ----- ----- ----- -----
-- 14 6 2 1 2 -- --
(455) 898 13 1,009 (71) 29 499 (144)
(133) (135) (177) (54) (75) (101) (82) (76)
- ----- ----- ----- ----- ----- ----- ----- -----
(588) 777 (158) 957 (145) (70) 417 (220)
- ----- ----- ----- ----- ----- ----- ----- -----
(838) 1,028 (213) 1,227 (232) 101 282 (4)
2,962 1,934 1,927 700 1,353 1,252 3,893 3,897
- ----- ----- ----- ----- ----- ----- ----- -----
2,124 2,962 1,714 1,927 1,121 1,353 4,175 3,893
===== ===== ===== ===== ===== ===== ===== =====
</TABLE>
27
<PAGE> 31
KILICO VARIABLE SEPARATE ACCOUNT
NOTES TO COMBINED FINANCIAL STATEMENTS
(1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION.
KILICO Variable Separate Account (the "Separate Account") is a unit
investment trust registered under the Investment Company Act of 1940, as
amended, established by Kemper Investors Life Insurance Company ("KILICO"). The
Separate Account receives and invests premiums under a variable life insurance
policy ("Policy"). The Separate Account is divided into five Subaccounts and
each Subaccount invests exclusively in a corresponding Portfolio of the Kemper
Investors Fund (The "Fund"), an open-end diversified management investment
company. The Fund has added two additional Subaccounts, the International
Portfolio and the Small Capitalization Equity Portfolio, which are not available
investment vehicles to policy owners of the Separate Account.
SECURITY VALUATION.
The investments are stated at current value which is based on the closing
bid price, net asset value, at December 31, 1994.
SECURITY TRANSACTIONS AND INVESTMENT INCOME.
Security transactions are accounted for on the trade date (date when KILICO
accepts risks of providing insurance coverage to the insured). Dividends and
capital gains distributions are recorded as income on the ex-dividend date.
Realized gains and losses from security transactions are reported on an
identified cost basis.
ACCOUNT UNIT TRANSACTIONS.
Proceeds from a Policy are automatically allocated to the Money Market
Subaccount on the trade date for a 15 day period. At the end of this period, the
Separate Account value (cash value) may be allocated to other Subaccounts as
designated by the owner of the Policy.
ACCUMULATION UNIT VALUATION.
On each day the New York Stock Exchange (the "Exchange") is open for
trading, the accumulation unit value is determined as of the earlier of 3:00
p.m. (Chicago time) or the close of the Exchange by dividing the total value of
each Subaccount's investments and other assets, less liabilities, by the number
of accumulation units outstanding in the respective Subaccount.
FEDERAL INCOME TAXES.
The operations of the Separate Account are included in the Federal income
tax return of KILICO. Under existing Federal income tax law, investment income
and realized capital gains and losses of the Separate Account increase
liabilities under the contract and are, therefore, not taxed. Thus the Separate
Account may realize net investment income and capital gains and losses without
Federal income tax consequences.
28
<PAGE> 32
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(2) SUMMARY OF INVESTMENTS
Investments, at cost, at December 31, 1994, are as follows (in thousands):
<TABLE>
<CAPTION>
Shares
Owned Cost
----- -------
<S> <C> <C>
INVESTMENT PORTFOLIO
Kemper Investors Fund Money Market Portfolio................................................. 1,308 $ 1,308
Kemper Investors Fund Total Return Portfolio................................................. 1,006 2,185
Kemper Investors Fund High Yield Portfolio................................................... 1,450 1,774
Kemper Investors Fund Equity Portfolio....................................................... 421 1,007
Kemper Investors Fund Government Securities Portfolio........................................ 3,659 4,073
-------
TOTAL INVESTMENTS........................................................................ $10,347
=======
</TABLE>
The underlying investments and significant industry concentrations are
summarized below.
MONEY MARKET PORTFOLIO: This Portfolio invests primarily in short-term
obligations of major banks and corporations. At December 31, 1994, no industry
exceeded 20% of the Portfolio's assets.
TOTAL RETURN PORTFOLIO: This Portfolio's investments will normally consist
of fixed-income and equity securities. Fixed-income securities will include
bonds and other debt securities and preferred stocks. Equity investments
normally will consist of common stocks and securities convertible into or
exchangeable for common stocks, however, the Portfolio may also make private
placement investments (which are normally restricted securities). At December
31, 1994, no industry exceeded 20% of the Portfolio's assets.
HIGH YIELD PORTFOLIO: This Portfolio invests in fixed-income securities, a
substantial portion of which are high yielding fixed-income securities. These
securities ordinarily will be in the lower rating categories of recognized
rating agencies or will be non-rated, and generally will involve more risk than
securities in the higher rating categories. At December 31, 1994, 21.3% of the
Portfolio's assets were invested in the manufacturing, metals and mining
industry. No other industry exceeded 20% of the Portfolio's assets.
EQUITY PORTFOLIO: This Portfolio's investments normally will consist of
common stocks and securities convertible into or exchangeable for common stocks,
however, it may also make private placement investments (which are normally
restricted securities). At December 31, 1994, no industry exceeded 20% of the
Portfolio's assets.
GOVERNMENT SECURITIES PORTFOLIO: This Portfolio invests primarily in U.S.
Government Securities. The Portfolio will also invest in fixed-income securities
other than U.S. Government securities and will engage in options and financial
futures transactions. At December 31, 1994, the Portfolio had 89.6% of its
assets invested in U.S. Government obligations.
(3) TRANSACTIONS WITH AFFILIATES
KILICO assesses a monthly charge to the Subaccounts for the cost of
insurance. The cost of insurance charge is allocated among the Subaccounts in
the proportion of each Subaccount to the Separate Account value. Cost of
insurance charges totaled approximately $150,000 for the year ended December 31,
1994. Additionally, KILICO assesses a daily charge to the Subaccounts for
mortality and expense risk assumed by KILICO at an annual rate of .90% of
assets.
Proceeds payable on the surrender of a Policy are reduced by the amount of
any applicable contingent deferred sales charge. During the year ended December
31, 1994, KILICO received contingent deferred sales charges of approximately
$19,900.
Kemper Financial Services, Inc., an affiliated company, is the investment
manager and principal underwriter of the Portfolios of the Fund which serve as
the underlying investments of the Separate Account.
29
<PAGE> 33
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(4) POLICY OWNERS' EQUITY
Policy owners' equity at December 31, 1994 is as follows (in thousands,
except unit value; differences are due to rounding):
<TABLE>
<CAPTION>
Number Policy
of Unit Owners'
Units Value Equity
------ ----- -------
<S> <C> <C> <C>
Money Market Subaccount.............................................................. 912 1.437 $1,310
Total Return Subaccount.............................................................. 1,465 1.449 2,124
High Yield Subaccount................................................................ 1,021 1.681 1,714
Equity Subaccount.................................................................... 638 1.756 1,121
Government Securities Subaccount..................................................... 2,684 1.555 4,175
-------
TOTAL POLICY OWNERS' EQUITY.................................................. $10,444
========
</TABLE>
30
<PAGE> 34
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors
Kemper Investors Life Insurance Company:
We have audited the consolidated balance sheet of Kemper Investors Life
Insurance Company and subsidiaries as of December 31, 1994 and 1993, and the
related consolidated statements of operations, stockholder's equity and cash
flows for each of the years in the three-year period ended December 31, 1994.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Kemper
Investors Life Insurance Company and subsidiaries at December 31, 1994 and 1993,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1994, in conformity with generally
accepted accounting principles.
As discussed in the notes to the consolidated financial statements,
effective January 1, 1994, the Company changed its method of accounting for
investment securities to adopt the provisions of the Financial Accounting
Standards Board's Statement of Financial Accounting Standards ("SFAS") 115,
Accounting for Certain Investments in Debt and Equity Securities. Also, as
discussed in the notes, effective January 1, 1993, the Company changed its
method of accounting for impairment of loans receivable to adopt the provisions
of SFAS 114, Accounting by Creditors for Impairment of a Loan, and changed its
method of accounting for income taxes to adopt the provisions of SFAS 109,
Accounting for Income Taxes. Further, as discussed in the notes, the Company
adopted the provisions of SFAS 106, Employers' Accounting for Postretirement
Benefits Other than Pensions in 1992.
KPMG PEAT MARWICK LLP
Chicago, Illinois
March 3, 1995
31
<PAGE> 35
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------------
1994 1993
----------- -----------
<S> <C> <C>
ASSETS
Fixed maturities, available for sale, at market (cost: 1994,
$3,707,356; 1993, $3,333,202).................................... $ 3,463,732 $ 3,441,224
Equity securities, at market (cost: 1994, $14,947; 1993,
$35,170)......................................................... 14,767 67,700
Short-term investments............................................. 204,164 402,463
Joint venture mortgage loans....................................... 351,359 730,753
Third-party mortgage loans......................................... 318,682 132,162
Other real estate-related investments.............................. 237,242 291,489
Policy loans....................................................... 277,743 264,112
Other invested assets.............................................. 25,760 43,267
----------- -----------
Total investments........................................ 4,893,449 5,373,170
Cash............................................................... 23,189 7,487
Accrued investment income.......................................... 125,543 132,834
Deferred insurance acquisition costs............................... 310,465 288,097
Fixed assets, at cost less accumulated depreciation................ 3,735 6,413
Receivable for securities sold..................................... -- 26,631
Reinsurance recoverable............................................ 642,801 745,554
Other assets and receivables....................................... 29,914 34,058
Assets held in separate accounts................................... 1,507,984 1,499,471
----------- -----------
Total assets............................................. $ 7,537,080 $ 8,113,715
========== ==========
LIABILITIES
Future policy benefits............................................. $ 4,843,690 $ 5,040,002
Ceded future policy benefits....................................... 642,801 745,554
Payable for securities purchased................................... 574 43,758
Other accounts payable and liabilities............................. 66,687 66,298
Deferred income taxes.............................................. 41,364 64,045
Liabilities related to separate accounts........................... 1,507,984 1,499,471
----------- -----------
Total liabilities........................................ 7,103,100 7,459,128
----------- -----------
Commitments and contingent liabilities
STOCKHOLDER'S EQUITY
Capital stock--$10 par value,
authorized 300,000 shares; outstanding 250,000 shares............ 2,500 2,500
Additional paid-in capital......................................... 491,994 409,423
Unrealized gain (loss) on investments.............................. (236,443) 93,096
Retained earnings.................................................. 175,929 149,568
----------- -----------
Total stockholder's equity............................... 433,980 654,587
----------- -----------
Total liabilities and stockholder's equity............... $ 7,537,080 $ 8,113,715
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
32
<PAGE> 36
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------------
1994 1993 1992
--------- --------- ---------
<S> <C> <C> <C>
REVENUE
Net investment income..................................... $ 353,084 $ 339,274 $ 404,758
Realized investment losses................................ (54,557) (27,584) (83,502)
Fees and other income..................................... 31,950 25,687 32,360
--------- --------- ---------
Total revenue................................... 330,477 337,377 353,616
--------- --------- ---------
BENEFITS AND EXPENSES
Benefits and interest credited to policyholders........... 248,494 275,689 348,555
Commissions, taxes, licenses and fees..................... 26,910 33,875 49,309
Operating expenses........................................ 25,324 24,383 38,617
Deferral of insurance acquisition costs................... (31,852) (31,781) (46,649)
Amortization of insurance acquisition costs............... 20,809 12,376 29,119
--------- --------- ---------
Total benefits and expenses..................... 289,685 314,542 418,951
--------- --------- ---------
Income (loss) before income tax expense (benefit) and
cumulative effect of changes in accounting principles... 40,792 22,835 (65,335)
Income tax expense (benefit).............................. 14,431 11,142 (13,730)
--------- --------- ---------
Income (loss) before cumulative effect of
changes in accounting principles.............. 26,361 11,693 (51,605)
Cumulative effect of changes in accounting principles, net
of tax.................................................. -- 2,350 (281)
--------- --------- ---------
Net income (loss)............................... $ 26,361 $ 14,043 $ (51,886)
========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
33
<PAGE> 37
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
(in thousands)
<TABLE>
<CAPTION>
1994 1993 1992
--------- --------- ---------
<S> <C> <C> <C>
CAPITAL STOCK, beginning and end of year................ $ 2,500 $ 2,500 $ 2,500
--------- --------- ---------
ADDITIONAL PAID-IN CAPITAL, beginning of year........... 409,423 310,237 280,237
Capital contributions from Parent....................... 82,500 90,000 30,000
Transfer of limited partnership interest to Parent...... 71 9,186 --
--------- --------- ---------
End of year................................... 491,994 409,423 310,237
--------- --------- ---------
UNREALIZED GAIN (LOSS) ON INVESTMENTS, beginning of
year.................................................. 93,096 39,872 (830)
Unrealized gain (loss) on revaluation of investments,
net................................................... (329,539) 53,224 40,702
--------- --------- ---------
End of year................................... (236,443) 93,096 39,872
--------- --------- ---------
RETAINED EARNINGS, beginning of year.................... 149,568 136,055 187,941
Net income (loss)....................................... 26,361 14,043 (51,886)
Dividend of limited partnership interest to Parent...... -- (530) --
--------- --------- ---------
End of year................................... 175,929 149,568 136,055
--------- --------- ---------
Total stockholder's equity.................... $ 433,980 $ 654,587 $ 488,664
========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE> 38
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------------------
1994 1993 1992
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)............................... $ 26,361 $ 14,043 $ (51,886)
Reconcilement of net income (loss) to net cash
provided:
Realized investment losses................... 54,557 27,584 83,502
Interest credited and other charges.......... 242,591 269,766 343,788
Deferred insurance acquisition costs......... (11,043) (19,405) (17,529)
Amortization of discount and premium on
investments................................ (1,383) (203) (4,699)
Deferred income taxes........................ 20,809 14,596 16,599
Other, net................................... (13,352) 30,148 (33,740)
------------ ------------ ------------
Net cash provided from operating
activities............................ 318,540 336,529 336,035
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash from investments sold or matured:
Fixed maturities held to maturity............ 144,717 187,949 96,588
Fixed maturities sold prior to maturity...... 910,913 1,652,119 2,939,784
Mortgage loans, policy loans and other
invested assets............................ 536,668 881,505 557,237
Cost of investments purchased or loans
originated:
Fixed maturities............................. (1,447,393) (2,322,085) (3,456,016)
Mortgage loans, policy loans and other
invested assets............................ (281,059) (443,445) (326,899)
Short-term investments, net..................... 198,299 (214,999) 474,280
Net change in receivable and payable for
securities transactions...................... (16,553) 39,078 (70,088)
Net reductions in fixed assets.................. 2,678 8,062 2,667
------------ ------------ ------------
Net cash provided by (used in) investing
activities............................ 48,270 (211,816) 217,553
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Policyholder account balances:
Deposits..................................... 215,034 246,219 440,576
Withdrawals.................................. (652,513) (516,340) (498,287)
Capital contributions from Parent............... 82,500 90,000 30,000
Reinsured life reserves......................... -- -- (515,684)
Other........................................... 3,871 16,776 7,934
------------ ------------ ------------
Net cash used in financing activities... (351,108) (163,345) (535,461)
------------ ------------ ------------
Net increase (decrease) in cash.... 15,702 (38,632) 18,127
CASH, beginning of period......................... 7,487 46,119 27,992
------------ ------------ ------------
CASH, end of period............................... $ 23,189 $ 7,487 $ 46,119
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
35
<PAGE> 39
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
Kemper Investors Life Insurance Company and subsidiaries (the "Company")
issues fixed and variable annuity products and interest-sensitive life insurance
products marketed primarily through a network of financial institutions,
nonaffiliated and affiliated securities brokerage firms, insurance agents and
financial planners. The Company is a wholly-owned subsidiary of Kemper Financial
Companies, Inc. ("KFC"), which in turn is a holding company formed by Kemper
Corporation ("Kemper"), the Company's ultimate parent.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles. The statements include the accounts of
the Company on a consolidated basis. All significant intercompany balances and
transactions have been eliminated.
Life insurance revenue and expenses
Revenue for annuities and interest-sensitive life products consists of
investment income, and policy charges such as mortality, expense and surrender
charges. Expenses consist of benefits and interest credited to contracts, policy
maintenance costs and amortization of deferred insurance acquisition costs. Also
reflected in fees and other income are ceding commissions received as a result
of certain reinsurance transactions entered into by the Company during 1992.
(See the note captioned "Reinsurance" on page 50.)
Deferred insurance acquisition costs
The costs of acquiring new business, principally commission expense and
certain policy issuance and underwriting expenses, have been deferred to the
extent they are recoverable from estimated future gross profits on the related
contracts and policies. The deferred insurance acquisition costs for annuities,
separate account business and interest-sensitive life products are being
amortized over the estimated contract life in relation to the present value of
estimated gross profits. Beginning in 1994, deferred insurance acquisition costs
reflect the estimated impact of unrealized gains or losses on fixed maturities
held as available for sale in the investment portfolio, through a credit or
charge to stockholder's equity, net of income tax.
Future policy benefits
Liabilities for future policy benefits related to annuities and
interest-sensitive life contracts reflect net premiums received plus interest
credited during the contract accumulation period and the present value of future
payments for contracts that have annuitized. Current interest rates credited
during the contract accumulation period range from 4 percent to 8.75 percent.
Future minimum guaranteed interest rates vary from 4 percent to 8.75 percent for
periods ranging from a portion of 1995 up to a portion of 1999 and are generally
3 percent to 4.5 percent thereafter. For contracts that have annuitized,
interest rates that are used in determining the present value of future payments
range principally from 3 percent to 11.25 percent.
Invested assets and related income
Investments in fixed maturities (bonds and redeemable preferred stocks) are
carried at market value at December 31, 1994 and 1993, as they are currently
considered available for sale. Short-term investments are carried at cost, which
approximates market value. Equity securities of nonrelated companies are
generally carried at market value using the closing prices as of the balance
sheet date derived from either a major securities exchange or the National
Association of Securities Dealers Automated Quotations system.
Mortgage loans are carried at their unpaid balance net of unamortized
discount and any applicable reserve. Other real estate-related investments net
of any applicable reserve and write-downs include certain bonds issued by real
estate finance or development companies; notes receivable from real estate
ventures; investments in real estate ventures carried at cost, adjusted for the
equity in the operating income or loss of such ventures; and real estate owned
carried primarily at fair value.
The Company evaluates its real estate-related assets (including accrued
interest) by estimating the probabilities of loss utilizing various projections
that include several factors relating to the borrower,
36
<PAGE> 40
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
property, term of the loan, tenant composition, rental rates, other supply and
demand factors and overall economic conditions. Real estate reserves are
established when declines in collateral values, estimated in light of current
economic conditions and calculated in conformity with Statement of Financial
Accounting Standards ("SFAS") 114, indicate a likelihood of loss. Generally, the
reserve is based upon the excess of the loan amount over the estimated future
cash flows from the loan discounted at the loan's contractual rate of interest
taking into consideration the effects of recourse to, and subordination of loans
held by, affiliated non-life realty companies. Changes in the Company's real
estate reserves and write-downs are included in revenue as realized investment
gain or loss.
The Company adopted SFAS 114, Accounting by Creditors for Impairment of a
Loan, in the fourth quarter of 1993. SFAS 114 defines "impaired loans" as loans
in which it is probable that a creditor will be unable to collect all amounts
due according to the contractual terms of the loan agreement. In the fourth
quarter of 1994, the Company adopted SFAS 118, Accounting by Creditors for
Impairment of a Loan-- Income Recognition and Disclosures. SFAS 118 amends SFAS
114, providing clarification of income recognition issues and requiring
additional disclosures relating to impaired loans. The adoption of SFAS 118 had
no effect on the Company's financial position or results of operations at or for
the year ended December 31, 1994.
At December 31, 1994 and 1993, total impaired loans amounted to $75.9
million and $179.4 million, respectively. Impaired loans with reserves were
$67.6 million and $91.9 million with corresponding reserves of $18.8 million and
$38.5 million at December 31, 1994 and 1993, respectively. In determining
reserves relative to impaired loans, the Company also considered the deficit in
equity investments in real estate of $2.0 million and $35.0 million at December
31, 1994 and 1993, respectively.
The Company had an average balance of $93.9 million and $158.0 million in
impaired loans for 1994 and 1993, respectively. Cash payments received on
impaired loans are generally applied to reduce the outstanding loan balance. At
December 31, 1994 and 1993, loans on nonaccrual status amounted to $274.6
million and $563.6 million, respectively. Impaired loans are generally included
in the Company's nonaccrual loans. The additional amount of nonaccrual loans in
excess of impaired loans represents the Company's consideration of market risks
associated with the real estate loan portfolio.
Upon adoption of SFAS 114, the Company determined that its previous
disclosures relating to impaired loans and recorded real estate reserves were
adequate. As such, restating prior quarters' operating results for the impact of
SFAS 114 was not considered necessary.
Policy loans are carried at their unpaid balance. Other invested assets
consist primarily of venture capital and a leveraged lease and are carried at
cost.
Realized gains or losses on sales of investments, determined on the basis
of identifiable cost on the disposition of the respective investment,
recognition of other-than-temporary declines in value and changes in real
estate-related reserves and write-downs are included in revenue. Unrealized
gains or losses on revaluation of investments are credited or charged to
stockholder's equity net of deferred income tax.
The amortized cost of fixed maturities is adjusted for amortization of
premiums and accretion of discounts to maturity, or in the case of
mortgage-backed securities, over the estimated life of the security. Such
amortization is included in net interest income. Amortization of the discount or
premium from mortgage-backed securities is recognized using a level effective
yield method which considers the estimated timing and amount of prepayments of
the underlying mortgage loans and is adjusted to reflect differences which arise
between the prepayments originally anticipated and the actual prepayments
received and currently anticipated. To the extent that the estimated lives of
mortgage-backed securities change as a result of changes in prepayment rates,
the adjustment is also included in net investment income. The Company does not
accrue interest income on fixed maturities deemed to be impaired on an
other-than-temporary basis, or on mortgage loans, real estate-related bonds and
other real estate loans where the likelihood of collection of interest is
doubtful.
37
<PAGE> 41
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Separate account business
The assets and liabilities of the separate accounts represent segregated
funds administered and invested by the Company for purposes of funding variable
annuity and variable life insurance contracts for the exclusive benefit of
variable annuity and variable life insurance contract holders. The Company
receives administrative fees from the separate account and retains varying
amounts of withdrawal charges to cover expenses in the event of early
withdrawals by contract holders. The assets and liabilities of the separate
accounts are carried at market value.
Income tax
The operations of the Company are included in the consolidated federal
income tax return of Kemper. Income taxes receivable or payable are determined
on a separate return basis, and payments are received from or remitted to Kemper
pursuant to a tax allocation arrangement between Kemper and its subsidiaries,
including the Company. The Company generally receives a tax benefit for losses
to the extent such losses can be utilized in Kemper's consolidated tax return.
Upon adoption of SFAS 109, Accounting for Income Taxes, effective January
1, 1993, deferred taxes are provided on the temporary differences between the
tax and financial statement basis of assets and liabilities. Deferred income tax
previously was provided on the tax effects of timing differences between
financial statement and taxable income.
Fixed assets
Fixed assets, consisting primarily of electronic data processing equipment,
are recorded at cost and are depreciated over the useful lives of the assets on
a straight-line method. At December 31, 1994 and 1993, the accumulated
depreciation on fixed assets was $20.8 million and $21.6 million, respectively.
Other
Certain reclassifications have been made in the consolidated financial
statements for the years 1993 and 1992 to conform to 1994 reporting.
(2) CASH FLOW INFORMATION
The Company defines cash as cash in banks and money market accounts.
Federal income tax paid to (refunded by) Kemper under the tax allocation
arrangement for the years ended December 31, 1994, 1993 and 1992 amounted to
$(10.7) million, $4.2 million and $7.8 million, respectively.
Not reflected in the statement of cash flows are rollovers of mortgage
loans, other loans and investments totaling $57 million, $146 million and $229
million in 1994, 1993 and 1992, respectively.
Reflected in the statement of cash flows is the 1992 sale of $515.7 million
of reinsured life reserves for which the Company delivered an investment
portfolio that included $151.4 million of mortgage loans, $294.8 million of
fixed maturities and $69.5 million of other investments.
The Company also transferred its equity ownership interests in two limited
partnerships during 1994 and 1993. (See the note captioned "Related-Party
Transactions" on page 50.)
38
<PAGE> 42
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME
Fixed maturities are considered available for sale, depending upon certain
economic and business conditions. The Company is carrying its fixed maturity
investment portfolio at estimated market value, with the aggregate unrealized
appreciation or depreciation being recorded as a separate component of
stockholder's equity net of any applicable income tax effect. The carrying value
(estimated market value) of fixed maturities compared with amortized cost,
adjusted for other-than-temporary declines in value, at December 31, 1994 and
1993, was as follows:
<TABLE>
<CAPTION>
ESTIMATED UNREALIZED
CARRYING AMORTIZED ---------------------
(in thousands) VALUE COST GAINS LOSSES
---------- ---------- -------- ---------
<S> <C> <C> <C> <C>
1994
U.S. treasury securities and obligations of U.S.
government agencies and authorities............ $ 10,682 $ 10,998 $ 24 $ (340)
Obligations of states and political subdivisions,
special revenue and nonguaranteed.............. 25,021 25,691 -- (670)
Debt securities issued by foreign governments.... 109,624 120,950 50 (11,376)
Corporate securities............................. 1,679,428 1,805,933 7,027 (133,532)
Mortgage-backed securities....................... 1,638,977 1,743,784 -- (104,807)
---------- ---------- -------- ---------
Total fixed maturities.................... $3,463,732 $3,707,356 $ 7,101 $(250,725)
========== ========== ========= ==========
1993
U.S. treasury securities and obligations of U.S.
government agencies and authorities............ $ 11,686 $ 11,464 $ 240 $ (18)
Obligations of states and political subdivisions,
special revenue and nonguaranteed.............. 16,434 15,232 1,202 --
Debt securities issued by foreign governments.... 114,275 112,825 2,782 (1,332)
Corporate securities............................. 2,025,888 1,948,268 89,445 (11,825)
Mortgage-backed securities....................... 1,272,941 1,245,413 34,268 (6,740)
---------- ---------- -------- ---------
Total fixed maturities.................... $3,441,224 $3,333,202 $127,937 $ (19,915)
========== ========== ========= ==========
</TABLE>
Upon default or indication of potential default by an issuer of fixed
maturity securities, the Company-owned issue(s) of such issuer would be placed
on nonaccrual status and, since declines in market value would no longer be
considered by the Company to be temporary, would be analyzed for possible write-
down. Any such issue would be written down to its net realizable value,
determined in the manner described in the following paragraph, during the fiscal
quarter in which the impairment was determined to have become other than
temporary, unless such net realizable value exceeded the Company's carrying
value for such issue. Thereafter, each issue on nonaccrual status is regularly
reviewed, and additional write-downs may be taken in light of later
developments.
The Company's computation of net realizable value involves judgments and
estimates, so such value should be used with care. Such value determination
considers such factors as the existence and value of any collateral security;
the capital structure of the issuer; the level of actual and expected market
interest rates; where the issue ranks in comparison with other debt of the
issuer; the economic and competitive environment of the issuer and its business;
the Company's view on the likelihood of success of any proposed issuer
restructuring plan; and the timing, type and amount of any restructured
securities that the Company anticipates it will receive.
39
<PAGE> 43
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
The Company's $907 million real estate portfolio consists of the following:
SUMMARY OF GROSS AND NET REAL ESTATE INVESTMENTS
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31
-----------------
1994 1993
------ ------
<S> <C> <C>
Investments before reserves, write-downs and net joint venture operating
losses:
Joint venture mortgage loans................................................ $ 358 $ 766
Third-party mortgage loans.................................................. 353 200
Other real estate-related investments....................................... 350 354
------ ------
Subtotal............................................................... 1,061 1,320
Reserves.................................................................... (43) (61)
Write-downs................................................................. (97) (88)
Cumulative net operating losses of joint ventures owned..................... (14) (17)
------ ------
Net real estate investments................................................... $ 907 $1,154
====== ======
</TABLE>
At December 31, 1994, the Company had $216.2 million of mortgage loans and
other real estate-related investments (net of reserves and write-downs) that
were non-income producing for the preceding 12 months.
The Company evaluates its real estate-related assets (including accrued
interest) by estimating the probabilities of loss utilizing various projections
that include several factors relating to the borrower, property, term of the
loan, tenant composition, rental rates, other supply and demand factors and
overall economic conditions. Because the Company's real estate review process
includes estimates, there can be no assurance that current estimates will prove
accurate over time due to changing economic conditions and other factors.
The Company's real estate reserve was allocated as follows:
REAL ESTATE RESERVE
(in millions)
<TABLE>
<CAPTION>
JOINT VENTURE THIRD-PARTY OTHER REAL
MORTGAGE MORTGAGE ESTATE-RELATED
LOANS LOANS INVESTMENTS TOTAL
------------- ----------- -------------- ------
<S> <C> <C> <C> <C>
Balance at 12/31/92................................. $ 64.4 $ 5.0 $ 23.4 $ 92.8
1993 change in reserve.............................. (29.3) (5.0) 2.6 (31.7)
---------- -------- ---------- ------
Balance at 12/31/93................................. 35.1 -- 26.0 61.1
1994 change in reserve.............................. (28.0) 10.4 (.5) (18.1)
---------- -------- ---------- ------
Balance at 12/31/94................................. $ 7.1 $10.4 $ 25.5 $ 43.0
========== ======== ========== ======
</TABLE>
In addition to the reserve, the Company's provision for real estate-related
losses (on assets held at the respective period end) included cumulative
write-downs (both by the Company and including the Company's share of
write-downs by joint ventures) totaling $96.6 million at December 31, 1994 and
$88.3 million at December 31, 1993. The 1994 decrease in reserves was primarily
due to write-downs which increased in 1994 as reserves for general real estate
risks were allocated to certain specific loans and equity investments in real
estate, particularly with respect to investments in land. In 1993, the Company's
real estate reserve and write-downs reflected declining valuations in the
Company's real estate portfolio, offset in part by the positive effects of
recourse to, and subordination of loans held by, affiliated non-life realty
companies. The declining valuations in 1993 reflected the Company's view, based
on economic data then available, that there will be slower than previously
anticipated economic growth in the future and therefore slower absorption of
real estate, particularly undeveloped land. Due to the Company's assessment for
slower economic growth, its plans with respect to certain projects were changed
to reflect deferrals of their commencement or completion.
40
<PAGE> 44
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
The Company's real estate experience could continue to be adversely
affected by overbuilding and weak economic conditions in certain real estate
markets and by fairly restrictive lending practices by banks and other lenders.
Stagnant or worsening economic conditions in the areas in which the Company has
made loans, or additional adverse information becoming known to the Company
through its regular reviews or otherwise, could result in higher levels of
problem loans or potential problem loans, reductions in the value of real estate
collateral and adjustments to the real estate reserve. The Company's net income
and stockholder's equity could be materially reduced in future periods if real
estate market conditions remain stagnant or worsen in areas where the Company's
portfolio is located.
Current conditions in the real estate markets have been adversely affecting
the financial resources of certain of the Company's joint venture partners.
Every partner, however, remains active in the control of its respective joint
ventures. In evaluating a partner's ability to meet its financial commitments,
the Company considers the amount of all applicable debt and the value of all
properties within that portion of the Company's portfolio consisting of loans to
and investments in joint ventures with such partner.
The following table is a summary of the Company's troubled real
estate-related investments:
TROUBLED REAL ESTATE-RELATED INVESTMENTS
(BEFORE RESERVES AND WRITE-DOWNS, EXCEPT FOR REAL ESTATE OWNED)
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1994 1993
------ ------
<S> <C> <C>
Potential problem loans(1)................................................. $ 57.9 $ 20.2
Past due loans(2).......................................................... -- 2.8
Nonaccrual loans(3)........................................................ 274.6 563.6
Restructured loans (currently performing)(4)............................... 50.5 56.7
Real estate owned(5)....................................................... 57.3 55.1
------ ------
Total(6)(7)......................................................... $440.3 $698.4
====== ======
</TABLE>
- ---------------
(1) These are real estate-related investments where the Company, based on known
information, has serious doubts about the borrowers' abilities to comply
with present repayment terms and which the Company anticipates may go into
nonaccrual, past due or restructured status.
(2) Interest more than 90 days past due but not on nonaccrual status.
(3) The Company does not accrue interest on real estate-related investments when
it judges that the likelihood of collection of interest is doubtful. The
1994 decrease in nonaccrual loans primarily reflected sales and foreclosures
as well as write-offs of certain fully reserved loans.
(4) The Company defines a "restructuring" of debt as an event whereby the
Company, for economic or legal reasons related to the debtor's financial
difficulties, grants a concession to the debtor it would not otherwise
consider. Such concessions either stem from an agreement between the Company
and the debtor or are imposed by law or a court. By this definition,
restructured loans do not include any loan that, upon the expiration of its
term, both repays its principal and pays interest then due from the proceeds
of a new loan that the Company, at its option, may extend (roll over).
(5) Real estate owned is carried at fair value and includes deeds in lieu of
foreclosure and certain purchased property. Cumulative write-downs to fair
value were $67.5 million and $20.6 million at December 31, 1994 and 1993,
respectively.
(6) Total reserves and cumulative write-downs on properties owned at December
31, 1994 (excluding fair value adjustments to real estate owned) were 16.4
percent of total troubled real estate-related investments and 7.4 percent of
the Company's total real estate portfolio before reserves and write-downs.
(7) Equity investments in real estate are not defined as part of, and therefore
are not taken into account in calculating, total troubled real estate. The
Company's equity investments also involve real estate risks.
Based on the level of troubled real estate-related investments the Company
experienced in 1994 and 1993, the Company anticipates additional foreclosures
and deeds in lieu of foreclosure in 1995 and beyond. Any consolidation
accounting resulting from foreclosures would add the related ventures' assets
41
<PAGE> 45
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
and senior third-party liabilities to the Company's balance sheet and eliminate
the Company's loans to such ventures.
Due to the adverse real estate environment affecting the Company's
portfolio in recent years, the Company has continued to devote significant
attention to its real estate portfolio, enhancing monitoring of the portfolio
and formulating specific action plans addressing nonperforming and potential
problem credits. Since 1991, the Company has intensified its attention to
evaluating the asset quality, cash flow and prospects associated with each of
its projects. The Company continues to analyze various potential transactions
designed to reduce both its joint venture operating losses and the amount of its
real estate-related investments. Specific types of transactions under
consideration (and previously utilized) include loan sales, property sales,
mortgage refinancings and real estate investment trusts. However, there can be
no assurance that such efforts will result in continued improvements in the
performance of the Company's real estate portfolio.
At December 31, 1994, securities carried at approximately $5.3 million were
on deposit with governmental agencies as required by law.
Proceeds from sales of investments in fixed maturities prior to maturity
were $910.9 million, $1.7 billion and $2.9 billion during 1994, 1993 and 1992,
respectively. Gross gains of $6.0 million, $80.4 million and $69.5 million and
gross losses of $55.9 million, $37.8 million and $101.7 million were realized on
sales of fixed maturities in 1994, 1993 and 1992, respectively. Gross unrealized
gains and losses on equity securities at December 31, 1994 amounted to $469
thousand and $649 thousand, respectively.
The following table sets forth the maturity aging schedule of fixed
maturity investments at December 31, 1994:
<TABLE>
<CAPTION>
CARRYING AMORTIZED
(in thousands) VALUE COST VALUE
---------- ----------
<S> <C> <C>
One year or less........................................................ $ 1,135 $ 1,135
Over one year through five.............................................. 346,841 357,697
Over five years through ten............................................. 1,011,526 1,088,547
Over ten years.......................................................... 465,253 516,193
Securities not due at a single maturity date(1)......................... 1,638,977 1,743,784
---------- ----------
Total fixed maturities........................................... $3,463,732 $3,707,356
========== ==========
</TABLE>
- ---------------
(1) Weighted average maturity of 7 years.
The sources of net investment income were as follows:
<TABLE>
<CAPTION>
(in thousands) 1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Interest and dividends on fixed maturities................. $274,231 $221,144 $210,047
Dividends on equity securities............................. 1,751 3,084 2,061
Income from short-term investments......................... 10,668 12,155 18,249
Income from mortgage loans................................. 41,713 82,028 149,816
Income from policy loans................................... 18,517 16,826 17,052
Income from other real estate-related investments.......... 21,239 11,755 17,915
Income from other loans and investments.................... 3,533 8,008 2,580
-------- -------- --------
Total investment income............................. 371,652 355,000 417,720
Investment expense......................................... (18,568) (15,726) (12,962)
-------- -------- --------
Net investment income............................... $353,084 $339,274 $404,758
========= ========= =========
</TABLE>
42
<PAGE> 46
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVESTED ASSETS AND RELATED INCOME (CONTINUED)
Unrealized gains (losses) are computed below as follows: fixed
maturities--the difference between market and amortized cost, adjusted for
other-than-temporary declines in value; equity securities and other--the
difference between market value and cost. The realized and change in unrealized
investment gains (losses) by class of investment for the years ended December
31, 1994, 1993 and 1992 were as follows:
<TABLE>
<CAPTION>
REALIZED GAINS (LOSSES)
------------------------------------------
(in thousands) 1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Real estate-related.................................. $(41,720) $(79,652) $(94,995)
Fixed maturities..................................... (49,857) 36,234 11,150
Equity securities.................................... 28,243 17,086 109
Other................................................ 8,777 (1,252) 234
-------- -------- --------
Realized investment losses before income tax
benefit......................................... (54,557) (27,584) (83,502)
Income tax benefit................................... (19,095) (7,917) (21,256)
-------- -------- --------
Net realized investment losses..................... $(35,462) $(19,667) $(62,246)
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
CHANGE IN UNREALIZED GAINS (LOSSES)
------------------------------------------
(in thousands) 1994 1993 1992
--------- ------- --------
<S> <C> <C> <C>
Fixed maturities.................................... $(351,646) $60,258 $ 88,820
Equity securities................................... (32,710) 19,882 14,882
Adjustment to deferred insurance acquisition
costs............................................. 11,325 -- --
--------- ------- --------
Unrealized gain (loss) before income tax.......... (373,031) 80,140 103,702
Income tax expense (benefit)........................ (43,492) 26,916 20,968
--------- ------- --------
Net unrealized gain (loss) on investments.... $(329,539) $53,224 $ 82,734
========== ======== =========
</TABLE>
(4) UNCONSOLIDATED INVESTEES
At December 31, 1994, the Company, along with other Kemper subsidiaries,
directly held partnership interests in a number of real estate joint ventures.
Also, the Company and Lumbermens Mutual Casualty Company ("Lumbermens") and
certain subsidiaries of Kemper and Lumbermens are partners in a master limited
partnership (the "MLP") formed, effective January 1, 1993, to hold the equity
interests each partner's organization separately held previously in joint
ventures with Peter B. Bedford or his affiliates ("Bedford"), and in January
1994, the MLP acquired substantially all of Bedford's interests in such joint
ventures. Kemper and Lumbermens each own 50 percent of the MLP.
The Company's direct and indirect real estate joint venture investments are
accounted for utilizing the equity method, with the Company recording its share
of the operating results of the respective partnerships. The Company, as an
equity owner, has the ability to fund, and historically has elected to fund,
operating requirements of certain of the joint ventures. Consolidation
accounting methods are not utilized as the Company, in most instances, does not
own more than 50 percent in the aggregate, and in any event, major decisions of
the partnership must be made jointly by all partners.
43
<PAGE> 47
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) UNCONSOLIDATED INVESTEES (CONTINUED)
Selected financial information, as of December 31, 1994 and 1993, is
presented below separately for the MLP, ventures with the Prime Group, Inc. or
its affiliates ("Prime"), and other real estate-related partnerships. (See the
note captioned "Concentration of Credit Risk" on page 30.) Such real
estate-related information for 1994 and 1993 was based on unaudited financial
information received by the Company from the respective entities.
SELECTED FINANCIAL INFORMATION
(in thousands)
<TABLE>
<CAPTION>
REAL ESTATE-RELATED
-------------------------------------------------------
PRIME-RELATED
-------------------------
MLP DOMESTIC SPANISH OTHER
VENTURES PARTNERSHIPS PROJECTS PARTNERSHIPS
---------- ------------ --------- ------------
<S> <C> <C> <C> <C>
1994
Revenue.......................................... $ 104,827 $ 14,966 $ 22,095 $ 52,295
Expenses......................................... 192,492 18,881 45,256 49,011
---------- ------------ --------- ------------
Operating income (loss).......................... (87,665) (3,915) (23,161) 3,284
Asset writedowns(1).............................. (23,536) (621) (102,031) (17,037)
---------- ------------ --------- ------------
Net loss......................................... $ (111,201) $ (4,536) $(125,192) $(13,753)
========== ========= ========== =========
The Company's share of operating loss(1)......... $ (121) $ (1,140) $ -- $ (145)
========== ========= ========== =========
The Company's share of net loss(1)............... $ (156) $ (1,244) $ -- $ (4,915)
========== ========= ========== =========
Properties at cost, net of depreciation.......... $ 879,352 $ 55,804 $ 338,923 $ 38,075
========== ========= ========== =========
Total assets..................................... $1,049,019 $ 77,751 $ 373,637 $153,785
========== ========= ========== =========
Mortgages, notes payable and related accrued
interest payable to:
The Company.................................... $ 207,909 $ 31,767 $ 36,606 $ 7,436
Kemper subsidiaries other than the Company..... 417,967 2,713 394,764 2,411
Lumbermens..................................... 181,325 -- 92,592 26,734
Fidelity Life Association...................... 46,036 -- -- --
Other third parties............................ 411,795 42,048 98,076 51,303
Total liabilities................................ $1,354,624 $ 82,770 $ 660,557 $110,334
========== ========= ========== =========
The Company's net equity investment(1)........... $ 1,953 $ (585) $ 36,624 $ 7,415
========== ========= ========== =========
</TABLE>
- ---------------
(1) Excluded from the Company's share of operating and net losses and related
net equity investment in real estate-related entities is interest expense
related to loans by the Company which are on nonaccrual status and
write-downs taken directly by the Company. Included in the Company's share
of current year results are immaterial prior year audit adjustments by the
respective entities.
Included in the immediately preceding and immediately following tables are
real estate loans to partnerships or corporations in which the Company and other
Kemper subsidiaries hold equity interests. At December 31, 1994, the Company had
other joint venture-related loans totaling $16.0 million before reserves, not
included in the table above, to partnerships in which the Company has options to
acquire equity interests or has made loans with additional interest features.
These joint venture-related loans
44
<PAGE> 48
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) UNCONSOLIDATED INVESTEES (CONTINUED)
totaled $38.5 million at December 31, 1993. Also at December 31, 1994, the
Company had joint venture-related loans totaling $37.5 million before reserves,
not included in the table above, to partnerships in which Lumbermens and
Fidelity Life Association, an affiliated mutual insurance company ("FLA"), had
equity interests. These joint venture-related loans totaled $68.1 million before
reserves at December 31, 1993. (See the note captioned "Financial
Instruments--Off-Balance-Sheet Risk" on page 52.)
SELECTED FINANCIAL INFORMATION
(in thousands)
<TABLE>
<CAPTION>
REAL ESTATE-RELATED
------------------------------------------------------
PRIME-RELATED
------------------------
MLP DOMESTIC SPANISH OTHER
VENTURES PARTNERSHIPS PROJECTS PARTNERSHIPS
---------- ------------ -------- ------------
<S> <C> <C> <C> <C>
1993
Revenue........................................... $ 101,694 $ 50,636 $ 36,607 $ 60,701
Expenses.......................................... 226,282 65,824 76,449 66,978
---------- ------------ -------- ------------
Operating loss.................................... (124,588) (15,188) (39,842) (6,277)
Asset writedowns(1)............................... (107,135) -- (39,274) --
---------- ------------ -------- ------------
Net loss.......................................... $ (231,723) $(15,188) $(79,116) $ (6,277)
========== ========= ========= =========
The Company's share of operating loss(1).......... $ (172) $ (7,548) $ -- $ (852)
========== ========= ========= =========
The Company's share of net loss(1)................ $ (409) $ (7,548) $ -- $ (852)
========== ========= ========= =========
Properties at cost, net of depreciation........... $1,161,025 $278,635 $253,321 $ 46,184
========== ========= ========= =========
Total assets...................................... $1,426,638 $375,738 $292,825 $225,019
========== ========= ========= =========
Mortgages, notes payable and related accrued
interest payable to:
The Company..................................... $ 298,447 $ 48,303 $ 31,871 $ 5,287
Kemper subsidiaries other than the Company...... 490,031 56,602 305,335 5,430
Lumbermens...................................... 245,890 17,262 51,423 30,226
Fidelity Life Association....................... 65,691 -- -- --
Other third parties............................. 752,239 199,765 88,558 56,622
Total liabilities................................. $1,895,260 $390,888 $539,728 $153,334
========== ========= ========= =========
The Company's net equity investment(1)............ $ 18,548 $ 7,626 $ 31,871 $ 15,524
========== ========= ========= =========
</TABLE>
- ---------------
(1) Excluded from the Company's share of operating and net losses and
related net equity investment in real estate-related entities is
interest expense related to loans by the Company which are on
nonaccrual status and write-downs taken directly by the Company.
Included in the Company's share of current year results are immaterial
prior year audit adjustments by the respective entities.
45
<PAGE> 49
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) CONCENTRATION OF CREDIT RISK
The Company generally strives to maintain a diversified invested asset
portfolio; however, certain concentrations of credit risk exist, including
mortgage-backed securities and real estate.
Approximately 49.2 percent of the Company's investment-grade fixed
maturities at December 31, 1994 were mortgage-backed securities. These
investments consist primarily of marketable mortgage pass-through securities
issued by the Government National Mortgage Association, the Federal National
Mortgage Association or the Federal Home Loan Mortgage Corporation and other
investment-grade securities collateralized by mortgage pass-through securities
issued by these entities. The Company has not made any material investments in
interest-only or other similarly volatile tranches of mortgage-backed
securities. The Company's mortgage-backed investments are generally of AAA
credit quality, and the markets for the Company's investments in mortgage-backed
securities have been and are expected to remain liquid.
Future investment income from mortgage-backed securities may be affected by
the timing of principal payments and the yields on reinvestment alternatives
available at the time of such payments. Due to the fact that the Company's
investments in mortgage-backed securities predominately date from recent years,
the current rise in interest rates is not expected to cause any material
unanticipated extension of the average maturities of these investments.
Prepayment activity on securities purchased at a discount is not expected to
result in any material losses to the Company because such prepayment would
generally accelerate the reporting of the discounts as investment income.
Prepayments resulting from a decline in interest rates related to securities
purchased at a premium would accelerate the amortization of premiums on such
purchases which would result in reductions of investment income related to such
securities. At December 31, 1994, the Company had unamortized discounts and
premiums of $20.4 million and $14.8 million, respectively, related to
mortgage-backed securities. Given the credit quality, liquidity and anticipated
payment characteristics of the Company's investments in mortgage-backed
securities, the Company believes that the associated risk can be managed without
material adverse consequences on its consolidated financial statements.
The Company's real estate portfolio is distributed by geographic location
and property type, as shown in the following two tables:
<TABLE>
<S> <C>
GEOGRAPHIC DISTRIBUTION AS OF DECEMBER 31, 1994
California........................ 26.9%
Illinois.......................... 26.2
Texas............................. 11.2
Ohio.............................. 6.3
Spain............................. 4.0
Colorado.......................... 3.8
Oregon............................ 3.0
Indiana........................... 2.7
Washington........................ 2.7
Hawaii............................ 2.5
Virginia.......................... 2.5
Florida........................... 2.1
Other(1).......................... 6.1
-----
Total........................ 100.0%
=====
DISTRIBUTION BY PROPERTY TYPE AS OF DECEMBER 31, 1994
Office............................ 21.5%
Land.............................. 20.4
Industrial........................ 14.7
Retail............................ 13.9
Hotel............................. 11.7
Apartment......................... 5.0
Residential....................... 4.7
Mixed use......................... 2.1
Other............................. 6.0
-----
Total........................ 100.0%
=====
</TABLE>
- ---------------
(1) No other single location exceeded 2.0 percent.
The Company had $246.3 million (5.0 percent of invested assets and cash),
$240.5 million (4.9 percent of invested assets and cash) and $102.8 million (2.1
percent of invested assets and cash) of mortgage loans and other real estate
investments in California, Illinois and Texas, respectively, at December 31,
1994. The majority of the Illinois and Texas loans and other investments are
Prime-related. The majority of the California loans and other investments are
MLP-related. (See the note captioned "Unconsolidated Investees.") Real estate
markets have been depressed in recent periods in areas where most of the
Company's real estate portfolio is located. Southern California shows signs of
improvement,
46
<PAGE> 50
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) CONCENTRATION OF CREDIT RISK (CONTINUED)
although real estate market conditions there have continued to be worse than in
many other areas of the country. Northern California and Illinois currently
reflect some stabilization and improvement.
The Company had $184.9 million (3.8 percent of invested assets and cash) of
below investment-grade securities (including real estate-related bonds) totaling
$49.9 million, or 1.0 percent of invested assets and cash) at December 31, 1994.
At December 31, 1994, the Company held only one investment which exceeded
10 percent of stockholder's equity. This investment, amounting to $47.6 million,
is a joint venture mortgage loan to Lisle Park Plaza.
The following table shows the amounts of the Company's real estate
portfolio at December 31, 1994 which consisted of loans to or investments in
joint ventures with the MLP and Prime:
<TABLE>
<CAPTION>
(in millions) MLP PRIME
------ ------
<S> <C> <C>
Mortgage loans................................................................ $161.6 $150.3
Real estate-related bonds..................................................... 2.9 36.2
Other real estate loans....................................................... 54.5 29.7
Real estate owned............................................................. 98.3 --
Equity investments............................................................ 7.4 42.9
Reserves...................................................................... (8.9) (21.0)
Write-downs................................................................... (61.5) (.1)
------ ------
Total....................................................................... $254.3 $238.0
====== ======
</TABLE>
At December 31, 1994, the Company's real estate portfolio also included
$36.6 million of loans carried as equity investments in real estate related to
land for office and retail development and residential projects located in
Barcelona, Spain. Such equity investments in Spain totaled $31.9 million at
December 31, 1993, after accounting for fundings of $151.3 million during 1993.
The Spanish projects accounted for $29.4 million of net fundings during 1994 and
represented approximately 4.0 percent of the Company's real estate portfolio at
December 31, 1994. These investments, which began in the late 1980s, accounted
for $14.1 million of the December 31, 1994 off-balance-sheet commitments, of
which the Company expects to fund $7.1 million. Also during 1994, loans to the
Spanish projects totaling $24.7 million were sold at book value to an affiliated
real estate subsidiary of KFC.
Undeveloped land, including the Spanish projects, represented approximately
20.4 percent of the Company's real estate portfolio at December 31, 1994. To
maximize the value of certain land and other projects, additional development is
proceeding or is planned. Such development of existing projects may continue to
require substantial funding, either from the Company or third parties. In the
present real estate markets, third-party financing can require credit enhancing
arrangements (e.g., standby financing arrangements and loan commitments) from
the Company. The values of development projects are dependent on a number of
factors, including Kemper's and the Company's plans with respect thereto,
obtaining necessary permits and market demand for the permitted use of the
property. There can be no assurance that such permits will be obtained as
planned or at all, nor that such expenditures will occur as scheduled, nor that
Kemper's and the Company's plans with respect to such projects may not change
substantially.
(6) INCOME TAXES
Income tax expense (benefit) was as follows for the years ended December
31, 1994, 1993 and 1992:
<TABLE>
<CAPTION>
(in thousands) 1994 1993 1992
-------- -------- ---------
<S> <C> <C> <C>
Current.................................................... $ (6,898) $ (5,773) $ (9,457)
Deferred................................................... 21,329 16,915 (4,273)
-------- -------- ---------
Total............................................ $ 14,431 $ 11,142 $ (13,730)
======== ======== =========
</TABLE>
47
<PAGE> 51
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) INCOME TAXES (CONTINUED)
The actual income tax expense (benefit) for 1994, 1993 and 1992 differed
from the "expected" tax expense (benefit) for those years as displayed below.
"Expected" tax expense (benefit) was computed by applying the U.S. federal
corporate tax rate of 35 percent in 1994 and 1993 and 34 percent for 1992 to
income (loss) before income tax expense (benefit) and cumulative effect of
changes in accounting principles.
<TABLE>
<CAPTION>
(in thousands) 1994 1993 1992
-------- -------- ---------
<S> <C> <C> <C>
Computed expected tax expense (benefit).................... $ 14,277 $ 7,992 $ (22,214)
Difference between "expected" and actual tax expense
(benefit):
State taxes.............................................. 645 332 777
Foreign tax credit....................................... (155) 358 (611)
Change in tax rate....................................... -- 1,441 --
Change in valuation allowance............................ -- 701 --
Unutilized capital losses................................ -- -- 8,286
Other, net............................................... (336) 318 32
-------- -------- ---------
Total actual tax expense (benefit)............... $ 14,431 $ 11,142 $ (13,730)
======== ======== =========
</TABLE>
The Company adopted SFAS 109, Accounting for Income Taxes, as of January 1,
1993. SFAS 109 established new principles for calculating and reporting the
effects of income taxes in financial statements. SFAS 109 replaced the income
statement orientation inherent in APB Opinion 11 with a balance sheet approach.
Under the new approach, deferred tax assets and liabilities are generally
determined based on the difference between the financial statement and tax bases
of assets and liabilities using enacted tax rates in effect for the year in
which the differences are expected to reverse. Under SFAS 109, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. SFAS 109 allows
recognition of deferred tax assets if future realization of the tax benefit is
more likely than not, with a valuation allowance for the portion that is not
likely to be realized.
The implementation of SFAS 109 resulted in a one-time increase to earnings
of $2.4 million in the first quarter of 1993. Prior years' financial statements
have not been restated to apply the provisions of SFAS 109.
Upon adoption of SFAS 109, a valuation allowance was established to reduce
the deferred federal tax asset related to real estate and other investments to
the amount that, based upon available evidence, is, in management's judgment,
more likely than not to be realized. Any reversals of the valuation allowance
are contingent upon the recognition of future capital gains in Kemper's federal
income tax return or a change in circumstances which causes the recognition of
the benefits to become more likely than not. During 1994, the valuation
allowance was increased by $85.3 million. This increase in the valuation
allowance is solely attributable to the decrease in the net deferred federal tax
liability from unrealized losses on investments.
48
<PAGE> 52
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the Company's net deferred federal tax liability were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
(in thousands) 1994 1993
--------- --------
<S> <C> <C>
Deferred federal tax assets:
Unrealized losses on investments..................................... $ 85,331 $ --
Life policy reserves................................................. 51,519 60,446
Real estate-related.................................................. 39,360 45,851
Other investment-related............................................. 7,435 12,498
Other................................................................ 6,415 5,804
--------- --------
Total deferred federal tax assets................................. 190,060 124,599
Valuation allowance.................................................. (100,532) (15,201)
--------- --------
Total deferred federal tax assets after valuation allowance....... 89,528 109,398
--------- --------
Deferred federal tax liabilities:
Deferred insurance acquisition costs................................. 108,663 100,834
Unrealized gains on investments...................................... -- 49,193
Depreciation and amortization........................................ 18,878 21,367
Other................................................................ 3,351 2,049
--------- --------
Total deferred federal tax liabilities............................ 130,892 173,443
--------- --------
Net deferred federal tax liabilities................................... $ (41,364) $(64,045)
========== =========
</TABLE>
The valuation allowance of $100.5 million is subject to future adjustments
based on, among other items, Kemper's estimates of future operating earnings and
capital gains.
Pursuant to the deferred method under APB Opinion 11, deferred income taxes
were recognized for income and expense items that were reported in different
years for financial reporting purposes and income tax purposes using the tax
rate applicable for the year of the calculation. Under the deferred method,
deferred taxes were not adjusted for subsequent changes in tax rates.
The sources of deferred tax expense (benefit) and their tax effect were as
follows:
<TABLE>
<CAPTION>
(in thousands) 1992
--------
<S> <C>
Deferred insurance acquisition costs.................................................. $ 6,172
Future policy benefit reserves tax adjustment......................................... 5,692
Timing differences in recognition of accrued liabilities for GAAP and tax purposes.... (397)
Tax versus GAAP separate account gain................................................. (3,277)
Tax versus GAAP capital losses........................................................ 4,350
GAAP versus tax investment income on bonds............................................ (4,380)
Joint venture partnership income adjustments.......................................... 1,491
Leasing transactions.................................................................. 2,567
Change in real estate reserve......................................................... (21,305)
Tax capitalization of policy acquisition costs........................................ 555
Tax versus GAAP depreciation.......................................................... 490
Unutilized capital losses............................................................. 8,286
Other, net............................................................................ (4,517)
--------
Total....................................................................... $ (4,273)
=========
</TABLE>
The tax returns through the year 1986 have been examined by the Internal
Revenue Service ("IRS"). Changes proposed are not material to the Company's
financial position. The tax returns for the years 1987 through 1990 are
currently under examination by the IRS.
49
<PAGE> 53
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) RELATED-PARTY TRANSACTIONS
The Company received cash capital contributions from KFC of $82.5 million,
$90.0 million and $30.0 million during 1994, 1993 and 1992, respectively.
In 1994 and 1993, the Company transferred the majority of its deficit
equity ownership interest in two limited partnerships to KFC resulting in an
increase of the Company's additional paid-in capital of $71 thousand and $9.2
million, respectively. The Company also paid a non-cash dividend of $530
thousand to KFC in December 1993, which represented the positive equity
ownership interests of the majority of one of its limited partnerships. Net
losses associated with the Company's ownership interests in these limited
partnerships amounted to $1.4 million, $5.4 million and $3.9 million in 1994,
1993 and 1992, respectively, and are included in the Company's consolidated
statement of operations.
The Company has loans to joint ventures, consisting primarily of mortgage
loans on real estate, in which the Company and/or one of its affiliates has an
ownership interest. At December 31, 1994 and 1993, joint venture mortgage loans
totaled $351 million and $731 million, respectively, and during 1994, 1993 and
1992, the Company earned interest income on these joint venture loans of $22.0
million, $63.1 million and $116.3 million, respectively.
As of January 1, 1993, all of the Company's personnel are employees of
Federal Kemper Life Assurance Company ("FKLA"), an affiliated company. Prior to
January 1, 1993, the majority of the Company's personnel were employees of
another affiliated company, Kemper Financial Services, Inc. ("KFS"). The Company
is allocated expenses for the utilization of KFS and FKLA employees and
facilities and the information systems of Kemper Service Company ("KSvC") based
on the Company's share of administrative, legal, marketing, investment
management, information systems and operation and support services. During 1994,
1993 and 1992, expenses allocated to the Company from KFS and KSvC amounted to
$6.5 million, $3.1 million and $28.2 million, respectively. The Company also
paid to KFS investment management fees of $6.0 million, $6.7 million and $5.9
million during 1994, 1993 and 1992, respectively. The Company paid Kemper Sales
Company $7.1 million in 1992 for services relating to the distribution of the
Company's products. In addition, expenses allocated to the Company from FKLA
during 1994, 1993 and 1992 amounted to $11.1 million, $13.1 million and $1.1
million, respectively.
During 1994, 1993 and 1992, the Company sold certain mortgages and real
estate-related investments, net of reserves, amounting to approximately $154.0
million, $343.7 million and $144.8 million respectively, to KFC Portfolio Corp.,
an affiliated non-life realty company, in exchange for cash. No gain or loss was
recognized on the sales.
(8) REINSURANCE
In the ordinary course of business, the Company enters into reinsurance
agreements to diversify risk and limit its overall financial exposure to certain
blocks of fixed-rate annuities. The Company generally cedes 100 percent of the
related annuity liabilities under the terms of the reinsurance agreements.
Although these reinsurance agreements contractually obligate the reinsurers to
reimburse the Company, they do not discharge the Company from its primary
liabilities and obligations to policyholders. As such, these amounts paid or
deemed to have been paid are recorded on the Company's consolidated balance
sheet as reinsurance recoverables and ceded future policy benefits.
In 1992 and 1991, the Company entered into 100 percent indemnity
reinsurance agreements ceding $515.7 million and $416.3 million, respectively,
of its fixed-rate annuity liabilities to FLA. FLA is a mutual insurance company
that shares common management with the Company and FKLA and certain common board
members with the Company and Kemper. The 1992 reinsurance agreement resulted in
the sale to FLA of approximately $500 million of certain assets, including $151
million of mortgage loans, while the 1992 agreement was all cash. As of December
31, 1994, the reinsurance recoverable related to the fixed-rate annuity
liabilities ceded to FLA amounted to approximately $643 million.
(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company and FKLA sponsor a welfare plan that provides medical and life
insurance benefits to their retired and active employees and the Company is
allocated a portion of the costs of providing such benefits. The Company is self
insured with respect to medical benefits, and the plan is not funded except
50
<PAGE> 54
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONTINUED)
with respect to certain disability-related medical claims. The medical plan
provides for medical insurance benefits at retirement, with eligibility based
upon age and the participant's number of years of participation attained at
retirement. The plan is contributory for pre-Medicare retirees, and will be
contributory for all retiree coverage for most current employees, with
contributions generally adjusted annually. Postretirement life insurance
benefits are noncontributory and are limited to $10,000 per participant.
The discount rate used in determining the allocated postretirement benefit
obligation was 8 percent and 7 percent for 1994 and 1993, respectively. The
assumed health care trend rate used was based on projected experience for 1994
and 1995, 10 percent in 1996, gradually declining to 6 percent by the year 1999
and remaining at that level thereafter.
The status of the plan as of December 31, 1994 and 1993, was as follows:
Accumulated postretirement benefit obligation:
<TABLE>
<CAPTION>
(in thousands) 1994 1993
---- ----
<S> <C> <C>
Retirees.......................................................................... $206 $171
Fully eligible active plan participants........................................... 58 90
Other active plan participants.................................................... 101 159
Unrecognized gain from actuarial experience....................................... 314 223
---- ----
Accrued liability....................................................... $679 $643
===== =====
Components of the net periodic postretirement benefit cost:
</TABLE>
<TABLE>
<CAPTION>
(in thousands) 1994 1993
---- ----
<S> <C> <C>
Service cost-benefits attributed to service during the period..................... $ 31 $ 84
Interest cost on accumulated postretirement benefit obligations................... 43 41
Amortization of unrecognized actuarial gain....................................... (35) --
---- ----
Total................................................................... $ 39 $125
===== =====
</TABLE>
A one percentage point increase in the assumed health care cost trend rate
for each year would increase the accumulated postretirement benefit obligation
as of December 31, 1994 and 1993 by $48 thousand and $69 thousand, respectively,
and the net postretirement health care interest and service costs for the years
ended December 31, 1994 and 1993 by $14 thousand and $19 thousand, respectively.
During 1994, the Company adopted certain severance-related policies to
provide benefits, generally limited in time, to former or inactive employees
after employment but before retirement. The effect of adopting these policies
was immaterial.
(10) COMMITMENTS AND CONTINGENT LIABILITIES
The Company is involved in various legal actions for which it establishes
liabilities where appropriate. In the opinion of the Company's management, based
upon the advice of legal counsel, the resolution of such litigation is not
expected to have a material adverse effect on the consolidated financial
statements.
Although none of the Company or its joint venture projects have been
identified as a "potentially responsible party" under federal environmental
guidelines, inherent in the ownership of or lending to real estate projects is
the possibility that environmental pollution conditions may exist on or near or
relate to properties owned or previously owned on properties securing loans.
Where the Company has presently identified remediation costs, they have been
taken into account in determining the cash flows and resulting valuations of the
related real estate assets. Based on the Company's receipt and review of
environmental reports on most of the projects in which it is involved, the
Company believes its environmental exposure would be immaterial to its
consolidated results of operations. However, the Company may be required in the
future to take actions to remedy environmental exposures, and there can be no
assurance that material environmental exposures will not develop or be
identified in the future. The amount of future environmental costs is impossible
to estimate due to, among other factors, the unknown magnitude of possible
exposures, the unknown timing and extent of corrective actions that may be
required, the determination of the Company's liability in proportion to others
and the extent such costs may be covered by insurance or various environmental
indemnification agreements.
51
<PAGE> 55
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
See the note captioned "Financial Instruments--Off-Balance-Sheet Risk"
below for the discussion regarding the Company's loan commitments and standby
financing agreements.
The Company is liable for guaranty fund assessments related to certain
unaffiliated insurance companies that have become insolvent during the years
1994 and prior. The Company's financial statements include provisions for all
known assessments that will be levied against the Company as well as an estimate
of amounts (net of estimated future premium tax recoveries) that the Company
believes it will be assessed in the future for which the life insurance industry
has estimated the cost to cover losses to policyholders. The Company is also
contingently liable for any future guaranty fund assessments related to
insolvencies of unaffiliated insurance companies, for which the life insurance
industry has been unable to estimate the cost to cover losses to policyholders.
No specific amount can be reasonably estimated for such insolvencies as of
December 31, 1994.
(11) FINANCIAL INSTRUMENTS--OFF BALANCE-SHEET RISK
The Company has continued to fund both existing projects and legal
commitments. At December 31, 1994, the Company had future legal loan commitments
and stand-by financing agreements totaling $376.1 million to support the
financing needs of various real estate investments. To the extent these
arrangements are called upon, amounts loaned would be secured by assets of the
joint ventures, including first mortgage liens on the real estate. The Company's
criteria in making these arrangements are the same as for its mortgage loans and
other real estate investments. The Company presently expects to fund
approximately $96.5 million of these arrangements, along with providing capital
to existing projects. The total legal commitments, along with estimated working
capital requirements are considered in the Company's analysis of real
estate-related reserves and write-downs. The disparity between total legal
commitments and the amount expected to be funded relates principally to standby
financing arrangements that provide credit enhancements to certain tax-exempt
bonds, which the Company does not presently expect to fund. The fair values of
loan commitments and standby financing agreements are estimated in conjunction
with and using the same methodology as the fair value estimates of mortgage
loans and other real estate-related investments.
(12) DERIVATIVE FINANCIAL INSTRUMENTS
The Company is party to derivative financial instruments in the normal
course of business for other than trading purposes to hedge exposures in foreign
currency fluctuations related to certain foreign fixed maturity securities held
by the Company. The following table summarizes various information regarding
these derivative financial instruments as of December 31, 1994 and 1993:
<TABLE>
<CAPTION>
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REPRICING
(in thousands) NOTIONAL CARRYING ESTIMATED YEARS TO FREQUENCY
1994 AMOUNT VALUE FAIR VALUE EXPIRATION (DAYS)
- ----------------------------------------------------------------- -------- -------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Non-trading foreign exchange forward options..................... $ 34,541 $ 18 $ 18 .25 30
</TABLE>
<TABLE>
<CAPTION>
1993
- -----------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-trading foreign exchange forward options..................... 69,241 2,194 2,194 .22 30
</TABLE>
The Company's hedges relating to foreign currency exposure are implemented
using forward contracts on foreign currencies. These are generally short
duration contracts with U.S. money-center banks. The Company records realized
and unrealized gains and losses on such investments in net income on a current
basis. The amounts of gain (loss) included in net income during 1994, 1993 and
1992 totaled $6.4 million, $(2.8) million and $(2.4) million, respectively.
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value disclosures are required under SFAS 107. Such fair value
estimates are made at specific points in time, based on relevant market
information and information about the financial instrument. These estimates do
not reflect any premium or discount that could result from offering for sale at
one time the Company's entire holdings of a particular financial instrument. A
significant portion of the Company's financial instruments are carried at fair
value. (See the note captioned "Invested Assets and Related
52
<PAGE> 56
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Income" on page 39.) Fair value estimates for financial instruments not carried
at fair value are generally determined using discounted cash flow models and
assumptions that are based on judgments regarding current and future economic
conditions and the risk characteristics of the investments. Although fair value
estimates are calculated using assumptions that management believes are
appropriate, changes in assumptions could significantly affect the estimates and
such estimates should be used with care.
Fair value estimates are determined for existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and certain liabilities that are not
considered financial instruments. Accordingly, the aggregate fair value
estimates presented do not represent the underlying value of the Company. For
example, the Company's subsidiaries are not considered financial instruments,
and their value has not been incorporated into the fair value estimates. In
addition, tax ramifications related to the realization of unrealized gains and
losses can have a significant effect on fair value estimates and have not been
considered in any of the estimates.
The following methods and assumptions were used by the Company in
estimating the fair value of its financial instruments:
Fixed maturities: Fair values for fixed maturity securities carried at
market value were determined by using market quotations, or independent pricing
services that use prices provided by market makers or estimates of market values
obtained from yield data relating to instruments or securities with similar
characteristics, or fair value as determined in good faith by the Company's
portfolio manager, Kemper Financial Services, Inc.
Equity securities: Fair values for equity securities were based upon quoted
market prices.
Cash and short-term investments: The carrying amounts reported in the
consolidated balance sheet for these instruments approximate fair values.
Mortgage loans and other real estate-related investments: Fair values for
mortgage loans and other real estate-related investments were estimated on a
project-by-project basis. Generally, the projected cash flows of the collateral
are discounted using a discount rate of 10 to 12 percent. The resulting
collateral estimates were then used to determine the value of the Company's real
estate-related investments. The estimate of fair value should be used with care
given the inherent difficulty of estimating the fair value of real estate due to
the lack of a liquid quotable market.
Other loans and investments: The carrying amounts reported in the
consolidated balance sheet for these instruments approximate fair values. The
fair values of policy loans were estimated by discounting the expected future
cash flows using an interest rate charged on policy loans for similar policies
currently being issued.
Life policy benefits: Fair values of the life policy benefits regarding
investment contracts (primarily deferred annuities) and universal life contracts
were estimated by discounting gross benefit payments, net of contractual
premiums, using the average crediting rate currently being offered in the
marketplace for similar contracts with maturities consistent with those
remaining for the contracts being valued. The Company had projected its future
average crediting rate in 1994 and 1993 to be 5.5 percent and 5.0 percent,
respectively, while the assumed average market crediting rate was 6.5 percent in
1994 and 5.25 percent in 1993.
53
<PAGE> 57
KEMPER INVESTORS LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying values and estimated fair values of the Company's financial
instruments at December 31, 1994 and 1993 were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------------------------------------
1994 1993
------------------------ ------------------------
CARRYING FAIR CARRYING FAIR
(in thousands) VALUE VALUE VALUE VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial instruments recorded as assets:
Fixed maturities(1)........................ $3,463,732 $3,463,732 $3,441,224 $3,441,224
Equity securities.......................... 14,767 14,767 67,700 67,700
Cash and short-term investments............ 227,353 227,353 409,950 409,950
Mortgage loans and other real
estate-related assets................... 907,283 804,867 1,154,404 1,010,038
Policy loans............................... 277,743 277,743 264,112 264,112
Other invested assets...................... 25,760 25,760 43,267 43,267
Financial instruments recorded as
liabilities:
Life policy benefits....................... 4,843,690 4,709,561 5,040,002 5,120,000
</TABLE>
- ---------------
(1) Includes $18 and $2,200 carrying value and fair value for 1994 and 1993,
respectively, of derivative securities used to hedge the foreign currency
exposure on certain specific foreign fixed maturity investments.
(14) STOCKHOLDER'S EQUITY--RETAINED EARNINGS
The maximum amount of dividends which can be paid by insurance companies
domiciled in the State of Illinois to shareholders without prior approval of
regulatory authorities is restricted if such dividend, together with other
distributions during the twelve preceding months would exceed the greater of ten
percent of statutory surplus as regards policyholders as of the preceding
December 31, or statutory net income for the preceding calendar year, then such
proposed dividend must be reported to the Director of Insurance at least 30 days
prior to the proposed payment date and may be paid only if not disapproved.
Illinois insurance laws also permit payment of dividends only out of earned
surplus, exclusive of most unrealized capital gains. The maximum amount of
dividends which can be paid by the Company in 1995 is currently $0. The Company
paid no cash dividends in 1994, 1993 or 1992.
The Company's net income (loss) and stockholder's equity as determined in
accordance with statutory accounting principles are as follows:
<TABLE>
<CAPTION>
(in thousands) 1994 1993 1992
-------- -------- ---------
<S> <C> <C> <C>
Net income (loss)............................................ $ 44,491 $(36,178) $(141,975)
========= ========= ==========
Statutory surplus............................................ $416,243 $329,430 $ 251,283
========= ========= ==========
</TABLE>
54
<PAGE> 58
APPENDIX
ILLUSTRATIONS OF CASH VALUES,
CASH SURRENDER VALUES,
DEATH BENEFITS
The tables in this Prospectus have been prepared to help show how values
under a Policy change with investment experience. The tables illustrate how Cash
Values, Surrender Values (reflecting the deduction of Surrender Charges, if any)
and Death Benefits under a Policy issued on an insured of a given age would vary
over time if the hypothetical gross investment rates of return were a uniform,
after tax, annual rate of 0%, 6%, and 12%. If the hypothetical gross investment
rate of return averages 0%, 6%, or 12%, but fluctuates over or under those
averages throughout the years, the Cash Values, Surrender Values and Death
Benefits may be different.
The amounts shown for the Cash Value, Surrender Value and Death Benefit as
of each Policy Anniversary reflect the fact that the net investment return on
the assets held in the Subaccounts is lower than the gross return. This is
because of a daily charge to the Subaccounts for assuming mortality and expense
risks, which is equivalent to an effective annual charge of 0.90%. In addition,
the net investment returns also reflect the deduction of the Fund investment
advisory fees and other Fund expenses, approximated at 0.65%. The tables also
reflect the fact that KILICO makes monthly charges for providing insurance
protection. For each hypothetical gross investment rate of return, tables are
provided reflecting current and guaranteed cost of insurance charges.
Hypothetical gross average investment rates of return of 0%, 6% and 12%
correspond to the following approximate net annual investment rate of return of
- -1.55%, 4.45% and 10.45%, respectively. Cost of insurance rates vary by age, sex
and rating class and, therefore, are not reflected in the approximate net annual
investment rate of return above.
The values shown are for Policies which are issued as standard. Values for
Policies issued on a substandard basis would result in lower Cash Values,
Surrender Values and Death Benefits than those illustrated.
The tables also reflect the fact that no charges for federal, state or
other income taxes are currently made against the Separate Account. If such a
charge is made in the future, it will take a higher gross rate of return than
illustrated to produce the net after-tax returns shown in the tables.
Upon request, KILICO will furnish an illustration based on the proposed
Insured's age, sex and premium payment requested.
55
<PAGE> 59
FLEXIBLE PREMIUM VARIABLE LIFE INSURANCE POLICY
MALE NON-SMOKER $10,000 INITIAL PREMIUM ISSUE AGE 25
$88,520 INITIAL DEATH BENEFIT:
VALUES--CURRENT COST OF INSURANCE
<TABLE>
<CAPTION>
PREMIUM 0% HYPOTHETICAL 6% HYPOTHETICAL 12% HYPOTHETICAL
PAID GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN
PLUS ------------------------------ -------------------------------- -----------------------------------
POLICY INTEREST CASH SURRENDER DEATH CASH SURRENDER DEATH CASH SURRENDER DEATH
YEAR AT 5% VALUE VALUE BENEFIT VALUE VALUE BENEFIT VALUE VALUE BENEFIT
- ---------- -------- ------- ------- -------- -------- -------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1........ $ 10,500 $ 9,733 $ 8,857 $ 88,520 $ 10,329 $ 9,429 $ 88,520 $ 10,926 $ 10,026 $ 88,520
2........ 11,025 9,469 8,712 88,520 10,674 9,874 88,520 11,951 11,151 88,520
3........ 11,576 9,209 8,565 88,520 11,035 10,335 88,520 13,084 12,384 88,520
4........ 12,155 8,953 8,416 88,520 11,412 10,812 88,520 14,337 13,737 88,520
5........ 12,763 8,701 8,266 88,520 11,806 11,306 88,520 15,724 15,224 88,520
6........ 13,401 8,452 8,114 88,520 12,218 11,818 88,520 17,257 16,857 88,520
7........ 14,071 8,206 7,960 88,520 12,650 12,350 88,520 18,953 18,653 88,520
8........ 14,775 7,964 7,805 88,520 13,101 12,901 88,520 20,830 20,630 88,520
9........ 15,513 7,726 7,648 88,520 13,573 13,473 88,520 22,905 22,805 88,520
10........ 16,289 7,481 7,481 88,520 14,058 14,058 88,520 25,192 25,192 88,520
15........ 20,789 6,191 6,191 88,520 16,726 16,726 88,520 40,721 40,721 101,804
20........ 26,533 4,649 4,649 88,520 19,744 19,744 88,520 65,732 65,732 145,924
25........ 33,864 2,661 2,661 88,520 23,051 23,051 88,520 105,857 105,857 202,188
30........ 43,219 0 0 0 26,499 26,499 88,520 170,337 170,337 267,429
</TABLE>
ASSUMPTIONS:
(1) NO ADDITIONAL PREMIUMS PAID AND NO POLICY LOANS HAVE BEEN MADE.
(2) VALUES REFLECT CURRENT COST OF INSURANCE CHARGES.
(3) NET INVESTMENT RETURNS ARE CALCULATED AS THE HYPOTHETICAL GROSS INVESTMENT
RETURN LESS ALL CHARGES AND DEDUCTIONS SHOWN IN THE PROSPECTUS APPENDIX.
(4) DEATH BENEFIT REFLECTS CURRENT INTERNAL REVENUE CODE REQUIREMENTS.
(5) ZERO VALUES INDICATE POLICY LAPSE IN ABSENCE OF AN ADDITIONAL PREMIUM
PAYMENT.
THE HYPOTHETICAL INVESTMENT RATES OF RETURN SHOWN ABOVE AND ELSEWHERE IN
THIS PROSPECTUS ARE ILLUSTRATIVE ONLY AND SHOULD NOT BE DEEMED A REPRESENTATION
OF PAST OR FUTURE INVESTMENT RATES OF RETURN. ACTUAL RATES OF RETURN MAY BE MORE
OR LESS THAN THOSE SHOWN AND WILL DEPEND ON A NUMBER OF FACTORS, INCLUDING THE
INVESTMENT ALLOCATIONS MADE BY AN OWNER AND ACTUAL EXPENSES. THE DEATH BENEFIT,
CASH VALUE AND SURRENDER VALUE FOR A POLICY WOULD BE DIFFERENT FROM THOSE SHOWN
IF THE ACTUAL RATES OF RETURN AVERAGED 0%, 6% AND 12% OVER A PERIOD OF YEARS BUT
ALSO FLUCTUATED ABOVE OR BELOW THOSE AVERAGES FOR INDIVIDUAL POLICY YEARS. NO
REPRESENTATIONS CAN BE MADE BY KEMPER INVESTORS LIFE INSURANCE COMPANY THAT
THESE HYPOTHETICAL RATES OF RETURN CAN BE ACHIEVED FOR ANY ONE YEAR OR SUSTAINED
OVER ANY PERIOD OF TIME.
56
<PAGE> 60
FLEXIBLE PREMIUM VARIABLE LIFE INSURANCE POLICY
MALE NON-SMOKER $10,000 INITIAL PREMIUM ISSUE AGE 25
$88,520 INITIAL DEATH BENEFIT:
VALUES--GUARANTEED COST OF INSURANCE
<TABLE>
<CAPTION>
PREMIUM 0% HYPOTHETICAL 6% HYPOTHETICAL 12% HYPOTHETICAL
PAID GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN
PLUS ------------------------------ -------------------------------- -----------------------------------
POLICY INTEREST CASH SURRENDER DEATH CASH SURRENDER DEATH CASH SURRENDER DEATH
YEAR AT 5% VALUE VALUE BENEFIT VALUE VALUE BENEFIT VALUE VALUE BENEFIT
- ---------- -------- ------- ------- -------- -------- -------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1........ $ 10,500 $ 9,728 $ 8,852 $ 88,520 $ 10,325 $ 9,425 $ 88,520 $ 10,921 $ 10,021 $ 88,520
2........ 11,025 9,462 8,705 88,520 10,667 9,867 88,520 11,943 11,143 88,520
3........ 11,576 9,202 8,557 88,520 11,026 10,326 88,520 13,074 12,374 88,520
4........ 12,155 8,946 8,408 88,520 11,403 10,803 88,520 14,327 13,727 88,520
5........ 12,763 8,693 8,258 88,520 11,796 11,296 88,520 15,712 15,212 88,520
6........ 13,401 8,443 8,105 88,520 12,208 11,808 88,520 17,243 16,843 88,520
7........ 14,071 8,195 7,949 88,520 12,636 12,336 88,520 18,935 18,635 88,520
8........ 14,775 7,947 7,787 88,520 13,080 12,880 88,520 20,804 20,604 88,520
9........ 15,513 7,697 7,620 88,520 13,540 13,440 88,520 22,866 22,766 88,520
10........ 16,289 7,445 7,445 88,520 14,017 14,017 88,520 25,143 25,143 88,520
15........ 20,789 6,116 6,116 88,520 16,629 16,629 88,520 40,597 40,597 101,493
20........ 26,533 4,547 4,547 88,520 19,589 19,589 88,520 65,495 65,495 145,399
25........ 33,864 2,543 2,543 88,520 22,834 22,834 88,520 105,448 105,448 201,405
30........ 43,219 0 0 0 26,179 26,179 88,520 169,610 169,610 266,288
</TABLE>
ASSUMPTIONS:
(1) NO ADDITIONAL PREMIUMS PAID AND NO POLICY LOANS HAVE BEEN MADE.
(2) VALUES REFLECT GUARANTEED COST OF INSURANCE CHARGES.
(3) NET INVESTMENT RETURNS ARE CALCULATED AS THE HYPOTHETICAL GROSS INVESTMENT
RETURN LESS ALL CHARGES AND DEDUCTIONS SHOWN IN THE PROSPECTUS APPENDIX.
(4) DEATH BENEFIT REFLECTS CURRENT INTERNAL REVENUE CODE REQUIREMENTS.
(5) ZERO VALUES INDICATE POLICY LAPSE IN ABSENCE OF AN ADDITIONAL PREMIUM
PAYMENT.
THE HYPOTHETICAL INVESTMENT RATES OF RETURN SHOWN ABOVE AND ELSEWHERE IN
THIS PROSPECTUS ARE ILLUSTRATIVE ONLY AND SHOULD NOT BE DEEMED A REPRESENTATION
OF PAST OR FUTURE INVESTMENT RATES OF RETURN. ACTUAL RATES OF RETURN MAY BE MORE
OR LESS THAN THOSE SHOWN AND WILL DEPEND ON A NUMBER OF FACTORS, INCLUDING THE
INVESTMENT ALLOCATIONS MADE BY AN OWNER AND ACTUAL EXPENSES. THE DEATH BENEFIT,
CASH VALUE AND SURRENDER VALUE FOR A POLICY WOULD BE DIFFERENT FROM THOSE SHOWN
IF THE ACTUAL RATES OF RETURN AVERAGED 0%, 6% AND 12% OVER A PERIOD OF YEARS BUT
ALSO FLUCTUATED ABOVE OR BELOW THOSE AVERAGES FOR INDIVIDUAL POLICY YEARS. NO
REPRESENTATIONS CAN BE MADE BY KEMPER INVESTORS LIFE INSURANCE COMPANY THAT
THESE HYPOTHETICAL RATES OF RETURN CAN BE ACHIEVED FOR ANY ONE YEAR OR SUSTAINED
OVER ANY PERIOD OF TIME.
57
<PAGE> 61
FLEXIBLE PREMIUM VARIABLE LIFE INSURANCE POLICY
MALE NON-SMOKER $10,000 INITIAL PREMIUM ISSUE AGE 45
$39,290 INITIAL DEATH BENEFIT:
VALUES--CURRENT COST OF INSURANCE
<TABLE>
<CAPTION>
PREMIUM 0% HYPOTHETICAL 6% HYPOTHETICAL 12% HYPOTHETICAL
PAID GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN
PLUS ------------------------------ -------------------------------- -----------------------------------
POLICY INTEREST CASH SURRENDER DEATH CASH SURRENDER DEATH CASH SURRENDER DEATH
YEAR AT 5% VALUE VALUE BENEFIT VALUE VALUE BENEFIT VALUE VALUE BENEFIT
- ---------- -------- ------- ------- -------- -------- -------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1........ $ 10,500 $ 9,747 $ 8,870 $ 39,290 $ 10,345 $ 9,445 $ 39,290 $ 10,943 $ 10,043 $ 39,290
2........ 11,325 9,487 8,728 39,290 10,695 9,895 39,290 11,977 11,177 39,290
3........ 11,576 9,222 8,576 39,290 11,056 10,356 39,290 13,116 12,416 39,290
4........ 12,155 8,950 8,413 39,290 11,424 10,824 39,290 14,370 13,770 39,290
5........ 12,763 8,670 8,236 39,290 11,800 11,300 39,290 15,751 15,251 39,290
6........ 13,401 8,382 8,046 39,290 12,184 11,784 39,290 17,276 16,876 39,290
7........ 14,071 8,082 7,839 39,290 12,574 12,274 39,290 18,957 18,657 39,290
8........ 14,775 7,766 7,611 39,290 12,967 12,767 39,290 20,812 20,612 39,290
9........ 15,513 7,435 7,360 39,290 13,364 13,264 39,290 22,862 22,762 39,290
10........ 16,289 7,095 7,095 39,290 13,772 13,772 39,290 25,136 25,136 39,463
15........ 20,789 5,125 5,125 39,290 15,903 15,903 39,290 40,553 40,553 54,340
20........ 26,533 2,294 2,294 39,290 18,008 18,008 39,290 65,452 65,452 79,851
25........ 33,864 0 0 0 19,735 19,735 39,290 105,357 105,357 122,214
30........ 43,219 0 0 0 20,624 20,624 39,290 169,799 169,799 181,685
</TABLE>
ASSUMPTIONS:
(1) NO ADDITIONAL PREMIUMS AND NO POLICY LOANS HAVE BEEN MADE.
(2) VALUES REFLECT CURRENT COST OF INSURANCE CHARGES.
(3) NET INVESTMENT RETURNS ARE CALCULATED AS THE HYPOTHETICAL GROSS INVESTMENT
RETURN LESS ALL CHARGES AND DEDUCTIONS SHOWN IN THE PROSPECTUS APPENDIX.
(4) DEATH BENEFIT REFLECTS CURRENT INTERNAL REVENUE CODE REQUIREMENTS.
(5) ZERO VALUES INDICATE POLICY LAPSE IN ABSENCE OF AN ADDITIONAL PREMIUM
PAYMENT.
THE HYPOTHETICAL INVESTMENT RATES OF RETURN SHOWN ABOVE AND ELSEWHERE IN
THIS PROSPECTUS ARE ILLUSTRATIVE ONLY AND SHOULD NOT BE DEEMED A REPRESENTATION
OF PAST OR FUTURE INVESTMENT RATES OF RETURN. ACTUAL RATES OF RETURN MAY BE MORE
OR LESS THAN THOSE SHOWN AND WILL DEPEND ON A NUMBER OF FACTORS, INCLUDING THE
INVESTMENT ALLOCATIONS MADE BY AN OWNER AND ACTUAL EXPENSES. THE DEATH BENEFIT,
CASH VALUE AND SURRENDER VALUE FOR A POLICY WOULD BE DIFFERENT FROM THOSE SHOWN
IF THE ACTUAL RATES OF RETURN AVERAGED 0%, 6% AND 12% OVER A PERIOD OF YEARS BUT
ALSO FLUCTUATED ABOVE OR BELOW THOSE AVERAGES FOR INDIVIDUAL POLICY YEARS. NO
REPRESENTATIONS CAN BE MADE BY KEMPER INVESTORS LIFE INSURANCE COMPANY THAT
THESE HYPOTHETICAL RATES OF RETURN CAN BE ACHIEVED FOR ANY ONE YEAR OR SUSTAINED
OVER ANY PERIOD OF TIME.
58
<PAGE> 62
FLEXIBLE PREMIUM VARIABLE LIFE INSURANCE POLICY
MALE NON-SMOKER $10,000 INITIAL PREMIUM ISSUE AGE 45
$39,209 INITIAL DEATH BENEFIT:
VALUES--GUARANTEED COST OF INSURANCE
<TABLE>
<CAPTION>
PREMIUM 0% HYPOTHETICAL 6% HYPOTHETICAL 12% HYPOTHETICAL
PAID GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN GROSS INVESTMENT RETURN
PLUS ------------------------------ -------------------------------- -----------------------------------
POLICY INTEREST CASH SURRENDER DEATH CASH SURRENDER DEATH CASH SURRENDER DEATH
YEAR AT 5% VALUE VALUE BENEFIT VALUE VALUE BENEFIT VALUE VALUE BENEFIT
- ---------- -------- ------- ------- -------- -------- -------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1........ $ 10,500 $ 9,744 $ 8,867 $ 39,290 $ 10,342 $ 9,442 $ 39,290 $ 10,940 $ 10,040 $ 39,290
2........ 11,325 9,484 8,725 39,290 10,692 9,892 39,290 11,973 11,173 39,290
3........ 11,576 9,217 8,571 39,290 11,051 10,351 39,290 13,110 12,410 39,290
4........ 12,155 8,932 8,406 39,290 11,417 10,817 39,290 14,362 13,762 39,290
5........ 12,763 8,662 8,229 39,290 11,791 11,291 39,290 15,742 15,242 39,290
6........ 13,401 8,371 8,036 39,290 12,172 11,772 39,290 17,263 16,863 39,290
7........ 14,071 8,069 7,827 39,290 12,559 12,259 39,290 18,941 18,641 39,290
8........ 14,775 7,753 7,598 39,290 12,951 12,751 39,290 20,794 20,594 39,290
9........ 15,513 7,420 7,346 39,290 13,346 13,246 39,290 22,841 22,741 39,290
10........ 16,289 7,068 7,068 39,290 13,744 13,744 39,290 25,106 25,106 39,417
15........ 20,789 4,923 4,923 39,290 15,718 15,718 39,290 40,415 40,415 54,156
20........ 26,533 1,693 1,693 39,290 17,472 17,462 39,290 65,045 65,045 79,355
25........ 33,864 0 0 0 18,490 18,490 39,290 104,335 104,335 121,028
30........ 43,219 0 0 0 17,668 17,668 39,290 167,401 167,401 179,120
</TABLE>
ASSUMPTIONS:
(1) NO ADDITIONAL PREMIUMS AND NO POLICY LOANS HAVE BEEN MADE.
(2) VALUES REFLECT GUARANTEED COST OF INSURANCE CHARGES.
(3) NET INVESTMENT RETURNS ARE CALCULATED AS THE HYPOTHETICAL GROSS INVESTMENT
RETURN LESS ALL CHARGES AND DEDUCTIONS SHOWN IN THE PROSPECTUS APPENDIX.
(4) DEATH BENEFIT REFLECTS CURRENT INTERNAL REVENUE CODE REQUIREMENTS.
(5) ZERO VALUES INDICATE POLICY LAPSE IN ABSENCE OF AN ADDITIONAL PREMIUM
PAYMENT.
THE HYPOTHETICAL INVESTMENT RATES OF RETURN SHOWN ABOVE AND ELSEWHERE IN
THIS PROSPECTUS ARE ILLUSTRATIVE ONLY AND SHOULD NOT BE DEEMED A REPRESENTATION
OF PAST OR FUTURE INVESTMENT RATES OF RETURN. ACTUAL RATES OF RETURN MAY BE MORE
OR LESS THAN THOSE SHOWN AND WILL DEPEND ON A NUMBER OF FACTORS, INCLUDING THE
INVESTMENT ALLOCATIONS MADE BY AN OWNER AND ACTUAL EXPENSES. THE DEATH BENEFIT,
CASH VALUE AND SURRENDER VALUE FOR A POLICY WOULD BE DIFFERENT FROM THOSE SHOWN
IF THE ACTUAL RATES OF RETURN AVERAGED 0%, 6% AND 12% OVER A PERIOD OF YEARS BUT
ALSO FLUCTUATED ABOVE OR BELOW THOSE AVERAGES FOR INDIVIDUAL POLICY YEARS. NO
REPRESENTATIONS CAN BE MADE BY KEMPER INVESTORS LIFE INSURANCE COMPANY THAT
THESE HYPOTHETICAL RATES OF RETURN CAN BE ACHIEVED FOR ANY ONE YEAR OR SUSTAINED
OVER ANY PERIOD OF TIME.
59
<PAGE> 63
TABLE OF CONTENTS
<TABLE>
<S> <C>
Summary.................................. 2
Financial Highlights..................... 3
Investment Objectives, Policies and Risk
Factors................................ 7
Investment Techniques.................... 16
Net Asset Value.......................... 20
Purchase and Redemption.................. 21
Dividends and Taxes...................... 22
Capital Structure and General
Information............................ 22
Investment Manager....................... 23
Distributor.............................. 25
Appendix................................. 26
</TABLE>
This prospectus contains information about the Fund that you should know before
investing and should be retained for future reference. A Statement of Additional
Information dated May 1, 1995, has been filed with the Securities and Exchange
Commission and is incorporated herein by reference. It is available upon request
without charge from the Fund at the address or telephone number shown above.
AN INVESTMENT IN THE MONEY MARKET PORTFOLIO IS NEITHER INSURED NOR GUARANTEED BY
THE U.S. GOVERNMENT. THERE CAN BE NO ASSURANCE THAT THE PORTFOLIO WILL BE ABLE
TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
KEMPER
INVESTORS
FUND
PROSPECTUS MAY 1, 1995
KEMPER INVESTORS FUND
120 SOUTH LASALLE STREET
CHICAGO, ILLINOIS 60603
1-800-621-1048
Kemper Investors Fund (the "Fund") offers a choice of seven investment
portfolios to investors applying for certain variable life insurance and
variable annuity contracts offered by Participating Insurance Companies.
The seven investment portfolios are:
MONEY MARKET PORTFOLIO
TOTAL RETURN PORTFOLIO
HIGH YIELD PORTFOLIO
EQUITY PORTFOLIO
GOVERNMENT SECURITIES PORTFOLIO
INTERNATIONAL PORTFOLIO
SMALL CAPITALIZATION EQUITY PORTFOLIO
Shares of the Portfolios are available exclusively as pooled funding vehicles
for the variable life insurance and variable annuity contracts of Participating
Insurance Companies.
<PAGE> 64
SUMMARY
FUND INVESTMENT CONCEPT. Kemper Investors Fund (the "Fund") is an open-end
management investment company established on March 24, 1987 as a Massachusetts
business trust. The Fund is a series fund consisting of seven portfolios
("Portfolios"): Money Market, Total Return, High Yield, Equity, Government
Securities, International and Small Capitalization Equity ("Small Cap").
Additional Portfolios may be created from time to time. The Fund is the funding
vehicle for variable life insurance contracts ("VLI contracts") and variable
annuity contracts ("VA contracts") offered by the separate accounts of certain
life insurance companies ("Participating Insurance Companies"). The Fund
currently does not foresee any disadvantages to the holders of VLI contracts and
VA contracts arising from the fact that the interests of the holders of such
contracts may differ. Nevertheless, the Fund's Trustees intend to monitor events
in order to identify any material irreconcilable conflicts that may arise and to
determine what action, if any, should be taken. The VLI contracts and VA
contracts are described in the separate prospectuses issued by the Participating
Insurance Companies. The Fund assumes no responsibility for such prospectuses.
Individual VLI contract holders and VA contract holders are not the
"shareholders" of the Fund. Rather, the Participating Insurance Companies and
their separate accounts are the shareholders or investors (the "Shareholders"),
although such companies may pass through voting rights to their VLI and VA
contract holders.
INVESTMENT OBJECTIVES. The Money Market Portfolio seeks maximum current income
to the extent consistent with stability of principal from a portfolio of high
quality money market instruments. The Total Return Portfolio seeks a high total
return, a combination of income and capital appreciation, by investing in a
combination of debt securities and common stocks. The High Yield Portfolio seeks
to provide a high level of current income by investing in fixed-income
securities. The Equity Portfolio seeks maximum appreciation of capital through
diversification of investment securities having potential for capital
appreciation. The Government Securities Portfolio seeks high current return
consistent with preservation of capital from a portfolio composed primarily of
U.S. Government securities. The International Portfolio seeks total return, a
combination of capital growth and income, principally through an internationally
diversified portfolio of equity securities. The Small Cap Portfolio seeks
maximum appreciation of investors' capital. All portfolios except the Money
Market Portfolio may engage in options and financial futures transactions. The
Total Return, High Yield, Equity and Small Cap Portfolios each may invest a
portion of its assets in foreign securities and engage in related foreign
currency transactions. The International Portfolio will invest a substantial
portion of its assets in foreign securities and engage in related foreign
currency transactions. Foreign securities may include investments in developing
countries. The High Yield Portfolio will, and the Total Return and Government
Securities Portfolios may, invest in high yield (high risk) bonds. All of the
Portfolios are diversified. See "Investment Objectives, Policies and Risk
Factors."
RISK FACTORS. There is no assurance that the investment objective of any
Portfolio will be achieved and investment in each Portfolio includes risks that
vary in kind and degree depending upon the investment policies of the Portfolio.
The returns and net asset value of a Portfolio will fluctuate (except that the
Money Market Portfolio seeks to maintain a net asset value of $1.00 per share).
Investors should note that investments in high yield securities by certain
portfolios (principally the Total Return and High Yield Portfolios) entail
relatively greater risk of loss of income and principal than investments in
higher rated securities; and market prices of high yield securities may
fluctuate more than market prices of higher rated securities. The government
guarantee of the U.S. Government securities in which the Government Securities
Portfolio may invest does not guarantee the market value of the shares of the
Portfolio. Normally the value of investments in U.S. Government securities
varies inversely with changes in interest rates. Foreign investments by certain
Portfolios (principally the International Portfolio) involve risk and
opportunity considerations not typically associated with investing in U.S.
companies. The return of such a Portfolio can be adversely affected by changes
in currency exchange rates. Investment by the Small Cap Portfolio primarily in
smaller companies involves greater risk than investment in larger, more
established companies. There are special risks associated with options,
financial futures and foreign currency transactions and there is no assurance
that use of those investment techniques will be successful. Some of the
Portfolios may experience high portfolio turnover which would involve
correspondingly greater brokerage commissions or other transaction costs. See
"Investment Objectives, Policies and Risk Factors."
PURCHASES AND REDEMPTIONS. The separate accounts of the Participating Insurance
Companies place orders to purchase and redeem shares of each Portfolio based on,
among other things, the amount of premium payments to be invested and surrender
and transfer requests to be effected on that date pursuant to VLI and VA
contracts. See "Purchase and Redemption."
INVESTMENT MANAGER. Kemper Financial Services, Inc. ("KFS" or "investment
manager") serves as investment manager for each of the Portfolios at an
effective annual rate, payable monthly, of .50%, .55%, .60%, .60%, .55%, .75%
and .65% of average daily net assets of the Money Market, Total Return, High
Yield, Equity, Government Securities, International and Small Cap Portfolios,
respectively. See "Investment Manager."
GENERAL INFORMATION AND CAPITAL. Since the Fund offers multiple Portfolios, it
is known as a "series company." Shares of each Portfolio have equal
non-cumulative voting rights and equal rights with respect to dividends, assets
and liquidation of such Portfolio. Each Portfolio has its own objective,
policies and restrictions. The Fund is not required to hold annual shareholder
meetings, but will hold special shareholder meetings as required or deemed
desirable. See "Capital Structure and General Information."
2
<PAGE> 65
FINANCIAL HIGHLIGHTS
The tables below show financial information for each Portfolio expressed in
terms of one share outstanding throughout the period. The information for the
Money Market, Total Return, High Yield and Equity Portfolios for fiscal periods
prior to 1990 reflects the operations of certain Separate Accounts as discussed
under "Capital Structure and General Information." The information in the tables
for the years ended December 31, 1990 through 1994 is covered by the report of
the Fund's independent auditors. The report is contained in the Fund's
Registration Statement and is available from the Fund. The financial statements
contained in the Fund's 1994 Annual Report to Shareholders are incorporated
herein by reference and may be obtained by writing or calling the Fund.
MONEY MARKET PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year $1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment
income and
dividends
declared .04 .03 .03 .06 .08 .09 .07 .06 .06 .08
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value,
end of year $1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%) 3.96 2.83 3.43 5.89 8.08 9.11 7.47 6.58 6.61 8.13
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE
NET ASSETS (%):
Expenses .53 .56 .57 .56 .58 .57 .56 .55 .56 .58
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment
income 3.95 2.79 3.38 5.80 7.78 8.75 7.19 6.43 6.44 7.86
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end
of year (in
thousands) $83,821 68,177 75,270 76,479 95,759 78,683 80,362 92,130 83,793 96,270
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE TO MONEY MARKET PORTFOLIO:
The total return for 1994 includes the effect of a capital contribution from the
investment manager. Without the capital contribution, the total return would
have been 3.47%.
TOTAL RETURN PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year $2.586 2.473 2.658 2.071 2.021 1.707 1.605 1.661 1.496 1.214
- ---------------------------------------------------------------------------------------------------------------------------------
Income from
investment
operations:
Net investment
income .069 .069 .061 .080 .113 .102 .086 .075 .060 .057
- ---------------------------------------------------------------------------------------------------------------------------------
Net realized and
unrealized gain
(loss) on
investments (.313) .214 (.026) .677 (.013) .298 .102 (.056) .165 .282
- ---------------------------------------------------------------------------------------------------------------------------------
Total from
investment
operations (.244) .283 .035 .757 .100 .400 .188 .019 .225 .339
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distributions
from net
investment
income .060 .050 .080 .110 .020 .086 .086 .075 .060 .057
- ---------------------------------------------------------------------------------------------------------------------------------
Distributions
from net
realized gain
on investments .168 .120 .140 .060 .030 -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Distributions in
excess of net
realized gain
on investments .002 -- -- -- -- -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Total dividends .230 .170 .220 .170 .050 .086 .086 .075 .060 .057
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value,
end of year $2.112 2.586 2.473 2.658 2.071 2.021 1.707 1.605 1.661 1.496
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%) (9.50) 12.13 1.69 37.90 5.04 24.16 11.98 .62 15.13 28.42
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE
NET ASSETS (%):
Expenses .61 .59 .60 .61 .61 .58 .61 .58 .60 .66
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment
income 3.13 3.19 3.41 3.46 5.94 5.43 5.19 4.04 3.59 4.23
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end
of year (in
thousands) $ 586,594 643,830 528,007 412,772 272,747 262,652 206,262 214,203 146,324 103,249
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover
rate (%) 128 191 160 187 139 102 152 129 136 117
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
3
<PAGE> 66
HIGH YIELD PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year $1.338 1.209 1.144 .914 1.122 1.258 1.225 1.290 1.226 1.143
- ---------------------------------------------------------------------------------------------------------------------------------
Income from investment
operations:
Net investment income .116 .120 .125 .140 .170 .151 .152 .139 .142 .150
- ---------------------------------------------------------------------------------------------------------------------------------
Net realized and
unrealized gain
(loss) on investments (.149) .109 .070 .300 (.338) (.163) .033 (.065) .064 .083
- ---------------------------------------------------------------------------------------------------------------------------------
Total from investment
operations (.033) .229 .195 .440 (.168) (.012) .185 .074 .206 .233
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends from net
investment income .120 .100 .130 .210 .040 .124 .152 .139 .142 .150
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of
year $1.185 1.338 1.209 1.144 .914 1.122 1.258 1.225 1.290 1.226
=================================================================================================================================
TOTAL RETURN (%) (2.25) 20.00 17.76 51.83 (15.45) (1.22) 15.66 5.82 17.63 21.58
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS (%):
Expenses .65 .63 .64 .67 .68 .63 .66 .62 .66 .69
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income 9.49 9.54 10.44 12.95 16.27 12.50 11.98 10.81 11.06 12.56
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of year
(in thousands) $ 219,415 233,964 162,158 121,608 88,566 150,674 138,461 95,502 143,605 71,282
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate
(%) 98 84 57 31 28 81 52 122 158 130
=================================================================================================================================
</TABLE>
EQUITY PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
year $2.935 2.631 2.642 1.681 1.692 1.348 1.374 1.377 1.283 1.058
- ---------------------------------------------------------------------------------------------------------------------------------
Income from investment
operations:
Net investment income .018 .004 .007 .017 .032 .039 .032 .030 .024 .036
- ---------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized
gain (loss) on investments (.138) .370 .082 .974 (.023) .338 (.026) (.003) .094 .225
- ---------------------------------------------------------------------------------------------------------------------------------
Total from investment
operations (.120) .374 .089 .991 .009 .377 .006 .027 .118 .261
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distributions from net
investment income -- .010 .005 .030 .010 .033 .032 .030 .024 .036
- ---------------------------------------------------------------------------------------------------------------------------------
Distributions from net
realized gain on
investments .150 .060 .095 -- .010 -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Total dividends .150 .070 .100 .030 .020 .033 .032 .030 .024 .036
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $2.665 2.935 2.631 2.642 1.681 1.692 1.348 1.374 1.377 1.283
=================================================================================================================================
TOTAL RETURN (%) (4.02) 14.63 3.57 59.47 0.60 27.87 .40 1.67 9.10 25.08
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
(%):
Expenses .66 .64 .64 .67 .68 .70 .71 .64 .70 .72
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income .69 .30 .65 .83 2.23 2.49 2.34 1.85 1.82 3.11
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of year (in
thousands) $ 321,708 284,461 203,624 118,983 61,621 51,961 45,833 46,474 30,228 45,913
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 106 78 78 106 135 93 301 165 262 95
=================================================================================================================================
</TABLE>
4
<PAGE> 67
GOVERNMENT SECURITIES PORTFOLIO
<TABLE>
<CAPTION>
Year ended December 31,
1994 1993 1992 1991 1990(a) 1989(a) 1988 1987(c)
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $1.267 1.277 1.287 1.175 1.091 1.053 1.020 1.000
- ---------------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .067 .060 .064 .090 .093 .092 .089 --
- ---------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on
investments (.102) .020 .006 .082 .011 .036 (.056) .020
- ---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations (.035) .080 .070 .172 .104 .128 .033 .020
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distributions from net investment income .060 .060 .050 .060 .020 .090 -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Distributions from net realized gain on
investments .024 .030 .030 -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Distributions in excess of net realized gain
on investments .006 -- -- -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Total dividends .090 .090 .080 .060 .020 .090 -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $1.142 1.267 1.277 1.287 1.175 1.091 1.053 1.020
=================================================================================================================================
TOTAL RETURN (%) (2.74) 6.48 5.90 15.22 9.81 13.14 3.27 --
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses .63 .60 .61 .63 .58 .53 1.81 --(b)
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income 5.69 5.05 6.08 7.42 8.48 8.73 7.94 --(b)
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of year (in thousands) $95,782 121,912 98,814 59,064 31,929 14,878 1,170 311
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 606 534 492 141 174 28 25 --
=================================================================================================================================
</TABLE>
NOTES TO GOVERNMENT SECURITIES PORTFOLIO:
(a) KFS waived its investment management fee from March 1, 1989 to March 1,
1990. Absent this waiver, the ratio of expenses to average net assets and
the ratio of net investment income to average net assets would have been
1.04% and 8.22%, respectively, in 1989 and .66% and 8.40%, respectively, in
1990.
(b) Because of the short start-up period from the Government Securities
Portfolio's initial public offering to December 31, 1987, ratios of expenses
and net investment income to average net assets for 1987 are not meaningful.
(c) For the period from September 3, 1987 (inception) through December 31, 1987.
INTERNATIONAL PORTFOLIO
<TABLE>
<CAPTION>
Year ended
December 31,
-------------------
1994 1993 1992(a)
-------- ------ -------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $1.306 .993 1.000
- ---------------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .009 .010 .010
- ---------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments (.056) .313 (.017 )
- ---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations (.047) .323 (.007 )
- ---------------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distributions from net investment income -- .009 --
- ---------------------------------------------------------------------------------------------------------------------------------
Distributions from net realized gain on investments .015 .001 --
- ---------------------------------------------------------------------------------------------------------------------------------
Total dividends .015 .010 --
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $1.244 1.306 .993
=================================================================================================================================
TOTAL RETURN (%) (3.59) 32.83 (.72 )
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses .93 .92 1.11
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income .74 .86 1.01
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of period (in thousands) $122,710 88,880 19,447
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 107 116 129
=================================================================================================================================
</TABLE>
NOTE TO INTERNATIONAL PORTFOLIO:
(a) For the period from January 6, 1992 (inception) through December 31, 1992.
5
<PAGE> 68
SMALL CAPITALIZATION EQUITY PORTFOLIO
<TABLE>
<CAPTION>
December 31, 1994(a)
--------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $1.000
- ---------------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .008
- ---------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain on investments .031
- ---------------------------------------------------------------------------------------------------------------------------------
Total from investment operations .039
- ---------------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $1.039
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%) 3.95
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.25
- ---------------------------------------------------------------------------------------------------------------------------------
Net investment income .91
- ---------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of period (in thousands) $12,909
- ---------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 58
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE TO SMALL CAPITALIZATION EQUITY PORTFOLIO:
(a) For the period from May 2, 1994 (inception) through December 31, 1994.
NOTE:
Ratios for all Portfolios have been determined on an annualized basis. Total
return is not annualized.
6
<PAGE> 69
INVESTMENT OBJECTIVES, POLICIES AND RISK FACTORS
The Fund has adopted for each Portfolio certain fundamental investment
restrictions which, together with the investment objective and policies, cannot
be changed with respect to a Portfolio without approval by holders of a majority
of the outstanding voting shares as defined in the Investment Company Act of
1940 ("1940 Act"). See "Investment Restrictions" in the Statement of Additional
Information.
Each Portfolio has a different investment objective which it pursues through
separate investment policies, as described below. The differences in objectives
and policies among the Portfolios can be expected to affect the degree of market
and financial risk to which each Portfolio is subject and the return of each
Portfolio. There are market risks in any investment and therefore there can be
no assurance that the objective of any Portfolio will be achieved. The actual
return of a holder of a variable life or variable annuity contract will be
affected by charges imposed by the separate accounts of Participating Insurance
Companies.
MONEY MARKET PORTFOLIO. The Money Market Portfolio seeks maximum current income
to the extent consistent with stability of principal from a portfolio of the
following types of U.S. Dollar denominated money market instruments that mature
in twelve months or less:
1. Obligations of, or guaranteed by, the U.S. or Canadian Governments,
their agencies or instrumentalities. The two broad categories of U.S.
Government debt instruments are: (a) direct obligations of the U.S.
Treasury and (b) securities issued or guaranteed by agencies and
instrumentalities of the U.S. Government. Some obligations issued or
guaranteed by agencies or instrumentalities of the U.S. Government are
backed by the full faith and credit of the United States and others are
backed exclusively by the agency or instrumentality with limited rights of
the issuer to borrow from the U.S. Treasury.
2. Bank certificates of deposit, time deposits or bankers' acceptances
limited to U.S. banks or Canadian chartered banks having total assets in
excess of $1 billion.
3. Bank certificates of deposit, time deposits or bankers' acceptances of
U.S. branches of foreign banks having total assets in excess of $10
billion.
4. Commercial paper rated Prime-1 or Prime-2 by Moody's Investors Service,
Inc. ("Moody's") or A-1 or A-2 by Standard & Poor's Corporation ("S&P"), or
commercial paper or notes of comparable quality, such as are issued by
companies with an unsecured debt issue outstanding currently rated A or
higher by Moody's or S&P where the obligation is on the same or a higher
level of priority as the rated issue, and investments in other corporate
obligations such as publicly traded bonds, debentures and notes rated A or
higher by Moody's or S&P. See "Appendix--Ratings of Investments" in the
Statement of Additional Information for a description of the ratings.
5. Repurchase agreements of obligations which are suitable for investment
under the categories set forth above. Repurchase agreements are discussed
under "Investment Techniques--Repurchase Agreements."
In addition, the Money Market Portfolio limits its portfolio investments to
securities that meet the quality and diversification requirements of Rule 2a-7
of the 1940 Act. See "Net Asset Value."
To the extent the Money Market Portfolio purchases Eurodollar certificates of
deposit issued by London branches of U.S. banks, or commercial paper issued by
foreign entities, consideration will be given to their marketability, possible
restrictions on international currency transactions and to regulations imposed
by the domicile country of the foreign issuer. Eurodollar certificates of
deposit may not be subject to the same regulatory requirements as certificates
issued by U.S. banks and associated income may be subject to the imposition of
foreign taxes. The Money Market Portfolio will normally invest at least 25% of
its net assets in instruments issued by domestic or foreign banks.
The Money Market Portfolio seeks to maintain its net asset value at $1.00 per
share by valuing its portfolio of investments on the amortized cost method in
accordance with Rule 2a-7 of the 1940 Act. See "Net Asset Value." While the
Portfolio will make every effort to maintain a fixed net asset value at $1.00
per share, there can be no assurance that this objective will be achieved.
The Money Market Portfolio may invest in instruments that bear rates of interest
that are adjusted periodically or that "float" continuously according to
formulae intended to minimize fluctuations in values of the instruments
("Variable Rate Securities"). The Fund determines the maturity of Variable Rate
Securities in accordance with Securities and Exchange Commission ("SEC") rules
that allow the Fund to consider certain of such instruments as having maturities
earlier than the maturity date on the instrument.
TOTAL RETURN PORTFOLIO. The Total Return Portfolio seeks a high total return, a
combination of income and capital appreciation, by investing in a combination of
debt securities and common stocks. The Portfolio's investments will
7
<PAGE> 70
normally consist of domestic and foreign fixed income and equity securities.
Fixed income securities will include bonds, money market instruments (including
repurchase agreements) and other debt securities (such as U.S. and foreign
government securities and investment grade and high yield corporate obligations)
and preferred stocks, some of which may have a call on common stocks through
attached warrants or a conversion privilege. The Portfolio may invest in fixed
income securities that are in the lower rating categories and those that are
non-rated (sometimes called "junk bonds"). The characteristics of the rating
categories are described in "Appendix--Ratings of Investments" in the Statement
of Additional Information. For a discussion of lower rated and non-rated
securities and related risks, see "High Yield Portfolio" and "Special Risk
Factors--High Yield (High Risk) Bonds" below. Equity investments normally will
consist of common stocks and securities convertible into or exchangeable for
common stocks; however, the Portfolio may also make private placement
investments (which are normally restricted securities). For a further
description of equity securities, see "Equity Portfolio" below. The percentage
of assets invested in specific categories of fixed-income and equity securities
will vary from time to time depending upon the judgment of the investment
manager as to general market and economic conditions, trends in yields and
interest rates, and changes in fiscal or monetary policies.
The Portfolio does not make investments for short-term profits nor does it have
a separate portfolio turnover policy for equity and fixed income segments of its
portfolio. The Portfolio is not restricted in policy with regard to portfolio
turnover and will make changes in its investment portfolio from time to time as
business and economic conditions or market prices may dictate and as its
investment policy may require.
The Portfolio may write and purchase put and call options traded on national
securities exchanges or over-the-counter, including options on securities
indices. The Portfolio may also engage in financial futures transactions and may
purchase foreign securities and engage in related foreign currency transactions.
The Portfolio may purchase or sell portfolio securities on a when-issued or
delayed delivery basis. See "Special Risk Factors--Foreign Securities" and
"Investment Techniques."
HIGH YIELD PORTFOLIO. The High Yield Portfolio seeks to provide a high level of
current income by investing in fixed income securities. Fixed income obligations
include corporate debt securities, U.S. and Canadian Government securities,
obligations of U.S. and Canadian banking institutions, convertible securities,
assignments or participations in loans, preferred stock, and cash and cash
equivalents, including repurchase agreements.
The fixed income securities purchased by the Portfolio may include those in the
lower rating categories of the established rating services and those that are
non-rated (sometimes called "junk bonds"). Investments in such securities entail
relatively greater risk of loss of income or principal than investments in
higher rated securities; market prices may fluctuate more than market prices of
higher rated securities. See "Special Risk Factors--High Yield Bonds (High
Risk)" below for a discussion of such risks. These fixed income securities (debt
and preferred stock issues, including convertibles) normally offer a current
yield or yield to maturity that is significantly higher than the yield available
from securities rated in the four highest categories assigned by Moody's or S&P.
See "Appendix--Ratings of Investments" in the Statement of Additional
Information for a description of Moody's and S&P ratings.
The average maturity and the mix of investments of the Portfolio will vary as
the investment manager seeks to provide a high level of income considering the
available alternatives in the market. See "Appendix--Portfolio Composition of
High Yield Bonds" in this prospectus. Since interest rates vary with changes in
economic, market, political and other conditions, there can be no assurance that
historic interest rates are indicative of rates which may prevail in the future.
Since the value of securities in the Portfolio fluctuates depending upon market
factors and inversely with current interest rate levels, the net asset value of
its shares will fluctuate. The investment adviser will adjust the investments of
the Portfolio as considered advisable in view of prevailing or anticipated
market conditions. Accordingly, certain portfolio securities may be purchased or
sold in anticipation of a rise or a decline in interest rates.
The Portfolio does not make investments for short-term profits, but it is not
restricted in policy with regard to portfolio turnover and will make changes in
its investment portfolio from time to time as business and economic conditions
or market prices may dictate and as its investment policy may require.
The Portfolio may write and purchase put and call options traded on national
securities exchanges or over-the-counter, including options on securities
indices. The Portfolio may also engage in financial futures transactions and may
purchase foreign securities and engage in related foreign currency transactions.
The Portfolio may purchase or sell portfolio securities on a when-issued or
delayed delivery basis. See "Special Risk Factors--Foreign Securities" and
"Investment Techniques."
EQUITY PORTFOLIO. The Equity Portfolio seeks maximum appreciation of capital
through diversification of investment securities having potential for capital
appreciation. Current income will not be a significant factor. The Portfolio's
8
<PAGE> 71
investments normally will consist of equity securities and securities
convertible into or exchangeable for equity securities; however, it may also
make private placement investments (which are normally restricted securities).
As a non-fundamental investment policy, the Equity Portfolio will invest at
least 65% of its total assets in equity securities under normal circumstances.
Equity securities include common stocks, preferred stocks, securities
convertible into or exchangeable for common or preferred stocks, equity
investments in partnerships, joint ventures and other forms of non-corporate
investment and warrants, options and rights exercisable for equity securities.
The common stocks or the other securities selected will be those which, in the
investment manager's judgment, have significant appreciation possibilities.
Investment opportunities will often be sought among securities of small, less
well-known companies; but securities of large, well-known companies will also be
purchased, particularly when the investment manager considers such securities to
be priced favorably in comparison with securities of smaller companies.
For defensive purposes the Portfolio may temporarily hold a significant portion
of its assets in cash or defensive type securities, such as liquid high grade
debt securities, high quality money market instruments and repurchase
agreements.
The Portfolio does not intend to engage actively in trading for short-term
profits, but it is not restricted in policy with regard to portfolio turnover
and will make changes in its investment portfolio from time to time as business
and economic conditions or market prices may dictate and as its investment
policy may require.
The Portfolio may write and purchase put and call options traded on national
securities exchanges or over-the-counter, including options on securities
indices. The Portfolio may also engage in financial futures transactions and may
purchase foreign securities and engage in related foreign currency transactions.
The Portfolio may purchase or sell portfolio securities on a when-issued or
delayed delivery basis. See "Special Risk Factors--Foreign Securities" and
"Investment Techniques."
GOVERNMENT SECURITIES PORTFOLIO. The Government Securities Portfolio seeks high
current return consistent with preservation of capital from a portfolio composed
primarily of U.S. Government securities. The Portfolio will also invest in
fixed-income securities other than U.S. Government securities, and will engage
in options and financial futures transactions. The Portfolio may purchase or
sell portfolio securities on a when-issued or delayed delivery basis. See
"Investment Techniques." The Portfolio's current return is sought from interest
income and net short-term gains on securities and options and futures
transactions.
Under normal market conditions, the Portfolio will, as a fundamental policy,
invest at least 65% of its total assets in U.S. Government securities and
repurchase agreements of U.S. Government securities. There are two broad
categories of U.S. Government securities: (a) direct obligations of the U.S.
Treasury and (b) obligations issued or guaranteed by agencies and
instrumentalities of the United States. Some obligations issued or guaranteed by
agencies or instrumentalities are backed by the full faith and credit of the
United States (such as Government National Mortgage Association "GNMA"
Certificates) and others are backed exclusively by the agency or instrumentality
with limited rights of the issuer to borrow from the U.S. Treasury (such as
Federal National Mortgage Association Bonds). GNMA Certificates are debt
securities which represent an interest in one or a pool of mortgages which are
insured by the Federal Housing Administration or the Farmers Home
Administration, or guaranteed by the Veterans Administration. U.S. Government
securities may include "zero coupon" securities that have been stripped by the
U.S. Government of their unmatured interest coupons (see "Investment Policies
and Techniques" in the Statement of Additional Information for a discussion of
their features and risks) and collateralized obligations issued or guaranteed by
a U.S. Government agency or instrumentality (see "Investment Techniques").
U.S. Government securities of the type in which the Portfolio may invest have
historically involved little risk of loss of principal if held to maturity. The
government guarantee of the securities in the Portfolio, however, does not
guarantee the market value of the shares of the Portfolio. There are market
risks inherent in all investments in securities and the value of an investment
in the Portfolio will fluctuate over time. Normally, the value of the
Portfolio's investments varies inversely with changes in interest rates. For
example, as interest rates rise, the value of the Portfolio's investments will
tend to decline and, as interest rates fall, the value of the Portfolio's
investments will tend to increase. In addition, the potential for appreciation
in the event of a decline in interest rates may be limited or negated by
increased principal prepayments in respect to certain mortgage-backed
securities, such as GNMA certificates. Prepayment of high interest rate
mortgage-backed securities during times of declining interest rates will tend to
lower the return of the Portfolio and may even result in losses to the Portfolio
if some securities were acquired at a premium. With respect to securities
supported only by the credit of the issuing agency or by an additional line of
credit with the U.S. Treasury, there is no guarantee that the U.S. Government
will provide support to such agencies and such securities may involve risk of
loss of principal and interest.
9
<PAGE> 72
The Portfolio will seek to enhance income through limited investment (up to 35%
of total assets) in fixed income securities other than U.S. Government
securities. Such other fixed-income securities include: (a) corporate debt
securities that are rated at the time of purchase within the four highest grades
by either Moody's (Aaa, Aa, A, or Baa) or S&P (AAA, AA, A, or BBB); (b)
commercial paper that is rated at the time of purchase within the two highest
grades by either Moody's (Prime-1 or Prime-2) or S&P (A-1 or A-2); (c) bank
certificates of deposit (including term deposits) or bankers' acceptances issued
by domestic banks (including their foreign branches) and Canadian chartered
banks having total assets in excess of $1 billion; and (d) repurchase agreements
with respect to any of the foregoing; provided, however, the Portfolio may
invest up to 10% of its total assets in fixed income securities without regard
to the foregoing limitations, including securities that are rated below Baa by
Moody's and BBB by S&P or are non-rated (sometimes called "junk bonds"). The
characteristics of the rating categories are described in "Appendix--Ratings of
Investments" in the Statement of Additional Information. For a discussion of
lower rated and non-rated securities and related risks, see "High Yield
Portfolio" above and "Special Risk Factors--High Yield Bonds (High Risk)" below.
The Portfolio may also invest in collateralized obligations which, consistent
with the limitations reflected above, may be privately issued or may be issued
or guaranteed by U.S. Government agencies or instrumentalities. See "Investment
Techniques."
During temporary defensive periods when the Fund's investment manager deems it
appropriate, the Portfolio may invest all or a portion of its assets in cash or
short-term high quality money market instruments, including short-term U.S.
Government securities and repurchase agreements with respect to such securities.
The yields on these securities tend to be lower than the yields on other
securities to be purchased by the Portfolio.
INTERNATIONAL PORTFOLIO. The International Portfolio seeks a total return, a
combination of capital growth and income, principally through an internationally
diversified portfolio of equity securities. Investments may be made for capital
growth or for income or any combination thereof for the purpose of achieving a
high overall return. There is no limitation on the percentage or amount of the
Portfolio's assets that may be invested for growth or income, and therefore at
any particular time the investment emphasis may be placed solely or primarily on
growth of capital or on income. While the Portfolio invests principally in
equity securities of non-U.S. issuers, it may also invest in convertible and
debt securities and foreign currencies. The Portfolio invests primarily in
non-U.S. issuers, and under normal circumstances more than 80% of the
Portfolio's total assets will be invested in non-U.S. issuers. In determining
whether the Portfolio will be invested for capital growth or income, the
investment manager analyzes the international equity and fixed income markets
and seeks to assess the degree of risk and level of return that can be expected
from each market. Also see "Special Risk Factors--Foreign Securities."
In pursuing its objective, the Portfolio invests primarily in common stocks of
established non-U.S. companies believed to have potential for capital growth,
income or both. However, there is no requirement that the Portfolio invest
exclusively in common stocks or other equity securities. The Portfolio may
invest in any other type of security including, but not limited to, convertible
securities (including warrants), preferred stocks, bonds, notes and other debt
securities of companies (including Euro-currency instruments and securities) or
obligations of domestic or foreign governments and their political subdivisions.
When the investment manager believes that the total return potential in debt
securities equals or exceeds that of equity securities, the Portfolio may
substantially increase its holdings of such debt securities. The Portfolio may
establish and maintain reserves for defensive purposes or to enable it to take
advantage of future buying opportunities. The Portfolio's reserves may be
invested in domestic as well as foreign short-term money market instruments
including, but not limited to, government obligations, certificates of deposit,
bankers' acceptances, time deposits, commercial paper, short-term corporate debt
securities and repurchase agreements.
The Portfolio makes investments in various countries. Under normal
circumstances, business activities in not less than three different foreign
countries will be represented in the portfolio. The Portfolio may, from time to
time, have more than 25% of its assets invested in any major industrial or
developed country that in the view of KFS poses no unique investment risk. The
Portfolio may purchase securities of companies, wherever organized, that have
their principal activities and interests outside the United States. Under
exceptional economic or market conditions abroad, the Portfolio may, for
defensive purposes, invest all or a major portion of its assets in U.S.
Government obligations or securities of companies incorporated in and having
their principal activities in the United States. The Portfolio may also invest
its reserves in domestic short-term money market instruments as described above.
In determining the appropriate distribution of investments among various
countries and geographic regions, the investment manager ordinarily considers
such factors as: prospects for relative economic growth among foreign countries;
expected levels of inflation; relative price levels of the various capital
markets; government policies influencing business conditions; the outlook for
currency relationships and the range of individual investment
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opportunities available to the international investor. Currently, more than 60%
of the market capitalization of equity securities are represented by securities
in currencies other than the U.S. Dollar.
The Portfolio may purchase and sell options on securities, index options,
financial futures contracts and options on financial futures contracts. The
Portfolio may enter into forward foreign currency exchange contracts, foreign
currency options and foreign currency futures contracts and options thereon to
protect against uncertainty in the level of future foreign exchange rates. See
"Investment Techniques" below.
Generally, the Portfolio will not trade in securities for short-term profits
but, when circumstances warrant, securities may be sold without regard to the
length of time held.
Investors should understand that the expense ratio of the Portfolio can be
expected to be higher than that of portfolios investing in domestic securities
since the costs of operation are higher.
SMALL CAP PORTFOLIO. The Small Cap Portfolio seeks maximum appreciation of
investors' capital. Current income will not be a significant factor. The
Portfolio is designed primarily for investors with substantial resources and the
investment experience to consider their shares as a long-term investment
involving financial risk commensurate with potential substantial gains. Since
many of the securities in the Portfolio may be considered speculative in nature
by traditional investment standards, substantially greater than average market
volatility and investment risk may be involved. There is no assurance that the
Portfolio's objective will be achieved and its returns and net asset value will
fluctuate.
The Small Cap Portfolio seeks attractive areas for investment opportunity
arising from such factors as technological advances, new marketing methods, and
changes in the economy and population. Currently, the investment manager
believes that such investment opportunities may be found among the following:
(a) companies engaged in high technology fields such as electronics, medical
technology and computer software and specialty retailing; (b) companies having a
significantly improved earnings outlook as the result of a changed economic
environment, acquisitions, mergers, new management, changed corporate strategy
or product innovation; (c) companies supplying new or rapidly growing services
to consumers and businesses in such fields as automation, data processing,
communications, and marketing and finance; and (d) companies having innovative
concepts or ideas.
As a non-fundamental investment policy, at least 65% of the Small Cap
Portfolio's total assets normally will be invested in the equity securities of
smaller companies, i.e., those having a market capitalization of $1 billion or
less at the time of investment, many of which would be in the early stages of
their life cycle. The investment manager currently believes that investment in
such companies may offer greater opportunities for growth of capital than
larger, more established companies, but also involves certain special risks.
Smaller companies often have limited product lines, markets or financial
resources, and they may be dependent upon one or a few key people for
management. The securities of such companies generally are subject to more
abrupt or erratic market movements and may be less liquid than securities of
larger, more established companies or the market averages in general.
The Small Cap Portfolio's investment portfolio will normally consist primarily
of common stocks and securities convertible into or exchangeable for common
stocks, including warrants and rights. The Portfolio may also invest to a
limited degree in preferred stocks and debt securities when they are believed by
the investment manager to offer opportunities for capital growth. The Portfolio
may also write and purchase options, engage in financial futures transactions,
purchase foreign securities, engage in related foreign currency transactions and
lend its portfolio securities. See "Special Risk Factors--Foreign Securities"
and "Investment Techniques" below. When a defensive position is deemed
advisable, the Portfolio may, without limit, invest in high grade debt
securities and securities of the U.S. Government and its agencies or
instrumentalities or retain cash or cash equivalents, including repurchase
agreements.
In the selection of investments, long-term capital appreciation will take
precedence over short range market fluctuations. The Small Cap Portfolio does
not intend to engage actively in trading for short-term profits, although it may
occasionally make investments for short-term capital appreciation when such
action is believed to be desirable and consistent with sound investment
procedure. Generally, the Portfolio will make long-term rather than short-term
investments. Nevertheless, it may dispose of such investments at any time it may
be deemed advisable because of a subsequent change in the circumstances of a
particular company or industry or in general market or economic conditions. The
rate of portfolio turnover is not a limiting factor when changes in investment
are deemed appropriate. In addition, market conditions, cash requirements for
redemption and repurchase of Portfolio shares or other factors could affect the
portfolio turnover rate.
SPECIAL RISK FACTORS--HIGH YIELD (HIGH RISK) BONDS. As reflected above, the
High Yield Portfolio intends to invest a substantial portion of its assets in
fixed income securities offering high current income. Subject to their specific
investment objectives and policies as described above, the Total Return and
Government Securities
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Portfolios also may invest a portion of their assets in such securities. Such
high yield (high risk) fixed income securities will ordinarily be in the lower
rating categories (securities rated below the fourth category) of recognized
rating agencies or will be non-rated. Lower rated and non-rated securities,
which are sometimes referred to by the popular press as "junk bonds," have
widely varying characteristics and quality. These lower rated and non-rated
fixed income securities are considered, on balance, as predominantly speculative
with respect to capacity to pay interest and repay principal in accordance with
the terms of the obligation and generally involve more credit risk than
securities in the higher rating categories. Accordingly, an investment in the
High Yield Portfolio may not constitute a complete investment program and may
not be appropriate for all investors.
The market values of such securities tend to reflect individual corporate
developments to a greater extent than do those of higher rated securities, which
react primarily to fluctuations in the general level of interest rates. Such
lower rated securities also are more sensitive to economic conditions than are
higher rated securities. Adverse publicity and investor perceptions regarding
lower rated bonds, whether or not based on fundamental analysis, may depress the
prices for such securities. These and other factors adversely affecting the
market value of high yield securities will adversely affect a Portfolio's net
asset value. Although some risk is inherent in all securities ownership, holders
of fixed income securities have a claim on the assets of the issuer prior to the
holders of common stock. Therefore, an investment in fixed income securities
generally entails less risk than an investment in common stock of the same
issuer.
The investment philosophy of the High Yield Portfolio with respect to high yield
(high risk) bonds is based upon the premise that over the long term a broadly
diversified portfolio of high yield fixed-income securities should, even taking
into account possible losses, provide a higher net return than that achievable
on a portfolio of higher rated securities. The Portfolio seeks to achieve the
highest yields possible while reducing relative risk through (a) broad
diversification, (b) credit analysis by the investment manager of the issuers in
which the Portfolio invests, (c) purchase of high yield securities at discounts
from par or stated value when practicable and (d) monitoring and seeking to
anticipate changes and trends in the economy and financial markets that might
affect the prices of portfolio securities. The investment manager's judgment as
to the "reasonableness" of the risk involved in any particular investment will
be a function of its experience in managing fixed income investments and its
evaluation of general economic and financial conditions; of a specific issuer's
business and management, cash flow, earnings coverage of interest and dividends,
ability to operate under adverse economic conditions, and fair market value of
assets; and of such other considerations as the investment manager may deem
appropriate. The investment manager, while seeking maximum current yield, will
monitor current corporate developments with respect to portfolio securities and
potential investments and to broad trends in the economy. In some circumstances,
defensive strategies may be implemented to preserve or enhance capital even at
the sacrifice of current yield. Defensive strategies, which may be used singly
or in any combination, may include, but are not limited to, investments in
discount securities or investments in money market instruments as well as
futures and options strategies.
High yield (high risk) securities frequently are issued by corporations in the
growth stage of their development. They may also be issued in connection with a
corporate reorganization or issued as part of a corporate takeover. Companies
that issue such high yielding securities often are highly leveraged and may not
have available to them more traditional methods of financing. Therefore, the
risk associated with acquiring the securities of such issuers generally is
greater than is the case with higher rated securities. For example, during an
economic downturn or recession, highly leveraged issuers of high yield
securities may experience financial stress. During such periods, such issuers
may not have sufficient revenues to meet their interest payment obligations. The
issuer's ability to service its debt obligations may also be adversely affected
by specific corporate developments, or the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing. The
risk of loss from default by the issuer is significantly greater for the holders
of high yielding securities because such securities are generally unsecured and
are often subordinated to other creditors of the issuer.
A Portfolio may have difficulty disposing of certain high yield (high risk)
securities because they may have a thin trading market. Because not all dealers
maintain markets in all high yield securities, the Fund anticipates that such
securities could be sold only to a limited number of dealers or institutional
investors. The lack of a liquid secondary market may have an adverse effect on
market price and a Portfolio's ability to dispose of particular issues and may
also make it more difficult for the Fund to obtain accurate market quotations
for purposes of valuing a Portfolio's assets. Market quotations generally are
available on many high yield issues only from a limited number of dealers and
may not necessarily represent firm bids of such dealers or prices for actual
sales.
Zero coupon securities and pay-in-kind bonds involve additional special
considerations. Zero coupon securities are debt obligations that do not entitle
the holder to any periodic payments of interest prior to maturity or a specified
cash payment date when the securities begin paying current interest (the "cash
payment date") and therefore are
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issued and traded at a discount from their face amount or par value. The market
prices of zero coupon securities are generally more volatile than the market
prices of securities that pay interest periodically and are likely to respond to
changes in interest rates to a greater degree than do securities paying interest
currently having similar maturities and credit quality. Zero coupon, pay-in-kind
or deferred interest bonds carry additional risk in that, unlike bonds that pay
interest throughout the period to maturity, a Portfolio will realize no cash
until the cash payment date unless a portion of such securities is sold and, if
the issuer defaults, a Portfolio may obtain no return at all on its investment.
Additional information concerning high yield (high risk) securities appears
under "Appendix--Portfolio Composition of High Yield Bonds" in this prospectus
and under "Appendix--Ratings of Investments" in the Statement of Additional
Information.
SPECIAL RISK FACTORS--FOREIGN SECURITIES. The Total Return, High Yield, Equity
and Small Cap Portfolios invest primarily in securities that are publicly traded
in the United States; but, they have discretion to invest a portion of their
assets in foreign securities that are traded principally in securities markets
outside the United States. As a non-fundamental policy, these Portfolios
currently limit investment in foreign securities not publicly traded in the
United States to 25% of their total assets. These Portfolios may also invest
without limit in U.S. Dollar denominated American Depository Receipts ("ADRs")
which are bought and sold in the United States. The Money Market Portfolio,
within its quality standards, may also invest in securities of foreign issuers.
However, such investments will be in U.S. Dollar denominated instruments.
Foreign securities in which a Portfolio may invest include any type of security
consistent with that Portfolio's investment objective and policies. In
connection with their foreign securities investments, such Portfolios may, to a
limited extent, engage in foreign currency exchange transactions and purchase
and sell foreign currency options and foreign currency futures contracts as a
hedge and not for speculation. The International Portfolio may invest without
limit in foreign securities and may engage in foreign currency exchange
transactions and may purchase and sell foreign currency options and foreign
currency futures contracts. See "Investment Techniques--Options and Financial
Futures Transactions--Foreign Currency Transactions." The International
Portfolio may invest without limitation in securities of foreign issuers.
Foreign securities involve currency risks. The U.S. Dollar value of a foreign
security tends to decrease when the value of the U.S. Dollar rises against the
foreign currency in which the security is denominated and tends to increase when
the value of the U.S. Dollar falls against such currency. Fluctuations in
exchange rates may also affect the earning power and asset value of the foreign
entity issuing the security. Dividend and interest payments may be repatriated
based on the exchange rate at the time of disbursement or payment, and
restrictions on capital flows may be imposed. Losses and other expenses may be
incurred in converting between various currencies.
Foreign securities may be subject to foreign government taxes that reduce their
attractiveness. Other risks of investing in such securities include political or
economic instability in the country involved, the difficulty of predicting
international trade patterns and the possibility of imposition of exchange
controls. The prices of such securities may be more volatile than those of
domestic securities. In addition, there may be less publicly available
information about foreign issuers than about domestic issuers. Many foreign
issuers are not subject to uniform accounting, auditing and financial reporting
standards comparable to those applicable to domestic issuers. There is generally
less regulation of stock exchanges, brokers, banks, and listed companies abroad
than in the United States. With respect to certain foreign countries, there is a
possibility of expropriation, excessive taxation or diplomatic developments
which could affect investment in these countries.
Emerging Markets. While a Portfolio's investments in foreign securities will
principally be in developed countries, a Portfolio may make investments in
developing or "emerging" countries, which involve exposure to economic
structures that are generally less diverse and mature than in the United States,
and to political systems that may be less stable. A developing or emerging
market country can be considered to be a country that is in the initial stages
of its industrialization cycle. Currently, emerging markets generally include
every country in the world other than the United States, Canada, Japan,
Australia, New Zealand, Hong Kong, Singapore and most Western European
countries. Currently, investing in many emerging markets may not be desirable or
feasible because of the lack of adequate custody arrangements for a Portfolio's
assets, overly burdensome repatriation and similar restrictions, the lack of
organized and liquid securities markets, unacceptable political risks or other
reasons. As opportunities to invest in securities in emerging markets develop, a
Portfolio may expand and further broaden the group of emerging markets in which
it invests. In the past, markets of developing or emerging market countries have
been more volatile than the markets of developed countries; however, such
markets often have provided higher rates of return to investors. The investment
manager believes that these characteristics can be expected to continue in the
future.
Many of the risks described above relating to foreign securities generally will
be greater for emerging markets than for developed countries. For instance,
economies in individual developing markets may differ favorably or unfavorably
from the U.S. economy in such respects as growth of domestic product, rates of
inflation, currency
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depreciation, capital reinvestment, resource self-sufficiency and balance of
payments positions. Many emerging markets have experienced substantial rates of
inflation for many years. Inflation and rapid fluctuations in inflation rates
have had and may continue to have very negative effects on the economies and
securities markets of certain developing markets. Economies in emerging markets
generally are dependent heavily upon international trade and, accordingly, have
been and may continue to be affected adversely by trade barriers, exchange
controls, managed adjustments in relative currency values and other
protectionist measures imposed or negotiated by the countries with which they
trade. These economies also have been and may continue to be affected adversely
by economic conditions in the countries with which they trade.
Also, the securities markets of developing countries are substantially smaller,
less developed, less liquid and more volatile than the securities markets of the
United States and other more developed countries. Disclosure, regulatory and
accounting standards in many respects are less stringent than in the United
States and other developed markets. There also may be a lower level of
monitoring and regulation of developing markets and the activities of investors
in such markets, and enforcement of existing regulations has been extremely
limited.
In addition, brokerage commissions, custodial services and other needs relating
to investment in foreign markets generally are more expensive than in the United
States; and this is particularly true with respect to emerging markets. Such
markets have different settlement and clearance procedures. In certain markets
there have been times when settlements could not keep pace with the volume of
securities transactions, making it difficult to conduct such transactions. Such
settlement problems may cause emerging market securities to be illiquid. The
inability of a Portfolio to make intended securities purchases because of
settlement problems could cause the Portfolio to miss attractive investment
opportunities. Inability to dispose of a portfolio security because of
settlement problems could result in losses to a Portfolio from subsequent
declines in value of the portfolio security or, if a Portfolio has entered into
a contract to sell the security, it could result in possible liability to the
purchaser. Certain emerging markets may lack clearing facilities equivalent to
those in developed countries. Accordingly, settlements can pose additional risks
in such markets and ultimately can expose the Portfolio to the risk of losses
resulting from a Portfolio's inability to recover from a counterparty.
The risk also exists that an emergency situation may arise in one or more
emerging markets as a result of which trading in securities may cease or may be
substantially curtailed and prices for a Portfolio's securities in such markets
may not be readily available. A Portfolio's securities in the affected markets
will be valued at fair value determined in good faith by or under the direction
of the Board of Trustees of the Fund.
Investment in certain emerging market securities is restricted or controlled to
varying degrees. These restrictions or controls may at times limit or preclude
foreign investment in certain emerging market securities and increase the costs
and expenses of a Portfolio. Emerging markets may require governmental approval
for the repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. In addition, if a deterioration occurs in an
emerging market country's balance of payments, the market could impose temporary
restrictions on foreign capital remittances.
Fixed Income. Since most foreign fixed income securities are not rated, a
Portfolio will invest in foreign fixed income securities based on KFS's analysis
without relying on published ratings. Since such investments will be based upon
KFS's analysis rather than upon published ratings, achievement of a Portfolio's
goals may depend more upon the abilities of KFS than would otherwise be the
case.
The value of the foreign fixed income securities held by a Portfolio, and thus
the net asset value of the Portfolio's shares, generally will fluctuate with (a)
changes in the perceived creditworthiness of the issuers of those securities,
(b) movements in interest rates, and (c) changes in the relative values of the
currencies in which a Portfolio's investments in fixed income securities are
denominated with respect to the U.S. Dollar. The extent of the fluctuation will
depend on various factors, such as the average maturity of a Portfolio's
investments in foreign fixed income securities, and the extent to which a
Portfolio hedges its interest rate, credit and currency exchange rate risks.
Many of the foreign fixed income obligations in which a Portfolio will invest
will have long maturities. A longer average maturity generally is associated
with a higher level of volatility in the market value of such securities in
response to changes in market conditions.
Investments in sovereign debt, including Brady Bonds, involve special risks.
Brady Bonds are debt securities issued under a plan implemented to allow debtor
nations to restructure their outstanding commercial bank indebtedness. Foreign
governmental issuers of debt or the governmental authorities that control the
repayment of the debt may be unable or unwilling to repay principal or pay
interest when due. In the event of default, there may be limited or no legal
recourse in that, generally, remedies for defaults must be pursued in the courts
of the defaulting party. Political conditions, especially a sovereign entity's
willingness to meet the terms of its fixed income securities, are of
considerable significance. Also, there can be no assurance that the holders of
commercial bank loans to the same
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sovereign entity may not contest payments to the holders of sovereign debt in
the event of default under commercial bank loan agreements. In addition, there
is no bankruptcy proceeding with respect to sovereign debt on which a sovereign
has defaulted, and a Portfolio may be unable to collect all or any part of its
investment in a particular issue.
Foreign investment in certain sovereign debt is restricted or controlled to
varying degrees, including requiring governmental approval for the repatriation
of income, capital or proceeds of sales by foreign investors. These restrictions
or controls may at times limit or preclude foreign investment in certain
sovereign debt or increase the costs and expenses of a Portfolio. A significant
portion of the sovereign debt in which a Portfolio may invest is issued as part
of debt restructuring and such debt is to be considered speculative. There is a
history of defaults with respect to commercial bank loans by public and private
entities issuing Brady Bonds. All or a portion of the interest payments and/or
principal repayment with respect to Brady Bonds may be uncollateralized.
Privatized Enterprises. Investments in foreign securities may include securities
issued by enterprises that have undergone or are currently undergoing
privatization. The governments of certain foreign countries have, to varying
degrees, embarked on privatization programs contemplating the sale of all or
part of their interests in state enterprises. A Portfolio's investments in the
securities of privatized enterprises include privately negotiated investments in
a government or state-owned or controlled company or enterprise that has not yet
conducted an initial equity offering, investments in the initial offering of
equity securities of a state enterprise or former state enterprise and
investments in the securities of a state enterprise following its initial equity
offering.
In certain jurisdictions, the ability of a foreign entity to participate in
privatizations may be limited by local law, or the price or terms on which the
entity may be able to participate may be less advantageous than for local
investors. Moreover, there can be no assurance that governments that have
embarked on privatization programs will continue to divest their ownership of
state enterprises, that proposed privatizations will be successful or that
governments will not re-nationalize enterprises that have been privatized.
In the case of the enterprises in which a Portfolio may invest, large blocks of
the stock of those enterprises may be held by a small group of stockholders,
even after the initial equity offerings by those enterprises. The sale of some
portion or all of those blocks could have an adverse effect on the price of the
stock of any such enterprise.
Prior to making an initial equity offering, most state enterprises or former
state enterprises go through an internal reorganization or management. Such
reorganizations are made in an attempt to better enable these enterprises to
compete in the private sector. However, certain reorganizations could result in
a management team that does not function as well as the enterprises's prior
management and may have a negative effect on such enterprise. In addition, the
privatization of an enterprise by its government may occur over a number of
years, with the government continuing to hold a controlling position in the
enterprise even after the initial equity offering for the enterprise.
Prior to privatization, most of the state enterprises in which a Portfolio may
invest enjoy the protection of and receive preferential treatment from the
respective sovereigns that own or control them. After making an initial equity
offering these enterprises may no longer have such protection or receive such
preferential treatment and may become subject to market competition from which
they were previously protected. Some of these enterprises may not be able to
effectively operate in a competitive market and may suffer losses or experience
bankruptcy due to such competition.
Depositary Certificates. For many foreign securities, there are U.S.
Dollar-denominated ADRs, which are bought and sold in the United States and are
issued by domestic banks. ADRs represent the right to receive securities of
foreign issuers deposited in the domestic bank or a correspondent bank. ADRs do
not eliminate all the risk inherent in investing in the securities of foreign
issuers. However, by investing in ADRs rather than directly in foreign issuers'
stock, the Portfolios avoid currency risks during the settlement period. In
general, there is a large, liquid market in the United States for most ADRs. The
Portfolios may also invest in European Depository Receipts ("EDRs"), which are
receipts evidencing an arrangement with a European bank similar to that for ADRs
and are designed for use in the European securities markets. EDRs are not
necessarily denominated in the currency of the underlying security.
THE FUND. The portfolio turnover rates for the Portfolios are listed under
"Financial Highlights." Since securities with maturities of less than one year
are excluded from portfolio turnover rate calculations, the portfolio turnover
rate for the Money Market Portfolio is zero. Frequency of portfolio turnover
will not be a limiting factor should the investment manager deem it desirable to
purchase or sell securities. Higher portfolio turnover (over 100%) involves
correspondingly greater brokerage commissions or other transaction costs. Higher
portfolio turnover may result in the realization of greater net short-term
capital gains. In order to continue to qualify as a regulated investment company
for federal income tax purposes, less than 30% of the annual gross income of a
Portfolio must be derived
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from the sale or disposition of securities and certain other investments held by
a Portfolio for less than three months. See "Dividends and Taxes" in the
Statement of Additional Information.
A Portfolio will not, as a non-fundamental policy, purchase illiquid securities
including repurchase agreements maturing in more than seven days, if, as a
result thereof, more than 15% (10% for the Money Market Portfolio) of the
Portfolio's net assets, valued at the time of the transactions, would be
invested in such securities.
INVESTMENT TECHNIQUES
LENDING OF PORTFOLIO SECURITIES. Consistent with applicable regulatory
requirements, any of the Portfolios may lend securities (principally to
broker-dealers) where such loans are callable at any time and are continuously
secured by segregated collateral (cash or U.S. Government securities) equal to
no less than the market value, determined daily, of the securities loaned. The
Portfolio will receive amounts equal to dividends or interest on the securities
loaned. It will also earn income for having made the loan. Any cash collateral
pursuant to these loans will be invested in short-term money market instruments.
As with other extensions of credit there are risks of delay in recovery or even
loss of rights in the collateral should the borrower of the securities fail
financially. However, the loans would be made only to firms deemed by the Fund's
investment manager to be of good standing, and when the Fund's investment
manager believes the potential earnings justify the attendant risk. The Fund
will limit such lending to not more than one-third of the value of a Portfolio's
total assets.
OPTIONS AND FINANCIAL FUTURES TRANSACTIONS. The Total Return, High Yield,
Equity, Government Securities, International and Small Cap Portfolios may each
deal in options on securities and securities indices, which options may be
listed for trading on a national securities exchange or traded over-the-counter.
The Money Market Portfolio does not engage in options transactions. The ability
to engage in options transactions enables a Portfolio to pursue its investment
objective and also to hedge against currency and market risks but is not
intended for speculation. In connection with their foreign securities
investments, the Total Return, High Yield, Equity, International and Small Cap
Portfolios may also purchase and sell foreign currency options.
The Government Securities Portfolio individually may write (sell) covered call
options on up to 100% of net assets, may write (sell) secured put options on up
to 50% of net assets and may purchase put and call options provided that no more
than 5% of net assets may be invested in premiums on such options. The Total
Return, High Yield, Equity, International and Small Cap Portfolios may write
(sell) covered call and secured put options on up to 25% of net assets and may
purchase put and call options provided that no more than 5% of its net assets
may be invested in premiums on such options.
The Total Return, High Yield, Equity, Government Securities, International and
Small Cap Portfolios may write (sell) covered call options so long as they own
securities or other assets that are acceptable for escrow purposes. Also, such
Portfolios may write (sell) secured put options, which means that so long as the
Portfolio is obligated as a writer of a put option, it will invest an amount not
less than the exercise price of the put option in money market instruments.
A call option gives the purchaser the right to buy, and the writer the
obligation to sell, the underlying security or other asset at the exercise price
during the option period. A put option gives the purchaser the right to sell,
and the writer the obligation to buy, the underlying security or other asset at
the exercise price during the option period. The writer of a covered call owns
securities or other assets that are acceptable for escrow and the writer of a
secured put invests an amount not less than the exercise price in eligible
securities or other assets to the extent that it is obligated as a writer. If a
call written by a Portfolio is exercised, the Portfolio foregoes any possible
profit from an increase in the market price of the underlying security or other
asset over the exercise price plus the premium received. In writing puts, there
is a risk that a Portfolio may be required to take delivery of the underlying
security or other asset at a disadvantageous price.
Over-the-counter traded options ("OTC options") differ from exchange traded
options in several respects. Such options are transacted with dealers directly
and not with a clearing corporation and there is a risk of non-performance by
the dealer as a result of the insolvency of such dealer or otherwise, in which
event a Portfolio may experience material losses. However, in writing options
the premium is paid in advance by the dealer. OTC options are available for a
greater variety of securities or other assets, and a wider range of expiration
dates and exercise prices, than for exchange traded options.
A Portfolio, as part of its option transactions, also may use index options.
Through the writing or purchase of index options a Portfolio can achieve many of
the same objectives as through the use of options on individual securities.
Options on securities indices are similar to options on a security except that,
rather than the right to take or make delivery of a security at a specified
price, an option on a securities index gives the holder the right to receive,
upon
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exercise of the option, an amount of cash if the closing level of the securities
index upon which the option is based is greater than, in the case of a call, or
less than, in the case of a put, the exercise price of the option.
Price movements in securities which a Portfolio owns or intends to purchase
probably will not correlate perfectly with movements in the level of an index
and, therefore, a Portfolio bears the risk of a loss on an index option which is
not completely offset by movements in the price of such securities. Because
index options are settled in cash, a call writer cannot determine the amount of
its settlement obligations in advance and, unlike call writing on specific
securities, cannot provide in advance for, or cover, its potential settlement
obligations by acquiring and holding the underlying securities.
The Total Return, High Yield, Equity, Government Securities, International and
Small Cap Portfolios may each engage in financial futures transactions. The
Money Market Portfolio does not engage in financial futures transactions.
Financial futures contracts are commodity contracts that obligate the long or
short holder to take or make delivery of a specified quantity of a financial
instrument, such as a security, or the cash value of a securities index during a
specified future period at a specified price. A Portfolio will "cover" futures
contracts sold by the Portfolio and maintain in a segregated account certain
liquid assets in connection with futures contracts purchased by the Portfolio as
described under "Investment Policies and Techniques" in the Statement of
Additional Information. In connection with their foreign securities investments,
the Total Return, High Yield, Equity, International and Small Cap Portfolios may
also engage in foreign currency financial futures transactions. A Portfolio will
not enter into any futures contracts or options on futures contracts if the
aggregate of the contract value of the outstanding futures contracts of the
Portfolio and futures contracts subject to outstanding options written by the
Portfolio would exceed 50% of the total assets of the Portfolio.
The Portfolios may engage in financial futures transactions and may use index
options as an attempt to hedge against currency and market risks. For example,
when the near-term market view is bearish but the portfolio composition is
judged satisfactory for the longer term, exposure to temporary declines in the
market may be reduced by entering into futures contracts to sell securities or
the cash value of an index. Conversely, where the near-term view is bullish, but
a Portfolio is believed to be well positioned for the longer term with a high
cash position, the Portfolio can hedge against market increases by entering into
futures contracts to buy securities or the cash value of an index. In either
case, the use of futures contracts would tend to reduce portfolio turnover and
facilitate a Portfolio's pursuit of its investment objective. Also, if a
Portfolio owned long-term bonds and interest rates were expected to rise, it
could sell financial futures contracts. If interest rates did increase, the
value of the bonds in the Portfolio would decline, but this decline would be
offset in whole or in part by an increase in the value of the Portfolio's
futures contracts. If, on the other hand, long-term interest rates were expected
to decline, the Portfolio could hold short-term debt securities and benefit from
the income earned by holding such securities, while at the same time the
Portfolio could purchase futures contracts on long-term bonds or the cash value
of a securities index. Thus, the Portfolio could take advantage of the
anticipated rise in the value of long-term bonds without actually buying them.
The futures contracts and short-term debt securities could then be liquidated
and the cash proceeds used to buy long-term bonds.
Futures contracts entail risks. If the investment manager's judgment about the
general direction of interest rates, markets or exchange rates is wrong, the
overall performance may be poorer than if no such contracts had been entered
into. There may be an imperfect correlation between movements in prices of
futures contracts and portfolio assets being hedged. In addition, the market
prices of futures contracts may be affected by certain factors. If participants
in the futures market elect to close out their contracts through offsetting
transactions rather than meet margin requirements, distortions in the normal
relationship between the assets and futures market could result. Price
distortions also could result if investors in futures contracts decide to make
or take delivery of underlying securities or other assets rather than engage in
closing transactions because of the resultant reduction in the liquidity of the
futures market. In addition, because, from the point of view of speculators,
margin requirements in the futures market are less onerous than margin
requirements in the cash market, increased participation by speculators in the
futures market could cause temporary price distortions. Due to the possibility
of price distortions in the futures market and because of the imperfect
correlation between movements in the prices of securities or other assets and
movements in the prices of futures contracts, a correct forecast of market
trends by the investment manager still may not result in a successful hedging
transaction. A Portfolio could also experience losses if it could not close out
its futures position because of an illiquid secondary market. If any of these
events should occur, a Portfolio could lose money on the financial futures
contracts and also on the value of its portfolio assets. The costs incurred in
connection with futures transactions could reduce a Portfolio's return.
Index options involve risks similar to those risks relating to transactions in
financial futures contracts described above. Also, an option purchased by a
Portfolio may expire worthless, in which case a Portfolio would lose the premium
paid therefor.
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A Portfolio may engage in futures transactions only on commodities exchanges or
boards of trade. A Portfolio will not engage in transactions in index options,
financial futures contracts or related options for speculation, but only as an
attempt to hedge against changes in interest rates or market conditions
affecting the values of securities which the Portfolio owns or intends to
purchase.
FOREIGN CURRENCY TRANSACTIONS. As indicated under "Investment Objectives,
Policies and Risk Factors--Special Risk Factors--Foreign Securities," the Total
Return, High Yield, Equity and Small Cap Portfolios may invest a limited portion
of their assets, and the International Portfolio may invest without limit, in
securities denominated in foreign currencies. These Portfolios may engage in
foreign currency transactions in connection with their investments in foreign
securities but will not speculate in foreign currency exchange.
The value of the foreign securities investments of a Portfolio measured in U.S.
Dollars may be affected favorably or unfavorably by changes in foreign currency
exchange rates and exchange control regulations, and the Portfolio may incur
costs in connection with conversions between various currencies. A Portfolio
will conduct its foreign currency exchange transactions either on a spot (i.e.,
cash) basis at the spot rate prevailing in the foreign currency exchange market,
or through forward contracts to purchase or sell foreign currencies. A forward
foreign currency exchange contract involves an obligation to purchase or sell a
specific currency at a future date, which may be any fixed number of days from
the date of the contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are traded directly between currency traders
(usually large commercial banks) and their customers.
When a Portfolio enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may want to establish the U.S. Dollar cost
or proceeds, as the case may be. By entering into a forward contract in U.S.
Dollars for the purchase or sale of the amount of foreign currency involved in
an underlying security transaction, the Portfolio is able to protect itself
against a possible loss between trade and settlement date resulting from an
adverse change in the relationship between the U.S. Dollar and such foreign
currency. However, this tends to limit potential gains that might result from a
positive change in such currency relationships. A Portfolio may also hedge its
foreign currency exchange rate risk by engaging in currency financial futures
and options transactions.
When the investment manager believes that the currency of a particular foreign
country may suffer a substantial decline against the U.S. Dollar, it may enter
into a forward contract to sell an amount of foreign currency approximating the
value of some or all of the Portfolio's securities denominated in such foreign
currency. In this situation the International Portfolio may, instead, enter into
a forward contract to sell a different foreign currency for a fixed U.S. Dollar
amount when the investment manager believes that the U.S. Dollar value of the
currency to be sold pursuant to the forward contract will fall whenever there is
a decline in the U.S. Dollar value of the currency in which portfolio securities
of the International Portfolio are denominated ("cross-hedge"). The forecasting
of short-term currency market movement is extremely difficult and whether such a
short-term hedging strategy will be successful is highly uncertain.
It is impossible to forecast with precision the market value of portfolio
securities at the expiration of a contract. Accordingly, it may be necessary for
a Portfolio to purchase additional currency on the spot market (and bear the
expense of such purchase) if the market value of the security is less than the
amount of foreign currency the Portfolio is obligated to deliver when a decision
is made to sell the security and make delivery of the foreign currency in
settlement of a forward contract. Conversely, it may be necessary to sell on the
spot market some of the foreign currency received upon the sale of the portfolio
security if its market value exceeds the amount of foreign currency the
Portfolio is obligated to deliver.
The Portfolios will not speculate in foreign currency exchange. A Portfolio will
not enter into such forward contracts or maintain a net exposure in such
contracts where the Fund would be obligated to deliver an amount of foreign
currency in excess of the value of the Portfolio's securities or other assets
(a) denominated in that currency or (b), in the case of a "cross-hedge" for the
International Portfolio, denominated in a currency or currencies that the Fund's
investment manager believes will have price movements that closely correlate
with that currency. The Fund's custodian bank segregates cash or liquid
high-grade debt securities in an amount not less than the value of each
Portfolio's total assets committed to forward foreign currency exchange
contracts entered into for the purchase of a foreign currency. If the value of
the securities segregated declines, additional cash or securities are added so
that the segregated amount is not less than the amount of the Portfolio's
commitments with respect to such contracts. The Portfolios do not intend to
enter into such forward contracts if they would have more than 15% of the value
of their total assets committed to such contracts. A Portfolio generally does
not enter into a forward contract with a term longer than one year.
RISK CONSIDERATIONS. The Statement of Additional Information contains further
information about the characteristics, risks and possible benefits of options,
futures and foreign currency transactions. See "Investment Policies and
Techniques" in the Statement of Additional Information. The principal risks are:
(a) possible imperfect correlation
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between movements in the prices of options, currencies or futures contracts and
movements in the prices of the securities or currencies hedged or used for
cover; (b) lack of assurance that a liquid secondary market will exist for any
particular option, futures or foreign currency contract at any particular time;
(c) the need for additional skills and techniques beyond those required for
normal portfolio management; (d) losses on futures contracts resulting from
market movements not anticipated by the investment manager; and (e) the possible
need to defer closing out certain options or futures contracts in order to
continue to qualify for beneficial tax treatment afforded regulated investment
companies under the Internal Revenue Code.
DELAYED DELIVERY TRANSACTIONS. The Total Return, High Yield, Equity and
Government Securities Portfolios may purchase or sell portfolio securities on a
when-issued or delayed delivery basis. When-issued or delayed delivery
transactions arise when securities are purchased by a Portfolio with payment and
delivery to take place in the future in order to secure what is considered to be
an advantageous price and yield to the Portfolio at the time of entering into
the transactions. The value of fixed yield securities to be delivered in the
future will fluctuate as interest rates vary. Because a Portfolio must set aside
cash or liquid high grade securities to satisfy its commitments to purchase
when-issued or delayed delivery securities, flexibility to manage the
Portfolio's investments may be limited if commitments to purchase when-issued or
delayed delivery securities were to exceed 25% of the value of its assets.
To the extent a Portfolio engages in when-issued or delayed delivery
transactions, it will do so for the purpose of acquiring portfolio securities
consistent with the Portfolio's investment objective and policies and not for
the purpose of investment leverage or to speculate in interest rate changes. A
Portfolio will make commitments to purchase securities on a when-issued or
delayed delivery basis only with the intention of actually acquiring the
securities, but a Portfolio reserves the right to sell these securities before
the settlement date if deemed advisable.
In some instances, the third-party seller of when-issued or delayed delivery
securities may determine prior to the settlement date that it will be unable to
meet its existing transaction commitments without borrowing securities. If
advantageous from a yield perspective, a Portfolio may, in that event, agree to
resell its purchase commitment to the third-party seller at the current market
price on the date of sale and concurrently enter into another purchase
commitment for such securities at a later date. As an inducement for a Portfolio
to "roll over" its purchase commitment, the Portfolio may receive a negotiated
fee.
REPURCHASE AGREEMENTS. Each Portfolio may invest in repurchase agreements,
under which it acquires ownership of a security and the broker-dealer or bank
agrees to repurchase the security at a mutually agreed upon time and price,
thereby determining the yield during the Portfolio's holding period. The
investment manager will evaluate the creditworthiness of all entities with which
the Fund intends to engage in repurchase agreements pursuant to procedures
adopted by the Board of Trustees of the Fund. Maturity of the securities subject
to repurchase may exceed one year. In the event of a bankruptcy or other default
of a seller of a repurchase agreement, the Portfolio might have expenses in
enforcing its rights, and could experience losses, including a decline in the
value of the underlying securities and loss of income. Repurchase agreements
maturing in more than seven days will be considered illiquid for purposes of the
Portfolios' limitations on illiquid securities.
SECTION 4(2) PAPER. Subject to its investment objectives and policies, a
Portfolio may invest in commercial paper issued by major corporations under the
Securities Act of 1933 in reliance on the exemption from registration afforded
by Section 3(a)(3) thereof. Such commercial paper may be issued only to finance
current transactions and must mature in nine months or less. Trading of such
commercial paper is conducted primarily by institutional investors through
investment dealers, and individual investor participation in the commercial
paper market is very limited. A Portfolio also may invest in commercial paper
issued in reliance on the so-called "private placement" exemption from
registration afforded by Section 4(2) of the Securities Act of 1933 ("Section
4(2) paper"). Section 4(2) paper is restricted as to disposition under the
federal securities laws, and generally is sold to institutional investors such
as a Portfolio who agree that they are purchasing the paper for investment and
not with a view to public distribution. Any resale by the purchaser must be in
an exempt transaction. Section 4(2) paper normally is resold to other
institutional investors like the Portfolio through or with the assistance of the
issuer or investment dealers who make a market in the Section 4(2) paper, thus
providing liquidity. The Fund's investment adviser considers the legally
restricted but readily saleable Section 4(2) paper to be liquid; however,
pursuant to procedures approved by the Board of Trustees of the Fund, if a
particular investment in Section 4(2) paper is not determined to be liquid, that
investment will be included within the 10% limitation on illiquid securities.
The Fund's investment manager monitors the liquidity of the Fund's investments
in Section 4(2) paper on a continuing basis.
COLLATERALIZED OBLIGATIONS. Subject to its investment objectives and policies, a
Portfolio may purchase collateralized obligations, including interest only
("IO") and principal only ("PO") securities. A collateralized obligation is a
debt security issued by a corporation, trust or custodian, or by a U.S.
Government agency or instrumentality, that is
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collateralized by a portfolio or pool of mortgages, mortgage-backed securities,
U.S. Government securities or other assets. The issuer's obligation to make
interest and principal payments is secured by the underlying pool or portfolio
of securities. Collateralized obligations issued or guaranteed by a U.S.
Government agency or instrumentality, such as the Federal Home Loan Mortgage
Corporation, are considered U.S. Government securities for purposes of this
prospectus. Privately-issued collateralized obligations collateralized by a
portfolio of U.S. Government securities are not direct obligations of the U.S.
Government or any of its agencies or instrumentalities and are not considered
U.S. Government securities for purposes of this prospectus. A variety of types
of collateralized obligations are available currently and others may become
available in the future.
Since the collateralized obligations may be issued in classes with varying
maturities and interest rates, the investor may obtain greater predictability of
maturity than with direct investments in mortgage-backed securities. Classes
with shorter maturities may have lower volatility and lower yield while those
with longer maturities may have higher volatility and higher yield. This
provides the investor with greater control over the characteristics of the
investment in a changing interest rate environment. With respect to interest
only and principal only securities, an investor has the option to select from a
pool of underlying collateral the portion of the cash flows that most closely
corresponds to the investor's forecast of interest rate movements. These
instruments tend to be highly sensitive to prepayment rates on the underlying
collateral and thus place a premium on accurate prepayment projections by the
investor.
A Portfolio, other than the Money Market Portfolio, may invest in collateralized
obligations whose yield floats inversely against a specified index rate. These
"inverse floaters" are more volatile than conventional fixed or floating rate
collateralized obligations and the yield thereon, as well as the value thereof,
will fluctuate in inverse proportion to changes in the index upon which rate
adjustments are based. As a result, the yield on an inverse floater will
generally increase when market yields (as reflected by the index) decrease and
decrease when market yields increase. The extent of the volatility of inverse
floaters depends on the extent of anticipated changes in market rates of
interest. Generally, inverse floaters provide for interest rate adjustments
based upon a multiple of the specified interest index, which further increases
their volatility. The degree of additional volatility will be directly
proportional to the size of the multiple used in determining interest rate
adjustments.
Additional information concerning collateralized obligations is contained in the
Statement of Additional Information under "Investment Policies and
Techniques--Collateralized Obligations."
NET ASSET VALUE
TOTAL RETURN, HIGH YIELD, EQUITY, GOVERNMENT SECURITIES, INTERNATIONAL AND SMALL
CAP PORTFOLIOS. The net asset value per share is determined by calculating the
total value of a Portfolio's assets, deducting total liabilities, and dividing
the result by the number of shares outstanding of such Portfolio. Portfolio
securities traded on a domestic securities exchange or securities listed on the
NASDAQ National Market are valued at the last sale price on the exchange or
market where primarily traded or listed or, if there is no recent sale price
available, at the last current bid quotation. Portfolio securities that are
primarily traded on foreign securities exchanges are generally valued at the
preceding closing values of such securities on their respective exchanges where
primarily traded. A security that is listed or traded on more than one exchange
is valued at the quotation on the exchange determined to be the primary market
for that security by the Board of Trustees or its delegates. Securities not so
traded or listed are valued at the last current bid quotation if market
quotations are available. Fixed income securities are valued by using market
quotations, or independent pricing services that use prices provided by market
makers or estimates of market values obtained from yield data relating to
instruments or securities with similar characteristics. Equity options are
valued at the last sale price unless the bid price is higher or the asked price
is lower, in which event such bid or asked price is used. Exchange traded fixed
income options are valued at the last sale price unless there is no sale price,
in which event current prices provided by market makers are used.
Over-the-counter traded fixed income options are valued based upon current
prices provided by market makers. Financial futures and options thereon are
valued at the settlement price established each day by the board of trade or
exchange on which they are traded. Other securities and assets are valued at
fair value as determined in good faith by the Board of Trustees. Because of the
need to obtain prices as of the close of trading on various exchanges throughout
the world; the calculation of net asset value does not necessarily take place
contemporaneously with the determination of the prices of a Portfolio's foreign
securities. For purposes of determining a Portfolio's net asset value, any
assets and liabilities initially expressed in foreign currency values will be
converted into U.S. Dollar values at the mean between the bid and offered
quotations of such currencies against U.S. Dollars as last quoted by a
recognized dealer. If an event were to occur, after the value of a security was
so established but before the net asset value per share was determined, which
was likely to materially change the net asset value, then that security would be
valued using fair value considerations by the Board of Trustees or its
delegates. On each day the New York Stock Exchange ("Exchange") is open for
trading, the net asset value is determined as of the earlier of 3:00 p.m.
Central time or the
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close of the Exchange, except that the net asset value will not be computed on a
day in which no order to purchase shares was received or no shares were tendered
for redemption.
MONEY MARKET PORTFOLIO. The net asset value per share of the Money Market
Portfolio is determined at 11:00 a.m. and as of the earlier of 3:00 p.m. Central
time or the close of the Exchange on each day the Exchange is open for trading,
except that the net asset value will not be computed on a day in which no orders
to purchase shares were received or no shares were tendered for redemption. The
net asset value per share is determined by dividing the total assets of the
Portfolio minus its liabilities by the total number of its shares outstanding.
The net asset value per share of the Money Market Portfolio is ordinarily $1.00
calculated at amortized cost in accordance with Rule 2a-7 under the 1940 Act.
While this rule provides certainty in valuation, it may result in periods during
which value, as determined by amortized cost, is higher or lower than the price
the Portfolio would have received if all its investments were sold. Under the
direction of the Board of Trustees, certain procedures have been adopted to
monitor and stabilize the price per share for the Portfolio. Calculations are
made to compare the value of its investments valued at amortized cost with
market-based values. Market-based values will be obtained by using actual
quotations provided by market makers, estimates of market value, or values
obtained from yield data relating to classes of money market instruments or
government securities published by reputable sources at the mean between the bid
and asked prices for the instruments. In the event that a deviation of 1/2 of 1%
or more exists between the Portfolio's $1.00 per share net asset value,
calculated at amortized cost, and the net asset value calculated by reference to
market-based quotations, or if there is any other deviation that the Board of
Trustees believes would result in a material dilution to shareholders or
purchasers, the Board of Trustees will promptly consider what action, if any,
should be initiated. In order to value its investments at amortized cost, the
Money Market Portfolio purchases only securities with a maturity of one year or
less and maintains a dollar-weighted average portfolio maturity of 90 days or
less. In addition, the Money Market Portfolio limits its portfolio investments
to securities that meet the quality and diversification requirements of Rule
2a-7. Under the quality requirements of Rule 2a-7, the Money Market Portfolio
may only purchase U.S. Dollar-denominated instruments that are determined to
present minimal credit risks and that are at the time of acquisition "Eligible
Securities" as defined in Rule 2a-7. "Eligible Securities" under Rule 2a-7
include only securities that are rated in the top two rating categories by the
required number of nationally recognized statistical rating organizations (at
least two or, if only one such organization has rated the security that one
organization) or, if unrated, are deemed comparable in quality. The
diversification requirements of Rule 2a-7 provide generally that the Fund may
not at the time of acquisition invest more than 5% of its assets in securities
of any one issuer or invest more than 5% of its assets in securities that are
Eligible Securities that have not been rated in the highest category by the
required number of rating organizations or, if unrated, have not been deemed
comparable in quality, except U.S. Government securities and repurchase
agreements of such securities.
PURCHASE AND REDEMPTION
The separate accounts of the Participating Insurance Companies place orders to
purchase and redeem shares of each Portfolio based on, among other things, the
amount of premium payments to be invested and surrender and transfer requests to
be effected on that day pursuant to VLI and VA contracts. The shares of Total
Return, High Yield, Equity, Government Securities, International and Small Cap
Portfolios are each purchased and redeemed at the net asset value of each
Portfolio's shares determined that same day or, in the case of an order not
resulting automatically from VLI and VA contract transactions, next determined
after an order in proper form is received. An order is considered to be in
proper form if it is communicated by telephone or wire by an authorized employee
of the Participating Life Insurance Company.
From time to time, the Fund may temporarily suspend the offering of shares of
one or more of its Portfolios. During the period of such suspension,
shareholders of such Portfolio are normally permitted to continue to purchase
additional shares and to have dividends reinvested.
The Fund seeks to have its Money Market Portfolio as fully invested as possible
at all times in order to achieve maximum income. Since the Money Market
Portfolio will be investing in instruments which normally require immediate
payment in Federal funds (monies credited to a bank's account with its regional
Federal Reserve Bank), the Fund has adopted certain procedures for the
convenience of its shareholders and to ensure that the Money Market Portfolio
receives investable funds.
No fee is charged the shareholders when they purchase or redeem Portfolio
shares.
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DIVIDENDS AND TAXES
DIVIDENDS FOR MONEY MARKET PORTFOLIO. The Money Market Portfolio's net
investment income is declared as a dividend daily. Shareholders will receive
dividends monthly in additional shares. If a shareholder withdraws its entire
account, all dividends accrued to the time of withdrawal will be paid at that
time.
DIVIDENDS FOR ALL PORTFOLIOS EXCEPT MONEY MARKET PORTFOLIO. The Fund normally
follows the practice of declaring and distributing substantially all the net
investment income and any net short-term and long-term capital gains of these
Portfolios at least annually.
TAXES. Under the current Internal Revenue Code ("Code"), Participating
Insurance Companies are taxed as life insurance companies and the operations of
their separate accounts are taxed as part of their total operations. Under
current interpretations of existing federal income tax law, investment income
and capital gains of separate accounts are not subject to federal income tax to
the extent applied to increase the values of VLI or VA contracts. Tax
consequences to VLI or VA contract holders are described in the separate
prospectuses issued by the Participating Insurance Companies.
Each Portfolio intends to continue to qualify as a regulated investment company
under subchapter M of the Code. As a result, with respect to any fiscal year in
which a Portfolio distributes all its net investment income and net realized
capital gains, that Portfolio will not be subject to federal income tax.
Subchapter M includes other requirements relating to the diversification of
investments. Subchapter M's diversification requirements are in addition to
diversification requirements under Section 817(h) of the Code and the 1940 Act.
Each applicable law's diversification requirement could require the sale of
assets of a Portfolio, which could have an adverse impact on the net asset value
of such Portfolio.
The preceding is a brief summary of certain of the relevant tax considerations.
The Statement of Additional Information includes a more detailed discussion.
This discussion is not intended, even as supplemented by the Statement of
Additional Information, as a complete explanation or a substitute for careful
tax planning and consultation with individual tax advisers.
CAPITAL STRUCTURE AND GENERAL INFORMATION
The Fund was organized as a business trust under the laws of Massachusetts on
March 24, 1987. The Fund may issue an unlimited number of shares of beneficial
interest all having no par value. Since the Fund offers multiple Portfolios, it
is known as a "series company." Shares of a Portfolio have equal noncumulative
voting rights and equal rights with respect to dividends, assets and liquidation
of such Portfolio. Shares are fully paid and nonassessable when issued, and have
no preemptive or conversion rights. The Fund is not required to hold annual
shareholders' meetings and does not intend to do so. However, it will hold
special meetings as required or deemed desirable for such purposes as electing
trustees, changing fundamental policies or approving an investment advisory
contract. If shares of more than one Portfolio are outstanding, shareholders
will vote by Portfolio and not in the aggregate except when voting in the
aggregate is required under the 1940 Act, such as for the election of trustees.
The Board of Trustees may authorize the issuance of additional Portfolios if
deemed desirable, each with its own investment objective, policies and
restrictions.
On November 3, 1989, KILICO Money Market Separate Account, KILICO Total Return
Separate Account, KILICO Income Separate Account and KILICO Equity Separate
Account (collectively, the Accounts), which were separate accounts organized as
open-end management investment companies, were restructured into one continuing
separate account (KILICO Variable Annuity Separate Account) in unit investment
trust form with subaccounts investing in corresponding Portfolios of the Fund.
An additional subaccount also was created to invest in the Fund's Government
Securities Portfolio. The restructuring and combining of the Accounts is
referred to as the Reorganization. In connection with the Reorganization,
approximately $550,000,000 in assets was added to the Fund (which at that time
consisted of approximately $6,000,000 in assets). Because the assets added to
the Fund as a result of the Reorganization were significantly greater than the
existing assets of the Fund, the per share financial highlights of the Money
Market, Total Return, High Yield and Equity Portfolios in this Prospectus
reflect the Accounts as the continuing entities.
Information about the Portfolios' investment performance is contained in the
Fund's 1994 Annual Report to Shareholders, which may be obtained without charge
from the Fund.
Shareholder inquiries should be made by writing the Fund at the address shown on
the front cover of this Prospectus.
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INVESTMENT MANAGER
INVESTMENT MANAGER. Kemper Financial Services, Inc. ("KFS"), 120 South LaSalle
Street, Chicago, Illinois 60603, is the investment manager of the Fund and
provides the Fund with continuous professional investment supervision. KFS is
one of the largest investment managers in the country and has been engaged in
the management of investment funds for more than forty-five years. KFS and its
affiliates provide investment advice and manage investment portfolios for the
Kemper Funds, the Kemper insurance companies, Kemper Corporation and other
corporate, pension, profit-sharing and individual accounts representing
approximately $60 billion under management. KFS acts as investment adviser for
24 open-end and seven closed-end investment companies, with 60 separate
investment portfolios representing more than 3 million shareholder accounts. KFS
is a wholly-owned subsidiary of Kemper Financial Companies, Inc., which is a
financial services holding company that is more than 96% owned by Kemper
Corporation, a diversified insurance and financial services holding company.
Kemper Corporation has entered into an agreement in principle with an investor
group led by Zurich Insurance Company ("Zurich") pursuant to which Kemper
Corporation would be acquired by the investor group in a merger transaction. As
part of the transaction, Zurich or an affiliate would purchase KFS.
A definitive agreement is expected in early May, 1995, subject to the completion
of the investor group's due diligence. Consummation of the transaction is
subject to a number of contingencies, including approval by the board and
stockholders of Kemper Corporation and the Zurich board and regulatory
approvals. Because the transaction would constitute an assignment of the Fund's
investment management agreement with KFS under the Investment Company Act of
1940, and therefore a termination of such agreement, the transaction is subject
also to approval of new agreements by Kemper Fund boards and shareholders. If
the contingencies are timely met, the transaction is expected to close early in
the fourth quarter of 1995.
After consummation of the transaction, it is anticipated that the KFS management
team and the Kemper Fund portfolio managers would remain in place and that the
Kemper Funds would be operated in the same manner as they are currently.
Responsibility for overall management of the Fund rests with the Board of
Trustees and officers of the Fund. Professional investment supervision is
provided by KFS. The investment management agreement provides that KFS shall act
as the Fund's investment adviser, manage its investments and provide it with
various services and facilities. For its services, KFS is paid a management fee
at an effective annual rate, payable monthly, of .50%, .55%, .60%, .60%, .55%,
.75% and .65% of average daily net assets of the Money Market, Total Return,
High Yield, Equity, Government Securities, International and Small
Capitalization Equity Portfolios, respectively. KFS may from time to time use
the services of Kemper Investment Management Company Limited ("KIMCO"), 1 Fleet
Place, London EC4M 7RQ, a wholly owned subsidiary of KFS, with respect to
foreign securities investments of the Portfolios including analysis, research,
execution and trading services.
Frank J. Rachwalski, Jr. is the portfolio manager of the Money Market Portfolio.
He has served in this capacity since the Portfolio commenced operations in 1982.
Mr. Rachwalski joined KFS in January 1973 and is currently a Senior Vice
President of KFS and a Vice President of the Fund. He received a B.B.A. and an
M.B.A. from Loyola University, Chicago, Illinois.
Karen A. Hussey has been the portfolio manager of the Small Cap Portfolio since
September 1994 when she joined KFS. She is a Vice President of the Fund. Prior
to joining KFS, she was a portfolio manager for a national bank. She received a
B.S. from Southwest Missouri State, Springfield, Missouri and did graduate work
towards an M.B.A. at St. Louis University. Ms. Hussey is a Chartered Financial
Analyst.
Dennis H. Ferro has been the portfolio manager for the International Portfolio
since March 1994 when he joined KFS. He is an Executive Vice President and the
Director of International Equity Investments of KFS and a Vice President of the
Fund. Mr. Ferro was President, Managing Director and Chief Investment Officer of
an international investment advisory firm prior to joining KFS. He received a
B.A. in Political Science from Villanova University, Villanova, Pennsylvania and
an MBA in Finance from St. Johns University, Jamaica, New York. Mr. Ferro is a
Chartered Financial Analyst.
Michael A. McNamara (since 1990) and Harry E. Resis, Jr. (since 1993) are the
co-portfolios managers of the High Yield Portfolio. Mr. McNamara joined KFS in
February 1972 and is currently a Senior Vice President of KFS and a Vice
President of the Fund. He received a B.S. in Business Administration from the
University of Missouri, St. Louis, Missouri, and an M.B.A. in Finance from
Loyola University, Chicago, Illinois. Mr. Resis joined KFS in 1988 and is
currently a First Vice President of KFS and a Vice President of the Fund. He
received a B.A. in Finance from Michigan State University, Lansing, Michigan.
Mr. Resis holds a number of NYSE and NASD licenses.
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<PAGE> 86
C. Beth Cotner has been the portfolio manager of the Equity Portfolio since
1986. Ms. Cotner joined KFS in January 1985 and is currently an Executive Vice
President and the Director of Domestic Equity Portfolio Management of KFS and a
Vice President of the Fund. She received a B.A. from Ohio State University,
Columbus, Ohio, and an M.B.A. from George Washington University, Washington,
D.C.
Paul F. Sloan has been the portfolio manager of the Government Securities
Portfolio since April 1995 when he joined KFS. Prior to joining KFS, Mr. Sloan
was the Director of Institutional Portfolio Management at an investment
management company and prior thereto he was a Vice President and Investment
Officer for a regional bank. He received a B.A. in English Literature from the
University of Detroit, Detroit, Michigan, and an M.B.A. in Finance and Business
Economics from Wayne State University, Detroit, Michigan.
Gary A. Langbaum has been the portfolio manager for the Total Return Portfolio
since February 1995. He is assisted by investment personnel who specialize in
certain areas. Mr. Langbaum joined KFS in 1988 and is currently an Executive
Vice President of KFS. He received a B.A. in Finance from the University of
Maryland, College Park, Maryland.
KFS has an Equity Investment Committee that determines overall investment
strategy for equity portfolios managed by KFS. The Equity Investment Committee
is currently comprised of the following members: Daniel J. Bukowski, Tracy
McCormick Chester, C. Beth Cotner, James H. Coxon, Richard A. Goers, Karen A.
Hussey, Frank D. Korth, Gary A. Langbaum, James R. Neel, Thomas M. Regner and
Stephen B. Timbers. The portfolio managers work together as a team with the
Equity Investment Committee and various equity analysts and equity traders to
manage the Fund's equity Portfolios. Equity analysts--through research, analysis
and evaluation--work to develop investment ideas appropriate for these
Portfolios. These ideas are studied and debated by the Equity Investment
Committee and, if approved, are added to a list of eligible investments. The
portfolio managers use the list of eligible securities to help them structure
the Portfolios in a manner consistent with each Portfolio's objective. The KFS
international investments area, directed by Dennis H. Ferro, provides research
and analysis regarding foreign investments to the portfolio managers. After
investment decisions are made, equity traders execute the portfolio manager's
instructions through various broker-dealer firms.
KFS also has a Fixed Income Investment Committee that determines overall
investment strategy for fixed income portfolios managed by KFS. The Fixed
Income Committee is currently comprised of the following members: J. Patrick
Beimford, Jr., Frank E. Collecchia, George Klein, Michael A. McNamara,
Christopher J. Mier, Frank J. Rachwalski, Jr., Harry E. Resis, Jr., Robert H.
Schumacher, John E. Silvia, Paul F. Sloan and Christopher T. Vincent. The
portfolio managers work together as a team with the Fixed Income Committee and
various fixed income analysts and traders to manage the Fund's fixed income
Portfolios. Analysts provide market, economic and financial research and
analysis that is used by the Fixed Income Committee to establish broad
parameters for these Portfolios, including duration and cash levels. In
addition, credit research by analysts is used by portfolio managers in selecting
securities appropriate for the Portfolios' policies. The KFS international
investments area provides research and analysis regarding foreign investments to
the fixed income portfolio managers, as it does for the equity portfolio
managers. After investment decisions are made, fixed income traders execute the
portfolio manager's instructions through various broker-dealer firms.
CUSTODIAN. Investors Fiduciary Trust Company ("IFTC"), 127 West 10th Street,
Kansas City, Missouri 64105, as custodian, and the United Missouri Bank, n.a.,
Tenth and Grand Streets, Kansas City, Missouri 64106 and State Street Bank and
Trust Company, 225 Franklin Street, Boston, Massachusetts 02110, as
sub-custodians, have custody of all securities and cash of the Fund maintained
in the United States. The Chase Manhattan Bank, N.A., Chase MetroTech Center,
Brooklyn, New York 11245, as custodian, has custody of all securities and cash
held outside the United States. They attend to the collection of principal and
income, and payment for and collection of proceeds of securities bought and sold
by the Fund. IFTC is also the Fund's transfer agent and dividend-paying agent.
IFTC receives an annual custodian fee from the Portfolios of $.085 for each
$1,000 of average monthly net assets plus certain transaction charges and
out-of-pocket expense reimbursements subject to the custody agreement. For its
services as custodian and transfer agent for the fiscal year ended December 31,
1994, IFTC received fees of $514,000. Prior to February 1, 1995, IFTC was 50%
owned by KFS.
PORTFOLIO TRANSACTIONS. KFS places all orders for purchases and sales of a
Portfolio's securities. Subject to seeking best execution of orders, KFS may
consider sales of shares of the Fund and other funds managed by KFS or variable
life insurance and variable annuity contracts funded by the Fund as a factor in
selecting broker-dealers. See "Portfolio Transactions" in the Statement of
Additional Information.
Each Portfolio pays its respective fees and expenses of independent auditors,
counsel, custodian, the cost of reports and notices to owners of VLI and VA
contracts, brokerage commissions or transaction costs, taxes and registration
fees.
24
<PAGE> 87
DISTRIBUTOR
Kemper Distributors, Inc. ("KDI"), an affiliate of KFS, serves as distributor
and principal underwriter for the Fund pursuant to an underwriting agreement.
KDI bears all its expenses of providing services pursuant to the agreement. KDI
provides for the preparation of advertising or sales literature, and bears the
cost of printing and mailing prospectuses to persons other than shareholders.
KDI bears the cost of qualifying and maintaining the qualification of Fund
shares for sale under the securities laws of Massachusetts and the Fund bears
the expense of registering its shares with the Securities and Exchange
Commission. KDI will pay all fees and expenses in connection with its
qualification and registration as a broker or dealer under Federal and state
laws, a portion of the toll free telephone service and of computer terminals,
and of any activity which is primarily intended to result in the sale of shares
issued by the Fund, unless a plan pursuant to Rule 12b-1 under the 1940 Act
("12b-1 Plan") is in effect that provides that the Fund shall bear some or all
of such expenses.
KDI currently offers shares of each Portfolio of the Fund continuously to the
separate accounts of Participating Insurance Companies where permitted by
applicable law. The underwriting agreement provides that KDI accepts orders for
shares at net asset value, as no sales commission or load is charged. KDI has
made no firm commitment to acquire shares of the Fund.
NOTE: Although the Fund does not currently have a 12b-1 Plan and shareholder
approval would be required in order to adopt one, the underwriting agreement
provides that the Fund will also pay those fees and expenses permitted to be
paid or assumed by the Fund pursuant to a 12b-1 Plan, if any, adopted by the
Fund, notwithstanding any other provision to the contrary in the underwriting
agreement, and the Fund or a third party will pay those fees and expenses not
specifically allocated to KDI in the underwriting agreement.
25
<PAGE> 88
APPENDIX--PORTFOLIO COMPOSITION OF HIGH YIELD BONDS
The table below reflects the composition by quality rating of the investment
portfolio of the High Yield Portfolio. Percentages for the Portfolio reflect the
net asset weighted average of the percentage for each category on the last day
of each month in the 12 month period ended December 31, 1994. The table reflects
the percentage of net assets represented by fixed income securities rated by
Moody's or S&P, by non-rated fixed income securities and by other assets. The
percentage shown reflects the higher of the Moody's or S&P rating. U.S.
Government securities, whether or not rated, are reflected as Aaa and AAA
(highest quality). Cash equivalents include money market instruments, repurchase
agreements, net payables and receivables and cash. Other assets include options,
financial futures contracts and equity securities. As noted under "Investment
Objectives, Policies and Risk Factors," the High Yield Portfolio invests in high
yielding, fixed income securities without relying upon published ratings. The
allocations in the table are not necessarily representative of the composition
of the Portfolio at other times. Portfolio composition will change over time.
END OF THE MONTH COMPOSITION OF PORTFOLIO BY QUALITY AS A PERCENTAGE OF
NET ASSETS (JANUARY 1994--DECEMBER 1994)
<TABLE>
<CAPTION>
HIGH
MOODY'S/S&P RATING YIELD GENERAL DESCRIPTION
OR OTHER CATEGORY PORTFOLIO OF BOND QUALITY
- ------------------------------------- ---- -------------------------------------------------
<S> <C> <C>
Cash Equivalents..................... 6%
Aaa/AAA.............................. 2 Highest quality
Aa/AA................................ 0 High quality
A/A.................................. 0 Upper medium grade
Baa/BBB.............................. 0 Medium grade
Ba/BB................................ 18 Some speculative elements
B/B.................................. 61 Speculative
Caa/CCC.............................. 6 More speculative
Ca/CC, C/C........................... 1 Very speculative
D.................................... 1 In default
Non-rated, Not in Default............ 2
Non-rated, In Default................ 0
Other Assets......................... 3
----
Net Assets........................... 100%
</TABLE>
The description of each bond quality category set forth in the table above is
intended to be a general guide and not a definitive statement as to how Moody's
and S&P define such rating category. A more complete description of the rating
categories is set forth under "Appendix--Ratings of Investments" in the
Statement of Additional Information. The ratings of Moody's and S&P represent
their opinions as to the quality of the securities that they undertake to rate.
It should be emphasized, however, that ratings are relative and subjective and
are not absolute standards of quality.
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<PAGE> 89
Distributed by
Investors Brokerage Services, Inc.
A Variable Life Product Offered by
KEMPER INVESTORS LIFE INSURANCE COMPANY
1 Kemper Drive
Long Grove, IL 60049 [KEMPER LOGO]
708/320-4500
[RECYCLE LOGO] PRINTED ON RECYLED PAPER
SEL 01 Policy Form Series L-8001
